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Office Hours: No going back for Greece and the EU

David Cleeton in his office

Department of Economics Chair and Professor David Cleeton.

The economic turmoil in Greece flared again this week, as public workers began a new two-day strike and clashes broke out during a demonstration in Athens.

Greece’s long recession—now in its sixth year—has led to strict austerity measures for the country in hopes of cutting its massive debt and budget deficit. Greece has been dependent on billions of euros in rescue loans from other European countries that use the currency.

In this latest installment of STATEside’s Office Hours, Department of Economics Chair and Professor David Cleeton discusses what makes Greece’s case unique, and why the country may never leave the European Union.

Recent protests in Greece have stirred up questions of whether it should remain with the European Union. Is it a result of the EU suffering from the global recession?

The EU has had the same basic kinds of problems that the U.S. faced with the recession, although they’ve taken longer mount a recovery. With 28 countries in the European Union, you get a lot of diversity. Just like our 50 states, if you asked what kinds of problems the great recession caused, you could get 50 different answers. Our biggest problems were based upon the financial sector, misappropriate handling of uncertainty and risk, and the housing sector problem. The Greek economy’s difficulties have been less of a housing sector-driven problem; it’s more directly attributed to mismanagement in the government.

Greece’s main problem is debt. It turns out that they did a lot of the borrowing over the past 10 years, and that capital didn’t go to the sectors that are new, growing, highly productive sectors, such as high tech. They didn’t totally waste their money—they invested significantly in new public infrastructure. Yet Greece has not managed to bring in sufficient private-sector capital investment, and the investments they did bring in were not geared toward industries with growth potential.

What are the chances Greece would leave the EU?

The rules and regulations connected with being a member of the EU have evolved over time through treaties, so any country can decide to leave, but it would be in violation of its treaty obligations. Violating international treaties doesn’t do a lot for building a long-term reputation in the world economy with your friends and neighbors.

Under the treaties, Greece is committed to remain in the EU. They also surrendered the Greek drachma for the common currency—the euro. So not only would it be a challenge in the political relations arena, leaving would endanger the investment in the common currency.

If it did leave, what would happen to the country’s currency?

If the Greek drachma would come back into existence, and then fall significantly in value versus the euro, they would still have bonds that were issued in euros. That means that debt burden would skyrocket, and be much more difficult for the Greeks to pay off. It would not be easy for them to return to their own currency.

Having a common currency helps with trade, because no longer do you have to incur the transaction costs of converting currency or worry about exchange rate risk. But countries also surrender a lot of fiscal and monetary autonomy. Really, this was a club, and the Greeks wanted in. It gave them a certain credibility in monetary policy.

Not all the EU countries have the common currency. The big outsiders are the United Kingdom and Sweden. For those wanting to join, there were prerequisites, established by the Maastricht Treaty in the early 1990s. Countries had to have lower interest rates and run only about a 3 percent deficit, or 3 percent of your gross national product.

In 1995, there were only a small number of countries that did qualify. Greece had not met the criteria, so they weren’t in the initial group for the common currency. But surprisingly, just a year or two later, the Greeks had met all the criteria. And if you look back in history now, there’s a great deal of concern about how reliable the statistics were that they had presented at the time.

How do austerity measures come into play with Greece’s debt? Why is it usually Germany that takes the lead in austerity talks?

Austerity is about trying to enforce the guidelines of the Maastricht Treaty and the subsequent Stability and Growth Pact, while also trying to ease the pain of Greece repaying their debt.

For years Greece has borrowed heavily, not only from German and French financial institutions, but also the European Central Bank and the International Monetary Fund. After 2008, several different packages were put together to help the Greek government. As part of those packages, they faced more rigid rules and regulations, or “austerity measures.”

If you put Germany and France together, they’re about half of the economy of the Eurozone. In 2008, all the countries of the EU took a big downturn, but some of them were hit a lot harder than others. Because of its strong export orientation, Germany made a pretty quick recovery. The other countries haven’t. So the German economy has gotten out of cycle with a lot of the rest of the common currency countries. There is some misalignment now, between what the poorly performing countries want and what the Germans want.

Rachel Hatch can be reached at rkhatch@IllinoisState.edu.

 

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