The root of the Greek economic crisis is that they have been living beyond their means. They paid themselves too much for producing too little and made up the gap with excessive borrowing.
Greece is an extreme example of a problem that left-leaning economies in the West have failed to address for more than a generation. There is a significant disparity in global labour costs. The average worker in the West earns $135 per day; the average worker in urban China earns $12 per day.
What entitles the rich world’s 500 million workers to salaries ten times greater than the 1.1 billion workers in urban bits of the developing world?
(Full, brilliant article is here: $135 – $12 = the pay gap the West can’t bridge.)
Greece has bigger problems because this issue is compounded by massive tax evasion, out-of-control corruption and a culture of taking Government hand-outs and public-sector salaries without giving anything in return. Greeks can retire at 58 and some professions retire even earlier. Clearly this has to end and the previous government was working hard to achieve this.
So now that Greece cannot borrow any more it must stop overpaying itself.
There are three ways to do this:
1. Devalue your currency.
Advantage: A tried and trusted mechanism that would have lowered their wages on international markets. This lowers domestic costs of production, which boosts exports and reduces imports whilst maintaining domestic living standards – so long as Greeks buy home grown goods and services.
Disadvantage: Doesn’t address the main structural problems of the Greek economy. It is just delaying much needed economic and structural reform required to address low productivity, tax evasion, corruption and a “something-for-nothing” culture. Also devaluation only works if a few countries use it.
Greece cannot devalue its currency as it is in the Euro. So it must choose from the other two options:
2. Cut Wages.
Advantage: This quickly addresses the problem allowing Greece to regain competitiveness in international markets, boosting exports, attracting internal investment and creating economic growth.
Disadvantage: Causes an instant reduction in living standards, which creates hardship, which reduces consumer spending, which slows down the internal economy further. i.e. the economy gets worse before it gets better.
This is painful solution but it is a shortcut to growth. Ireland used this method and quickly returned to growth after initial hardship. It concentrates the pain over a shorter time period than the only other alternative which is…..
3. Freeze Wages
This is a slower way to achieve a wage cut because it relies on inflation slowly eroding the wages compared to living costs – i.e. eventually causing an effective pay cut. The UK government has adopted this approach along with devaluation.
Advantage: Less painful way of cutting wages but…
Disadvantage: …delays the time it takes to regain competitiveness on international markets.
This is effectively the same solution as 2 but stretched over a longer time period.
The Greeks have suffered over the last few years but they required significant restructuring in order to develop a strong, sustainable economy. The medicine was working as Greece has slowly returned to growth and even has a small budget surplus.
Now Syriza want to adopt the usual socialist solution to a budget deficit – that is to get somebody else to pay for it. In this case they want Germany to write off their debt.
Many reference the 1953 London Debt Agreement that reduced Germany’s war debts by 50% and stretched the repayment of the remaining debt over a longer period. This led to German economic growth so surely this could also work for Greece? This may well be true, but at the time it was only Germany’s debt that was being written off. Poor old Britain repaid all its war debts, with the last payment being made to the USA on 29th December 2006. But this time we have France, Italy, Spain and Portugal waiting in the wings with beaks wide open and palms out-stretched. Any hint of weakness towards the Greeks will cause a landslide of similar political extremism and a similar expectation that their debts will also be forgiven. Why should Greece have special treatment?
In any case the Greeks have already been given voluntary debt forgiveness by private creditors. Banks have slashed billions from their debt. Their remaining official debt has a 16-year maturity and an average coupon of 2.4%. So despite Greece’s extraordinarily high public debt (175% of GDP last year) successive concessions have already eased its debt-servicing charges so that annual cash interest payments are now only 3% of GDP.
And yet Syriza has pledged to go on yet another spending spree. They have promised to launch a welfare package worth €2 billion; to rehire 12,000 sacked civil servants; to give a massive increase in the minimum wage and to freeze privatisations. They have agreed to tackle tax-avoidance and cronyism but these are unlikely to do enough to pay for their profligate promises. They will quickly return Greece to the mire from which it is slowly extricating itself.
The best compromise is for Syriza to jettison their ludicrous socialist economic policies and negotiate some further debt relief, perhaps by further pushing back the payment schedule (as did Britain in the 1950s), in return for further political and structural reforms. Greek wages must be linked to productivity, they must retire later, reduce their public sector costs to an affordable level and clamp down on corruption and tax evasion.