More than 60 percent of voters in Greece recently said a resounding “no” to an austerity package which would have paved the way for additional financial aid from the European Central Bank (ECB), International Monetary Fund (IMF), or others.
With the “no” vote, questions regarding the ability (and even the desire) of Greece to stay in the European Union and what an exit would mean have become more urgent. The likelihood of a financial crisis in Greece spreading to other areas is also a concern, although the potential for extensive fallout appears to be limited at this time.
The root of the problem is that Greece is deeply in debt, with hundreds of billions in loans from bailouts since 2010, and the economy is shrinking. A payment of about 1.5 billion euros on 21.2 billion euros in outstanding loans was due to the IMF at the end of June, but has not been paid (the first example of such a default by a developed nation). On July 20, another major challenge will arise in the form of a 3.5 billion euro bond redemption to the ECB. As I write this, Euro zone members have set forth a timeline for a proposal by Greece for reforms before further loans will be made, and Greece has indicated that such a plan will be forthcoming. A letter requesting a three-year extension and pledging to make reforms has been submitted, but is sketchy on the details that will likely make or break the deal.
The economic situation in Greece has gone downhill over the past several years, with very high unemployment, declining incomes, and a rapidly shrinking economy. Statistics maintained by the OECD (Organisation for Economic Co-operation and Development) indicate just how difficult things have become. Unemployment now stands at 26.5 percent. Problems with youth unemployment and long-term unemployment are far worse, with 33.0 percent of Greek youth not employed or in education or training. Household disposable income is shrinking (down at an 8.7 percent annual rate in the latest OECD estimates), and compensation per hour worked is also down slightly.
Gross domestic product (GDP) in Greece shrank by more than 25 percent in the wake of the global financial crisis, and continues to decline. This decline is comparable to that in the United States during the Great Depression of the 1930s. The Greek economy relies heavily on tourism (an estimated 18 percent of the economy according to the US Central Intelligence Agency’s World Fact book). Agriculture is a major source of employment, providing 12.9 percent of overall jobs. On a per-capita basis, GDP in Greece is about $26,016 per year, less than half the US level. The relatively low value-added nature of the industrial base in Greece makes it very difficult to stabilize the economy or return to growth.
At the same time, pensions comprise a very large component of both overall incomes and the government budget. The IMF stance is that comprehensive reform of the value-added tax (VAT) to widen its base and adjustments to pensions will be required. Pensions and wages account for about 75 percent of primary government spending; the other 25 percent have already been cut to the bone. Statements by the IMF further noted that pension expenditures account for over 16 percent of GDP, and transfers from the budget to the pension system are close to ten percent of GDP. The IMF suggests that pension expenditures be reduced by one percent of GDP (out of the current 16%). Of course, such measures will not be popular.
Even if another round of bailouts can be negotiated, challenges are almost sure to continue due to the structure of the European Union. Monetary policy for the EU is managed through the European Central Bank and decisions are made by the Governing Council (governors of the national central banks of the euro-area Member States and the members of the ECB’s Executive Board). Whereas an independent nation can influence interest rates and exchange rates to try to improve economic performance by controlling the supply of money in the economy, such tools are not available to Greece. Clearly, there are notable benefits to EU membership, but for a struggling economy and a people tired of austerity, the restrictions of the other members of the EU will surely be an ongoing source of conflict. On the other side of the conflict, recent reports indicate that other EU members are increasingly unwilling to fund overspending by Greece with further loans.
If a lasting solution proves impossible, Greece might leave or be forced out of the EU, a first since the Eurozone was established in 1999. Greece would have to begin to issue its own currency, and it is likely that the drachma would devalue significantly. While Greek people and businesses would suffer through a difficult transition, at least Greek products would become more competitive on world markets and Greece would become a less expensive destination for tourists. Even so, the downside of leaving the EU is very large, and such a step would do far more harm than good. As difficult as the austerity is (and it is certainly understandable that voters would like to end it), the alternative could be catastrophic.
Even if the situation deteriorates in Greece, it is unlikely that economic harms to the United States would be noted. Greece is a small economy, and business and financial ties to the US are limited. While scenarios in which other nations follow Greece in exiting the EU are being tossed around, it appears unlikely at this time that such a domino effect will actually happen. The pain that Greece would endure should be more than enough to discourage other nations from following a similar path.