Not Just A Greek Problem

With the Euro hitting a 14 month low, and with pressure from both Washington and Tokyo, the European Union (EU) finally acted in support of the Greek economy, as well as pledging aid to other Eurozone economies facing massive debt burdens. The 16 members of the single currency bloc will have access to 440bn euros of loan guarantees, and 60bn euros of emergency European Commission funding, along with another 250bn euros from the International Monetary Fund (IMF). The level of interconnection of economies not only in the Eurozone, but also around the world led to fears that the Greek debt crisis could have caused a world wide tumble as economies across the globe are starting to recover from the previous economic melt down. The stability package has eased fears of a collapse of the euro, and stock markets have reacted favorably to the news. However, there will be long term ramifications across Europe, and there is no guarantee that this package alone will ensure long term stability.

The Greek Government racked up an impressive amount of sovereign debt, by 2009 it was more than 13% of its gross domestic product (GDP), to the point that their credit rating was downgraded to junk last month. The large budget deficits were caused by excessive spending on social programs, defense and on the government itself. By some estimates the government was spending more than 50mn euro per year on pensions for civil servants that were eligible to retire in their 40s, and even their defense spending was mostly on staff and administrative costs. Furthermore, the inflated government bureaucracy has been infected with widespread corruption. For years Greek economy has been stymied because the best job to get is a government job, which generates no economic activity, and just drains the government coffers, while cheap credit and a strong euro did nothing to curb the excessive spending.

The 143bn loan from the EU and IMF is enough to stem the immediate crisis in Greece, and stabilize the euro for the rest of the EU, however, that money alone can’t fix the Greek economy. The government has already instituted an austerity package which has been incredibly unpopular even though most Greeks agree that something has to be done. Reductions in civil servants bonuses, social security payments and military expenditures have all been proposed, as well as increase in the value added tax, and taxes on fuel, cigarettes and alcohol will all be increased. The public reaction has been visceral, and in country where political and economic stability has been in short supply, it may be to much for the government to handle, there has been a bombings and protestors have been killed in violent protests. The IMF will monitor the governments headway, and try to enforce benchmarks for progress, but a protracted economic downturn unlikely. However, the Greece was not the only EU country living beyond it’s means, the crisis hit Greece earlier because it’s economy is one of the weakest of the single currency bloc.

Ireland, Spain and Portugal all could be as threatening to the euro, in some cases more so than Greece. Spain is in trouble because it’s economy for the last decade has been riding a housing boom that fueled the construction sector. That boom has collapsed, and unemployment has soared to over 20%, meanwhile the 2009 budget deficit spiked to 11.2% of GDP. Spain is one of the largest owners of Greek bonds, which led them to be the strongest supporters of the stability package. Prime Minister Jose Luis Rodriguez Zapatero has presented an economic savings and reform plan, containing similar measures to the Greek austerity package, which has not been received well. Meanwhile, there hasn’t been any progress on restructuring the economy, which will be hard to do under a strict savings plan. Portugal is suffering from an ineffective minority government that has been unable to implement any austerity measures, and has in fact passed spending measures that will increase the national debt, which was already at 9.3% of GDP in 2009. With no movement by the government, and a rapidly increasing debt to GDP ratio, Portugal looks to be as much of a problem as Greece. Ireland’s 2009 budget deficit was 12.9%, but Ireland has already implemented the type of austerity measures that these other countries are only beginning to address, although Ireland’s banking sector has struggled to recover.

The political ramifications of the stability package are already being felt in Germany, the country that will shoulder the greatest burden of any of the EU countries. German chancellor Angela Merkel‘s Christian Democrats lost an election in North Rhine-Westphalia, which no longer gives the party a majority in parliament’s upper house, leaving the government in limbo until a ruling coalition can be formed. The most contentious issue was the Greek bailout, which happened only days before the election, polls indicated 21% of voters would change their vote because of the bailout. Many Germans believe the 28bn euros German contributed should be used to ease the financial tightening at home. While the bailout has made the internal politics of EU nations tumultuous, it has also created tensions between the EU nations that are driving the economic recovery and those that are dragging the EU down.

The EU average for debt to GDP ratio is over 70%, and many of the EU member states are running budget deficits well over the 3% limit set the by the Stability and Growth Pact. Italy is not in immediate danger of economic collapse, but it’s debt to GDP ratio is 115%, has a budget deficit of over 5% and has a projected to hover around 1% GDP growth for the foreseeable future. If it wasn’t for a relatively strict banking oversight system, Italy would be in real trouble, and even so, the future doesn’t look very bright. After a disastrous 2009 and an tumultuous start to 2010, future growth is going to be slow at best, with France, Germany and the United Kingdom being the only strong economies, and even they have economic problems. Across Europe there is going to have to be a sea change in domestic policies to reduce spending to at least lower budget deficits under the 3% threshold, before every Eurozone country is carrying a burden of debt like Italy’s. Those changes are going to be incredibly unpopular, and while the public reaction might not be as violent as it is in Greece, but strikes and protests will certainly be common place as governments curb benefits and raise taxes. Nevertheless, fiscal responsibility is the only sensible way governing, but with many countries suffering from incompetent or corrupt governments the EU may be afflicted by a series of economic crises.