Seven years ago, in late 2009, with a fragile global financial system following the cataclysmic events of the previous two years, revelations emerged that previous data on public debt levels in Greece had been underreported by the Greek government. The ratio of public debt-to-GDP was revealed to be 130% and the yawning government deficit accounted for 12.5% of GDP. In response, the three major credit ratings agencies – Standard and Poor’s, Moody’s and Fitch – all began to downgrade the Greek government’s credit rating. The subsequent panic that unfolded in financial markets sent yields on Greek government bonds skyrocketing, plunging public finances into a deeper malaise.
The ensuing sovereign debt crisis posed an existential threat to both Greece and the wider Eurozone economy. Were Greece to default on its debts, the banks who owned the bonds – many of whom were headquartered in Germany and France – may have been subject to a similar fate to that of Lehman Brothers in 2008. Worse still, because of the opacity of the financial market, no one knew exactly how each bank would be affected – banks who had not lent to Greece might have lent to banks that had, so they, too, could be at risk.
Wishing to avert disaster, European economic policymakers intervened. Because the crisis stemmed from profligate government spending, it was thought that reining in public finances would provide the cure. The Troika – comprised of the European Commission, the European Central Bank and International Monetary Fund – agreed to bail the Greek government out, but with strict conditions. The Troika demanded that the Greek government embark on a programme of fiscal austerity designed to get the economy back on its feet. The line of reasoning went something like this: because financial markets had lost confidence in the Greek government’s ability to pay down its debt, aggressive fiscal consolidation was required to restore confidence in the market, thus encouraging private sector investment into the country and providing the much-needed boost to the economy. At the same time, the fall in wages that would result from public sector pay freezes and high levels of unemployment would make Greek exports more competitive. The normal mechanism for a country to regain competitiveness would be to devalue its currency, but as a member of the European single currency area, Greece was unable to do this.
Were Greece to default on its debts, the banks who owned the bonds may have been subject to a similar fate to that of Lehman Brothers in 2008.
However, as any first year economics student can tell you, cutting government spending reduces aggregate demand in the economy, stifling growth. Worse, when spending cuts are made at a time when the economy is fragile, and when there is no independent central bank to lower interest rates in order to offset the effects of austerity, the negative effects on the economy will be severely amplified.
In the case of Greece, it didn’t lead to lower growth, nor even a recession. It led to a full blown economic depression, comparable only to the one following the 1929 stock market crash. Greek GDP shrank by over 25% in five years (for comparison, the UK economy lost 6.4% in output during the 2008-09 recession) and youth unemployment soared above 50%. Thousands lost their jobs, while those that kept theirs were forced to endure massive pay cuts. The elderly saw their pensions slashed; the young saw their career prospects turn to ash, leading many to simply leave the country in search of work, starving the country of its young talent.
The design of the austerity programme set targets to reduce the size of the deficit and eventually reach a surplus. The programme currently mandates that Greece must hit a primary surplus (the excess of revenues over expenditures net of interest payments) of 3.5% of GDP by 2018. A surplus may sound like a good thing since it signals that the state has good control over its finances, but it’s not – it actually means that the government is taking more purchasing power away from its citizens in the form of taxes than it is giving back in the form of spending. If Greece complies with the target, then no matter how successfully it implements structural reforms or cracks down on tax avoidance, the depression will continue.
Thousands lost their jobs, while those that kept theirs were forced to endure massive pay cuts.
Large tax increases form a central pillar of the programme. VAT is set at 23% for a large number of goods and services which, when combined with an income tax that even for the low paid is set at around 22%, makes for an effective tax rate close to 40%. Worse, the Troika demanded that all Greek firms, including small businesses, pay their annual tax bill at the beginning of the year, before they have earned any money and before they even know what their annual revenues will be. In a country with a poorly functioning financial system where small and medium-sized businesses struggle to access credit, this policy has proved disastrous for the Greek economy. Such draconian measures inevitably lead to tax evasion, making the whole policy rather counterproductive.
The other pillar of the austerity programme entailed cutting public expenditure. In particular, the Troika has focussed its attention on the Greek public pension system – which is the EU’s most expensive, costing almost 18% of GDP. However, while some Greek pensions may be generous, others are barely enough for survival; 45% of pensioners in Greece live below the monthly poverty limit of €665. While initial reforms were necessary, the marginal gains from later cuts made in 2015 were small. Rather than making pensioners poorer, it would have perhaps been more constructive to make government spending cuts that would have had the least adverse effects on GDP and societal well-being. Defence would have been a good place to start. Europe has been at peace for decades, and in the event of any real attack, Greece would have been able to rely on NATO for support. Another possibility would be to remove a large fraction of the massive number of inefficient tax subsidies, often to well-off business groups, such as energy subsidies to fossil fuel producers. Removing these would go some way towards raising government revenues, increasing economic efficiency and creating a more equal society.
The economic programme imposed on Greece by the Troika has been ineffective, destructive and astonishingly narrow-minded. In fact, it’s bordered on inhumane. The technocrats of the Troika didn’t care, though. They failed to see the human misery that lay beneath the dismal economic statistics. Like a bomber dropping its payload from 50,000 feet, success was measured by targets hit, not by lives destroyed. It truly is a tragedy that such colossal levels of human misery have been caused almost entirely by macroeconomic policy failures.