This Greek Tragedy Is Only The Beginning

From Vision to America and Forbes.com:

Capital


This Greek Tragedy Is Only Beginning

Thomas F. Cooley, 06.02.10, 06:00 AM EDT

European spendthrifts will have to make some painful adjustments.









We have only seen the first act of this modern day tragedy--the sad tale of promises made that cannot be kept. After years of profligate spending and expansion of the public sector, the credit markets finally pulled the plug on Greece, making it all but impossible for the country to roll over its enormous debt. The specter of sovereign debt default by an E.U. member state so rattled markets that there were serious signs of contagion spreading to Portugal, Spain and Italy in about that order. The E.U. finally agreed to a community-wide lending facility, and the European Central Bank began buying sovereign debt. This seemed to calm markets briefly--but it shouldn't have. The drama is just beginning.



For the next several years Greece will face a huge drop in output and consumption. The magnitude of the drop in Greece will dwarf the U.S.'s experience in its recent recession. It will take years for consumption levels to return to anything close to pre-crisis levels. Wages will fall, and access to capital markets will be limited. Greece will be forced to restructure its debt. Several of the other debt-burdened economies in Southern Europe will face similar, painful adjustments.



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Yahoo! BuzzThe Greek story is familiar by now, but some of it is worth repeating. Greece's economy has been hugely uncompetitive and burdened by a bloated public sector that accounts for 40% of GDP. The projected fiscal deficit at the end of 2009 was 12.7% of GDP, and its outstanding debt is 124.9% of GDP. About 80% of the debt is external, meaning it is held by non-residents. Interest payments on the debt account for nearly 40% of the projected fiscal deficit--nearly all money that will flow out of the country. Greece is notable for its tax evasion, lack of transparency and large inefficient bureaucracy. Its pension system encourages early retirement with generous benefits.



According to Aristotle, the structure of Greek tragedies is such that the central character, however well-meaning, is brought down by a character flaw, usually hubris. The excessive pride begets decisions that lead to misery, and the realization of the failure always comes too late to reverse it.



It didn't have to be this way. The E.U. stretched its rules to allow Greece to join the currency union in 2001, a year before euro notes and coins went into circulation. Greece had every incentive to make it work. The stable currency meant low inflation and low interest rates for most of the euro's first decade. There was a very strong incentive to compete in the eurozone and instill fiscal discipline. Instead Greek politicians used it as a reason to borrow, creating a mess they won't easily escape. It is ridiculous to blame this problem on the euro.



On one level the Greeks' problem is relatively simple. They have made promises they can't possibly keep. They can't afford to have the level of tax evasion they now have; they can't afford the bloated public sector; they can't afford their pension system. That will have to change. The logic of improving the efficiency of their labor markets is inescapable. Whether they have the political will to do what is needed is another matter entirely. They have been beset by a series of nationwide strikes led by government employee unions since the austerity measures were announced.