Why Greece is the canary in the PIIGS coal mine

Vivek Kaul

Greece is a puny economy. It economy makes up less than 0.5% of the world’s Gross Domestic Product (GDP). And historically that’s how it has been, after the days of Alexander the Great ended. As economist Bill Bonner points out in a column “Greece, a small country with a small GDP and no oil…whose strategic export is olives…and whose last real military victory was the Battle of Jhelum in 326 BC, in which Alexander the Great defeated an Indian Rajah named Porus.
Given this background why is the world going mad over Greece. There are several reasons for the same.
Huge debt:
As John Mauldin and Jonathan Tepper write in Endgame – The End of the Debt Supercycle and How it Changes EverythingWhy is Greece important? Because so much of their debt is on the books of European banks. Hundreds of billions of dollars worth.
The fear is that if Greece defaults a lot of European banks particularly in Germany and France might get into trouble. In fact, Greece has already defaulted. Banks wrote off more than €100billion of Greek debt in March earlier this year.
But the market now fears a larger default. This could mean the Greek government stopping repayment of €240billion of bailout loans it has received from the International Monetary Fund and the European Union. The Greek central bank may also be in trouble and not be able to repay the €100billion it has borrowed from the European Central Bank in order to prop up the Greek banks, which in turn have lent money to the Greek government.
But didn’t we know all this already?
Satyajit Das, an internationally renowned derivatives expert and the author of Extreme Money – Masters of Universe and the Cult of Risk wrote in a column titled Nowhere To Run, Nowhere to Hide in July 2010 that “Greece’s significance is not its economic size (around 0.5% of global Gross Domestic Product (“GDP”)) but its significant debts. Profligate public spending, a large public sector, generous welfare systems particularly for public servants, low productivity, an inadequate tax base, rampant corruption and successive poor governments created the parlous state of public finances.”
In fact the welfare system of Greece is legendary. Greece categorises certain jobs as arduous. For such jobs the retirement age is 55 for men and 50 for women. “As this is also the moment when the state begins to shovel out generous pensions, more than 600 Greek professions somehow managed to get themselves classified as arduous: hairdressers, radio announcers, musicians…” write Mauldin and Tepper in Endgame, a book released in early 2011.
What also does not help is the fact that the average government job pays three times the average private sector job. “The national railroad has annual revenues of 100 million euros against an annual wage bill of 400 million, plus 300 million euros in other expenses. The average state railroad employee earns 65,000 euros a year. Twenty years ago a successful businessman turned finance minister named Stefanos Manos pointed out that it would be cheaper to put all Greece’s rail passengers into taxicabs,” write the authors.
And it doesn’t end with this. “The Greek public-school system is the site of breath taking inefficiency: one of the lowest-ranked systems in Europe, it nonetheless employs four times as many teachers per pupil as the highest ranked, Finland’s.” The worst thing of course is that the Greeks never learnt to pay their taxes because no one is ever punished.
But these things have been known for some time, so why is all the hullaballoo happening now?
So what has changed?
While the European Union and the International Monetary Fund may have been doling out rescue packages to Greece, but in lieu of that they expect Greece to reduce its fiscal deficit over the years by practicing austerity measures. Fiscal deficit is the difference between what the country earns and what it spends. This measure it is hoped will help Greece enough to repay its loans. But the loans are so large it is unlikely that something like this will ever happen.
Resorting to austerity measures is the traditional way of tackling debt problems. But when a government spends less; it also leads to the GDP shrinking in such situations because the private sector is not spending anyway, despite the interest rates being very low. As John Kenneth Galbraith The Economics of Innocent Fraud:
If in recession the interest rate is lowered by the central bank, the member banks are counted on to pass the lower rate along to their customers, thus encouraging them to borrow. Producers will thus produce goods and services, buy the plant and machinery they can afford now and from which they can make money, and consumption paid for by cheaper loans will expand..The difficulty is that this highly plausible, wholly agreeable process exists only in well-established economic belief and not in real life… Business firms borrow when they can make money and not because interest rates are low.
This is true of Greece as well as other sections of the European Union. So the private sector is not borrowing and spending. Neither are the consumers. Also with the government spending lesser, the economy has slowed down even further. With the entire economy spending lesser, tax collections are also down.
The unemployment rate has reached 25% and one in every two youths in Greece is unemployed. The GDP of Greece is expected to go down by 7% this year.
Hence in the eyes of the ordinary citizens of Greece the so called austerity programme is a villain which has made life difficult. In the recent elections Greeks voted for parties which are against the austerity programme that Greece is running in order to repay its loans. But the they ended up voting for a large number of small parties, making it difficult for anyone to form the government. Hence another election has now been scheduled for June 17. While no one knows what will happen on that day, chances are Greece might vote in favour of parties which are not in favour of any austerity programmes.
Greece is the canary in the coal mine
The austerity programme also requires Greece to collect taxes that are owed to the government. But like us Indians, Greeks also hate to pay taxes. As Satyajit Das points out in Extreme Money “Greece gives an appearance of a developed economy. In fact, Greece’s economy and its institutional infrastructure are weak with low productivity, low quality and endemic corruption. Around 30% of the Greek economy is unreported and informal, resulting in tax revenue losses of $30billion per month.”
One tax which almost no one pays in Greece is property tax. Recent attempts by the government to get the citizens to pay this tax by including it in their electricity bills came a cropper after unions led a massive civil disobedience movement. The government which had hoped to raise around €2billion through this move is now running out of cash. In total it owes around €500billion to various European entities. How can a government which is not able to collect €2billion of unpaid taxes mange t repay debt to the tune of €500billion?
Due to these reasons it is expected that Greece might leave the euro and technically default on its debts. For Greece it makes sense to do so (as I discuss here http://www.firstpost.com/world/if-piigs-have-to-fly-they-will-need-to-exit-the-euro-314589.html) and deem its debts to be in its own new currency.
But Greece is the smaller worry. The market and the European Union can handle Greece opting out of the euro and deciding to pay off its loans in its own new drachma. But what if Greece’s exit inspires the likes of Spain, Italy, Portugal etc. Then there will be real trouble because the amount of debt in these countries is bigger than that of Greece. Satyajit Das feels that Greece is the “canary in the coal mine”, which highlights similar problems in the other PIIGS countries(i.e. Portugal, Ireland, Italy, Greece and Spain) as well as some Eastern European countries. These countries have around €2 trillion of debt outstanding, much more than that of Greece. And that is the bigger problem.
To conclude, let me quote economist Tyler Cowen who runs the world’s most popular economics blog www.marginalrevolution.com:
It’s a moot point whether Greece is a poor country masquerading as a wealthy country or vice versa…If the old illusion was that Greece was a
wealthy country, the new illusion is that Greece will, in short order, become wealthy enough to pay back ever-growing sums of debt
(The article originally appeared at www.firstpost.com on May 22,2012. http://www.firstpost.com/economy/why-greece-is-the-canary-in-the-piigs-coalmine-317078.html)
(Vivek Kaul is a writer and can be reached at [email protected])