Countries like Greece caused the Eurozone crisis by running up too much debt, so it is only fair that they should bear most of the burden of fixing it. Discuss. Emilia Clark The Eurozone is ailing. The Greek debt problem dominates the headlines, so many have made it synonymous with the Eurozone crisis. However, I would argue that the deeper-rooted cause of the crisis was not the actions of countries like Greece, but the fact that the fundamental flaws of the Eurozone meant that such an outcome was inevitable. The long-term causes of the crisis are: the innate weaknesses of the European Monetary Union; a universal monetary policy that was applied to dissimilar member states; the global financial crisis which began in 2008; the current account imbalances of the member states, and the Union s response to the crisis. I will explain why each one of these factors is more significant than the Greek debt crisis in causing the Eurozone problem. Throughout this paper, I will use the state of Greece as an example of the situation in the EU periphery countries (most notably, Greece, Ireland, Portugal and Spain) that arguably caused the crisis, for two reasons. First of all, although all the periphery countries were indebted to some extent, Greece s debt level was highest at 129.7% of GDP in 2009 1, and secondly, although the high government debts in the other periphery countries were largely caused by their governments being forced to buy private sector debt after the crisis had begun, Greece had high debt in both the public and private sectors, making it the most extreme example. Greece undeniably sparked the crisis in 2009, when the Prime Minister at the time, George Papandreou, announced that the official debt figures had been misrepresented, and that the actual debt levels were much higher than those figures had suggested; this dramatically reduced the confidence of investors who had previously assumed that all countries within the Eurozone had the same risk of defaulting on their debt, and caused an unsustainable rise in bond spreads. This set off a domino effect in much of the rest of the Eurozone. The causes of Greece s debt crisis, defined as the government s inability to borrow money on the markets to fund their debt, were numerous. First, consecutive Greek governments, namely those of Nea Dimokratia and Pasok, oversaw a massive increase in government debt, and a decrease in competitiveness and growth potential. This happened because the creation of the euro meant that borrowing costs converged for all member states, so countries that previously had to offer higher interest rates were able to borrow more cheaply. The resulting capital inflows were not used to fund productive investments which could have supported the repayment of the debt, nor were the increased tax revenues generated by the increase in domestic demand used to repay debt. In fact, public sector wages rose by 50% between 1999 and 2007 2. Greece was allowed to build up a level of debt significant enough to spark the crisis because, despite the no bail-out clause in the Treaty on the Functioning of the European Union, the perception was 1 Google (2015). Government Debt in Europe - Google Public Data Explorer. [online] Available at: https://goo.gl/zyycdg [Accessed 24 Jun. 2 BBC News. (2015). Eurozone crisis explained - BBC News. [online] Available at: http://www.bbc.co.uk/news/business-13798000 [Accessed 7 Jun. 1
that every country in the Eurozone had the same risk of defaulting on their loans, so countries like Germany lent to Greece because they believed that, in the event of a crisis, the European Union would bail Greece out. This meant that credit was readily available: in the lead-up to the Athens Olympics in 2004, for example, the Greek government carried out improvements in Greek infrastructure; however, the required equipment could not be manufactured in Greece, and therefore had to be imported with borrowed money. The second cause of the Greek debt crisis is the country s current account deficit, which I will explain in more detail later. Essentially, the weak drachma had made Greek exports cheaper and imports more expensive, but the stronger euro made exports more expensive and imports cheaper, resulting in an increase in the propensity to import and therefore a large trade deficit. The trade deficit became a problem when there was a sudden stop in funding precipitated by the start of the crisis. Greece s debt level was even more problematic as Greece suffers from chronic tax evasion - the To Potami MP Haris Theoharis estimates that the state loses between 10 billion and 20 billion euro in tax revenue per year. This is because Greece s inefficient institutions and antiquated tax-collection system cannot impose its government s regulations, so it is impossible for a tax-paying business to compete with another which does not pay tax correctly. This yearly loss in tax revenue means that the government has less money with which to make repayments on its debt than it would otherwise. Combined, these three factors led to the unsustainable, soaring debt that sparked the Eurozone crisis. However, as I have suggested, though Greece s debt crisis precipitated the wider Eurozone crisis, Greece was not the cause of the crisis; rather, it was due to the underlying structural flaws of the Eurozone. The first, and perhaps most significant, factor in the Eurozone s troubles are the root problems of the European Monetary Union (EMU). This was perfectly summarised by Jay C. Shambaugh in his article The Euro s Three Crises : [the Euro area is] a monetary union of somewhat disparate economies that lacks the common political and economic institutions needed to manage various shocks. [It] lacks institutions sufficient to deal with banking problems at the supranational level, a unified debt market, [and] the ability to manage shocks that affect different parts of the region s economy differently. In his A Theory of Optimum Currency Areas, Robert Mundell set out the criteria which a monetary union ought to meet, the most significant of which are an absence of frequent, large-scale asymmetric shocks, and mobility in the factors of production. The EMU does not satisfactorily meet either of these criteria: in terms of an absence of shocks, the union probably exacerbated and certainly did not internationalise boom and bust dynamics, which continued to work at the national level. This was because although money and monetary policy were centralised, control over the rest of macroeconomic policy remained in the hands of national governments; this led to idiosyncratic movements which were not constrained by the existence of the common currency. In his The Theory of Optimum Currency Areas, Peter Kenen proposed fiscal integration as a method of dealing with asymmetric shocks; there is no fiscal integration in the Eurozone. The risk of asymmetric shocks would theoretically be mitigated by mobility of the factors of production, which reduces the need to adjust to temporary imbalances; however, the factor mobility in the Eurozone has tended to be low. It is evident that the EMU does not satisfy either of these two most important criteria for an optimum currency area, and that therefore the Eurozone crisis was due to flaws in the design of the euro area itself. Other problems exist with the EMU that are not predicted by optimum currency area theory. When the common currency was created, the automatic stabilisers in government budgets (namely, the existence of a lender of last resort, and the option for currency devaluation) that could have prevented the crisis 2
were removed at national levels and not replaced at the international level. The creation of the union also removed the market signals that usually warn countries about unsustainable borrowing, namely rising interest rates and a decline in the exchange rate. The absence of a lender of last resort was particularly problematic. Usually, national governments are able to issue debt in a currency over which they have control, meaning that they can guarantee solvency; however, the common currency meant that governments were constrained by a currency they could not control. As a result, the European Central Bank was the only institution that was able to buy up government bonds ad infinitum, and thus ought to have adopted the position of lender of last resort. It did not do this to a sufficient extent, and when it did begin to buy bonds, it structured its purchase programme poorly: it announced that it would be limited in size and time, and therefore did not succeed in boosting investor confidence. These two factors show that the flaws in the structure of the Eurozone made it prone to crises. These defects led to the crisis in the following way: it was assumed that countries would adopt sound fiscal policies and thus limit asymmetric shocks, and that they would reform their labour markets to make them sufficiently flexible to cope with such shocks if they should occur. This seems satisfactory in principle, but asymmetric shocks do not always arise from flawed policies - the Eurozone crisis is itself an asymmetric shock, caused by the creation of the euro, through the mechanism I have already mentioned. The creation of the euro led to a perception that the risks associated with cross-border investment within Europe had been eliminated. This pushed capital from the core countries to the periphery countries, causing economic booms and higher interest rates in the periphery. The European Central Bank was willing to tolerate this shift, although it was itself an asymmetric shock, but this changed when the capital flows came to a sudden stop following the Greek announcement in 2009. And though it could be argued that this imbalance would not have been a problem if the Greek situation had not become unsustainable, the capital movement was untenable, and would have eventually led to a crisis, even if Greek debt levels had remained viable. The universal monetary policy set by the European Central Bank for a group of disparate member states also contributed to the crisis. When joining the common currency, member states handed over control over monetary policy to the European Central Bank, which sets the interest rate for the whole Eurozone. The size of the German economy relative to the others in the Eurozone meant that the European Central Bank must give greater consideration to conditions in Germany than to those in other countries: the interest rate was set low because of the weak growth in Germany and some other Eurozone countries. The low interest rate and the availability of cheap credit that came with Euro membership enabled increased borrowing by the Greek public and private sectors, and caused a rapid rise in the ratio of both public and private debt to GDP. Usually, global capital markets would have responded by raising interest rates, but they did not do so because of the assumption that bonds issued by different EMU governments were equally safe. This meant that countries like Greece were allowed to continue to borrow without restraint. Furthermore, these capital inflows led to higher growth and resulting inflation, which reduced competitiveness in the periphery countries, especially against Germany, which had pursued policies to keep wages low and bolster exports. Had the periphery countries not been constrained by euro membership, they could have used devaluation of their currencies and fiscal consolidation to increase their propensity to export and reduce their propensity to import. The periphery countries were locked into a monetary policy that did not benefit them and prevented them from taking action to prevent the crisis. 3
The common monetary policy had another repercussion: it led to balance of payments deficits in the periphery countries. Low interest rates and cheap credit increased domestic demand in periphery countries, leading to an increased propensity to import, meaning that these countries started running trade deficits. They were not able to respond to these deficits by depreciating their currency and raising interest rates. Competitiveness in the periphery countries decreased because of high labour costs relative to the core countries, including Germany, which had a trade surplus of nearly $200 billion in 2011 3. These current account imbalances did not lead to income convergence by reallocating resources from the economically stronger core to the economically weaker periphery, nor did they promote consumption smoothing by the periphery countries; instead, they led to investment in capital which did not improve future productivity growth, and delayed the adjustment to structural shocks. These deficits only became problematic, however, when there was a sudden stop in the funding markets, meaning that the deficits needed to be narrowed quickly; and this is what happened. Although it could be argued that the immediate cause of this sudden stop was the Greek debt crisis, I would contest that the European Union s poor response to the crisis aggravated the problem. Had the European Union responded differently to the Greek announcement in 2009, the crisis could have been averted. The best initial policy would have been two-fold: first, the debtor countries should have reduced, and the creditor countries increased, spending. Instead, the European Community oversaw tight austerity measures on the debtor countries, while the creditor countries continued to aim to balance their budgets. This led to an asymmetric adjustment process that has prolonged the crisis. Secondly, the European Central Bank should have provided liquidity support in the secondary markets of sovereign bonds in order to impose a price floor: it should have provided lender of last resort support to governments, as I mentioned above. Had the European Central Bank clearly committed to maintaining bond prices, it could have prevented the massive price declines in some countries, and thus the European banking crisis. However, it decided to delegate the power to purchase government bonds to banks, erroneously believing that they would correctly decide to buy them; the banks were, and are, unconfident and uncertain, so their judgement should not have been trusted. As it was, they channelled only a fraction of the liquidity provided by the European Central Bank into government bond markets. Had the reaction been different, the crisis could have been mitigated or even prevented. It can be concluded that the Eurozone crisis was not the fault of Greece; rather, it was caused by the inherent flaws of the Eurozone, the common monetary policy, and the ill-judged response to the crisis. Whether or not something is fair is a moral question, so whether or not Greece ought to bear most of the burden of fixing the Eurozone crisis could be analysed from a perspective of moral responsibility. An agent is responsible for an action only if they have caused it; cause entails responsibility, and responsibility would put the burden of fixing the crisis on Greece. But Greece did not cause the Eurozone crisis, and so it is unfair that they should bear the burden of fixing it. In conclusion, countries like Greece should not have to bear the burden of the Eurozone crisis because they did not cause it. One questions how a country like Greece, which accounts for around 2% of the Eurozone s GDP, can be tried in the court of public opinion for causing such turmoil. 3 Feldstein, M. (2011) The Failure of the Euro. [online] Foreign Affairs. Available at: https://www.foreignaffairs.com/articles/europe/2011-12-13/failure-euro [Accessed 15 Jun. 4
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