Question

The Greek Debt Crisis and Its Aftermath

All economic crises eventually become political crises. But they don't all follow the same pattern. It floored countries like Iceland and Ireland, where the prosperity and property booms were found to be driven by a financial system that went quickly bust. But Greece is on a different level: it's not the banks that are bust but the country.

The incoming Pasok (Pan-hellenic socialist) government discovered that instead of 3%, or even the revised 6% of GDP, the budget deficit was running to 13%. Somebody had been misstating the figures; whole tranches of defence expenditure, for example, seem to have been covered up. But it's not just successive Greek governments that look culpable. The European Union (EU) turned a blind eye to consistent rule breaking. It offered the protection of a single currency and a central bank, without requiring fiscal discipline. Having scraped into the Eurozone at the height of an economic upturn, Greece has never looked like it could stay within the rules without some massive reform program that the political system is incapable of delivering.

If Greece were a "true sovereign", with its own currency, that currency would now be the subject of a massive speculation. But it is part of the Eurozone, so only the insurance policies on its national debt can be the subject of wild speculation. As George Magnus points out, sovereign debt crises usually need four measures to resolve: devalue the currency, slash interest rates, monetize the debt - by the central bank buying up government debt - and a bailout. Of these only a bailout would be possible for Greece. The Eurozone makes the first two impossible and the third nearly so. So it's bailout or bust.

Eventually Greece was financially rescued by the European Union and International Monetary Fund. Bailouts - emergency loans aimed at saving sinking economies - began in 2010. Greece received three successive packages, totaling €289bn (£259bn; $330bn), but they came with the price of drastic austerity measures. Consequently, the economy is now 25% smaller than when the crisis began and it will take decades to pay off its debt pile of 180% of GDP. More than 400,000 people emigrated and in 2013 the unemployment rate peaked at 27.5% - but for those under 25 it was 58%.

The adjustment from austerity was particularly painful for crisis-hit countries like Greece because as the member of a single-currency bloc it had to cut wages, domestic demand and employment. The resultant squeeze on consumption and investment from eight years of austerity, have resulted in more than 25% fall in imports compared to 2007. Due to this Greece’s current account deficit has shrunk significantly.

While current account deficits in Eurozone crisis countries keep shrinking, meanwhile surpluses in other Eurozone countries like Germany and the Netherlands have grown. As a consequence, the Eurozone in total has a substantial current-account surplus. In the year to June it was 3.6% of GDP (the same as the record for a calendar year, set in 2016). In 2017, according to the IMF’s External Sector Report, published last month, the Euro area had the world’s biggest absolute current-account surplus, $442bn. Germany has the largest of any single country. This current account surplus that the Eurozone as a whole bloc is now running is mostly at the expense of the US. But the US is becoming increasingly intolerant of being forced into the role of consumer of last resort. President Donald Trump already sees Europe as a “foe” because of its bilateral trade surplus with America. He has slapped tariffs on European steel and aluminum, and threatened them on cars. (Adapted from articles in BBC, Economist and Forbes)

(a) How did being a Eurozone member hinder Greece’s ability to resolve its debt crisis through domestic policy measures? Why are bailouts, that Greece eventually received, difficult to execute within an economic union like the Eurozone? Provide explanations through relevant concepts.

(b) How would the current account surplus of the Eurozone countries with the US affect the value of the Euro vis-à-vis the US$ eventually? What would be the impact of this change in Euro/US$ exchange rate be on Eurozone bloc companies either exporting to US or having operations through direct subsidiaries in the US? Please explain your answer using relevant concepts.

(c) Why does President Trump regard the trade surplus that the Eurozone countries have with the US adversely? How would the tariffs he has imposed on the European goods impact the trade surplus? Please explain your answer using relevant concepts.

Answer 1

a) The economic cycles such as recession and boom are the characteristic of capitalist system. The cycles are almost impossible to avoid but its effects can be smoothened out through fiscal as well as monetary policy measures.
The Greece had not been into the recession but it had some financial indiscipline that led to the crisis.
As a Eurozone member, it had no separate currency or separate central bank. It had to follow the policies of the ECB or European central Bank. Greece would have been out of the crisis through policy measures such as devaluation of its currency, lowering interest rate but not being in the Eurozone.

Greece had the only option of bail out package which it received through IMF and ECB but it could not use that to stimulate the consumption as IMF and ECB put some harsh conditions of austerity measures. That suppressed the consumption in the economy as cut in the wages affected aggregate demand in the economy. Further, the level of debt which was180% of the GDP has burdened the economy.

b) The mercantilism has advocated the trade surplus and Britain even went on to war against China to reduce its trade deficit. Those wars are known as 'Opium Wars'. However, being is always surplus is not that much beneficial according to the David Hume as it expands the monetary base and that causes the rise in inflation, wages and also appreciation of the currency. The Eurozone will witness the strengthening of its currency that is Euro against the USD and that will eventually lower its export competitiveness. The stronger Euro will spell out cheaper import but expensive export as the buyers will have to pay more for the Euro. The rise in wages will also raise the input cost.
The exporters or subsidiaries in the US will soon find themselves not so much competitive in the US market.

c) Trade surplus or deficit could good or bad according to the economic situation. The US has trade deficit with the Eurozone which indicates that the US was importing too much from the EU but its export was lower than its import.
The persistent trade deficit needs to be financed through reserves or borrowing. The large and persistent trade deficit also weakens the currency in the market.
The Trump government has resorted to protectionism and imposed a tariff of the EU goods. This raises the effective price of the EU goods so that it would be higher than the domestic price of the same good. The consumer prefers domestic goods over the foreign goods and if not the the government earns the revenue through tariffs.