What is the Eurozone Greek debt crisis, and what lessons does it offer for the GCC single currency?
In last week’s Econ 101 column, we learnt that when a government struggles to manage its finances, it will suffer inflation and high interest rates, and that one remedy is to join the currency of a fiscally disciplined country. By surrendering control of its monetary policy, the joining country gains credibility, earning lower interest rates.
We also learnt that the downside of a single currency is that when the economy recedes because, for example, there is a financial crisis, unemployment will increase sharply as wages are slow to fall and the country’s currency cannot devalue.
The Greek debt crisis is a perfect illustration of these principles. It also serves as a warning to the GCC countries as they plan their own single currency.
Throughout the 1980s and 1990s, when Greece had the Drachma, the government mismanaged its finances in two primary ways. First, it ran up a large debt (more than 75 per cent of GDP in the mid-1990s). Second, it used that debt to fund public-sector hiring that featured generous benefits, such as low retirement ages, and that was useless, if not damaging, to the economy. As expected, the Drachma’s value tumbled and inflation and interest rates rose to more than 25 per cent.
Just as the music was about to stop for Greece, the EU introduced a fortuitously timed, but ill-conceived, single currency and the European Commission was very keen on Greek membership for political reasons. Greece obliged and in so doing, saw its interest rates fall below 5 per cent. This allowed it to delay domestic reforms and the government persisted with of borrowing to fund an extravagant and ineffective public sector.
After the global financial crisis of 2008, Greece’s lenders began to question its creditworthiness and markets started to differentiate between the different Eurozone government bonds, with Greece’s interest rates shooting up beyond 30 per cent. Government insolvency ensued – this time the music did stop. If wages didn’t fall immediately, then unemployment would rise sharply.
As mentioned last week, wages are stubborn, especially public-sector ones, but a devaluing currency is a good substitute. The single currency ruled that option out but there was the alternative of Greeks relocating to more prosperous parts of the eurozone to ease unemployment. However, cultural barriers, as well as the poor health of the European economy in general, largely scuppered such plans.
A series of bailouts ensued but they were of limited help because they were designed to bail out the private European banks that had lent to Greece. Greek unemployment now exceeds 20 per cent and it will take a long time for the economy to readjust.
The Greek government’s irresponsible spending habits during the past 40 years are the biggest cause of the crisis but the European Commission also played a role by politicising the single currency, which is the mistake that the GCC countries must avoid.
A correctly conceived monetary union involves a series of economic qualifications before entry of a new member as well as automatic sanctions that prevent irresponsible fiscal management by member states. The European Commission established both nominally but overlooked egregious violations because all it cared about was the aggrandisement and empowerment of the central European institutions. Bureaucracies specialise in engineering situations that result in an expansion of their influence and resources, which is why we see former president of the EC Jacques Delors now calling for fiscal union as the “solution”. In the next two weeks, we will expand upon why the EU’s reforms are paving the way for its implosion and why the GCC’s commitment to decentralisation will be critical to the bloc’s continual cooperation – and hopefully to a successful single currency.