Greece Continues to Test European Solidarity

Greece’s fiscal woes are leading some to wonder whether it shouldn’t leave the eurozone. Others suggest closer union instead.

Prime Minister George Papandreou of Greece and Chancellor Angela Merkel of Germany during a press conference in Berlin, September 27, 2011
Prime Minister George Papandreou of Greece and Chancellor Angela Merkel of Germany during a press conference in Berlin, September 27, 2011

Standard and Poor’s cut Greece’s credit rating on Monday, ranking it as less creditworthy than several Third World countries. The company is worried about the highly indebted European nation possibly forcing its bondholders to accept a delay in the repayment of its debt.

The move follows a similar downgrading by Moody’s in March and further undercuts confidence in the country’s ability to continue to service its borrowing costs. Greece’s national debt rose to account for 142 percent of GDP in 2010 and is expected to reach 150 percent this year.

Greece’s fiscal woes sparked speculation this weekend that it might opt out of the eurozone. The German magazine Der Spiegel reported on its website that Greece was considering the possibility. European governments vehemently denied the rumor. Leaving the single currency bloc would likely amplify Greece’s debt struggles following the inevitable devaluation of a reintroduced drachma.

What is more, a Greek exit could prompt other nations in debt crises, notably Ireland and Portugal, to do the same and threaten the future of the entire eurozone.

Some sort of debt restructuring does appear likely. Senior eurozone finance officials met in Luxembourg on Friday, reportedly to discuss a “maturity extension” of Greece’s loans outstanding on the private market as well as additional financial support from fellow European Union member states.

Greece accepted a €110 billion European bailout last year but necessary austerity measures have been unpopular. Heavy labor regulations and widespread corruption continue to impede job creation while the socialist government has been hesitant to upset the country’s powerful trade unions with additional reforms.

Progress had been made. Unaffordable pension commitments, amounting to nearly 12 percent of GDP last year, were slashed while some labor market reforms were enacted. The government also sought to tackle entrenched monopolies such as the trucking industry despite many and loud protests.

Privatization is coming about slowly. Although public expenditures increased to almost 47 percent of GDP last year, the government remains heavily involved in energy, health care and public transportation. The country’s railway system alone needs €1 billion in yearly subsidies to keep afloat. Pharmacists have retained their monopoly and continue to enjoy fat profit margins. Law firms still cannot open branches in different cities.

In the short run, public-sector salary freezes, layoffs and attempts to crack down on tax evasion are dampening Greece’s growth forecasts. The economy is expected to contract by up to 3 percent this year while unemployment is rising to 15 percent, up from 9 percent mid 2009.

The government points to some encouraging signs — a rapid growth in goods exports, a significant fall in labor costs and indications that tourism might pick up this year. But Greek competitiveness overall is still lacking far behind many other European countries.

While unpopular, especially among the stronger “core” economies of northwestern Europe, further fiscal unification is favored by some in Greece. As it is, it is nigh impossible to devise a “one size fits all” monetary policy for a currency union with seventeen economies that are so divergent. While higher interest rates, for instance, are preferable in Germany where the economy has recovered, they would worsen the predicament of peripheral countries, including Greece, where banks are struggling as a result of the repeated sovereign debt downgrades.

Germany is imposing competitiveness standards on the rest of Europe — including raising the retirement age across the eurozone, abolishing the indexation of wages to inflation, harmonizing corporate tax rates and instituting a “debt brake” that would limit the ability of national governments to plunge deep in the red — but it shrinks from the responsibility that full fiscal convergence would imply, fearing permanent bailouts.

Countries outside of the eurozone are also skeptical, afraid that enhanced economic integration among the nations that carry the euro could leave them all the more plainly in the second tier of European union.