Economists are divided into macro and micro economists. The former focus on aggregates, like inflation, employment, and GDP growth. The latter worry about decision-making at the individual level—whether a consumer, worker or firm. The crisis in Greece poses both a macro and a micro problem—yet the cut and paste ‘austerity’ solutions proposed by the creditors have not tackled the enormity of either problem.
At the end of the 90s, Germany was facing a problem of aggregate demand—a macro concept. After a decade of wage restraint, lowering unit labour costs but also lowering living standards, there was not enough demand inside of Germany for Germany’s own goods. Hence demand had to be found externally. Excess cash in German banks was lent abroad, to foreign banks—such as those in Greece. Greek banks took the German loans and lent to Greek business to buy German goods, thus increasing German exports. This massively raised the level of Greek private and public debt. Indeed, as is well known, German banks own a large share of Greek debt (€21bn).
Crucially, the higher indebtedness was not accompanied by an increase in competitiveness—a microeconomic concept. Greek firms were not investing in areas that increase productivity, from human capital formation, research and development, new technology and strategic organizational changes. On top of this the State was not functioning, due to lack of serious public sector reform. Thus when the financial crisis hit, Greece’s private sector found itself highly indebted, without the capacity to react.
As happened elsewhere, the massive private debt later translated into a massive public debt. While the Greek system was laden with different types of inefficiencies, it is simply not true that the problems were solely due to an inefficient public sector and different types of ‘rigidities’. The problems were also caused by an inefficient private sector, that got by only through increased indebtedness and the use of “structural funds” from the EC to make up for their own lack of investments. When the financial crisis laid bare this problem, the government ended up having to bail out banks, and found itself with a massive fall in tax revenue due to falling incomes and jobs. Greek debt/GDP levels, like those in most countries, rose exponentially after the crisis for these reasons.
The reaction of the Troika was to impose austerity, which as we now well know caused Greek GDP to fall by 25% and unemployment to reach record levels—permanently destroying opportunities for generations of young Greeks. Syriza inherited the disaster and focused on the need to increase cash by increasing tax revenue through battling tax evasion, corruption, monopolistic practices, and even fuel and tobacco smugglers. It agreed to begin reforming labour laws, cut spending and to increase the retirement age. Some errors were made by the young government, but it surely cannot be said that they were not making headway as many of these reforms had indeed begun. Indeed, during the new government’s first four months, the treasury reduced the deficit massively, and had a primary budget surplus of €2.16bn (not including debt interest payments), which far exceeded their initial target of a €287m deficit.
Did the austerity help? No. As John Maynard Keynes stressed, during bad times when consumers and the private sector are cutting back, it makes no sense for government to cut as well. This is what makes recessions turn into depressions. Instead the Troika asked for more and more cuts, and wanted them made even more quickly, giving the Greeks little breathing room to continue with the reforms that they had begun. And making it impossible to get Greece back on its feet (only through future growth will they pay back the debt) through any sort of investment strategy.
The economic crisis later produced a full-blown humanitarian crisis, with Greeks unable to purchase medicines, and food. According to one study, every 1% fall in government spending in Greece led to a 0.43% rise in suicides among men. The report’s authors said that (after controlling for other characteristics that might lead to suicide) 551 men killed themselves “solely because of fiscal austerity” between 2009 and 2010. Syriza reacted by promising free medical care for the jobless and uninsured, housing guarantees and €60 million on free electricity for the Greeks. It also vowed to hand out €765 million to provide meal subsidies.
Syriza’s focus on the humanitarian crisis and the refusal to impose more austerity was met with loud concern by the Troika, and a total lack of appreciation of the reforms that had begun. The media fuelled this process and the rest is history, as the papers have of course been full of what happened next—often treating on a personal level (attacking Varoufakis or Tsipras) what should have been treated with socio-economic reasoning.
The unwillingness to forgive at least part of Greece’s debt is of course hypocritical given that after the war 60% of Germany’s debt was forgiven, and it was accompanied by an investment strategy through the Marshall Plan. Today both debt forgiveness and an investment plan are lacking in the EU’s approach to Greece. A second form of hypocrisy, often lost in the media, is just how much international private banks were saved and ‘forgiven’, with little scandal amongst the finance ministers. While Greece today needs a bailout of about €370 billion, this is nothing compared to the financial support given to international banks, through both direct bailouts and massive increases in liquidity, without a batting of the eye. In the US this began with the initial $700 billion through the Emergency Economic Stabilization Act of 2008, and was then massively ramped up through the Fed’s various ‘special facilities’ programmes which provided ‘Lender of Last Resort’(LOLR) functions. These are described in detail in both a US government GAO report, and developed further in this well researched Levy Institute working paper, by James Felkerson, which sums all direct lending plus asset purchases provided by the Fed between 2007-2012—totalling $29.7 trillion! Banks that benefitted from the Fed’s various LOLR programs include Citigroup ($2.6 trillion), Merrill Lynch ($ 2.4 trillion), Morgan Stanley ($2.2 trillion), Barclays ($1.03 trillion), Goldman Sachs ($995 billion), and more (see Table 13 in the paper). Indeed, Obama’s impatience with Merkel and the EU must be because he remembers these numbers, and knows full well that when debt is too large, and will not be paid back under current conditions, liquidity must be provided, and debt must be restructured—quickly. Should Greece pretend to be a bank to receive such support?
The third type of hypocrisy is that while the Eurogroup forced austerity on the Greeks (and other southern neighbours), Germany was increasing its own spending on R&D, science-industry links, strategic loans to their middle sized companies (through an active public bank, KfW), etc. This of course helped the competitiveness of German companies while starving the competitiveness of others in the Southern periphery (to keep public debt low Spain cut public R&D by 40% since 2009). Siemens wins contracts abroad because they are one of the most innovative companies in the world, the fruit (also) of public investments in training, and new technology. A monetary union is impossible in a ‘common’ area in which there is such large divergences in competitiveness. The EU should have a common innovation and industrial policy in order to reduce such divergences—not a common (and idiosyncratic) austerity policy.
So to summarise, the fiscal disciplinarianism being used today by the Eurogroup to put Greece ‘in line’, will not lead to growth in Greece. A lack of aggregate demand in Greece (macro), and a lack of investments in areas that increase future productivity and innovation (micro), will only make Greece weaker and dangerous to the same lenders. Yes, major reforms are needed, but those that help on both these fronts. Not just cuts. Equally, today Germany must invest to increase internal demand, and allow the kind of policies in other EU countries that will allow them to achieve real competitiveness. The fact that this is not understood by the Eurogroup shows both short-termism and economic ignorance (who will buy German goods when austerity chokes demand elsewhere?).
Let’s hope that this week we see less mediocrity and more big thinking—the kind we saw after the war, and need today after one of the worst financial crises in history.
While a short-term solution may be found later this week to keep Greece in the Eurozone, the truth is that the austere conditions being imposed will only postpone the problem. And this is a complete failure of both macro and micro policies.
I updated this blog on July 16/17th, 2015 to provide more background, and detailed sources, for the figures on the financial support provided to banks.