Greece Euro Crisis

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Hochschule Fr Technik und Wirtschaft Berlin [HTW]

University of Applied Sciences

University Department: Economics and Business

Winston Sayes (s0539276)

Muhammad Zia Ul Aein (s0534559)

Farrukh Javaid (s0541360)

Degree Program: International Business Bachelor

Theme: Greece Euro Crisis - A Look into Greece Crisis, Why It

Happened and the Progress since the Crisis, Bailouts and Consequences

Prof. Dr. C. Thomasberger

Submitted: 16.Jan.2014


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Contents

1. Introduction....................................................................................... 3

2. Trade Balance and Current Account..................................................... 4

3. Countrys Competitiveness Compared to EU Member Countries............ 74. Why Euro Failed Greece?................................................................. 11

5. Interest Levels on Long Term Government Bonds............................... 16

6. Bailouts for Greece........................................................................... 19

7. The Effects of Bailouts and Austerity Measures.................................. 21

8. Conclusion....................................................................................... 24

9. Bibliography.................................................................................... 25

Division of Work:

Winston Sayes (Intro, Trade Balance, Current Account)

Farrukh Javaid (Competitiveness, Interest Levels, Sovereign Debt Crisis)

Zia Ul Aein (Bailouts, Austerity Measures, Consequence, Conclusion)


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1.Introduction

The Euro Area, consisting of 17 member states, was conceived with the Maastricht

treaty in 1999,and was aimed to create mobility, growth, stability, a single currency

and to unite the countries of Europe, while one can argue that the aims of mobility

and a single currency have been met, on the contrary one can easily argue that both

growth. Stability and a united Europe have fallen short, and even in some

cases, the inverse is true, a prime example of this, and unfortunately not the only one,

is Greece. Since joining the EU in 2001 Greece and its economy has declined and

fallen into despair.

When one thinks of the European Union and the ongoing crisis, Greece is normally

the first thought that pops into our minds, to this day Greece and the Greek people

suffer and is considered the black sheep of Europe. But was it always this way in the

birthplace of democracy? And if not, what events created the crisis in Greece, how did

politicians allow it to happen? How a country that fulfilled all of the Maastricht

Criteria, and which looked so promising, could fall so badly? And what are the

consequences for Greece; are the Austerity measures destroying Greece more thanhelping? Is leaving the euro an option for Greece? And if not, is there a likelihood for

of a third bailout?

In this paper on Greece Euro Crisis, we aim to look at some financial data regarding

Greeces debt as well as its competitiveness. The paper also discusses all the bailout

packages Greece has been provided with along with the research into the fact if a

third bailout would be needed or not. The research also focuses on the austerity

measures and what changes, positive or negative, they brought to the economy and

public of Greece.


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12. Trade Balance and Current Account

Greece's current account year for year, during its accession and even before its

accession into the EU, was negative, it is however worth noting, the common

misconception that a trade deficit is always bad, A deficit, as stated by the IMF, is

actually a positive thing, as it potentially spurs faster output growth and economic

development (IMF) America for instance has a huge trade deficit and is a considered,

although not always, a financial stable country, this is partly explained by the

Pitchford thesis which states that a current account deficit does not matter if it is

driven by the private sector undertaking mutually beneficial trade. However as with

anything, an excess is normally a bad thing, and with the example of Greece, I willexplain in the following text why:

Once created, the idea of the Utopian Euro Zone soon came forth, it was seen by

many as a safe haven where nothing could go wrong, investment flooded in to all

countries that joined, and to begin with Greece was no exception. As stated by

Sauernheimer, during 2000 and 2005 Greece was a euro success story, only after

Ireland did they boast the highest growth rate in the Eurozone and their current

account deficit as a percentage of GDP decreased. This was mainly due to the fact

that after Greece's accession into the EU, investors perception changed (See: Figure

1, Interest rates for long term bonds), clearly shows this change in investors

perception of the stability of Greece, and its economy.

1 The current account can be expressed as the difference between the value of exports

of goods and services and the value of imports of goods and services . . A deficit then means that the

country is importing more goods and services than it is exporting The current account can also be

expressed as the difference between national (both public and private) savings and investment. A

current account deficit may therefore reflect a low level of national savings relative to investment or a

high rate of investmentor both. (IMF)


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(Figure 1)

In contrast, during the 90 there was low confidence and thus heavy refinancing costs

for the deficit states (Greece included), one can see the development of the interest

rate and thus confidence levels into the lines converge in the 00s with wealthier states.

This falsely put Greece, and interest rates on a level with countries such as Germany,

giving Greece cheaper refinancing that was formerly only available to theses more,

wealthy, stable economies. However at the same time Greeces trade balance deficit

becomes excessive, and persistent dipping in double-digit numbers as a percentage

of the GDP. The GDP share of current account deficit almost doubled between 2004

and 2006, only to increase substantially in the following year, (Figure 2, shows the

excessiveness of, the current account balance)

(Figure 2)


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It is important to remember that while year after year, Greece trade deficits increases

and cumulates, in effect liabilities are being built up to creditors which are financed

by flows in the financial accounts, eventually however these creditors must be paid

back.

However theses low interest rates reflect financial markets not good markets, the

latter are much slower in converging, this creates high inflation, making EU imports

more expensive, and erodes much of the real wage of greeks. Between 1999 and

2008 nominal wages increased by 10.9 percent in Germany, at the same time rising

by 36.1 percent in Portugal and by a staggering 76.5 percent in Greece (OECD

2010a). De Grauwe (2009) goes further in suggesting that much of these differences

in wages were not supported by an elevation in productivity and unit labour costs,

simultaneously international competitiveness substantially diverged. Normally

Under a regime of flexible labour markets, this loss in competitiveness would have

triggered an increase in unemployment, which in turn would have limited or even

averted wage growth. But the misuse of government debt (see Figure 3). Namely In

the form of increased Government spending in an effort to stem the negative effects

on GDP growth and employment, eliminated this control mechanism. Thepublic debt

was used not only to provide generous social benefits, but also to inflate public sector

employment .

(Figure 3)


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In Greece, per capita spending rose from 35 percent to 73 percent of German levels

between 1999 and 2010. In all the troublesome states of Spain, Greece and Portugal

one can seasily see the persistant spending on social security (see above)- In fact,

unknowingly, a vicious circles is started, as inflation rises, competitiveness is eroded,

low productivity triggering de-industrializing as imports become cheaper and greeces

own products more expensive, exports begin to decrease substantially, increasing

imports, and domestic jobs are lost, factories close, government spends more,

employees more public servents to stem unemployment, raising debt, and the vicious

cycle begins all over again.

3. Countrys Competitiveness Compared to EU Member

Countries

After joining the Eurozone in 2001, soon it was realized by the government of Greece

that the benefit of single currency was not getting into the roots of all the sectors of

the country. Single currency has paved the way of doing business and increased

tourism and money stability in the Eurozone but it also started springing up some

serious problems with and within the Government of Greece.

The problem was there were countries in the European zone and especially in the

Northern European countries, having higher productivity rates as compared to that of

Greece.

Lets take example of Germany which is the most economically developed in the

Eurozone region and form a productivity comparison with the productivity rates of

Greece.


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Table A 2000 2000 2010 2010

Greece Germany Greece Germany

Apparel/

Hour

5 5 10 20

Wages/ Hour DR. 5 Euro. 5 E. 10 E. 12

Cost to make

1 Shirt

DR. 2 Euro. 1 Euro. 1 Euro. 0.60

The above mentioned table2shows the competitiveness of Greece with the Germany.

3.1. Losing Competitiveness and Exchange Rates

To understand the changes in productivity, lets explain the above example. Consider

the apparel industry in Greece and in Germany. In Year 2000 Before Greece attended

the Eurozone, Greece worker was able to make 5 shirts/ Hr. and was paid 5 Drachma

/ hr. wage and in comparison with the German worker able to make 5 shirts / hr. and

was being paid 5 euros/ hr.

If Greeces and Germanys Exchange rate was equal (assuming if it was equal) then

the both of the workers in the two countries earn the same amount of money.

Mathematically;

Cost in euros = cost in drachma *exchange rate

If 1 Drachma had an exchange rate of 1 with the Germanys euro then

Cost in Euro = 1 Drachma * 1

= 1 Euro

2 The euro and greece explained by European Union Centre , Indiana university ,November 2011.


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But consider what would happen if the exchange rate was different between two of

the countries. If 2 drachma equalled 1 euro then the equation could be like below

Cost in Euro = 1 Drachma *

= .50

Then the equation shows that Greece was more competitive with respect to Germany

as the same shirt was costing only .50 euros. Then Greece could have comparative

advantage over the German industry.

Consider the third case in which 1 drachma equalled to 2 Euros then the equation

could change drastically

Cost in Euro = 1 Drachma *2

= 2 Euros.

Now according to this equation Greece loses all its advantage to the German industry

because the same shirt will cost you now 2 Euros which is twice the amount of

Germany.

3.2. Why It Happened? How Greece Lost Competitiveness?

Soon after joining the Eurozone the wages in Greece and in European area started to

increase drastically if we compare it with the German increase in wages, which was

far less.

During year 2000 till year 2012 the wages increased 33.7 % as compared to only 0.6

% in Germany which actually has no comparison with the other EU states.

Hence the total manufacturing cost of Greece increased manifold as compared to the

other Eurozone member countries.

This can be seen in the figure 43on the next page. According to the figure Greece

was on the highest landmark of increased wages and manufacturing cost followed by

3 Swiss bank .


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the immediate neighbours Italy and Spain. France remained in the middle. The best

of all the countries was Germany. A comparison between Greece and Germany can

be seen in Figure 5.

(Figure 4)

(Figure 5) Greece vs. Germany


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4. Why Euro Failed Greece?

According to the above situation Greece had two options to counteract and achieve

back its competitiveness.

1. Increase the Production per hour

2. Decrease of wages

3. Devaluation of the currency.

The currency devaluing would have allowed Greece to sell its products at cheaper

costs even the cost of good producing was ever increasing. But due to single currency

EURO Greece was not able to control, regulate or deregulate the Currency as it gave

up this right with the adoption of the euro. Hit Hard by the crisis, Greece in the

present condition working hard to cover up the government deficits and take to revive

of the economy. The austerity measures are hard and due to these the wages of Greece

in the year 2012 reduced to 30 % whereas in Germany the increase in wages rate is

about 10 % and it is expected that Greece would be back to the original level ofcompetitiveness by the year 2015.

4.1. Inflation

Inflation is something very important which can be seen in the Greece economy and

its contribution to the overall problems of Greece. For the reference purposes refer

to the Figure 6 (next page).


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(Figure 6)

In the case of Greece, it happened for the first time in 45 years that the consumer

prices actually adopted a deflationary pattern and as a result pushing the prices down

due to high recession the country is in right now.

The rise and fall in the inflation of Greece can be seen in the perspective of different

eras of time and during the different regimes that took over Greece.

1947 to 1974:

During the twenty years soon after the civil war that ended in the 1949, the average

inflation of Greece remained to 4 % which was in accordance with the average of the

OECD which was also 4 %.

1974 to 1994:

During this era that inflation rose sharply especially till 1990 to the level of 16 %

which was about 10 % more as compared to the OECD member states which

remained at the average of 4 %.


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4.2. Convergence of Inflation Rate

It was only after 1990, the inflation rate started converging from 16 %. This was only

possible because Greece starting preparing for the entry into the single currencyregime in the year 2000. Greece was one of the signatory of the Maastricht Treaty in

1991. But in spite of the fact it still remained higher even in the decade a bit higher

even compared to the other EU member states.

Reasons for Convergence of Inflation Rate:

Inflation convergence was due to the following reasons:

1. Wage Indexation.

2. Loose Monetary policy

3. Depreciation of Exchange rates.

In spite of all the efforts, the inflation rate remained one % higher than the other EU

member states till 2000. This was the point in spite of all the efforts, due to inflation,

that Greece started to lose competitiveness in comparison to other member states,

thus increasing wages, to fight the inflation which made the products costly rendering

in loss of markets and internal imbalances.

4.3. Budget Deficits

Greece inherited a unique structure and history in terms of its sovereign debt, Fiscal

deficits and Public debt. After the democracy prevailed in Greece in 1990, all the

preparations were to make amendments in Greece to prepare its entry into the EEC.

The economy during the 1990 to 2000 recovered as much it was anticipated as

unemployment was at its lowest and the inflation measures were brought down (as

mentioned above). The current accounts were in surpluses and government deficit

was kept till 3 % and the sovereign debt was kept under 25%.


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(Figure 7)

After this the other term Greece was hit with stagflation. When the second oil shock

hit the world the growth of economy was reduced from 7.2% in 1978 to 0.7 % in

1982. Inflation was increased during the period from 13.2 % to the all time high of

the 22.5% in 1980.

In electoral 1980 , which was seen around the world as the world recession phase due

to the oil shocks the Public debt of greece rose from the initial 2.3 % to the 9 % in

1981. The explosion of the Sovereign debt pr the public debt exploded in the coming

years

4.4. Debt Accumulation

There are four integral steps which could possibly depicts the raise or accumulation

in the fiscal deficits and the raise in the public or the sovereign debts4

4

Greece and Beyond: The debt Mechanism o f Euro, by MathiasBaumgarten and Henning Klodt. Kiel institute of World Economy. Aussenwirtschaft 65jahrgang (2010); Heft 4, Zurich. Ruegger p365-377


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1. Price Levels

The overall purchase levels are depicted by the overall purchasing power parities of

the consumer price index of the deficit states as compared to the PPP of Germany =

100 considered. The purchasing power parity from 1991 to 2000 can be clearly seen

in the Figure 8 below.

(Figure 8)

An explanation in the lower prices in the poorer states can be explained by the

Balassa Samuelson Effect (see e.g; Siebert and Lorz 2006)5which isInternational

Trade tends to equalize the Prices of tradable goods, while the prices of non-

tradable goods (services) may differ across the state. Therefore the price levels

raise so appreciably in the poor countries as compared to the rich or the wealthier

states that it certainly takes them time to recover from the differences as when the

countries with different economies and productivity level are united under single

currency regime, then the productivity differences are eliminated and the aggregate

price tends to increase sharply. This increase in aggregate prices without

improvement in productivity level will render the poor country incapable of

competing with the rich countries.

5

Greece and Beyond:The debt Mechanism o f Euro, by MathiasBaumgarten and Henning Klodt. Kiel institute of World Economy. Aussenwirtschaft 65jahrgang (2010); Heft 4, Zurich. Ruegger p365-377


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5. Interest Levels on Long Term Government Bonds

Higher Interest rates on Greeces government bonds as compared to the Eurozone

average is given in the Figure 96and 10 (next page).

(Figure 9)

6 www.wikipedia.com, Greek Government Debt Crisis Countermeasures ,01/12/2013.@ 12:31P.M


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(Figure 10)

Todays deficit governments have the long history of Re-Financing7their debts at the

higher cost. This was the state of Greece in 1991. This was because of higher inflation

rate of 13.2% and higher debt accumulation which was about 100 % as compared to

the average 70 %8of Euro zone. Due to the situation prevailed at that time, investors

were not confident whether Greece would recover from the situation and were trust

deficit. Second important thing that investor or the markets thought that the

Government might go Insolvent and might not be able to repay their debt obligations

which resulted in higher risk premium rates for Government bonds.

7 Re-Financing is the term used in Macroeconomics. Defining thatGovernment Buy loans to finance their existing activities of government in case of Budgetdeficits. When they are not able to pay back their debts, they again need to borrow the hugeloans to pay back the interests plus original amounts. this is called Re Financing8 According to ECB the standard for Budget Deficit is 3% and the sovereign

debt is about 60 %. The euro and greece explained by European Union Centre , Indiana university ,

November 2011.


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5.1. Implication of Single Currency

But considering that after entering the EURO Zone the convergence of the Interest

rates across all the nations takes place. All the economies due to single currencyshould be trusted by the investors but the events of 2008 rendered the trust level of

the investors shattered as they came to know that all the countries in the Eurozone

don't share the stability that was attributed to them.

(Figure 11)

5.2. Greek Sovereign debt Crisis

In the year 2004 the Greek general government deficit was being reduced from

staggering 7.5 % of GDP to 3.6 % in Year 2006. But it was not to last all, in the midst

of the year 2007 the situation started deteriorating again. Therefore, until 2009 the

bubble of sovereign debt has exploded when the debt crossed all the limits and ended

into the two figures which was 13.6 % of the GDP.

The very initial sign of this came in the year 2009 onwards when there has been seen

a staggering difference in the Greek government bonds as compared to the German

bonds. Therefore the serious crisis led to the trail of events which completely

shattered by the global financial crisis and then at last the European union set up the


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special support program for the Greek government which with the active

participation of IMF.

These bail out packages and their implications and the austerity measures will be

dealt in the later section completely

6. Bailouts for Greece

Till now, Greece has been provided with two bailout packages and there is a

speculation for a third one. Greek requested for an official financial help on 23rdApril

2010 after the achievements on long-term Greek government bonds were further

downgraded by the credit rating agencies.

6.1. Bailout Package May 2010

The Trio, which comprises of International Monetary Funds (IMF), European Central

Bank (ECB) and The European Commission (EC) agreed in May 2010 to provide

Greek with its first bailout package of 110 billion which was to be paid within three

years with the aim of reducing the budget deficit below 3% by year 2014. The aim

of this target was to ensure that Greece is able to make it return to the capital markets

in the period of three years.

It was agreed that IMF would bear 30bn whereas Eurozone would shoulder 80bn

based on bilateral loan commitments. The share of Germany in 80bn loan was 28%

whereas France paid 21%. It is to be noted here that Germany and France are the

countries to whom Greece owes the highest amount of debt. The numbers can be seen

in Figure 12 (next page).


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(Figure 12)

The first bailout package for Greece was released in May 2010 and it amounted to

20bn. The 20bn was comprised of 5.5bn from International Monetary Funds (IMF)

and 14.5bn from Eurozone.

The bailout amount was received by Greece in the form of instalments. The first

instalment for Greece was released in May 2010 amounting 20bn. The second and

third instalments were released on 13th September 2010 and 19 January 2011

respectively. The fourth instalment amounting 10.9bn was approved on 16 March

2011 followed by fifth instalment on 2nd July 2011. The sixth and final instalment

was paid out in December after a significant amount of delay amounting to 8bn.

6.2. Second Bailout Package

The first bailout package proved to be insufficient due to the fact that Greece was

making a very slow progress in implementing the reforms which lead to a need of a

second bailout package to be agreed upon. The deficit of Greece actually shrunk

along with many other factors and the numbers were more shocking than the deficitfor example employment, investment, social services, demand and revenues from


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taxes. There were many other implications and effects of first bailout, not actually

according to the expectation of IMF and EU but they are discussed later in the

implications section.

According to IMF and EU, the first bailout package could have solved all the

problems, which was very unrealistic and as expected, everyone saw that only one

bailout package was not enough. At the same time, the Greek bond yield kept getting

worse which was a sign for Greece getting kicked out of the private financial markets.

Before even the first two years of the bailout 2010, the leaders of the euro countries

decided to provide Greece with another bailout package amounting to 130bn. This

bailout package was significantly important because without it the country default

was on the edge.

6.3. Third Bailout Package

There is a speculation after seeing the slow and unsatisfactory recovery in Greece

situation that the country might need a third bailout package which can be no less

than 50bn.

7. The Effects of Bailouts and Austerity Measures

The aims which were kept in mind from the very start by the Trio, International

Monetary Funds (IMF), European Central Bank (ECB) and The European

Commission (EC), were without any doubt determined and they hoped to solve or at

least slow down the effects of a disastrous situation but it cannot be ignored here that

they were also very unrealistic and general neoliberal ideas which are always used

by IMF to help falling economies get back into shape. The aim of the first bailout

was for the deficit to be lowered to 3% of GDP by year 2013, sustainable Greece debt

which actually reached 120% by year 2010, improvement in foreign competitiveness

and increase in both investments and exports. It is to be noted here that such policies

were also implemented by IMF in many other parts of the world such as Africa, Latin

America and East European Nations. Those policies were always about budget


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reduction, cutting in public sector, elimination of social and benefits programs,

increase in taxes, and structuring of pension systems. In the case of Greece the

devaluation of currency was not possible due to the fact that Euro is used by all the

countries in the Eurozone so the alternative of this was seen as decrease in salaries,

wages and pension benefits.

Greece and IMF/EU were very confident that the austerity measures would show

positive and immediate results but within a few months of first bailout instalments,

the measures back-fired. The small-sized business were not able to keep up and

started to shut down at record levels. One of the worst hit factors is unemployment

and the upward trend can be seen in figure 13.

(Figure 13)

The employment rate for Greece got worse since 2010 (year of first bailout package)

and it stands current at more than 27%. The age group which suffers the most from

the unemployment is 15-24 years and the trend can be seen in Figure 14 (next page).


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8. Conclusion

Greece is losing the race both economically and politically. With the loss of the

countrys currency, we have also seen in previous parts of the paper that Greece has

a high public debt and it is losing its competitiveness.

According to our findings, it is not in the favour of Greece to leave EU because that

would make it more difficult for Greece in the future to borrow as the costs will be

much higher. It would be impossible or rather out of question for Greece to convert

the current obligations from Euros into New Drachmas. Greek debtors would not be

able to repay the loans because they will be way too expensive and that will lead to

defaults from Greek investors and the associated Greek banks.

We have also seen that the austerity measures of increase in taxes and spending cuts

lead to a high unemployment rate and deep recession. The austerity measures

provided Greece with fewer results and more economical and political issues which

answers our research question that if austerity measures destroyed Greece more than

helping it. If Greece and the trio EU, IMF and ECB follows the same pattern of

austerity measures over and over again, Greece will have a deeper recession, the

standard of living will keep getting lower and the country will be even more upset

politically and all of this will not lead to anything but more debt and higher chances

of default.

By having a wage moderation system in order to keep low production cost, Greece

could try to make it exports competitive thus moving towards an export-led growth.

By making use of fiscal policies which act more like conservative, the government

could encourage more savings and also think in the direction of privatization so that

the burden is taken off it. This definitely is not an easy way because many money

thirsty rich people from other countries are waiting to hear if privatization begins so

that they can buy cheaply into that.

Tourism and shipping are also two areas where Greece can focus some of its efforts

for monetary gains. Even though trade is always the one to receive the maximum

amount of focus but at the moment Greece has to do or die.


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It is very much clear at this point that Greece entered the EU before getting fully

prepared both competitively as well as economically.

9. Bibliography

Andre Cabannes The European Monetary crisis explained, PhD Stanford

University, California, USA. August 2011, Revised 2012.

http://lapasserelle.com/billets/greek_crisis.html

Angelos Antzoulatos, Adonis (2011) Greece in 2010: A Tragedy Without(?)

Catharsis, International Atlantic Economic Society

Antzoulatos, Angelos Adonis. "Greece in 2010: A Tragedy Without(?) Catharsis."

Thesis. International Atlantic Economic Society 2011, 2011. Springer (n.d.): 250-55.

De Grauwe, Paul (2009), The Euro at ten: achievements and challenges, Empirica 36

(1), pp. 520

Dunn, Bill. "The European Debt Crisis." Thesis. Department of Political Economy,

University of Sydney, Pg. 1-3 Greece and the IMF. IMF. Web. 22 Dec. 2013.

.

http://www.google.de/imgres?sa=X&rlz=1C1CHWA_enDE556DE556&espv=210

&es_sm=117&biw=1360&bih=667

Husain, I., & Diwan, I. (Eds.). (1989). Dealing with the Debt Crisis. Washington,

D.C: The World Bank.

K. Fouskas, Vassilis, (2012) Insight Greece: The Origins of the Present Crisis, Insight

Turkey Vol. 14 / No. 2 / pp. 27-36


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