The Euro Crisis: Why Greece is broke but Germany won’t do anything about it

Source: Dirk Vorderstraße

Anyone reading the news lately would’ve surely caught on that something is amiss in Europe: The so called ‘PIGS’ (Portugal, Ireland, Greece and Spain), and especially the Greeks have been on the edge of default for months, causing  rumours that the Euro may be headed to the scrap heap.  If any of you still remember, the Euro was introduced with great fanfare nearly ten years ago which was supposed to promote closer ties both politically and economically for the EU members in the Euro-zone (The sub-group in the EU that uses the Euro as their currency).  So why then, has the Euro’s health deteriorated to such a sickly state?

To grasp the full scope of the underlying problem we should examine what the Euro actually is. Having a single currency across independent sovereign states means that in effect, it is a fixed exchange rate policy enacted by its participants. A caveat is that Euro-zone nations surrender their ability print money meaning that countries surrender the ability to adjust monetary policy independently, which is instead set at a EU wide level by the European Central Bank (ECB). This distinction is key to understanding why the Euro is slowly breaking up the EU.

On the surface the benefits of having a unified currency is straightforward:  cross border exchange of goods and services is allowed to grow freely, improving the integration of the member state’s economy with each other. This vastly reduces costs of doing business in Europe, doing away with the need to change currencies between countries. With reduced exchange rate risk and transaction costs, in the good times businesses get, well, more business, and more investment activity happens in the Eurozone,.

The problem with fixed currency is that the Euro is undervalued in some countries and overvalued in others. Germany is an example where because it does a disproportionate share of production in the Euro-zone, the Euro is undervalued in Germany and German firms are able to take advantage of this since they can easily sell their goods, thanks to the fixed currency. On the flip side Greece can import cheaply, so when the economy is booming no one complains, and this trading arrangement leads to what is perceived as high levels of economic activity in the EU.

In reality though, what’s happening is that the countries who rely on the Euro to import cheaply is running up a huge trade deficit. The countries that use the Euro can borrow money cheaply compared to be before by piggybacking onto the low rates paid by Germany and France. After all, if one Euro in Germany is the same as one Euro in Greece, that implies that it is not possible for one country to default without the other failing too as long as they use the Euro.

But this is precisely what is happening at the moment: the governments of Greece, Spain, Ireland and Portugal over-expanded debt to fund spending and imports (from countries like Germany) during the boom years. But now that the economy is headed for a bust, people have realised that the Greeks may not, in fact mostly likely will not, be able to repay what they borrowed during the boom years. Part of the problem is that they can’t just print more money to first, meet their obligations and second, devalue the currency, which would have helped them increase exports and possibly boost their sclerotic economy.

Further exacerbating the problem is the fact that each EU member state is an independent political entity. The heads of state are voted in by their respective citizens and thus have no incentive to put the good of the whole union before the state. Again in the current situation, it means that countries like Germany will keep doing what they doing best: making and selling stuff to other countries taking advantage of their devalued currency in order to keep their economy from sliding into recession, even if it’s making the problem worse for the countries with huge deficits.

Now troubled Euro-zone members find they are tackling a problem with one arm tied behind their back because they can’t manipulate monetary policy to pull out of a recession. This is why Greece has resorted to raising taxes and imposing strict austerity measures in an economic downturn, which has been very unpopular. A default in Greece is not being allowed because it would result in Greece’s exit from the Euro-zone, an admission of failure of the Euro, the very thought deemed blasphemous to the ones who championed its cause, no prizes for guessing which countries in particular.

It seems that the leaders of a decade ago did not foresee the scale of the very real disaster that the Euro now faces very, very shortly. The question now is not whether the Euro was a good idea, but whether it will survive. If it is to survive,  how can we avoid a tragedy of this scale in the future?

4 thoughts on “The Euro Crisis: Why Greece is broke but Germany won’t do anything about it”

  1. A lot of good points made here but a lot of the complexity of the situation is missing. By no means all of which will be touched on by me.

    Firstly, yes Germany has benefited and continues to benefit from an undervalued currency. However the cynical argument that Germany is extending the euro crisis in order to continue to benefit from an undervalued currency does not automatically follow this fact. The risks involved are too great, and, as has been shown by the loss of France’s triple A rating, Germany couldn’t be naive enough to believe that they are immune from the effects of a protracted euro crisis.

    This article seems to suggest that Greece has accumulated a massive deficit simply as a result of a trade imbalance caused by an effectively overpriced currency. It is true that the euro has had a detrimental effect on Greek trade balance, for example loss of exports from the tourism industry which no longer benefits from Greece’s prior ‘cheap holiday’ status – losing out to alternate destinations, particularly in North Africa. However the factor that has been ignored here is that Greece has a hugely inefficient economy and that Greek citizens have long been beneficiaries of an overgenerous welfare state.

    The Euro-zone is not wrong in using its power as a financial benefactor to force Greece to institute reforms that will reduce inefficiencies, such as cutting down bureaucracy and over generous conditions for public sector workers who are virtually impossible to remove from their positions (removing any performance incentive) and benefit from huge pensions and other benefits. Privatisation of the many of the government run industries in the Greek economy will also be a necessary part of liberalising the economy however the Greek government and people are rightly concerned that this should not have to take place at ‘fire sale’ prices. Perhaps the net result of this crisis will be a Euro-zone that is more homogenous in the economic policy of its members… could this be the beginnings of a more fiscally integrated Euro-zone?

    Further complexity in resolving the crisis stems from them democratic frameworks within which all of the Euro-zone countries operate. German citizens feel they are suffering for the excesses of ‘lazy’ and inefficient economies, whilst members of PIGS countries feel that they are suffering for the excesses of financial investment bankers which led to the Financial Crisis. Greek citizens in particular have already suffered lower wages, higher taxes, and higher unemployment, and still face the imposition of yet more austerity. There is always the risk that German citizens will vote in someone who will be less inclined to provide debtor countries with further bailouts or will extract a much higher price, or that Greek citizens will revolt against their government bringing about a disorderly default which would benefit no-one within the Euro-zone, least of all themselves. For the moment the majority of Greeks wish to remain within the Euro – how long this remains the case will depend on whether austerity is able to be matched with targeted economic growth measures that will provide the Greek people and economy with the prospect of a brighter future.

    PS: There is a grammatical error in the title of this article that you may wish to rectify (remove the ‘the’ before Greece)

    • The title could have been worded better, it’s not that Germany is extending the crisis on purpose but counter-incentives exist for Germany to simply carry on, as you noted, in the short term because it simply is not affecting them that much. In the short term.

      Many of your points as well as Dean’s are very much valid, and the point of the article was to examine the effects of a unified monetary policy without fiscal policy consolidation and its effects on the two most contrasting members, economically speaking, in Europe. Interestingly enough is that Germany actually did propose or considered proposing fiscal policy unification with Germany at the center across the EU, which would have effectively created a Germany based super-economy.

      Unfortunately Germany’s plans for financial conquest of Europe was shot down when word got around to the other Members of the EU. Hardly surprising.

  2. David, you are right about Greece having an over-generous welfare system – but this is not uncommon. European economies are known for their generous welfare systems. The real problem in Greece is the lack of tax revenue collected to fund these welfare systems. Unlike the rest of Europe, which on average has much higher tax rates than the rest of the world, Greece has no proper mechanisms in place to collect tax, or punish those that illegally avoiding tax payment. This is not the Greek people’s fault – Australians employ specialist tax consultants so they can pay the least amount of tax possible; the Greek people are doing the same thing, but they have a much larger scope to do this due to the lack of accountability in the Greek system. Not only do these accountability mechanisms have to be put in place, but the Greek people also need to feel confident that their hard-earned money is being used for the public interest, and not going straight into the pockets of Greek politicians and bureaucrats.

    Moving on, fiscal integration is a must if you have a continent-wide monetary policy system. But the monetary policy framework is flawed in the first place – monetary policy is a very blunt instrument when it is used across one economy, let alone across 15-20. The fact that the ECB raised interest rates last year when most of Europe was still in the depths of recession illustrates the absurdity of the current system (ironically, the ECB is now cutting rates, an admission of how wrong they were last year). Furthermore, the ‘fiscal pact’ that is supposed to bring fiscal integration is a ridiculous policy that will not even allow the automatic stabiliser to work in future downturns in Europe.

    Very interesting times indeed.

  3. Everyone agrees the “troika” is focusing too much on austerity and not enough on growth reforms. All the above points are more than true, however most of the focus is on economic reform, which is pretty straightforward. The inability to solve the underlying problems (economic imbalances within, low growth in the periphery, excessive debt, etc.) stem from one problem: political ideology. Many ideas have been put forward in all these european summits, and even though not all of them are good, there are some that stand out to be the closest thing to a solution, such as eurobonds. However, all of them are not politically viable, as (quite rationally) politicians have to pay attention to the electorate, which is different in each member state, with different cultures and ideologies. As Dean points out, monetary integration without some form of fiscal consolidation (such as harmonised taxation across the board) is not feasible, as the current crisis proves. Sadly, fiscal consolidation of euro-zone members is quite impossible, because that means giving up more sovereignty than the different electorates (ergo their representatives) are willing to give up.
    The economics of the european debt crisis is quite clear, as are the potential solutions. But, as I said, they must be implemented by politicians, and we all know how that could end up.

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