After years of strict austerity and a worsening crisis, the Greek economy is still in a slump. However, Eurozone officials continue to prescribe the medicine of austerity. The diagnosis for the Greek crisis was the fiscal profligacy of its government, and thus to restore the health of its economy, Greece simply had to slash its spending. As with any prescription, some short-term side effects were expected. However, year after year the side effects have gotten worse, with unemployment and poverty at all-time highs and demand at all time lows. Meanwhile, the economy, in a deepening recession, is far from being cured. To make matters worse, despite the reduced fiscal deficits, the shrinking economy means the debt-to-GDP ratio is nevertheless growing.
In the aftermath of the Global Financial Crisis, Europe embraced austerity as the best medicine to cure its damaged economies. Conservative economists, and leading institutions such as the European Central Bank (ECB) and International Monetary Fund (IMF) promoted the concept of austerity. The EU imposed spending cuts on all its members, using the dire situation of Greece as warning against the accumulation of more debt. A council of Eurozone ministers, spearheaded by Germany, aggressively pushed for more austerity. Meanwhile, despite complying with the prescribed “medicine,” the health of the Greek economy grew increasingly worse…
However, the theoretical justification behind austerity is questionable. The fear of government deficits was backed by studies such as “Growth in a time of debt” by Carmen Reinhart and Kenneth Rogoff. This paper, published in 2010 predicted catastrophic economic consequences for any country surpassing a debt-to-GDP ratio of more than 90%. Backed by this research, high-ranking European officials made their case to abruptly cut government spending.
While Reinhart and Rogoff’s study created buzz amongst conservative politicians when it was published, it was mostly ignored by the same politicians when it was discredited. In 2013, it was shown that the spreadsheet used for the calculations in the study was laden with mistakes, and its results were gravely exaggerated. After the errors were fixed, some correlation between government debt and slow growth remained but not one sufficient to establish causation. It is as plausible to assume that slow growth is the cause of the increase in government debt. A summary of this controversy can be found here.
In the early 2000s, the Greek government began to accumulate massive amounts of debt;. by 2009, the government debt had reached almost 135% of GDP. The government quickly enacted extreme spending cuts, resulting in a ratio decrease that lasted until 2011. However the Greek economy, in the midst of a deep recession, did not respond very well to these cuts which came coupled with the added bonus of tax hikes. Domestic demand collapsed, unemployment soared, and overall confidence in the economy faded. Greek GDP fell, and the debt-to-GDP ratio exploded. Currently, that ratio is at about 180% of GDP, and is projected to reach 200% by 2020. (OECD) The Greek economy is on a downward spiral in which imposed spending cuts reduce incomes, reduce spending, and further contract the economy and limit its ability to repay its debts.
Despite the academic case for austerity weakening, the Greek parliament is forced to impose even deeper spending cuts to receive more funds from European institutions. Without additional loans, Greece would be unable to make the payments on its previous debt; however, most of the bailout money received by Greece has gone on payments for maturing loans.
The Greek sovereign debt has turned into a ponzi scheme, in which new loans are obtained to make interest payments on older ones, while the principals rise and the economy shrinks. The IMF, initially a main proponent of austerity, has recently come out in favor of restructuring Greece’s debt and allowing for some economic stimulus. It appears that EU officials are finally willing to listen, at least in respect, to debt restructuring. Last week, the council of Eurozone ministers agreed to discuss some debt relief. However, this comes with the same condition attached: more and even harsher austerity.
For a sick economy such as Greece’s, it is difficult to see how even aggressive spending cuts could nurse it back to health. After austerity has failed year after year in reducing Greek debt and revitalizing its economy, it is time to try a different medicine. Under EU agreements, countries are required to be fiscally conservative, and EU officials, under German direction, have refused to change their stance on weakening the austerity imposed on Greece.
Greece’s suffering has become the example of what happens when those rules are broken. However, if the EU wants Greece to repay its debt and recover, it needs stop punishing it and give it room for growth. The European officials who continue to force austerity on to Greece should take a step back and realize that the best way to reduce the Greek debt-to-GDP ratio, and make it sustainable, is to allow for its economy to grow. Clearly austerity measures have not brought about the desired growth and health. Greece needs a different prescription, one that would indeed stimulate its economy and not keep it locked in an ICU.
Written by Lara Merling
Illustrations by Heske van Doornen