Skip to main content

The Globe and Mail

Greece, Italy show perils of dragging heels on debt

An Occupy Frankfurt bonfire near the city's euro sculpture. Italy is the latest euro zone country to face harsh austerity programs.

Michael Probst/AP/Michael Probst/AP

The architects of postwar European unity saw economic integration as the key to perpetuating the peace and breaking the continent's age-old cycle of bloody conflict. But Europe's social peace – and hope for economic resurrection – is now threatened by the very union formed to preserve it.

The harsh austerity measures demanded of Greece and other wayward members of the euro zone are sowing political unrest and rekindling old resentments. In exchange for bailing out their weaker neighbours, European leaders are insisting on deep budget cuts and structural reforms to attack the massive government debts that plague the continent. Pensioners, public servants and politicians be damned.

For Greece and others, sharp budget cuts threaten to create a "no-growth trap" as fiscal consolidation leads to economic contraction. That in turn could depress government tax revenues, requiring even deeper cuts.

Story continues below advertisement

It's not pretty. But the sad fact of the matter is that Europe's weak links have been whistling past the graveyard for too long. By failing to address their spiralling debt burdens sooner, they have surrendered their options.

The good news, as Estonia recently proved and Ireland is poised to, is that bitter medicine in large doses can produce miracles. Both countries moved swiftly to control unsustainable budgets and today are reaping the benefits.

Estonia this year became the first ex-Soviet republic to earn entry into the euro zone, and economic growth is expected to hit 5 per cent in 2011. Ireland's borrowing costs have been cut almost in half since the summer, while those of reform laggards Greece and Italy continue to spike.

"The way to think about this problem of growth is that, at some point, countries will get to growth, but the sooner they do what Estonia did, and what Ireland is doing now, the sooner they'll get there," says Yale University European scholar David R. Cameron.

The reforms demanded of Greece, Ireland, Portugal – and now Italy – are supposed to lay the foundation for growth by setting those countries on a sustainable fiscal track.

But if they do not set a disciplined course to fix government finances, public pension and health-care costs will outpace economic growth for years to come as fewer working-age citizens are left to pay for the benefits of retirees. Italy already spends 14 per cent of its gross domestic product on public pension benefits; in Greece, the figure is 12 per cent.

By comparison, in Canada, old age pension benefits and Canada Pension Plan payouts together amount to less than 5 per cent of GDP. The United States spends the equivalent of about 7 per cent of its GDP on Social Security benefits for seniors.

Story continues below advertisement

With baby boomer North Americans beginning to retire en masse, fears that Canada and the United States could eventually face debt crises of their own are driving the push for budget cuts on this continent, especially among Republicans in Congress. But both countries have time to fix their long-term finances without lenders breathing down their necks.

The lesson North America should take from Europe, Prof. Cameron argues, is that Greece and Italy made their current plight worse by dragging their feet for too long.

"Greece has not been implementing the austerity very effectively, in part because the people who are being asked to implement it are the same people who thrive on public sector jobs," Prof. Cameron offers. "Had they cut their deficit substantially in 2009 and 2010, they would probably be growing right now."

He cites as an example Estonia, which, in 2009, cut its budget by the equivalent of 10 per cent of gross domestic product. Foreign capital poured in, competitiveness improved and exports soared, enabling Estonia to meet the criteria to join the euro zone this year.

Estonia earned its membership in the euro zone; Greece did not. All of its current difficulties stem from this fact.

European Union leaders were eager to bring Greece into the fold in 1981 (many argue prematurely) in order to prevent the then-fledgling democracy from sliding back into the military dictatorship that it had escaped less than a decade earlier. Then, in 2001, Greece was allowed enter the common currency zone under false pretenses.

Story continues below advertisement

"They cooked the books," explains Sherrill Brown Wells, an expert on postwar Europe and former senior historian at the U.S. State Department. "They lied about their ability to adhere to the strict criteria for admission to the euro zone."

Those criteria – targets for inflation, deficits and the ratio of government debt to gross domestic product – were never enforced anyway. Greece had all the benefits of the euro zone, including the ability to borrow at German-level interest rates. But after the 2008 financial crisis, Greek bond yields began to spike and are now at out-of-control levels.

Greece now faces what Prof. Cameron calls "a very simple but brutal choice." It either embraces the austerity its European partners demand of it or it leaves the euro zone.

The mere suggestion that Greece readopt its old currency, the drachma, was considered taboo until Greek prime minister George Papandreou, who stepped down this week, called for a referendum on the bailout terms. Ruffled European leaders insisted that any vote be on the country's continued membership in the euro zone.

Quitting the euro zone – the so-called "Argentina option" – has its proponents. Greece would regain the ability to devalue its currency and set its own monetary policy, allowing it to improve its export competitiveness, which would likely spark economic growth.

By defaulting, as Argentina did in 2002, Greece would be freed from making the interest payments on its debt that are now the principal cause of its unwieldy budget deficit. Indeed, Greece maintains that, excluding debt service, it will run a budget surplus in 2012.

But the shock of leaving the euro zone would be no less devastating for Greek citizens. The country would likely experience a run on its banks and be forced to impose capital controls. It would be shut out of financial markets for years and face runaway inflation.

In other words, Greek citizens would face a different, but possibly more painful, form of austerity.

Greece is a tiny country, representing less than 3 per cent of Europe's economy. But the lesson it offers for other heavily indebted countries – especially the United States – is that denial only compounds future pain.

Report an error Licensing Options
About the Author

Columnist Konrad Yakabuski writes on politics, policy and business for The Globe and Mail’s Comment section and Report on Business. More

Comments are closed

We have closed comments on this story for legal reasons. For more information on our commenting policies and how our community-based moderation works, please read our Community Guidelines and our Terms and Conditions.