Greece faces the most difficult situation that has ever confronted a eurozone country since the birth of the common currency in 1999. Without draconian measures by the Athens government the fiscal situation of the country will soon become unsustainable. A failure to pay off its debt, though remote, cannot be completely ruled out with risks of contagion for the rest of the euro area.
For all its difficulties the Greek lesson, as at gymnasiums, is hard but inspiring. Everybody in the European Union seems to be scared and is learning fast—both within and outside the euro area. Ireland and Lithuania—like Greece, threatened by the crisis—are taking the right course. The perception of a common problem is growing. What is still missing is the courage to set up a new institutional arrangement for the euro area.
The main problem for Greece is to restore its credibility. It will not be easy. Since its bid to enter the euro area, Athens has been responsible of cooking the figures of its economy. Since its adoption of the euro in 2001 it has never, even during years of robust growth, managed to comply with the deficit threshold mandated by the Stability and Growth Pact of the European Union Treaty.
Greece's governments have been misleading the world and especially their European partners in the financial area. In March the European Commission forecasted that the Greek public deficit would be more than 3 percent in 2009 and more than 4 percent in 2010. Nobody was prepared for the shock unveiled by the new government elected in October: according to the latest Commission projections, the deficit is around 12.7 percent this year and 12.2 percent next year. The final figures could be higher. Furthermore, and in contrast to those of most other EU countries, Greece's deficits are due in only small part to the financial crisis. They are structural and they have had a long period of incubation.
Unfortunately, Greece's main economic problems require a strong—and credible—political will. They are all politically costly to be tackled: pension reform is unavoidable; wages have to be reduced—having soared 33 percent more than German wages since 1998 (see graph); and the required budget primary surplus (i.e., the budget that does not include interest rate payments on the debt) will have to come close to 10 percent of GDP. Without such credibility, even steps in the right direction will not help the country to finance its debt. One aspect is particularly relevant in this regard: when the current account deficit is at 15 percent of GDP (in 2008), credibility must be established far beyond the country's borders.
But even this is not enough. It is not only Greece's credibility that is on the line. Also at stake is the credibility of a European mechanism unable to defend itself from felonious behavior by its country members. The lack of credibility of Greece undermines the credibility of Europe. And the two must be restored together.
Greece has been monitored by the European Union for years. The Economic and Financial Affairs Council (Ecofin) must make a determination that Greece has failed to implement the measures called for by the European Union to correct its deficit. Such a finding would then enable further steps to be taken in the "excessive deficit procedure," as the mechanism of enforcing fiscal discipline in the European Union is called. If Greece does not comply with the Commission's recommendations by February 2010 it could be "given notice" by the Ecofin. If once again no effective corrective measures are taken, sanctions could be imposed four months later (June 2010): Greece would then have to lodge a noninterest-bearing "deposit" equal to at least 0.2 percent of its GDP for two years—and this would ultimately be retained as a fine by the Commission after two years of further inaction.
But in the past this sanctioning procedure has been marred by discretionary application and politics. Indeed it has never been enacted. Even so, it is doubtful that sanctions—or the threat of sanctions—can function as discipline once the damage is done on such a large scale. The same is true for another kind of sanction that has been evoked recently: the conditional support coming from the EU Cohesion Fund. The EU Council could decide in the next months to freeze €3.7 billion that Greece expects to receive from the European Union between 2007 and 2013. But, again, does such a punitive measure make any sense? The process of fiscal re-equilibrium will be painful enough and protracted by itself. It will have to cut deep into the structure of the Greek economy and society. This is not a matter of a one year U-turn, but of a five-year-long political strategy, at the least. For reform to occur over such a long span there has to be credibility conferred from outside the normal national political time horizon.
The common wisdom holds that the Stability and Growth Pact rules—together with the market pressure on interest rates (both direct and via rating agencies)—serve to discipline national politics. But if that is so, why did Greece not act before now? Why could the Greek bubble be permitted to inflate until a crisis struck? Weren't the Pact monitors and market forces paying attention? Let's admit it: they were not because they could not. They too seldom are until it is too late because their powers are limited when confronted with national fiscal authorities.
The German Chancellor, Angela Merkel, acknowledged on December 10 that the Greek situation and those of other indebted countries call for a much closer coordination of fiscal surveillance in the European Union or at least in the euro area. This is a great step forward. But still it is only one half of the truth. Surveillance, in order to be effective, must mean conditional aid requiring approval of the budget by the European Union, along with transparency and a public acceptance of responsibility. There is no escaping the political nature of the process. And in order to be acceptable the process must apply to all countries in the euro area. The fiscal and budget rules must be met by surplus countries as well deficit countries: toward Germany as well as Greece.
And unfortunately there is only one way to establish such a complex mechanism: to form a fiscal authority at the euro level in a new European federalist structure.
Is it too early for such an institutional leap? The prospect for public debts in Europe in the next ten years will likely force the euro area to cope with instability for decades. When this awareness becomes public, the leap could well come too late.
Unit labor costs in Greece and Germany (1998 = 100)