The European Union was mooted in 1945 after World War II. A united Europe was the answer to the repeated attempts of an ambitious Germany to expand, which resulted in two world wars. It progressed from the European Coal and Steel Community, to the European Free Trade Area, a European Economic Community, a European Council in 1975, a common European currency - the euro - in 1999, and the issue of euro currency in 2002. A political union has been blocked by Britain.
Greece was a founding member of the Organization for Economic Cooperation and Development and joined the European Community in 1981. With a common currency, fixed exchange rate for a member's currency and a European Central Bank, members were expected to follow certain macroeconomic disciplines, especially in relation to deficits and debt. Sovereignty of nations was left intact. Monitoring of member economies by the bank was weak. The European Central Bank was there to provide funds when needed. The 'Union' was of paramount importance.
The service sector contributes close to 81 per cent to Greece's gross domestic product and consists mostly of small enterprises. Taxes are difficult to collect, and tax increases are not effective. Greece has been "socialist", against labour reforms, in favour of state ownership and of generous social benefits, including pensions. Support from the ECB and the International Monetary Fund prevented the Greek economy from collapse during the global financial crisis of 2008-09. It was EU-support that led Greece onto years of unrestrained spending, cheap lending, generous social programmes and no financial reforms. Greece also underreported its debts. Greek balance of payments and budget deficits rose from below five per cent of the GDP in 1999 to around 15 per cent of GDP in 2008-09. Greece was the classic case of a chronic borrower and defaulter who was protected because the EU did not want a Greek exit.
As member of the EU, the Greek drachma had a fixed value to the euro. Its devaluation could have been a corrective to a mismanaged economy. The GDP declined by over 25 per cent, and unemployment and debt ballooned. Since May 2010, EU member-states and the IMF had an 'economic adjustment programme' to stop the deterioration of Greece's finances and restore its fiscal health. The programme required Greece to implement structural reforms for improving the competitiveness of the economy to sustain economic growth. But Greece cheated on its debt statistics and the international lenders did not have a sound monitoring mechanism. Its deficit actually exceeded Eurozone limits. Greece's national debt - at 300 billion euros ($413.6 billion) - was bigger than the economy, and it was growing. High deficit to the GDP, its downgraded credit-rating - to the lowest in the Eurozone - made Greece a financial black hole for foreign investors.
Unfortunately, every elected Greek government has contributed to the financial mess. A military junta ruled Greece from 1967 to 1974. Its rule was marked by high rates of economic growth, low inflation and low unemployment. Economic growth was driven by investment in tourism and industry, emigration policies, public spending and pro-business incentives for domestic and foreign capital spending. Economic growth started losing steam by 1972.
The loan adjustments and fresh advances that Greece has now agreed with the EU also have a tough programme of pension cuts, privatization and higher taxation. Given the Greek preference for a soft life, no elected government can persist for long with these policies. Greece is headed for another spate of military junta rule. That will set the economy right till the Greeks can go back to their soft ways.
The EU has brought disparate economies together that varied greatly in the size of their GDP, GDP-composition, labour discipline, government regulation, quality of corporate management, statistical base and so on. The engine of this was provided by the well-led German economy. Many weak economies benefited from a single currency and the ECB. They borrowed heavily from European banks - take Greece, Ireland, Iceland, Spain, Portugal - not as much for building assets and competitiveness as for enhancing consumption. Greece went through periodic crises. It was unable to service debts and asked for more time to repay or for the waiving of debts and then, for more loans.
The Indian culture, traditionally, abhors debt except for emergencies, family investment, say in higher education, marriages and so on. Loans are sought to be repaid as soon as possible. Suicides among farmers every time there is a crop failure illustrate their shame at being unable to repay debts. Since 1991, household borrowings in India have risen. But rarely do households borrow to splurge on consumption far beyond their means.
Companies borrow for working capital and investment. In many cases, delays in getting government permission might make the repayment period longer. Since the lenders are usually commercial banks, (and mostly state-owned banks), bank balance sheets show a high proportion of such "sticky" loans.
Governments borrow because their revenues are inadequate to meet current and capital expenditures and they are reluctant to raise taxes, cut expenditures or sell unproductive assets to raise funds. Emergencies such as floods, earthquakes, and so on, deny governments of a financial cushion, making them borrow for alleviating hardships and facilitating reconstruction. Populist governments (such as the communist government in West Bengal), borrow and accumulate huge debts. They build few assets that could earn and pay off the debts. Successor governments then have to curtail their programmes or persuade the Central government to help them write off the debts.
Individuals and companies are watched over (although not always adequately) by lenders. Governments have political masters and strong Central banks to ensure monetary stability for macroeconomic sustainability. Rarely do governments borrow to enable people live an unaffordable lifestyle. This has happened with many countries in the EU. Portugal, Spain, Italy, even France, have large debts and loose macroeconomic policies. They would have imitated Greece had the country been allowed to get away with reneging on its commitments. India has never defaulted on debt repayments nor asked creditors to take a "haircut", that is, forgive a portion of the loans.
Many intellectuals argue that the Greeks should not be made to suffer more austerity and reduced living standards. But Greeks prospered on funds from Europe, mainly from Germany. Either Greece goes its own way or follows strict discipline in servicing its borrowings. A Greek bailout (by lenders such as the IMF and European banks) could lead to other countries asking creditors to take a haircut. They could refuse reforms to live within their means within a given period. Lenders like the IMF are there to help during an emergency. Without the possibility of repayment, international financial transactions could become very risky.
Greece is a serious serial economic offender. It needed to be compelled to correct itself. It must pay for a 'haircut' over fiscal and labour reforms. It should not be permitted to lead other debtor countries to follow its route.
Europe undeniably faces a dilemma. Greece is the home of European civilization and must remain in Europe. The EU is a dream that requires all members to stand by a common currency and take the first steps towards political union. One exit could trigger other exits. The EU will do a lot to help Greece. But Greeks must face hardships it has brought on itself.
It is impossible that Europe should have a central bank and a common currency but not the powers to rectify a member-state's macroeconomic imbalance. That requires both political union and steadfast central fiscal and monetary management. How to do all this will be the central debate of this decade. Britain has a strong public opinion against economic union, a common currency and even more against political union. It may well exit the EU, but the EU must go all out to strengthen the union. Commercial banks, the IMF and other lenders did inadequate diligence and monitoring of the performance on loans. The global financial system must not be allowed to give loans so carelessly.
The author is former director-general, National Council of Applied Economic Research
