Inter-generational pyramid schemes are the easiest to get away with. The people whose money you’re getting have not yet been born, at least when the scheme starts. It also isn’t evident what’s being done. When economies are growing and the demographics favor the young, it appears that tax revenues will easily cover commitments, and debt can be managed. Moreover, countries like Greece (and earlier Italy and France) managed it in part through acceptance of inflation and lower currency values.
Yet if the demographics switch and suddenly the old are outnumbering the young, with birth rates falling, pension plans and other government guarantees start to look overwhelming. In Greece it has led to a collapse in the Greek economy, as the country is no longer able to borrow, is running a budget deficit of over 13% of GDP (the maximum allowed in the Eurozone is 3% of GDP), and faces massive protests and a rise in anti-capitalism (and especially anti-German) fervor. Suddenly the Euro, the EU, and the world economy are again at risk.
To be sure, for all the talk of the Euro’s value collapsing, today it stood at $1.33 per Euro, not an especially low value. The Euro has cost as much as $1.60 in the past, but has also sold below a dollar. The Euro is not in free fall. Moreover, Greece’s economy is relatively small. Still, with a common currency interest rate contagion is evident, especially in countries like Spain, Portugal and the one time success story Ireland. So what’s next?
Back in 1997 our university hosted a member of the German Bundestag, Sigrid Sperk-Skarpelis (SPD) who while here got the news on who would be part of the Euro zone. Greece was the only major western state left out (though three would voluntarily choose to remain without the Euro). The debate within Europe at the time was an interesting mix of politics vs. economics. Euro rules were tight — to get in you had to keep the budget deficit under 3% of GDP, total debt under 60% of GDP, and interest rates needed to be within 1.5% of the average of the best three states. Greece was distant from that, as were a few other countries (notably Italy).
The economists said not to include those states (including Italy, Spain and Portugal as well as Greece), since the Euro would be under threat should those states not improve their economic policies. Politicians, however, tended to see it a bit differently. If those states could show a willingness to change their economic policies, then they could be allowed in, even if debt to GDP levels were too high. The idea was that, like France in the late eighties, states could transition to a fiscally sound budgetary policy and then be supported by the rest of the EU. The penalties for violating the 3% of GDP deficit rule were originally harsh, and the hope was that once brought in, these countries would be strengthened and stabilized by the rest of the Euro-zone. Greece made an effort to show it could do so as well.
When the Euro became official in 1999, Greece remained outside. At that point, Euro currency was not yet in use, even though exchange rates were fixed and the Euro became the main EU accounting unit. Before the jump to the Euro as the mass currency on January 1, 2002, Greece was allowed to join the club. It was a political decision taken with known economic risks. Yet Greece was a small economy trying to improve its economic policies; the risk seemed worth helping the country overcome decades of economic mismanagement.
Then came the big bubble. For countries like Ireland and Iceland (the latter not in the EU), this meant an artificial boom, buoyed by cheap credit and de-regulation which allowed all sorts of bubble time shenanigans. For countries like Greece, this was a respite from the pressures of the 90s, meaning that they found it possible to avoid solving their problems without seeming to risk running too far afoul the EU. With France and Germany having problems and pushing for a relaxation of EU penalties, the precedent was set to ignore problems the small countries had as well.
The one-two punch of demography and the collapse of world financial markets in the post-bubble era shattered Iceland and Ireland’s miracle stories, and now has rendered Greece nearly a third world country, forced to undertake extensive austerity measures to get an IMF bailout. The Greek left blame capitalism, economists blame policies lacking any sort of fiscal discipline, but the reality is more that Greece never overcame the corruption that kept it from joining the first tier European economies. The blame is shared between deregulation that allowed elites to protect their wealth, social welfare programs meant to buy off workers, and a government bureaucracy protected from cuts and spoiled with high pay. And, of course, as the economy crashes the poor suffer most (they always do), as the wealthy find ways to try to evade the perils of economic collapse.
So whither the Euro? At this point, I would not bet against the Euro’s survival. First of all, as dangerous as the toxicity from small, weak economies may be, the idea of losing the potential clout of the Euro as a world currency and throwing the EU back into a jumble of traded national currencies may be even riskier. Add to that the instability of the dollar due to increasing US debt, and the desire to collaborate vis-a-vis both the US and China, the major European economies have reason to hold on to the Euro. Also, the political symbolism in this capstone of European integration being thrown aside would be immense, and something most European leaders want to avoid. The history of the EU is one in which they muddle through existential crises, learning by doing.
Still, one lesson here is that in questions of the political economy, warnings from economists about risk need to be taken seriously, even if the political calculations make it tempting to brush them aside. Greece should not have been allowed to join the Eurozone in 2001. East European EU members now need to be all put on a very slow track. If things get worse, the club may have to contract. Those will be political backsteps with severe consequences, but not as severe as losing the Euro.
In a worst case scenario, Greece’s collapse causes a domino effect which undermines Europe’s recovery and stalls the world economy yet again. If that were to go on for too long, then even the Euro might not survive. A best case scenario is still bad — the IMF and the EU help bail Greece out and they muddle through. It’s hard to imagine that without causing severe political unrest in Greece, and a potential shifting of the political winds in Europe to a more nationalist and fearful tone. This “great recession” is the EU’s most profound challenge to date.