EC6201

National Economy
The Greek Debt Crisis

The roots of Greece’s economic problems extend deep down

into the recesses of history. After the government dropped the
drachma for the euro in 2001, the economy started to grow by
an average of 4% annually, almost twice the European Union
average. Interest rates were low, unemployment was
dropping, and trade was at an all-time high. However, these
promising indicators masked horrible fiscal governance,
growing government debt and declining current account
balances. Greece was banking on the rapid economic growth to
build upwards on highly unstable foundations. In 2008, the
inevitable happened – the Greek debt crisis.

In this research paper, we will be covering the causes, financial

repercussions and social implications of this crisis. We will
also be examining the methods used by the Greek government
to rescue the economy. To conclude, we will discuss possible
resolution measures and objectively forecast the future of
Greece.
RKTBJ

Timothy Tan Xin Zhong

M11605
 The Greek Debt Crisis
EC6201 National Economy
Timothy Tan Xin Zhong

Table of Contents

Introduction ..................................................................................................................................................................... 2
Causes .............................................................................................................................................................................. 3
The Eurozone ...................................................................................................................................................... 3
The Tax Evasive Population ................................................................................................................................. 3
The Corrupt and Spendthrift Government ......................................................................................................... 4
Economic Growth of Greece ........................................................................................................................................... 6
Financial Repercussions .................................................................................................................................................. 7
Global Panic ......................................................................................................................................................... 7
Current Account Deficits ..................................................................................................................................... 8
Social Implications ........................................................................................................................................................... 9
Unemployment ................................................................................................................................................. 10
Bad Business ...................................................................................................................................................... 10
Political Instability ............................................................................................................................................. 11
Greek Riots ........................................................................................................................................................ 11
Resolution ...................................................................................................................................................................... 11
Conclusion ...................................................................................................................................................................... 12
References ..................................................................................................................................................................... 13

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 The Greek Debt Crisis
EC6201 National Economy
Timothy Tan Xin Zhong

Introduction
Greece is a highly developed country with the 27th highest GDP and the 22nd highest HDI in the world.

According to the World Bank, Greece’s GDP for fiscal year 2010 was USD 300 billion. Much of this is
attributed to the service sector (78%), which includes the public and tourism sector. The second largest
slice of pie belongs to the industrial sector, which contributes to 18% of Greece’s GDP. Greece’s

agricultural sector contributes a mere 4%, as shown in Figure 1.

GDP by Sector Workforce Makeup

Figure 1: Contribution of various economic sectors to the GDP and to the workforce

The workforce makeup is also shown in Figure 1. It is noteworthy to point out that the Hellenic agricultural
sector, though taking up a significant 20% of the entire workforce, only contributes to 4% of the Greek GDP,

suggesting vast income inequalities and high GINI coefficients.

As of now, the economy of Greece back on track, with appropriate steps being taken by the government
and the EU to beat the recent financial downturn. However, the economic situation wasn’t always like this.

Greece has a long history of fiscal trouble, having spent much of the past 2 centuries in default. Prone to
fiscal profligacy, government corruption and pandemic tax evasion, her economy is highly unstable and

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EC6201 National Economy
Timothy Tan Xin Zhong

treads dangerously close to insolvency. The recent global downturn was the last straw that broke the
horse’s back, triggering the Greek debt crisis of 2008, which is the focus of this paper. However, it wasn’t

the only straw.

Causes
Many factors led to the Greek economic crisis, each of them playing varying parts with varying levels of
significance. The Greek economic crisis can be blamed on three main causes - the Eurozone, rampant tax
evasion, and the corrupt and spendthrift government.

As mentioned in the report abstract, Greece adopted the euro and entered the Eurozone in 2001. To get
admitted into the Eurozone, countries had to meet a specific criterion, namely the Maastricht convergence

criteria. However, at the point of entry, Greece was far from meeting the requirements. For example,
countries were required to have a national deficit to GDP ratio that did not exceed 60%. Greece’s ratio was

more than twice that, at an astounding value of 126.4%. Like premature birth, this inopportune entry into
the Eurozone came with many complications. The Eurozone is a regime with a single interest rate, a
common exchange rate and a hard currency peg. It deprives its member countries of sovereign fiscal policy
and key economic weapons such as devaluation. Greece, being one of the weaker Eurozone members,

was more vulnerable to economic troubles. Thus, when the economic recession arrived, Greece was one of
the most badly hit. As the euro was in the way, fiscal policy couldn’t be changed to save the economy. Like

a turtle caught out of its shell, the results were horrendous.

This is not all. In economics, we learn that there are three main sources from which governments get their
revenue – tax receipts, fees and charges, and other receipts. Out of all these, the most important and

significant source of revenue is taxation. However, many Greeks fail to pay their taxes. In 2008, Greece’s
tax take was a measly 31.3%. Among all the Eurozone members, only Ireland’s figure was lower. Endemic
tax evasion amongst the Greek populace has led to reduced government revenues, increasing the

likelihood of government debt.

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EC6201 National Economy
Timothy Tan Xin Zhong

The last cause of this crisis is the corrupt and spendthrift nature of the Greek government. In order to boost
popularity ratings, large sums were spent on providing huge salaries and pensions for the general

population. Government expenditure has therefore been extremely high, billions of euros higher than
government revenue. This creates budget deficit, which is calculated in the following formula:

Government expenditure and government revenue are displayed in Figure 2. The resulting budget deficit is

also presented in the same figure, calculated with the above formula. Note that data from 2011 to 2013 are
simply estimates from the Greek Ministry of Finance. The sharp, one-off increase in the Greek budget
deficit in fiscal year 2009 is explained by the fact that in that year, Greece decided to issue bonds worth

£5.5 billion in order to support the banking sector, while continuing on to spend another £2.5 billion on
weapons and armaments, further aggravating the economic situation.

Figure 2: Budget Deficit from 2008 to 2010 and from 2011 to 2013 (est.)

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EC6201 National Economy
Timothy Tan Xin Zhong

During the global economic boom from 1997 to 2007, the government also prioritized growth over fiscal

prudence and borrowed excessively without having the ability to pay back in full. Most of these funds were
spent on expansionary monetary policies in order to increase aggregate demand. As shown in Figure 3,
this caused government debt to snowball to unacceptable and unsustainable levels. For example,

compared to a high government debt of £386.4 billion in 2008, the GDP was a mere £350.3 billion (red line).

Figure 3: Government Debt of Greece

The government of Greece is also famous for its corruption. Bribery is rampant. In 2009, Greece had the
European Union’s 2nd lowest Index of Economic Freedom and ranked 81st in the world. According to recent

surveys, 78% of the Greek population believe that the government is corrupt and that government funds

are being squandered. It does not help that the government is also highly inefficient. The implementation of
financial reforms came too late, and the institutional, legislative and regulatory framework of Greece is

much too bureaucratic and complicated. There are simply too many laws, too many policies and too many
overlapping control mechanisms such that the entire system is inefficient and costly to maintain. However, it
is timely to remind ourselves that errors caused by the government are also errors caused by the
population as Greece is a democracy. Civil society ought to be operating as a counter-balance mechanism

that wards off unhealthy practices and policies.

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EC6201 National Economy
Timothy Tan Xin Zhong

Economic Growth of Greece

Figure 4: GDP of Greece in current US$

Since the 1960s, Greece’s GDP has been increasing. Due to improvements in technology and the
increasing quality and quantity of other factors of production, the rate of this increase is also increasing,

depicted by the rising gradient of the GDP curve in Figure 4. A sudden dip is observed after 2008 in the
wake of the financial downturn. Plotting the gradient of the GDP curve over the years will provide us with
the GDP growth rate. Figure 5 shows the GDP growth rate of Greece since 1992.

Figure 5: GDP Growth Rate of Greece

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EC6201 National Economy
Timothy Tan Xin Zhong

The increase in GDP from 1960 to 2001 depicted in Figure 4 has a relatively small gradient as compared to
the increase in GDP from 2001 to 2008. This is attributed to the Greek adoption of the Euro on the 1st of

January 2001. Being in the Eurozone brought monetary benefits and greatly boosted the Greek economy.
In this period of time, Greece became increasingly slack and profligate. As mentioned earlier, the
government also embarked on an expansionist policy instead of adopting a more conservative approach.

Saving and setting aside funds for the future was the last thought on everybody’s minds as they tried to

take advantage of the economic boom. The high levels of growth seen after 2001 were beneficial but highly
unsustainable. These set the stage for the spectacular crumble of the Greek economy in 2008. For the first

time since 1993, the GDP growth rate dropped into the negatives, suggesting a contraction of the Greek

economy. Standard & Poor’s, a rating agency, estimates that Greece’s GDP will not regain its pre-2008
level until 2017.

Financial Repercussions
Greece joined the Eurozone and adopted the euro in 2001. Being part of a shared currency and a collective
economy that was integrated over various countries meant that Greece became part of a family that shared
weal and woe. Like the constituent logs of a wooden boat, the countries in the EU were together for the
long haul. If one of the logs became lighter and more buoyant, these improvements would benefit all the

other logs and improve the overall performance of the boat. However, on the other hand if one of the many
logs got eaten through and started to take in water, the entire boat would get pulled down with it. This was

what happened in the Greek debt crisis.

Upon hearing word of the crisis, global financial markets went into a major panic on fears that the crisis
would spread. It became a contagion that spread to other EU members, with the most badly affected

countries being those that were already having some economic troubles of their own – Portugal, Italy,
Ireland and Spain. With Greece, these countries were collectively known by the insinuating acronym PIIGS.
The market reaction to the crisis caused some collateral damage to these other economies, mostly due to

well-supported fears of financial contagion. Although the Greek economy accounts for only 2% of the
Eurozone’s GDP, Italy and Spain account for 12.3% and 8.5% respectively, and are the 4th and 5th largest
economies in the Eurozone. This is a very clear-cut example of the strength and significance of financial

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EC6201 National Economy
Timothy Tan Xin Zhong

contagion. Even giants could be downed. European bank shares fell substantially, taking major stock
market indices down with them. The German DAX index dropped 3.3%, accompanied by the British FTSE

index and the French CAC-40 index, which fell by 2.6% and 4.1% respectively. This was not all. Japanese
markets fell by up to 4%. Blue-chip stocks like 3M and Procter & Gamble also fell by up to 40%, causing
the Dow Jones index to drop by 9%. On the other side of the world, Brazil was forced by skeptical and

jittery investors to scale back bond sales, while Asian currencies like the Korean won weakened. “It’s not

just a European problem, it’s the US, Japan and the UK right now,” said Ian Kelson, a bond fund manager
with T. Rowe Price. “It’s across the board.”

The Greek current account figures paint an alternative view of the entire economic situation in Greece. This
different perspective however, is no less grave. Simply put, the current account balance is the sum of the

balance of trade (X-M), net factor income (interests and dividends), and net transfer payment (foreign aid).

Figure 6: Current Account Balance

Greece’s current account balance has always been in the negatives. This isn’t a good sign as it hints at

possible overdependence and low self-sufficiency. However, it wasn’t a worrying problem until after 1998
when the current account balance took a turn for the worse. The Greek population became more and more
well to do and aggregate demand increased. These increases in domestic and consumer demand

produced larger, ever increasing current account deficits as more and more goods and services were
imported into Greece for supply to meet demand. Greece also started to borrow more and more from other

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EC6201 National Economy
Timothy Tan Xin Zhong

countries, further increasing debt and the corresponding interests. These trends were more pronounced
after 2001 when entry into the Eurozone further boosted the population’s economic wellbeing. For reasons

unknown, authorities appeared at ease with the consumption boom and never considered any policy
measures that could have reversed this upsetting trend. In fact, the exact opposite was true with several
policies being created that further exacerbated this trend. Surcharges on imported cars were reduced and

favorable tax treatments were imposed on various offshore companies. A massive salary hike was also put

in place just a few months before the elections. These policies immediately worsened the current account
balance and depleted much needed government revenue.

As observed in Figure 6, the lowest point of Greece’s current account balance came in 2008 when the
current account deficit reached USD 51.31 billion, which is approximately 14.42% of the GDP of that year.

The current account was saved when the crisis arrived and zapped it back up to USD 37.1 billion, a 27.69%
reduction in the current account deficit. This reduction in deficit can be attributed to sharp declines in

imports due to decreasing aggregate demand caused by increased market uncertainty. It can also be

attributed to the reduction in national debt as it gets paid off with the help of foreign aid such as the EU/IMF
rescue package.

The Greek financial crisis came with several negative consequences such as financial contagion, falling
share prices and global paranoia. It also increased market uncertainty and reduced aggregate demand. In

normal circumstances, this would be bad for the economy. However, the Greek consumer market was

overheating. The debt crisis managed to salvage the situation by acting like a dampener, effectively
reducing current account deficits.

Social Implications
The economy is an ever-encompassing medium that governs the flow of money and affects most, if not all
facets of the world around us. When the Greek economy collapsed, there were numerous impacts on

society. In this section, we will be discussing Greece’s unemployment rate and political stability. We will
also be briefly covering the recent Greek riots.

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EC6201 National Economy
Timothy Tan Xin Zhong

Figure 7 presents the Hellenic unemployment rate from 2000 to 2011. It can be observed that the general

trend before 2008 was that of a decreasing one. In 2008, the unemployment rate reached an all-time low of
7.65%. However, this was completely undone by the economic crisis of 2008 which brought the
unemployment rate up to 9.4% in 2009 and 12.0% in 2010. Both the EU and IMF predict further increases

to as high as 15% in the next two years.

14.6

12.0

9.4

7.65

Figure 7: Greek Unemployment Rate

As labor is one of the 4 factors of production beside land, capital and entrepreneurship, incomplete usage
of labor reduces the productivity and efficiency of Greece. Increasing unemployment pushes the point on

the production-possibility curve (PPC) further away from the curve. However, at this point of time, the debt
crisis is the main puzzle to crack. To do so, Greece would have to undergo severe austerity measures such

as spending cuts and increased taxes which will negatively affect employment.

The debt crisis is also bad for business. A survey published in March 2010 said that of all small business

owners in Athens fear that they may have to close down within the next 3 years. 5 months later, research

published by retail confederation ESEE claims that approximately have already closed down as a result of

the recession. Even major companies like Aldi and FNAC are leaving the Greek market, taking numerous

jobs with them.

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EC6201 National Economy
Timothy Tan Xin Zhong

With the various economic problems and the many other perceived failures of the government to contain

the crisis, confidence in the Greek political system began to fade. This is a completely different crisis
altogether – a crisis of confidence. Surveys show that 52% never trust Greek governments, while 40% trust
them only partially and occasionally. 72% of Greeks are also looking forward to a change in government.

What started out economical gradually became political. This is because money, jobs and businesses are

all very important possessions and these are supposedly safeguarded by the government. When they fail to
do so, political dissent and turmoil undoubtedly come into the picture.

The problems mentioned above such as high unemployment generated a countrywide feeling of frustration
and discontent. In 2008, a 15-year old student was accidentally killed in Athens by two policemen, sparking

off the infamous Greek riots. Hundreds of youth rioters damaged public utilities and property. The riots then
spread to other Greek cities such as Thessaloniki. In February 2010, several nationwide strikes were

organized as a response to the government’s plan to slash dozens of bonuses and benefits. Finally, on the

6th of May 2010, while voters in Britain went to the polls, Greece was busy battling demonstrators outside
parliament that were against another round of cuts.

As mentioned above, the Greek debt crisis brought about various financial and social consequences. Jobs
were lost. Businesses and livelihoods crumbled. Shares worldwide tumbled. Rioters took to the streets. The

economy plays a key role in everyday life. When it starts to crack and go under, there will always be far

reaching implications.

Resolution
To get out of this economic mire, Greece will have to decide how to deal with the debt, how to reduce
damages, and how to distribute the pain of doing so as equitably as possible. A country that is heavily in
debt has to accept that once the money runs out, it must cut spending. If necessary, living standards must

fall. Once that hit has been taken, growth can resume again. Greece has therefore adopted a plan to
reduce her budget deficit by £30 billion over the next three years through various reforms and policies.
These austerity measures are either to reduce government expenditure or to increase government revenue.

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EC6201 National Economy
Timothy Tan Xin Zhong

Measures carried out by the Greek government to reduce government expenditure include slashing civil

servant salaries and reducing benefits and pensions. Measures to increase government revenue include
increasing the VAT (value added taxes) from 19% to 21% and increasing the excise tax on demand-
inelastic goods such as fuel, tobacco and alcohol. As expected, these measures were accepted with great

optimism overseas and great pessimism within Greece. However, it is imperative to note that ending this

crisis ultimately depends on one single factor: the willingness of the Greek population to absorb the
significant short-run welfare loss that will have to accompany such reforms.

The austerity measures mentioned above require a great deal of financing and liquidity to fall back on while
the appropriate reforms and policies get implemented and gradually gain credibility. This was granted by

the EU and the IMF. On the 10th of May 2010 after several conferences and discussions, a £110 billion
stabilization package was agreed upon for Greece. Although this monetary support package bought

Greece substantial relief and time to stabilize their economy and to solve their debt issues, it does not

resolve the underlying structural difficulties. The only way to cut the budget deficit would be for Greece to
push through with her austerity measures and successfully implement them.

Conclusion
Today, the budget deficit of Greece stands at 8.7% of GDP. The government plans to cut it down to 3% by

2012. A lot needs to be done if that is to be accomplished, and if Greece is to get back on her feet. The

government needs to get rid of its spendthrift and corrupt nature, while the population needs to stop
evading taxes. The unemployment rate and current account deficits need to get reduced, while small local
businesses need more support from the government and the public. Most importantly, the government

needs to regain the trust of the populace. A country distrustful of her leaders is bound for failure.

At the end of the day, the citizens are the people who pay. Any progress made will only be gradual and will

certainly not come easy. For everyone, the Greek debt crisis serves as a wakeup call for structural reform
which, despite the inevitability of hard times ahead, can serve as a catalyst for targeting a more suitable
growth model in the long run.

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EC6201 National Economy
Timothy Tan Xin Zhong

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