The Euro’s Greek Tragedy

AMSTERDAM – When the euro was introduced in 1999, European countries agreed that fiscal discipline was essential for its stability. While the common currency has benefited all countries that have adopted it – not least as an anchor in the current economic crisis – the failure of euro-zone members to abide by their agreement risk could yet turn the euro into a disaster.

Indeed, too many members simply behave as if there were no Stability and Growth Pact. The state of Greek public finances, for example, is “a concern for the whole euro zone,” according to European Commissioner for Monetary Affairs Joaquin Almunia. Greece’s fiscal deficit is expected to reach 12.7% of GDP this year, far exceeding the SGP’s 3%-of-GDP cap.

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Of course, every euro-zone country is breaching the SGP’s deficit ceiling as a result of the current crisis. But consider the Netherlands, which will do so this year for only the second time since 1999. When the Netherlands first exceeded the SGP limit – by only 0.1% of GDP – the government immediately took tough measures to rein in the deficit. Germany and Austria behaved the same way. Those countries are already working to reduce their crisis-inflated deficits as soon as possible.

Down in southern Europe, things look very different. Exceeding the SGP’s deficit cap is the rule rather than the exception. Indeed, throughout the euro’s first decade, Greece managed to keep within the SGP limits only once, in 2006 (and by a very narrow margin).

Moreover, the Greek government turned out to be untrustworthy. In 2004, Greece admitted that it had lied about the size of its deficit ever since 2000 – precisely the years used to assess Greece’s application to join the euro zone. In other words, Greece qualified only by cheating. In November 2009, it appeared that the Greek government lied once again, this time about the deficit in 2008 and the projected deficit for 2009.

Italy also has a long history of neglecting European fiscal rules (as do Portugal and France). Like Greece, Italy was admitted to the euro zone despite being light-years away from meeting all the criteria. Public debt in both countries was well above 100% of GDP, compared to the SGP’s threshold of 60% of GDP. Italy did not fulfill another criterion as well, as its national currency, the lira, did not spend the mandatory two years inside the European Exchange Rate Mechanism.

Ten years later, it seems as if time has stood still down south. Both the Greek and Italian public debt remain almost unchanged, despite the fact that both countries have benefited the most from the euro, as their long-term interest rates declined to German levels following its adoption. That alone yielded a windfall of tens of billions of euros per year. But it barely made a dent in their national debts, which can mean only one thing: massive squandering.

That is evident from their credit ratings. Greece boasts by far the lowest credit rating in the euro zone. Standard & Poor’s has put the already low A- rating under review for a possible downgrade. Fitch Ratings has cut the Greek rating to BBB+, the third-lowest investment grade. Indeed, those scores mean that Greece is much less creditworthy than for example Botswana and Malaysia, which are rated A+ .

What if Greece gets into so much trouble that it cannot service its debt? That is not impossible. According to calculations by Morgan Stanley, with relatively low long-term interest rates, Greece needs a primary surplus of at least 2.4% of GDP each year just to stabilize its national debt at 118% of GDP.

Current European rules prohibit other European countries or the EU itself from helping Greece. But recent history teaches us that European rules are made to be broken. Already, many (former) politicians and economists (no prizes for guessing whence they mostly hail) are proposing that the EU issue its own sovereign debt, which would alleviate the problems of countries such as Greece and Italy.

But such schemes would come at a high cost. They would punish fiscally prudent governments, as interest rates would inevitably increase in countries like the Netherlands or Germany. Just a 0.1% increase in borrowing costs would mean hundreds of millions of euros in extra debt-service payments a year.

Moreover, even if the plan for EU sovereign debt never takes off, fiscally prudent euro-zone countries will face higher borrowing costs. As financial integration in Europe deepens, the lack of fiscal discipline in one or more euro-zone countries will push up interest rates throughout the currency area.

A member of the euro zone cannot be expelled under current rules, allowing countries like Greece to lie, manipulate, blackmail, and collect more and more EU funds. In the long term, this will be disastrous for greater European cooperation, because public support will whither.

Europe should therefore consider bearing the high short-term costs of changing the rules of the game. If expelling even one member could establish a more credible mechanism for guaranteeing fiscal discipline in the euro zone than the SGP and financial fines have proven to be, the price would be more than worth it.