Greek Debt Crisis: Causes, Responses, and Solutions

Introduction: The European Debt Crisis

The debt crisis engulfing the European Union (EU) is immensely threatening to the economic and political conditions in Europe. The economic and financial crisis has shaken the foundations of European construction — more precisely, its most visible and successful symbol: the common currency, the Euro. The debt crisis in the EU is attributed to the inability of some countries to gain control over their growing debt, which has pressurized the stability and survival of the Euro (Todorivic and Bogdanovic 2012). The mounting debt and budget deficits of some countries in the European Monetary Union caused a reaction in financial markets that punished countries with high debts by increasing the cost of additional borrowing. The inability to adjust exchange rates created pressure in labour markets and unemployment, which further aggravated fiscal slippage (Adrain 2012).

Minescu (2011) believed that the core reasons behind the current European financial crisis are low risk premiums, strong leveraging, prolonged periods of rapid credit growth, abundant liquidity, and soaring asset prices. European banks lent billions to financially struggling nations and now face the prospect of enormous losses, which could in turn cause the crisis to spread to more stable nations and the United States. All EU countries thus adopted austerity measures for improving fiscal strength and competitiveness. EU leaders adopted the Euro Plus Pact, which included the commitment of each country to introduce a balanced budget amendment as part of their national law. The debt crisis in the European Union clarified the fact that an economic model based on financing consumption through borrowing would not bear fruit in the future (Todorivic and Bogdanovic 2012).

The economy of Greece functioned as a relatively closed economy for decades, bearing a characteristically large public sector. Tourism and shipbuilding are the core sources of state revenue, yet the state faced a downfall in industrial production. The reliability of Greek economic indicators had been questioned by the European Union, and Greece's position was quite precarious even before the broader European crisis. Greece gained easy access to longer-term borrowing due to the under-pricing of default risk. Statistics indicated that general government revenue as a percentage of GDP consistently remained lower than government expenditure in Greece (Taylor 2011).

Occurrence of the Greek Debt Crisis

Greece was engulfed in large budget deficits, public debt, current account deficits, and a decline in competitiveness. One fundamental reason for the crisis was the large amount of borrowing in international capital markets to finance both the current account deficit and the budget deficit. The delay in implementing structural tax reforms and pension system changes was also a contributing factor. Poor collection of budget revenues, tax evasion, and high government spending were significant internal causes of the debt crisis. The accumulation of foreign debt mounted drastically due to external factors — including easy access to external capital markets at lower rates after joining the EMU, and poor application of EU rules concerning public debt and budget deficits (Todorivic and Bogdanovic 2012).

Greece faced the prospect of sovereign debt default following the downgrading of its credit rating and the halt of positive economic growth. The European Union and the IMF worked out rescue loan plans to assist Greece. While the loan bailouts may alleviate short-term liquidity problems, Greece remained at risk of encountering long-term debt obligations it could not meet (Abboushi 2012).

The worsening economic conditions in Greece made it the victim of a tremendous debt crisis. A number of factors are responsible for the fiscal crisis Greece has experienced since 2008. Some of these factors are endogenous and linked with the internal structure of the Greek economy, including prolonged macroeconomic imbalances and credibility issues surrounding macroeconomic policies. Other factors are exogenous and linked with the financial turmoil encountered across all of Europe (Kouretas, Georgios, and Vlamis 2010).

Core Causes of the Financial Crisis in Greece

The high growth rate of real GDP during the period 2001–2008 was the result of growth in personal consumption and public investments financed from public funds and EU sources. The public debt of Greece increased drastically due to extensive borrowing from international capital markets to finance the government's deficit (Gibson, Hall, and Tavlas 2012). The reliance on external borrowing to cover both the budget deficit and the current account deficit led to high sensitivity in capital markets (Todorivic and Bogdanovic 2012). The borrowing was aimed at raising the income of average Greek households and was channelled toward higher consumption levels in an effort to improve living standards. This process was further fuelled by incoming capital flows from the EU, accumulated in the form of agricultural subsidies and infrastructure financing under the EU's convergence and cohesion policy frameworks (Kouretas, Georgios, and Vlamis 2010).

The Greek economy lacked the will to maintain fiscal discipline and possessed a wasteful and inefficient state administration. An immensely expensive pension and welfare system, combined with widespread tax evasion, further aggravated the public debt situation. Poor collection of tax revenues generated drastically high budget deficits. The industrial structure of Greece and low competitiveness also contributed to the debt crisis. Low productivity and relatively high earnings played a major role in diminishing the competitiveness of Greek products abroad, ultimately reducing exports and widening the current account deficit.

Greece encountered another massive hurdle when it was discovered that the government had misrepresented and falsified data about its public finances — an effort to appear compliant with the monetary guidelines of the Eurozone. Abboushi (2012) notes that Greece had particularly precarious debt dynamics and was the only member state that manipulated its statistics over a prolonged period. The statistics show that the Greek government revised its deficit for 2008 from 5.0% to 7.7% of GDP, and its 2009 deficit from 3.7% to 12.5%, which was subsequently revised further to 13.6%. Greece not only reported incorrect data but also committed acts of non-transparency, improper bookkeeping, and exhibited a lack of accountability within its statistics agency.

The disclosure of these facts spooked bond markets and credit rating agencies, which determined that Greece was neither trustworthy nor creditworthy. Bond yield spreads widened rapidly and the Greek government's credit rating dropped severely. Greece eventually faced the prospect of being unable to raise new debt to pay off existing obligations.

Another factor inhibiting Greek economic success was that Greece had not been a particularly business-friendly country and appeared to hinder entrepreneurship and capital investment. The World Bank surveys countries around the world by evaluating them across dimensions such as "starting a business," "employing workers," "protecting investors," and "registering property." Recent OECD data showed that Greece was among the least recipients of foreign direct investment capital in Europe. This cold business climate reduced the chances of attracting foreign capital needed to service the country's debts (Abboushi 2012).

The real appreciation of wages in the public sector and the increase of employees in government and municipalities led to a reallocation of capital and labour away from the private sector, particularly from export-oriented sectors, resulting in a loss of competitiveness and an increase in the current account deficit (Kouretas, Georgios, and Vlamis 2010). The private sector received a setback, as it was heavily dependent on government projects and invested little in its own research, development, and innovation. High wages offered to government employees encouraged people to seek public-sector employment, where pay was unrelated to productivity, which ultimately deteriorated the competitiveness of the Greek economy. Kouretas, Georgios, and Vlamis (2010) provide evidence that Greece experienced the highest growth in public spending and public administration employment, leading to a bloated public sector during the period 1999–2005. Additionally, Greek entrepreneurs faced bureaucratic obstacles in starting businesses, which further entrenched corruption.

Conclusion

In order to compile reliable data about the country's economy, a separate and independent national agency needs to be established — one that is insulated from political influence. Such an agency could assist market participants and policy makers in making sound decisions by accurately measuring key variables such as GDP, employment, deficits, and debts. The agency should also commit to making reliable data available to international statistical agencies for research and development purposes (Wignall 2012).

Major structural reforms and comprehensive fiscal policy changes are required to resolve the Greek debt crisis. Policy must be formulated with the understanding that both the banking crisis and the sovereign debt crisis need to be addressed simultaneously. The principal market risk is deflation, not inflation. Long-term policies focusing on new fiscal rules and unit labour cost reduction are essential. Debt haircuts should also be encouraged by new policies in order to stabilize the economy (Wignall 2012).

The deteriorated economic conditions in Europe engulfed the continent in a severe debt crisis, most acutely affecting Greece and Ireland. The economic and financial crisis shook the foundations of Europe due to the inability of certain countries to manage their mounting debts, placing the survival of the common currency — the Euro — in jeopardy. Greece accumulated large budget deficits and public debts through extensive borrowing in international capital markets and a sustained decline in export competitiveness. The Greek economy lacked proper implementation of fiscal policy rules and suffered from inefficient public administration, both of which aggravated its debt crisis. The misrepresentation of public financial records led to a collapse in Greece's credit rating, preventing it from raising new debt to service existing obligations. Public sector inefficiencies — characterized by high wages and low productivity — reduced competitiveness in trade, while the unfriendly business environment further discouraged foreign investment and entrepreneurship.

To cope with its mounting debt, the Greek government implemented severe austerity measures including budget cuts, freezing of public sector wages, raising the retirement age, increasing VAT, and reducing pension and social service payments. Prime Minister Papandreou's structural reforms sought to boost competitiveness through private sector development, research and innovation, and increased employment. Eurozone member states and the IMF also provided loans to help Greece manage the crisis. Despite these measures, Greece remained unable to pay off all its debts, and the austerity programme generated significant political tension and social hardship among the population.

A major solution would be to reduce the Debt-to-GDP ratio as a means of stabilizing the economy. Another viable option would be for Greece to default on its debts and detach from the Eurozone, which would allow currency devaluation and improved economic competitiveness. Additional measures — including anti-corruption enforcement, Eurobond issuance, the establishment of an independent national statistics agency, and credible tax audit systems — represent meaningful steps that could collectively contribute to stabilizing the Greek economy over the long term.