SPECIAL ARTICLE
Economic Turbulence in Greece
Rania Antonopoulos, Dimitri B Papadimitriou
The current approaches to the Greek and eurozone
crises that are being pushed by Germany, France and the
European Union are failing because they suffer from a
fatal misdiagnosis. The central problem is not profligate
spending in the periphery, but the very set-up of the
European Monetary Union. Without attending to current
account imbalances within the eurozone, austerity will
be self-defeating. Deflation and depressed growth will
heighten the debt problem while continuing to ignite
social ruin. The eu must become an entity with a unified
and expanded fiscal policy and a central bank willing
and able to act as lender of last resort. If austerity and
structural reform continue to be the only options, Greece
will bear witness to a lost generation and a likely end to
the euro project in its present form.
Rania Antonopoulos (rania@levy.org) is senior scholar at the Levy
Economics Institute. Dimitri B Papadimitriou is president of the Levy
Institute and also Jerome Levy Professor of Economics at Bard College.
The Levy Economics Institute and Bard College are at Annandale-on-
Hudson in New York state, the United States.
Economic & Political Weekly  EPW   february 4, 2012  vol xlviI no 5
E
urope’s crisis has spread from Greece to Spain, Italy, and
beyond, with a high probability of a fallout to the other
side of the Atlantic pond, striking the United States’ already
teetering financial system. Greece, a small country of roughly
10.8 million, is in the centre of the vortex. Despite her minimal
contribution of only 2% of European Union (EU) gross domestic
product (GDP), for more than two years the country’s sovereign
debt crisis has inflicted instability on the global financial markets
and threatened to unravel Europe’s Economic and Monetary
U­nion (EMU) throwing the European financial system into com-
plete disarray. When and how the country’s public debt became
unsustainable is not discussed, while the policy response
i­mposed by the European leaders has pushed the country into a
deepening recession and led to deep cuts in basic services like
healthcare and education for more than three years. The disturb-
ing social and economic trends emanating from accelerating
l­evels of unemployment, decreasing incomes, daily worker
strikes and/or stoppages, a jump in suicides among men and a
dramatic increase in crime are all characteristics of a dysfunc-
tional society. Citizen unrest is unparalleled in recent memory,
matched only by events that took place during the civil war in the
mid-late 1940s and the military junta period of 1967-74.
The messages that are being sent on a regular basis from the
European leaders – including the latest one subsequent to the
new rescue package crafted for Greece along with the proposed
expansion of the European Financial Stability Facility (EFSF) –
were that the EU can be held together with a combination of bail-
outs and continued austerity that will isolate the highly indebted
countries, and leave the rest of Europe economically intact. This,
of course, has been shown to be pure fantasy. Since then, we are
witnessing a slow-motion train wreck that will dissolve an eco-
nomically united Europe, a union that, despite its many down-
sides, is in the best interests of the con­tinent’s countries – rich
and poor – and the global economy ­(Papadimitriou 2011a).
The need to push forward on Greece’s solvency problem is a
positive development, but the current fix basically amounts to
extending the life support for a little longer. Assuming the new
technocratic Greek government passes the programme, with
more austerity measures and structural reforms attached to it,
Greece’s payments on its debt principle will be postponed, inter-
est payments maybe lowered by the “haircut” of its debt held by
private sector investors – still to be negotiated and highly resisted
by private banks – it will have a limited impact. It is possible that
in 2013-14, the structural deficit in public finances will be brought
under control or even eliminated. This is no achievement to be
proud, however, since it will come at the cost of unprecedented
levels of unemployment and poverty. And, most significantly, the
55
SPECIAL ARTICLE
underlying problem of an economy with no growth will not have
been addressed (Papadimitriou 2011b).
Treating the symptom while ignoring the fundamental causes
behind the crisis has led to the wrong medicine. The misdiagno-
sis, however, is not accidental. The EU’s neo-liberal thinkers are
using the crisis not only to impose austerity but also to roll back
social legislation while privatising as much of the economy as
possible. They, then, move the focus away from the problems
with the private sector – especially with the excesses perpetrated
by financial institutions that created the global financial crisis –
and on to governments’ profligacy and “coddling” of the popula-
tion in the form of a decent social safety net.
So, “big government” and “inflexible labour markets” have
been presumed by European leaders to be the true culprits, de-
manding immediate deficit reduction and structural reform poli-
cies that have proved to be ineffective. On the other hand, the
rules set out by the 1993 Maastricht treaty and signed on by all
EMU members, have recently been made more painful by the
E­uropean Union Parliament that voted to make sanctions more
automatic on countries that exceed the treaty’s criteria for debts
and deficits (Stearns 2011). This is ironic since only four of the 27
member states meet the Maastricht deficit criteria (Liu 2011).
Germany does not meet the criteria and will have to pay the
fines. And it was Germany that originally had the rules relaxed
when its own slow growth period caused it to chronically exceed
Maastricht limits on deficits and debts. What is more ironic is that
loosening the rules allowed Greece and Portugal to build to
higher debt ratios that Germany and France now admonish.
Whether inspired leadership will emerge in Greece in the next
few months or whether the European project as is currently con-
structed will be sustainable are the two key issues that are in the
minds of the players in the financial markets.
A Chronology of Events1
The new government of George Papandreou, once voted into
power in October 2009, announced that it would embark on
s­evere spending cuts and concentrate on tax evasion and avoid-
ance to increase public revenues as necessary steps to deal with a
projected public deficit of 12.7%, much larger than originally esti-
mated by the outgoing conservative government. Papandreou,
nonetheless, reaffirmed that he will stand firm to the “commit-
ments for more social justice”, a pre-election campaign promise
for a social contract that got his party PASOK elected. A month
later it was revealed that the Greek Statistical Agency had mis­
reported economic data and that the country for the previous
year, at least, was in recession during which time the deficit GDP
ratio had grown rapidly. Declaring the country to be in a finan-
cial crisis and a threat to “national sovereignty”, he put forward a
budget proposal that would cut the public deficit to 9.1% of GDP.
His administration anticipated neither the financial markets’
response nor the tenacious inaction of the EU. By the time the EU
responded with a rescue package of ¤ 110 billion crafted in con-
cert with IMF and ECB (the “troika” plan as it is referred to in
Greece), the three main credit rating agencies, Fitch, Standard &
Poor’s and Moody’s, had significantly downgraded Greece’s
­sovereign debt, signalling the high risk involved in holding such
56
debt and making it difficult for the Greek government to borrow
in international markets. The rescue plan called for austerity
measures and the adoption of neo-liberal structural r­eforms
along with periodic progress reports as a condition for releasing
funds. What, in retrospect, proved to be “mild” austerity meas-
ures was met with general strikes by public and private sector
workers and professional unions with riot police violently clash-
ing with demonstrators. Periodic progress reviews by representa-
tives of the troika that followed revealed serious shortcomings in
meeting deficit reduction targets, necessitating the government
to introduce even more severe austerity measures that were, and
still are, met with further demonstrations, general strikes and at
times violent events and uncontrollable civil unrest.
The rescue package notwithstanding, Greece, as the media
r­eported, “fails to reassure investors” that austerity measures are
effective and the deficit crisis can be handled, pushing stock
m­arkets around the globe down while the Standard & Poor’s cuts
the status of Greece’s government bonds to the level of “junk”.
While the omens for the necessity of a debt restructuring were
clear, the Papandreou government’s willingness to consider it
was absent: it was portrayed from the beginning as anathema
and to the contrary, avoiding any type of restructuring of the
debt and giving assurances against “defaulting” became a matter
of national pride according to Papandreou. The calls for reconsid-
eration of the severe austerity measures and labour market
r­eforms by members of the Papandreou party were deemed un-
patriotic and were met with expulsion leaving him in Parliament
with a thin majority. For example, speaking up against the strin-
gent conditionalities of the EU/ECB/IMF bailout, Louka Katseli,
the courageous minister of labour, was ousted from her post in
the summer of 2011 only to be expelled from the PASOK party by
Papandreou in October 2011 when she voted against Article 37,
which was calling for the elimination of collective bargaining, by
the EU/ECB/IMF bailout memorandum. Even in January 2012,
d­espite continuing civil unrest, there is little social dialogue about
the future of the country silencing harshly voices of dissent.
Austerity measures and reforms, and calls to continue or
i­ncrease them will not work. Raising taxes in a country known
for its flagrant tax evasion has only boosted the shadow economy.
Wage and pension cuts are further lowering tax receipts. Worse,
these measures are depressing production levels, demand and
r­etail sales resulting in more unemployment (Papadimitriou
2011b). A little too late, on 26 October 2011, the leaders of
France and Germany came up with a second rescue package
for Greece. We will return to the details of this newest European
rescue later.
The Social and Economic Context
In the period of mid-1990s to mid-2000s, Greece’s economy was
growing faster than the other eurozone countries and was treated
as a poster child by the EU. Among other developments, the gov-
ernment capitalised on this advantage and borrowed cheaply.
International banks and investment houses were happy to oblige.
The government was running a deficit above 3% of GDP but so
were many other countries, including on occasion Germany, with
no penalties enforced and no news reporting about the dangers
february 4, 2012  vol xlviI no 5  EPW   Economic & Political Weekly

ahead. Tax revenues, despite pervasive tax evasion and a 30%
shadow economy, were stable. But, when the world economy
slowed in late 2007 and early 2008, and when the global financial
crisis hit Greece, tax receipts declined abruptly. In the meantime,
government spending did not. This was a proper reaction to the
cooling off of the economy. It is precisely in these circumstances
that countercyclical policy is called for. Instead of acknowledging
its necessity, it was branded later “a continuation of the profligate
Greek state”. The result was that the country’s deficit began to
grow rapidly in 2008. This was not disclosed as we discussed ear-
lier and in early 2010, “concerns” about Greece’s sustainability of
huge national debt became headline news around the globe.
Greek citizens found themselves in the midst of a severe struc-
tural adjustment programme, one that was embraced whole-
heartedly by the ruling elites. The explanation and therefore jus-
tification was that the sovereign debt crisis was brought about by
(a) a profligate state and (b) very much below European average
productivity workers. The prescription? The State must spend
less and tax more; workers must either become more productive
or accept wage cuts and even higher joblessness. Policies and
measures were announced, so as to shrink the government’s
share in GDP by firing or retiring early public sector workers and
suppressing the wages of those who remained. Further measures
included cutting appropriations to health, education, infrastruc-
ture maintenance, unemployment insurance, old age minimum
pensions, and other social protection benefits to low income fam-
ilies while simultaneously increasing VAT, lowering the tax-­
exempt annual income from ¤ 12,000 to ¤ 5,000 and imposing
special “solidarity” taxes to close the deficit. The result has been
incomes of middle class households have come down by 40% and
there has been a further expansion of the shadow economy.
Other measures include the sale of public assets to decrease out-
standing debt that stood at ¤ 366 billion, together with new legis­
lative changes aimed at improving “labour market functioning”
and competitiveness via eliminating national collective bargain-
ing agreements and more generally, reducing other kinds of
l­abour market “rigidities”.
A concrete example is instructive here: to transform oligopolis-
tic labour markets, the occupation chosen to be transformed was
that of pharmacists. As a result, new legislation was announced
that imposed longer hours of operation of pharmacies and re-
moval of zoning restrictions that previously prohibited opening a
pharmacy within two blocks or so of an existing one. Besides
longer hours of work imposed on the owners, the vast majority
being women, of the traditional one-to three-person small enter-
prises, increased competition is set to bankrupt these small-scale
establishments, enforcing in effect sector consolidation and capi-
tal centralisation. Presumably the system that had worked so
well until now and allowed for neighbourhood-based close
p­ersonal care provisioning of patients by pharmacists, is to be
r­estructured because it is holding back market competition.
M­ultinationals and their franchise businesses will do a better job.
This has brought about massive mobilisation and resistance by
the pharmacists’ union.
To be sure, some changes may be necessary, but not on such a
wholesale scale. In this regard we are not defending the indefensible
Economic & Political Weekly  EPW   february 4, 2012  vol xlviI no 5
SPECIAL ARTICLE
oligopolistic business behaviour and tax evasion nor condoning
the pervasive clientilism and the corruption-prone behaviour of
the Greek state, both of which are often used to secure political
allegiance. Tax evasion for a variety of historical reasons and
petty corruption of public sector employees (including tax collec-
tors) has been disturbingly rampant and Greek citizens are them-
selves complicit. This is an inconvenient truth, because systemic
corruption worked for all parties involved. It is clearly preferable
to pay lower taxes, including the bribe, than paying the official
taxes due. There are historical, sociological and cultural elements
to tax compliance by business and citizens, but a discussion of them
is beyond the scope of this article. Suffice it to say that tax revenue
problems are multifaceted in Greece and cannot be r­educed to a
vague “tax avoidance” culture. The Greek shipping industry, for
e­xample, is unquestionably one of the largest and most significant
in the world, representing 22.4% of EU gross tonnage for vessels
under the EU flag and holding 16% of the world’s total tonnage.
Apart from its size, it is also a key component for the Greek eco­
nomy as it employs almost 5% of the Greek population. Above all, it
produces 8% of GDP. Yet, it pays zero taxes. Legally, that is. When-
ever an elected government administration has tried to negotiate
transforming the tax code, the leverage exerted was excessively
strong. The response has been that companies and capital are
m­obile and relocation to another country that provides a tax haven
would simply result in unemployment for Greece and empty busi-
ness buildings around the main port of Athens.
A Traumatised People
Whatever the causes for the rapid increase in the deficit position
of the country – we will discuss this further in the next section –
the wrath of the troika on the Greek population was devastating.
In 2011 alone, the cumulative decline in GDP as of the third quar-
ter was a recorded 5.5%, as per EL-STAT, the Hellenic Statistical
Authority and expected to have hit over 6% for the year. Unem-
ployment has risen to over 18% and in some provinces the 50%
mark. Youth unemployment is over 52% and among young
women (aged 20-24 years of age) it is about 49% (Antonopoulos
et al 20011). A recent poll – reported in a respected Greek news-
paper – found one in three adults aged 22-34 with a university
degree migrating or making plans to migrate within the year to
Australia or anywhere outside Greece. Negative social and eco-
nomic trends are already in sight, with poverty, homelessness
and crime accelerating rapidly. Soup kitchens have been set up
around Athens and are visited by even well-dressed Athenians,
working adults and those looking for work, who line up early in
the morning along with immigrants and the homeless. Combined
with dangerous ideological anti-immigrant sentiments (immi-
grant population in Greece is about 7%) and shifts to the extreme
right, such trends threaten to wreak havoc, dismantle social
c­ohesion and destabilise the nation. While the course of policy
action has been charted – with the very stringent austerity meas-
ures dictated by the EU/ECB/IMF – the question still remains:
what will happen to Greece in the years ahead?
On the eve of November 2011, Group of 20 summit, the ­Institute
of International Finance’s (IIF) managing director, Charles Dallara,
wrote to world leaders gathered in Cannes, France (http://www.
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iif.com/press/press+218.php) that the IIF believed the summit
“should focus squarely on setting out strong, convincing meas-
ures to revitalise growth”. Even this is on record saying so (on
several occasions, including as reported in Kathimerini, 30 Nov­
ember 2011). They know what “a lost decade” is all about; it hap-
pened in the 1980s and 1990s in many countries around the
globe and Latin America was especially hard-hit. Austerity pro-
grammes produce deep and prolonged recessions. Indeed it is the
reason they are implemented. They “help” reduce consumer
spending and trade deficits by lowering incomes and demand for
imports, reducing both external and internal imbalances by min-
imising government spending and shrinking the economy. But
the added pressure on Greece and the other eurozone highly in-
debted n­ations is that with no sovereign currencies, they are left
with no policy tools to use. No monetary policy, no ability to
m­onetise debt, no ability to borrow and no ability to devalue the
s­overeign currency. With no policy space for monetary policy,
counter­cyclical fiscal policy, currency devaluation and no central
bank to act as the lender of last resort, what remains? The means
of “rebalancing” the economy is to restart the engine of produc-
tion in a much smaller size economy, create a fire sale on all sorts
of productive assets and land, and lower employment costs that
will make investment profitable. Ultimately, this amounts to
i­nternal devaluation: suppressed wages and drastic reduction of
productive assets’ capital value.
This is the trajectory Greece is now on. As we will see, in what
follows, it is the wrong remedy. Besides “socialising” the cost by
spreading misery on even the most vulnerable segments of soci-
ety, this is not only a “Greek” crisis but also a eurozone crisis.
Greece and the European Monetary Union: A Closer Look
of What Each Party Contributes to the Crisis
Following the original rescue plan for ¤ 110 billion, a­nother
r­escue plan of 130 billion for Greece was crafted and approved by
the EU economic finance ministers (Ecofin) in late 2011. At the
insistence of Germany, the new rescue plan requires the private
sector investors (PSI) – mostly financial institutions – to accept a
voluntary “haircut” of 50% on their Greek sovereign debt hold-
ings. The PSI holdings of Greek debt is now 40% of the public
debt, representing a possible relief of only 20% (the PSI have been
resisting and have yet to agree to the plan). The remaining 60%
not subject to any haircut is or will be on the balance sheets of the
EFSF and the IMF. This 20% reduction is not large enough to
render the country’s remaining debt level sustainable. Our own
estimate for its sustainability requires a haircut that will r­educe
its total public sector debt by 60% or close to ¤ 200 b­illion. A
r­ecent article in Kathimerini reports that officials of IMF doubt
that the proposed 50% haircut of the PSI would render the coun-
try’s debt level ­sustainable.
Ongoing negotiations for disbursements of funds emanating
from the troika’s periodic reviews and the imposition of more aus-
terity have been met with more demonstrations and workers’ strikes
paralysing public administration and creating chaos. Attempting to
reverse the explosive climate of the European leaders’ intransigence
to continued and even harsher austerity, the then prime minister
(first) Papandreou announced last November that he would hold a
58
referendum on the new European rescue deal. The European leaders
were stunned and imposed a different dictum. The referendum
should be structured in such a manner so that the question should be
framed as: “Do the Greeks want to remain in the eurozone and meet
the country’s obligations or exit the euro”? The overwhelming
m­ajority of Greeks wants to stay in the eurozone.
Papandreou swiftly reversed course as the Europeans lost their
nerve and stock markets went into turmoil: What if Greeks cast a
vote of no to the euro? After a rebellion within his own Socialist
Party over the referendum, the prime minister ignored repeated
calls for resignation and immediate elections, but instead called
for a vote of confidence promising to resign and allow for a unity
government representing the main parties to be headed by a
technocrat. On 10 November 2011, former European Central
Bank vice-president Loukas Papademos was named the new
prime minister. In late 2011, the new prime minister had a new
budget approved for 2012 showing the budget deficit falling
sharply and even beginning to show a primary surplus. But this,
as we have argued here, is not a “Euro Success Story” that solves
Greece’s problems and prevents a larger eurozone crisis.
Greece lacks both an industrial base and the widespread avail-
ability of technology. It simply cannot be productive enough to
compete with neighbours like Germany, France, or the Nether-
lands. The expected “convergence” has not taken place. That it
could have taken place is yet another fantasy based on assump-
tions of allocative efficiency of investment. Without planning
that was guided by a strong government’s visible hand, markets
did not invest and did not generate jobs. The state, instead of en-
gaging and renegotiating high value-added agricultural produc-
tion and investment in energy, tourism and green technologies
kept absorbing surplus labour by adding new public sector jobs.
This is a failure of markets and public policy but to argue that the
public sector is “crowding-out” private investment is misleading.
The public sector has been making up for deindustrialisation and
the decline in agriculture. Textile manufacturing has migrated
on a large scale to Turkey. Cheap imports from China displaced
small-scale production enterprises, and financialisation has seen
the buy out, chopping up, parcelling out and overall reduction of
heavy industrial production. Tourism has been taken over by
g­lobal multinational concerns. These are globally-induced trends.
In a deep recession Greece does not have the resources to grow
out of it, even with an easing of its still-enormous debt level. As
discussed above, calls for reform and most of the austerity meas-
ures have huge social costs and will continue to remain ineffec-
tive from a macroeconomic standpoint.
As the financial market behaviour has shown, thus far, the
c­risis has spread to Italy, Spain and even France unless European
leaders greatly increase the funds available for bailouts. The
amount of ¤ 3 trillion has been suggested. To put that in perspec-
tive, the US collective bailout of its financial system after 2008
came to $29 trillion. The ¤ 1 trillion of the leveraged EFSF will
most certainly prove to be wishful thinking, if sovereign debt
goes bad. All the major European banks are too closely entwined
and will be hit – and so will the $3 trillion US money market
m­utual funds, which have about half their funds invested in
E­uropean banks. There is other US bank exposure to Europe with
february 4, 2012  vol xlviI no 5  EPW   Economic & Political Weekly

a potential of a total $3 trillion hit to US finance. No wonder the
US administration has taken a keen interest in Euroland, with the
US Federal Reserve ramping up lending to European financial in-
stitutions. This includes the December 2011 coordinated effort
with five other central banks to improve liquidity in the market
and bring down interest rates. Critics (of this move) point out that
despite the temporary infusion of cash into the system on the brink,
the temporary fix fails to address investors’ loss of confidence in
the ability of Greece, Portugal, Italy, and Spain to pay back loans.
The October 2011 initiative of the EU ordered Europe’s banks to
recapitalise to prevent this scenario. Are there sufficient private
investors to do so? Or will financial institutions need support
from their governments, creating yet a new layer of financial
d­emands on Europe’s taxpayers? There is also a provision to
i­ncrease the resources of the eurozone’s emergency fund, the
EFSF by leveraging its remaining uncommitted funds of approxi-
mately ¤ 250 billion (out of ¤ 440 billion) to a multiple reaching
the order of ¤ 1 trillion. The experience in the US has shown that
while leverage is great on its way up, it is painful on its way down.
Thus far, only vague ideas have been offered. The tricky deci-
sions – to say the least – on who will pick up which tab remain to
be worked out.
In the rest of this essay we want to briefly summarise the situa-
tion in Euroland. The main argument will be that the problem is
not due to profligate spending by some nations, and not even by
Greece, but rather with the set-up of the EMU itself. We will then
conclude that difficult times lie ahead if all remains as it is and
that there is a high probability that another collapse may be trig-
gered by events in Euroland. Finally, we will offer an assessment
of ­possible ways out.
The View from the Euroland2
It is becoming increasingly clear that the EU authorities are
merely trying to buy time to figure out how they can save the
f­inancial system from a cascade of likely sovereign defaults.
Meanwhile, they demand far-reaching reforms and austerity in
the periphery countries. They know this will do no good at all.
Indeed, it will increase the eventual costs of the bailout while
stoking north-south hostility. Leaders like German Chancellor
Merkel and French President Sarkozy are insisting on these
measures for purely domestic political consumption. If the EMU is
eventually saved, however, the rancour will make it very difficult
to mend fences.
To them, there is no alternative to debt relief for Greece and
other periphery countries. Even though Merkel reportedly told
her parliament that she could not exclude the possibility of a
Greek default – at the same time warning Greece that the rescue
package approved last October would not be enacted if Athens
failed to agree to deficit reduction targets – all her economic ad-
visors recommended significant debt relief for Greece. But Mer-
kel continues to insist that to punish profligate consumption
fuelled by runaway government spending and avoid moral
­hazard, austerity is necessary and if that forces default, so be it.
Even as Europe’s leaders were putting together the latest res-
cue package (the process started last July), the EU Parliament
voted to make sanctions more automatic on countries that
Economic & Political Weekly  EPW   february 4, 2012  vol xlviI no 5
SPECIAL ARTICLE
e­ xceeded Maastricht criteria, debts and deficits. Previously,
­although penalties were threatened, they were never actually
­imposed.
The recent higher yields on Italy’s sovereign bonds have
r­esulted in many voices singing the same tune in demanding the
country move more quickly to a balanced budget. They also
urged adoption of the favourite neo-liberal package of policies,
i­ncluding “full liberalisation of local public services”, “a thorough
review of the rules regulating the hiring and dismissal of employ-
ees”, “administrative efficiency”, and “structural reforms”. And
of course what they demanded has come to pass.
How Did the Euroland Get into Such a Mess?
While the story of fiscal excess is a stretch even in the case of
Greece, it certainly cannot apply to Ireland and Iceland – or even
to Spain. These nations adopted the neo-liberal attitude towards
banks that was pushed by policymakers in Europe and the
United States, with disastrous results. The banks blew up in a
speculative fever and then expected their governments to
­absorb all the losses.
Further, as Ambrose Evans-Pritchard (2011) argues, even
Greece’s total outstanding debt (private plus sovereign) is not
high: 250% of GDP (versus nearly 400% in the US); Spain’s gov-
ernment debt ratio is just 65%, and together with the private
level of 215% is higher than that of Greece. And while it is true
that Italy’s government debt ratio is high, its household debt ratio
of 105% is very low by western standards. Before the economic
crisis, only Greece and Italy significantly exceeded 60% of the
GDP Maastricht limit. However, the other countries in the euro-
zone had private sector debt ratios above 100% and by the time
the crisis hit, a good number of them including Spain, the Nether-
lands, Ireland and Portugal had ratios above 200%. To ­label this
a sovereign debt crisis is rather strange. Remarkably, Italy and
Greece have the lowest private debt ratios, which is not consist-
ent with the view that consumers in those nations are profligate.
As we discuss below, it is not surprising that these two nations
have this combination of relatively high government debt ratios
and low private debt ratios as these are related through the
“three sectors identity”.
If you take the west as a whole what you find is that over the
past 30 years there has been a long-term upward trend growth of
debt relative to GDP, from just under 180% of GDP in 1980 to al-
most 320% today. It is true that government has contributed to
that, growing from some 40% of GDP to about 90% – a doubling
to be sure. But the private sector’s debt ratio grew from a bit over
100% to around 230% of GDP.
The dynamics are surely complex, but it is clear that there is
something that is driving debt growth in the developed world
that cannot be reduced to runaway government budget deficits.
The obsessive focus on sovereign debt and austerity also betrays
a lack of understanding of the current account imbalances that
plague the eurozone. There is a nearly unacknowledged identity
that shows ex-post relations (without necessarily saying any-
thing about the complex endogenous dynamics): the domestic
private balance equals the sum of the domestic government
­balance less the external balance. To put it succinctly, if a nation
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runs a current account deficit, then its domestic private balance
(households plus firms) equals its government balance less the
current account deficit. To make this concrete, when Greece runs
a current account deficit of 10% of GDP and a budget deficit of 9%
of GDP its domestic sector has a deficit of 1% of GDP (roughly the
balances presently). Or if the current account deficit is 10% of
GDP and its budget deficit is 3% (the Maastricht limit) then the
private sector must have a deficit of 7% – running up its debt.
The proponents of austerity see the solution for these deficits
in belt-tightening. But that tends to slow growth, increase unem-
ployment, and hence increase the burden of private sector debt.
The idea is that austerity will reduce government debt and defi-
cit ratios, but in practice that may not work due to impacts on
the domestic private sector. Tightening the fiscal stance can
o­ccur in conjunction with reduction of private sector debts and
deficits only if somehow this reduces current account deficits.
Yet many nations around the world rely on current account sur-
pluses to fuel domestic growth and to keep domestic govern-
ment and private sector balance sheets strong. They therefore
react to fiscal tightening by trying to pass it on to the trading
partners – either by depreciating their exchange rates or by
l­owering their costs. In the end, this sets off a sort of modern
mercantilist dynamic that leads to a race-to-the-bottom policies
that few western nations can win.
Germany has specialised in such dynamics and has played its
cards very well. It has held the line on nominal wages while
greatly increasing productivity. As a result, in spite of reasonably
high living standards it has become a low-cost producer in
E­urope. Given productivity advantages it can go toe-to-toe
against non-Euro countries in spite of what looks like an overval-
ued currency. For Germany, however, the euro is significantly
undervalued – even though most euro nations find it overvalued.
The result is that Germany has operated with a current account
surplus that has allowed its domestic private sector and govern-
ment to run deficits that were relatively small. Hence Germany’s
overall debt ratio is at 200% of GDP, approximately 50% of GDP
lower than the eurozone average.
Not surprisingly, the “three sectors balances identity” hit the
periphery nations particularly hard, as they suffer from what is
for them an overvalued euro and lower productivity than what
Germany enjoys. With current accounts biased towards deficits it
is not a surprise to find that the Mediterranean countries have
bigger government and private sector debt loads. If Europe’s cen-
tre understood balance sheets, it would be obvious that Germa-
ny’s relatively “better” balances rely to a large degree on the pe-
riphery’s relatively “worse” balances. If each had separate cur-
rencies, the solution would be to adjust exchange rates so that the
debtors would have depreciation and Germany would have an
appreciating currency. Since within the euro this is not possible,
the only price adjustment that can work would either be increas-
ing wages and prices in Germany or falling wages and prices in
the periphery. But the ECB, Bundesbank and EU policy, more gen-
erally, will not allow significant wage and price inflation in the
centre. Hence, the only solution is persistent deflationary pres-
sures on the periphery. These dynamics lead to slow growth and
hence compound the debt burdens.
60
But if Germany refuses to inflate and if Greece and other
p­eriphery nations cannot depreciate their currencies, then debt
deflation dynamics become the only way to counter increasingly
non-competitive wages and prices.
Those non-competitive wages and prices almost guarantee
current account deficits that, in turn, according to the identity
explored earlier, guarantee rising debt – either by the govern-
ment or by the private sector. And if debt grows faster than GDP,
the debt ratio rises. Note that these are statements informed by
identities. They are not meant to be policy statements. But policy
cannot avoid identities. Reduction of deficits and debts in periph-
ery nations requires changes to balances outside the periphery. If
we want Greece, Portugal and Italy to lower debt ratios they must
change current account balances. That, in turn, requires that
some nations reduce their current account surpluses. For exam-
ple, if Germany was willing to run large current account deficits,
it would be easier for periphery nations to reduce domestic
deficit spending. A way to even out trade imbalances would be by
“refluxing” the surpluses of countries such as Germany, France
and the Netherlands to deficit countries by, for example, invest-
ing euros in them. Germany did this with the former East
G­ermany following reunification.
Proposed Solutions to the Euro Problem
Rather than doing the obvious, Europe’s centre insists on under-
funded bailouts plus austerity imposed on the periphery. But the
periphery is left with too much debt and at the same time, it faces
German intransigence on changing the internal dynamics. Given
these dynamics, debt relief – which might take the form of d­efault
– is the only way that Greece, Ireland, Portugal and perhaps
Spain and Italy can remain within the EMU. But it is not at all
clear that the nuclear option – dissolution – will be avoided. Even
the most mainstream commentators are providing analyses of a
Euroland divorce with a resolution ranging from a complete
break-up to a split between a “Teutonic Union” embracing fiscal
rectitude with an overvalued currency and a “South Union” with
a greatly devalued currency. In a recent poll, global investors put
a 72% probability on a country leaving the euro within five years
and over 75% expect a recession in Euroland within 2012 while
PIMCO thinks the recession has already begun (Kennedy 2011).
A report from Credit Suisse (2011) dares to ask “What if?”
there is a disorderly break-up of the EMU, with the narrowly de-
fined periphery (Portugal, Ireland, Greece and Spain) abandon-
ing the euro and each adopting its own currency. The report
paints a bleak picture. The currencies on the periphery would
depreciate, raising the cost of servicing euro debt and leading to
a snowball of sovereign defaults across highly indebted euro na-
tions. With the weaker nations gone, the euro used by the
stronger nations would appreciate, hurting their exports. That
would increase the pressures for trade wars, and for a Great De-
pression No 2 (the report puts this probability at an optimum
level of 10%). The report assumes Italy does not default, but if it
did, losses on sovereign debt would be very, very much higher.
With the assumption that Italy remains on the euro and man-
ages to avoid default, total losses to the core European banks
would be ¤ 300 billion and ¤ 630 billion for the periphery
february 4, 2012  vol xlviI no 5  EPW   Economic & Political Weekly

n­ations’ banks (excluding Italy), while the ECB’s losses would be
150 billion. This is serious money.
A popular but ultimately misguided proposal is to take the
EFSF’s funding as capital to create a sort of structured investment
vehicle (SIV) (following the instructive example of US mortgage
securitisers!) that buys sovereign debt and issues its own bonds
secured by the ¤ 440 billion bailout fund serving as equity. If
l­everaged, total funding available to buy risky government debt
could be several trillions of euros. But as we found during the US
crisis in mortgage-backed securities, leverage is great on the way
up, but very painful on the way down. When a crisis hits, the SIV
cannot continue to finance its position so it must sell assets into
declining markets. If leverage is eight to one, its capital is quickly
wiped out by a fairly small reduction (12%) of the value of its assets;
problems are reinforced by price reductions that lower capital
and reduced willingness of lenders to hold the SIV’s debt.
So this proposal only works if: (a) the SIV buys the assets at
fire-sale prices now, so that (b) the risks of further large price de-
clines are remote. If the SIV’s own debt is long-term, it does not
need to worry about refinancing its position. But that will make
the initial financing more expensive since the risk is shifted to
creditors. One of the reasons that the American SIVs seemed to
work is that they rely on very short-term, and thus cheap finance.
However, that permitted a run out of the SIVs as soon as the crisis
hit. In the case of this European proposal it is difficult to see why
lenders to the SIVs would prefer to get stuck in bonds that effec-
tively place highly leveraged bets on troubled assets. Anyone who
wants to take a chance on Greek debt can just go out and buy it.
Furthermore, the fate of EMU nations is highly interconnected –
with the exception of those with little debt plus Germany and
possibly France. If one of the dominoes falls, however, there will
be a run out of the other dominoes ending the charade.
A different solution offered by Jacques Delpla and Jakob von
Weizs�������������������������������������������������������
a������������������������������������������������������
cker (2011) would pool a portion of each member’s gov-
ernment debt – equal to the Maastricht criterion of 60% of GDP.
This would be allocated to a “blue bond” classification, with any
debt above that classified as the “red bond”. The idea is that the
blue bonds would be low risk, with holders serviced first. Holders
of red bonds would only be paid once the blue bonds are serviced.
About half the current EMU members would have quite small is-
sues of red bonds; about a quarter would not even be close to
their limit on blue bond issues at current debt ratios.
The proposal draws on the US experiment with “tranching” of
mortgages to produce “safe” triple-A mortgage-backed securi-
ties protected by “overcollateralisation” since the lower-grade
securities supposedly took all the risks. Needless to say, that did
not turn out so well. The idea is that markets will discipline debt
i­ssues, since blue bonds will enjoy low interest rates and red
bonds will pay higher rates. Again, the US experience proves
that markets are far too clever for that. If anything market dis­
cipline delivered precisely the opposite. The risks on the lower
tranches were underestimated and vastly underpriced. In search
for yield, financial institutions held onto a lot of trash. Still, this
proposal should not be dismissed. Since the scheme has some
potential if the full faith and credit of the entire EMU (including
most im­portantly that of the ECB) were put behind the blue
Economic & Political Weekly  EPW   february 4, 2012  vol xlviI no 5
SPECIAL ARTICLE
bonds, and substantial non-market discipline (strong and en-
forceable regulation) was put on the red bonds.
Yanis Varoufakis and Stuart Holland (2011) have issued a simi-
lar proposal in that the ECB would buy member sovereign debt in a
volume up to 60% of the member’s GDP. These would be held as
eurobonds and nations would continue to service them, albeit at a
lower rate to reflect the ECB’s lower costs of issuing its own liabili-
ties. By moving so much debt to the ECB, nations would meet the
Maastricht criteria (excluding Greece) that would be applied only
to remaining debt outstanding in markets. The ECB, in turn, could
sell Eurobonds to provide liquid and safe euro-denominated debt
to markets; attracting foreign investors, especially central banks
and sovereign wealth funds. That would help to finance the Euro-
pean Recovery Programme, providing new funding to the Euro-
pean Investment Bank. So Varoufakis and Holland not only ad-
dress the current insolvency problems, the recapitalisation and
Europeanisation of the banking system, but also tackle the prob-
lem of recovery. Our preferred solution would involve a similar
i­ssuance of bonds backed by the ECB, as we will describe below.
After the failure to expand the EFSF from ¤ 440 billion to
the trillions needed to backstop Italy and Spain, the European
Commission (EC) proposed an alternative to allow every euro-
zone country to issue “Eurobonds” guaranteed by all 17 members
with the requirement that the Commission would control
n­ational budgets.
Even the IMF has come out with its own strategy in creating a
fund to lend to troubled eurozone member nations financing it
through loans from the ECB. This would ingeniously circumvent
the Maastricht treaty’s rules against bailouts and the purchase of
new government bonds. It will, however, entail the control of
n­ational budgets of the borrowing member states by both the
commission and IMF with conditionalities and sanctions.
The EC and IMF proposals would deny governments the ability
to institute their own tax and spending policies. The civil disobe-
dience in Athens and other European cities suggest what would
happen if the Brussels bureaucracy and German ­finance ministry
came to have veto power over national economic policies (Feld-
stein 2011).
A Path to Recovery
The proposed solutions, for Euroland and Greece in particular,
are difficult because as discussed above, these nations do not
i­ndividually have the fiscal capacity to deal with their problems.
So when the signals from the institutions charged with running
the EU inspire no confidence, it becomes imperative to consider
alternative strategies. Greece’s exit from the euro either as a tem-
porary or permanent strategy has been suggested by many eco­
nomists, both from the left and right (Roubini 2011; Feldstein
2011). The transition would be disruptive, with near-term costs.
We should expect an immediate devaluation of the national cur-
rency, inflationary pressures, runs on its banks and their nation-
alisation together with perilous economic and social trends
­characteristic of a dysfunctional economy. The benefit would be
to create domestic fiscal and monetary policy space to deal with
the crisis. Default on euro-denominated debt would be necessary
and retaliation by the EU is possible. However, in our view, this is
61
SPECIAL ARTICLE
preferable to the two currency scheme discussed above – which
would simply tie Greece to another external currency. It would
have no more fiscal or monetary policy space than it now has,
a­lbeit with a currency that would be devalued relative to the euro.
If dissolution is not chosen, then the only real solution is to re-
formulate the EMU. Many critics of the EMU have long blamed the
ECB for sluggish growth, especially on the periphery. But a com-
parable analysis of the ECB and the US Federal Reserve interest
rate policy showed that the real problem is in the set-up of the
EMU with fiscal policy constraints (Sardoni and Wray 2005). The
eurozone architecture even though it resembles the US states, dif-
fered in two key ways: first, while US states rely on inter-regional
redistribution channels to households for social welfare expendi-
tures (health, retirement, poverty alleviation programmes) and
expenditures for the military from Washington, commanding
a budget (from tax revenues) of more than 20% of US GDP, and
usually running a budget deficit of several per cent of GDP that
contrasts sharply with the EU Parliament’s budget of less than 1%
of GDP. While individual nations tried to fill the gap with deficits
by their own governments, these created the problems we see
t­oday. As deficits and debt rose markets reacted by increasing
i­nterest rates, precisely because they recognised that unlike the
sovereign countries like the US, Japan, or the UK, the EMU mem-
bers were users of an external currency.
Once the EMU weakness is understood, it is not hard to see the
solutions. They include ramping up fiscal policy space of the EU
Parliament – for example, increasing its budget to 15% of GDP
with a capacity to issue debt. Whether the spending decisions
should be centralised is a political matter. Funds could simply be
transferred to individual states on a per capita basis.
ECB rules could also be changed to allow it to buy an amount
equal to a maximum of 6% of Euroland GDP each year in the form
of government debt issued by EMU members. As the buyer, it can
set the interest rate. It might be best to mandate that at the
ECB’s overnight interest rate target or some mark-up above the
target. Again, the allocation would be on a per capita basis across
the members.
One can conceive of variations on this theme, such as creation
of some EMU-wide funding authority backed by the ECB that i­ssues
debt to buy government debt from individual nations – along the
lines of the blue bond proposal. What is essential, however, is that
the backing comes from the centre. The ECB or the EU stands b­ehind
the debt. That will keep interest rates low, removing “market disci-
pline” and vicious debt cycles due to exploding interest rates. With
lending spread across nations on some formula (i e, per capita)
every member state should have the same interest rate.
All of these are technically simple and economically sound
proposals. They are politically difficult. The longer the EU waits,
the more difficult these solutions become. Crises only increase
the forces of disunion or dissolution, increasing the likelihood of
eventual divorce and increasing hostility that in turn forestalls a
real solution and makes a Great Depression even more probable.
Conclusions
The grand experiment of a unified Europe with a shared common
currency has run its course. If the current trajectory continues,
62
the disintegration of the euro is inevitable. The newest “rescue
plan” embraced by Greece and now set to be enforced by the
technocratic prime minister, Loukas Papademos, certainly will
not save the system, and it will not save Greece from a sovereign
default. The bailout conditions demanded by the troika that
holds the purse strings include continuous surveillance of the
country’s adherence of the agreed reforms and austerity meas-
ures. Their periodic progress reviews will show that Greece has
no hope of meeting its targets.
Greece’s sovereign debt problem is not limited to Greek lenders
solely, but it affects the entire eurozone, requiring a eurozone-
wide solution. The immediate problem of Greece can be resolved
along the lines of the US programme, buying bonds to calm vola-
tility – as the ECB has been performing but going to pains denying
it – until a bold, permanent solution is crafted. The ECB’s message
would quickly calm the financial turbulence and solve the euro-
zone markets problem. But such a bold approach is not forthcom-
ing from the ECB or from the continuing uninspired leadership of
Germany and France.
European Union politicians and the IMF are cognisant of the
fact that irrespective of the success or failure of the harsh auster-
ity, the country’s debt level is increasing while the European
f­inancial system remains at risk and will, in all likelihood, see the
unravelling of the euro project. In November 2011, newly r­evised
and updated figures indicated deficit reduction targets are not
met. In the meantime, the proportion to tax revenues dedicated
to repayment of debt obligations paints a rather grim picture. Ac-
cording to the “Public Finance Monitor” semi-annual, the IMF fig-
ures tell the story: the debt to GDP ratio increased from about
122% of GDP in 2009, to 145% in 2010 to an estimated 166% in
2011, and will reach 189% of GDP in 2012.
Notwithstanding these projections, it is remarkable that
­German Chancellor Merkel has not already recognised that, as
the EU’s largest exporter, her insistence on fiscal austerity for its
troubled neighbours is a losing proposition. Ireland, the poster
child of the eurozone’s austerity drive, saw its economy shrink in
the third quarter of 2011. Yet, Merkel praised Ireland as an “out-
standing example” of a country that has fulfilled the terms of its
bailout (Chu 2011).
In a climate of denial, the ECB is keeping the show on the road,
but the cascade across the continent of credit downgrades will
keep yields and credit default swaps increasing. The political fall-
out will quickly become unworkable for both stronger and
weaker nations.
So in sum, the collapse of the euro project will evolve in one of
two ways. First, and looking increasingly likely, and least desira-
ble, is that nations will leave the euro in a coordinated dissolu-
tion that might ideally resemble an amicable divorce. As with
most divorces, it would leave all the participants financially
worse off. But it will give back sovereignty for charting alter­
native course of action to countries that needed it badly, includ-
ing Greece.
Second, and less likely, but more desirable, would be a major
European institutional and economic restructuring. The doomed
rescue plans we are seeing do not address the central problem.
Nations like Greece are not positioned to compete with countries
february 4, 2012  vol xlviI no 5  EPW   Economic & Political Weekly
 SPECIAL ARTICLE

that are more productive, like Germany, or have lower produc-
tion costs, like Latvia. Any workable plan to save the euro has to
address those differences.
The founding of the EU was a political venture that emerged
from the ambitious heads of the two leading continental powers,
Germany and France. Their creation grew into a promising
e­conomic laboratory. It is ironic that it is the absence of political
action by them that makes the union unsustainable. Their refusal
to consider EU as an entity with a unified fiscal policy and a fully
functioning central bank that includes the function of lender of
last resort and its mandate goes beyond addressing the German
fears of inflation, might turn out to be the EU’s endgame.

Notes publications/publication-detail/publication/ A Solution?”, 8 December.

1 Much of the information here can be found in the
Financial Times, “Interactive Timeline: Greek Debt
Crisis”, http://www.ft.com/intl/cms/s/0/003cbb92-
4e2d-11df-b48d-00144feab49ahtml#axzz1g2
YDOOAO and draws mostly from various issues of
Kathimerini, a daily premier Greek newspaper,
http://www.ekathimerini.gr/.
2 The sections hereafter are drawn largely from
­Papadimitriou and Wray (2011), Papadimitriou
et al (2011) and Antonopoulos et al (2011).
References
Antonopoulos, R, D Papadimitriou and T Toay (2011):
“Direct Job Creation for Turbulent Times in
Greece”, a report prepared for the Observatory of
Economic and Social Developments of the Labour
Institute of the Greek General Confederation of
Workers, available on the Levy website, http://
www.levyinstitute.org/publications/?docid=1458
Chu, Ben (2011): “Austerity Discredited: Ireland Goes
into Reverse”, The Independent, 17 December.
Credit, Suisse (2011): “Global Equity Strategy”, Global
Equity Research, 23 September.
Delpla, J and J von Weizsacker (2011): “Eurobonds:
The Blue Bond Concept and Its Implications”,
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implications/
Evans-Pritchard, A (2011): “Frau Merkel, It Really Is a
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Feldstein, M (2010): “Let Greece Take a Eurozone
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Debt Crisis in Greece and the Eurozone: Is There
– (2011b): “The Achilles’ Heel of the Eurozone”, Los
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Papadimitriou, Dimitri B and L Randall Wray (2011):
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Up Speed”, Levy Economics Institute, Working
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Papadimitriou, Dimitri, L Randall Wray and Yeva Ner-
siyan (2011): “Endgame for the Euro? Without Ma-
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Economics Institute, Public Policy Brief No 113,
Levy Economics Institute, July.
Roubini, N (2011): “Greece Should Default and Aban-
don the Euro”, Financial Times, 19 September.
Sardoni, C and L R Wray (2005): “Monetary Policy
Strategies of the European Central Bank and the
Federal Reserve System of the US”, Working Pa-
per No 431, Levy Economics Institute of Bard Col-
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Stearns, J (2011): “EU Stiffens Deficit, Debt Rules to
Prevent Further Crises”, Bloomberg, 28 Septem-
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deficit-rules.html
Varoufakis, Y and S Holland (2011): “A Modest Pro-
posal for Overcoming the Euro Crisis”, Policy
Note No 4, Levy Economics Institute of Bard Col-
lege, Annandale-on-Hudson, NY.

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Who will turn the spotlight on the Media?

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Economic & Political Weekly  EPW   february 4, 2012  vol xlviI no 5 63