To the great consternation of much of the eurozone leadership, the Greek people voted overwhelmingly to reject the austerity package that they had been offered. While this was a strong show of support for Syriza, the governing party, it is far from clear where it will lead.
The best solution would be a turn by the eurozone leadership away from austerity. The eurozone economy has recovered from the low points of the recession, but is still far below its potential. As a result millions of people across the eurozone are needlessly unemployed. Taken as a whole, the eurozone economy is still smaller than it was in 2008 before the crisis hit. As a result, employment is down by more than 3 million from its pre-recession level even as the population of the region has grown.
And the impact of this continuing weakness has not been even. Germany and Austria both have unemployment rates that are comparable or lower than their pre-recession level. On the other hand, Spain, Italy, Ireland and of course Greece struggle with double digit unemployment. It is important to realize that the weakness of the eurozone economy is the main factor behind Greece’s deficit problems, not its refusal to curtail its profligate spending.
The I.M.F. estimates that Greece’s structural deficit has been reduced by more than 15 percentage points of GDP since 2008. This is the equivalent of a reduction in the annual deficit in the United States of almost $2.7 trillion, or more than $30 trillion in our standard 10-year budget window. The reason this deficit reduction has not led to balanced budgets for Greece and a shrinking debt is that the spending cuts and tax increases used to reduce the deficit also shrank Greece’s economy.
Less spending in an economy means less demand. When the government reduces its spending, as it has in a big way in Greece, this means less money going to hire workers, pay contractors, or to pay for pensions. The same story applies with taxes. When the Greek government increased its taxes, it pulled money out of consumers’ pockets leaving them with less money to spend.
Due to the shrinking of Greece’s economy, even though the government hugely cut spending and raised taxes, the country still faces the budget deficit. This is because unemployed people are not paying taxes, nor are businesses that are losing money. Similarly, the inability to get a job causes formerly employed people to get unemployment benefits and for many older workers to retire early and start drawing their pensions.
This backdrop is important. Germany and other countries are not lending money to the Greeks to support their profligate lifestyles, they are lending money to Greece to allow the country to get through the austerity that its creditors have imposed on the country. If Greece’s economy was allowed to grow, then it would not be facing a budget deficit.
This gets to the heart of both the economics and the morality of the situation. Germans and others in northern Europe may hate the idea of their hard-earned euros going to “lazy” Greeks and other southern Europeans. But it is only because of the economic policies of the northern Europeans that the southerners are running deficits. So if the Germans are angry that their money is going to people in other countries, they should direct their hostility first and foremost at their own leaders. If Germany had supported more expansionary fiscal policy across the eurozone, which means having relatively rich countries like Germany run larger deficits to boost the poorer countries, then the poor countries would have no need of handouts from Germany.
As a practical matter, it appears that the Germans and their allies are as dug into their positions as deniers of global warming. They care little about the evidence, even the research from the I.M.F. showing the harm from austerity.
Faced with the reality of continuing austerity and intransigence from leaders of the eurozone, the Greek government should be making plans to return to the drachma. There is no doubt that leaving the euro will not be easy, but staying with the euro is a guarantee of indefinite depression. There is always the hope that German Chancellor Angela Merkel and other leaders in the eurozone may learn economics and change their tune, but you would not want to bet a country on such an unlikely event.
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