Greek Tragedy’s Final Act Still to be Staged

Greek Tragedy’s Final Act Still to be Staged

On July 12th, the Greek government and its creditors reached an agreement, avoiding a Grexit for now, and the world stock markets breathed a sigh of relief. However, on Monday the Athens Stock Exchange opened and proceeded to drop 23%. Bank stocks lost the maximum of 30% for the day. This selloff is probably a better gauge of the work that lies ahead before Greece’s troubles are in the past. After Greece’s Prime Minister, Alexis Tsipras, pushed the Greeks to vote against austerity, he then quickly agreed to all the austerity measures. For more information on the agreement, please read Steve’s blog.

The terms are stiff, but most are essentially the same as those agreed to in 2010, so Greece’s ability and willingness to meet these terms has to be questioned. Their current debt-to-GDP is about 180%, which is probably not sustainable. However, beyond a reduction in debt, Greece needs to change the way its economy is structured if it is going to succeed. Greece has been in some sort of default or rescheduling 25% of the time during the past 200 years. Clearly, the system is not working. Greece has to move its budget from a deficit to a surplus. To do this, it must increase revenues, reduce government spending, and reform the pension system.

The tax-to-GDP ratio, at 32%, is nearly eight percentage points below the EU average. Tax collection needs to be improved and the fight against tax evasion must be strengthened. While the tax base needs to be simplified and widened, the primary problem is tax evasion. Increasing tax collection would improve the budget meaningfully.

The dramatic rise of public expenditure between 2006 and 2009 is the main cause of the deficit. Greece needs to enhance budgetary control over public entities and restructure loss-making state owned enterprises (SOEs). Over the years, the use of SOEs as a source of patronage has rendered large segments of the sector overstaffed. At the same time, there are wide technology gaps relative to other countries. The resulting combination of relatively high labor costs and low productivity explains the poor performance in utilities, transportation and finance, where SOEs are dominant.

To ensure the long-term financial viability of the pension system, which is among the most generous in the OECD, it has to be reformed. According to the most recent long-term projections, pension spending is expected to rise by more than 12% of GDP by 2050, compared with less than 3% of GDP in the average of other EU countries.

None of these reforms are easy, but if Greece wishes to build a durable economy, at some point these reforms will have to be made.

Germany, which has been the toughest negotiator and is holding Greece’s feet to the fire, is not innocent in all this. German banks were eager to lend to Greece in order to keep their export driven economy humming. Roughly 40% percent of Germany’s GDP comes from exports (in the U.S. it’s about 13%), and about half of that stays within Europe. By blindly lending to Greece, German employment and growth have benefited. Additionally, the absence of Greece and other weaker countries from the Euro would automatically cause the currency to appreciate, making German goods less competitive in world markets. It’s no wonder that Volkswagen is now the world’s largest car manufacturer.

While the global equity markets have responded favorably to the agreement, expect much wrangling in the coming days with no resolution to Greece’s main problems. Long-term, our view remains the same. We see an exit strategy for Greece as the most likely outcome. Without a free floating currency to devalue, it is hard to see how Greece can become economically competitive. Before this happens, however, more hard decisions are going to be pushed off into the future and our Greek tragedy will play on.


Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

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