Who is Paying for the Greek Island?

GG 2020 - 30th April 2010

by Rainer Breul

Similar to my colleague Rajeev who applied his engineering skills to analyze the financial crisis last week, I feel obliged to go back to my original field of studies to take a fresh look. From the perspective of a political scientist the question of the half-empty/half-full glass is not whether the glass should have been constructed in a different way. What I want to know is: Who drank the first half? Who is going to get the second half? And even more important: Who is buying the next round?

This last question is the most worrying to me. The first wave of the financial crisis has shaken the financial sector and caused a slump in the real economy, from which we seem to be slowly recovering, but the crisis has also dramatically reduced the capacity of governments to act. The rescue of the banking sector, sinking tax income and the economic stimulus packages have led to an unseen deterioration of public finances in the developed economies. In many developed countries public debts have already become or are on the brink of becoming unsustainable. Deutsche Bank predicts that the public-debt-to-GDP ratio in developed markets will soar to 133% in 2020 from just over 100% in 2010.

In other words, governments no longer seem to have the means to pay for the next round. Even worse, they have to start looking for ways to get their money back from the first round. For a political scientist this looming sovereign debt crisis is troublesome in two ways:

Firstly, high public debt is severely limiting the policy options for any national government and thus democratic choice. Public discontent and reduced trust in the effectiveness of the current political regime are likely consequences. Combine distrust in the government with the necessity to increase public income, i.e. as taxes, and to cut public spending, i.e. pensions, road repairs or social welfare, and you have just the perfect ingredients for social unrest and political instability.

Secondly, with increasing political discontent and pressure at home the marge de manoeuvre for governments to compromise on the international scene narrows. National policy makers will be looking for scapegoats and ways to regain control over economic policy. That does not bode well for a situation in which we need more global public policy and shared sovereignty than before to regulate what has become a truly global financial market.

Let me illustrate my worries with the example of Greece. Its public debt currently stands at about 123% of GDP. According to a recent model Greece would have to run a budget surplus of 4 % per year for the next ten years in order to reduce its debt to pre-crisis levels (2007) Make it a 8,2% budget surplus for Greece in order to meet the Maastricht criterion of 60% debt-to-GDP-ratio by 2020. Just to remind you, in 2009 Greece ran a budget deficit of 13,6% of GDP.

Within the framework of the EU‘s growth and stability pact Greece public finances are de facto no longer run by the Greek government. The government can merely implement what is imposed by the EU if it wants to avoid further sanctions. The forthcoming €45 billion joint rescue package of the EU and the IMF will further reduce the public choice options of Greece. The government has started to painfully cut pensions and public salaries. But even if the Greek growth prospective was robust (the GDP is predicted to shrink by 4% in 2010) it had a long way to go.

For the time being the Papandreou government can blame the prior team for failing to address the looming problem for too long. But for how long will the Greek electorate accept to pay for the mistakes of the past? For how long will the public support a government which is not able to make their own choices on public spending?

Admittedly, Greece is an extreme example and not all developed countries are in such a bad shape. At the same time, though, the public debt of the United States and the United Kingdom increased by over 30% during the past three years. The looming crisis of public finances in the developed world needs to be addressed, otherwise what has happened in the financial sector may have just been the prelude to something bigger.