Sometime this European summer the Greek government will default on its euro debts and attempt to manage an exit from the common currency. This will not occur because people want it (though some do), nor because it is the wisest policy (it is not). Fault and exit will occur because they cannot be prevented.
This outcome has been over a decade in the making. After an uneven performance in 1990s, economic growth in re-unified Germany declined during the first five years of the Schroeder government (see Figure 1). In response to this decline, the Social Democratic government embarked on an export-led growth strategy. This strategy was based on an agreement with trade unions for real wage restraint, reduction of labor protection to allow for a lower wages in a segmented labor market, and de facto export subsidies through tax incentives linked to exports.
The growth rate recovered, with as much as three-quarters of the recovery due to export growth (Figure 2). The major determinant of the export growth itself, again about three-quarters of the change, was unit labor costs, which either declined or grew slowly (Figure 3). As one would suspect, a large portion, about one-half, of the change in unit labor cost resulted from nominal wage changes (Figure 4). Simple multiplication suggests that we can attribute one-quarter of Germany’s growth performance to the policy of real wage suppression (.75 x .75 x .5 = .28 or 28%). A planned or unplanned side effect of the wage repression was slow import growth in Germany, implying an increasing trade surplus.
Figure 1: GDP growth in Germany, 1992-2011
Note: All statistics from www.oecd.org
Figure 2: Percentage change in real export growth and GDP growth in Germany, 1992-2011
Figure 3: Percentage change in real export growth and nominal unit labor cost in Germany, 1992-2011
Figure 4: Percentage change in nominal unit labor cost and nominal wages in Germany, 1992-2011
Because most of Germany’s exports went to other members of the European union, an export-led growth strategy necessarily implied an import-led outcome by the other countries. In 2000 Germany had a positive trade balance of US$ 6 billion, and the other euro zone countries generated a combined positive balance of US$ 33 billion (see Figure 5). Two years later both balances had grown, to 92 and 77 billion, respectively. Then, the German government’s export-led growth strategy kicked in. By the start of the financial crisis in 2008 the German balance had grown to 227 billion, while the balance for the others had dropped to minus 95 billion (see Figure 6). The beg-thy-neighbor growth strategy had run its unnatural course.
The growth strategy of the Social Democratic government, continued with zeal by Angela Merkel’s coalition, represented a crisis of the euro in the making. The widening trade gaps went from problem to disaster when the financial crisis hit. By the end of the decade the only question was, which country will take the first hit. The first would be Greece, because it was the only euro member to have both a large trade deficit and a large fiscal deficit (the latter about seven percent of GDP in 2007, going to ten percent in 2008 and 16 in 2009). At this point the subsequent European disaster was in train, as a few at the time recognized. Like Cassandra they went unheeded. The only uncertainty about the eventual outcome would be, when would Greece be driven to default and exit?
When the inevitable Greece insolvency occurred in the first half of 2010, the obvious short term solution was to suspend or amend the charter of the European Central and have the ECB purchase the entire Greek debt. This would have avoided disaster by limiting the Greek adjustment task to trade competitiveness. The triad of the German government, the European Commission and the International Monetary Fund chose instead to enforce an austerity policy that no government could implement, and, if implemented, would have made servicing the public debt impossible. Greek default and exit from the euro was now a question of how soon.
Having sent financial speculators the clear signal that it would not protect Greek bonds, the German government and the EC, but not apparently the IMF, appeared surprised by the spread of the crisis to Italy, Spain and Portugal (the spread engendering the acronym “PIGS”). Far from prompting a reconsideration of policy, this so-called contagion would bring an increasingly hard line from Berlin and Brussels (supported by secondary and minor henchmen in Austria, France, the Netherlands and Finland).
When the elected Greek government failed to implement successfully the impossible, was replaced by an unelected one, the first such event in Western Europe since World War Two. The reward to the Greek government of two years of dutifully attempting to implement impossible austerity would be economic collapse and a public debt beyond management (Figure 7). A public debt that during 2000-08 averaged 115 percent of GDP would rise to 133 percent in 2009, 150 percent in 2010, and 165 percent by the end of 2011.
Figure 5: Balance on trade in goods and services, Germany and the other euro countries, 2000-2011 (US$ bns)
Figure 6: Goods and services balances of the “PIGS”, 2000-2011, ($US bns)
Figure 7: GDP growth & the public debt as percentage of GDP, Greece, 1996-2011.
The final element to fulfill disaster came when at the G8 meeting and then the summit of euro countries this week. The German Chancellor reaffirmed her refusal to consider the only possible measure ot avoid default by the Greek government, immediate debt reduction through “forgiveness” or radical rescheduling. Having long anticipated this refusal, major banks throughout Europe and especially in German had prepared, mainly by increasing their asset base with cheap credit from the ECB. One of the ironies of the coming Greek default would be that credit creation by the ECB, ostensibly intended to help avoid default, would facilitate it.
On 17 June 2012 an election will occur in Greece. The subsequent government, if one can be formed, will default (if creditors do not force it before the election). If the Left forms a government it will attempt to manage the default in a rational manner. It is possible that foreign leaders of the likes of David Cameron along with the financial press will induce sufficient fear in the Greek electorate to bring the usual suspects back to government. If so, the default will be chaotic as the same old crowd continues the charade of servicing the public debt under watchful eyes in Berlin and Brussels.
A sensible response to the Greek insolvency in May 2010 could have avoided default; indeed, the possibility would never have arisen. Introduction of a common euro bond as late as mid-2011 would have ended the crisis of the euro and simplified the Greek problem to balance of payments adjustment (albeit a major adjustment). Last week Angela Merkel might have opened the G8 meeting with the dramatic announcement that her government would immediately guarantee the Greek debt, support a common euro bond, and convene a meeting of EU heads of governments to embark on an expansionary fiscal policy.
None of that happened. There was no reason to expect any of these rational steps to be taken. The Greek default and exit are a disaster foretold, and what happens after is anyone’s guess.