Greece: Back To A Fiscal Disaster Zone

In my book Industrial Poverty: Yesterday Sweden, Today Europe, Tomorrow America, I analyzed the causes and consequences of what was then an ongoing fiscal crisis in the European Union. I pointed to how several countries – far more than what the public narrative in America would suggest – were subject to harsh austerity measures in the wake of the Great Recession. These measures were suggested by the EU in line with the Union’s constitution, which prescribes fiscal measures to avoid excessive budget deficits and government debt.

In some countries, the EU joined forces with the European Central Bank and the International Monetary Fund to enforce harsh fiscal policies, with sharp tax hikes and crippling cuts in government spending. Greece was not the only country subjected to such measures, but it was by far the worst example. The fiscal iron fist has been holding the Greek economy in a chokehold since the first austerity measures went into effect in 2010; today, when America finds herself on the brink of a major fiscal crisis, it is time to take a look back at what happened to Greece, where the country is today – and what we can learn from their experience.

Austerity: The Theory

To begin with, it is essential to establish what we actually mean by “austerity”. The term is revered among many libertarians who think that austerity means that you liberate the economy from the burden of big government. This is a mistake, and it is based in large part on the inability among libertarian pundits to distinguish between government spending and taxes. Austerity means, simply, that government tries to close a budget deficit by cutting spending, or raising taxes, or both. Unfortunately for my libertarian friends, all three versions have the same effect:

  • Spending cuts at constant taxes means government gives back less to the economy of every dollar it takes;
  • Tax hikes at given spending means government raises the price – charges more – for every dollar it gives back to the economy;
  • A combination of the two means you absolutely raise the cost of government while giving less back.

One way to understand these effects of austerity is to think of a Ford dealer that wants to sell you a new 2017 Explorer but wants you to pay the same price as for a new 2022 example.

In other words, austerity does not shrink government. It makes government more expensive. Economic doctrinaires from the Austrian background will protest and say that when government cuts spending, it leaves more resources out there in the economy for the private sector to use. They point, e.g., to laid-off government workers who are now free to be scooped up by private employers who can then expand their businesses and help grow the economy.

The only problem is that those private businesses still pay the same high taxes. Even if the austerity measures consist exclusively of spending cuts, the private sector is not better off as a result. Consumers do not have more money; businesses do not have less of a government burden to carry. On the contrary, given the structure of the government spending cuts, the private sector can actually see its costs of operation and of living go up. If government runs the health care system and reduces the number of doctors, nurses and other employees, then health care quality declines, waiting lists grow longer and households lose income when they have to stay away from work longer while waiting for medical treatment. Employers find themselves crippled when employees cannot return to work as quickly as they could before.

To deal with a situation like this, the private sector now has to take money out of its other spending commitments and divert it to alternative paths to medical care. This reduces spending elsewhere, contributing to economic stagnation rather than economic growth.

The more areas of the economy that government spends money on, and therefore the more areas government pulls back from without cutting taxes, the more of this re-allocation of scarce private money we will see. Just imagine the effects on the economy if spending cuts on public schools force families to reduce workforce participation to homeschool their kids. Or cuts in Social Security force consumers to considerably increase their retirement savings.

None of this is an argument against reductions in the size of government. It is, however, an argument against doing it by means of austerity; the correct way to reduce the size of government is to do it structurally, through reforms that permanently reduce both spending and taxes. I am not going to discuss such reforms today; for those who are interested, I published a collection of papers back in 2012 about structural spending reform.

In addition to understanding the fiscal and macroeconomic mechanics of austerity, it is important to see what those mechanics tell us about the policy purpose behind austerity. When the size of government does not shrink – when the only result is an increase in its price to the private sector – it is because the purpose is not to shrink government but to preserve it. Governments implement fiscal austerity because they want to save as much as they can of government programs in an economy with a weaker tax base.

In short: austerity is the fiscal equivalent of what Cinderella’s stepsisters did to be able to wear the famous glass slipper.

Greece Today: A Macroeconomic Overview

The bulk of the Greek austerity experience took place in 2009-2014. It did not end there, but that was when the harshest budget cuts and most crippling tax hikes went into effect. I account for them in detail in my 2018 two-part series for Prosperitas on the Greek lessons for America; see Part 1 and Part 2.

Figures 1a and 1b report government spending, tax revenue and budget deficits as share of current-price GDP. Starting with the deficit, prior to the austerity campaign it was as chronic as the U.S. budget deficit:

Figure 1a

Source of raw data: Eurostat

The elimination of the budget deficit came at a heavy price:

  • Taxes rose as share of GDP from 38.9 percent in 2009 to 49.5 percent in 2013, a combination of massive tax hikes and an imploding GDP;
  • Spending increased at first, 47.1 percent of GDP in 2007 to 62.9 percent in 2013, due to the entitlement structure of the welfare state which obligates government to spend more the worse the economy is doing;
  • When austerity finally caught up with the welfare state, the Greek parliament cut spending from the extreme 2013 level down to 48.5 percent in 2017.

Figure 1b

Source of raw data: Eurostat

Since 2016 the Greek government has been able to balance its budget (the 2020 artificial economic shutdown being an expectable exception), but this has come at an enormous cost for the economy. The tax hikes and spending cuts have taken such a big toll on the Greek economy that adjusted for inflation, in 2019 it was just one percent bigger than it was in 2000 and three percent smaller than in 2001:

Figure 2

Source of raw data: Eurostat

The big decline happened in 2009-2014, a period during which Greece lost 26 percent of its GDP, as much of its private consumption – and 63 percent of its business investments (all figures adjusted for inflation).

It is absolutely exceptional for a developed country to lose one quarter of its economy, especially in peace time. What is even more disturbing is the the Greeks have not been able to recover, having lost two decades’ worth of standard of living.

Imagine earning the same money you did 20 years ago while paying today’s cost of living.

The Greek economy has undergone another remarkable, and equally troubling transformation. Its youth has left the country in droves: in 2019 the total workforce aged 15-24 amounted to 234,000 individuals; in 1999, that same demographic equaled 583,000. In other words, over the past two decades Greece has lost 60 percent of its youth workforce.

This has happened in two phases, the first taking place during the time period (1) in Figure 3 below. Already in the late ’90s Greek youth began looking for work in other EU member states. This trend continued into the 2000s: from 1999 to 2009 the Greek youth workforce fell by 36.4 percent. The decline continued during the tougher austerity episode, (2) in Figure 3, with a 17.5-percent drop from 2009 to 2014.

As yet more evidence of how the Greek youth have lost hope for a future in their own country, from 2014 to 2019 the youth workforce fell by 72,000 individuals. By 2019, again, the number of young workers in the Greek economy was 60 percent lower than it was two decades earlier:

Figure 3

Source of raw data: Eurostat

This almost unprecedented loss of hope among an entire generation is backdropped by exceptional unemployment rates. Among the 15-24-year-olds in Greece,

  • 55.3 percent were unemployed in 2013;
  • 58.4 percent were unemployed in 2014; and
  • 52.3 percent were unemployed in 2015.

It was not until 2018 that youth unemployment fell below 40 percent, but that did not happen because of a strong recovery on the labor market. In ’18 there were 42,000 fewer unemployed, only 6,000 of whom had found a job. The rest left the workforce, ostensibly for emigration.

Another piece of evidence proving the loss of hope in the Greek economy: adjusted for inflation, business investments in 2019 were half of what they were in 1999.

These numbers only give a partial view of the Greek economy and its journey through a decade of austerity. However, they do tell a story of what can only be characterized as the macroeconomic destruction of a country. This destruction, in turn, is exclusively and entirely the result of unforgiving austerity measures, taken by a Greek government that lost its ability to finance its deficits, ran into a fiscal dead end and fell at the mercy of its creditors.

Can the same happen in America? Of course it can. If we continue to deficit-spend like there is no tomorrow, it will happen soon.