By Troy Stangarone
For Greeks and European officials alike, the last five years must have seemed like the Greek myth of Sisyphus who was condemned to roll an immense bolder up a hill only to have it roll down and have to start over again for all eternity. In 2010 as the euro crisis began to heat up in the aftermath of the U.S. financial crisis and the earlier acknowledgement by Greece that it had been understating the actual level of its government debt, Greek and European officials faced the prospect of Greece being pushed out of the Eurozone in what has commonly become known as Grexit. With the call for a referendum this past weekend by Greek Prime Minister Alexis Tsipras and the breakdown of talks between Greece and its creditors once again leaves Greece and its European partners facing the possibility of Greece leaving the euro.
How did we get to this point?
In some ways, Greece faced a task of Sisyphean order. It would need to engage in strict austerity and an internal devaluation to reduce debt and make the Greek economy competitive since as a member of a currency union it did not have the option of engaging in a devaluation to increase the economy’s competitiveness. However, the task has been more trying than many would have hoped. Since the crisis broke out in 2010, the results of efforts to reduce Greece’s debt and revive its economy have been meager. Despite a 240 billion euro aid package designed to help Greece meet its debts, Greece’s debt to GDP ratio has grown since 2010 to 177 percent as opposed to 148 percent when the crisis began. The debt to GDP ratio has grown despite significant European and IMF aid packages because over the same period the economy has contracted by 25 percent and unemployment has risen to 25 percent as the government has laid off workers to move its annual budget into a surplus. All of this has combined with other factors to make it difficult for Greece to grow its way out of its debt.
As a result of five grueling years of economic struggle there was a significant political shift earlier this year as Greek Prime Minister Alexis Tsipras and his Sryiza won elections on promises of ending the austerity that has been the condition of Greece’s aid. However, Tsipras and his government have managed to alienate other Eurozone members in France and Italy among others who might have been sympathetic to their efforts for a more pro-growth policy and also found themselves in the politically untenable spot of having to undertake policies they were elected to reverse due to their inability to convince their other European partners to take a more lenient approach.
Where are things now?
Unlike Sisyphus, Greece and its creditors are not condemned by the gods to their fate. The call for a referendum on the Eurogroup’s latest proposal by Greek Prime Minister Alexis Tsipras has raised the stakes in Greece’s ongoing struggle with its creditors and precipitated a series of responses. In response to Tsipras’ call for a referendum on the terms of the new deal, in which he and his government have said they would fight for a no vote, the Eurogroup has removed its offer and the European Central Bank, while not ending its Emergency Liquidity Assistance, has decided to cap it at the previous level of 89 billion euros. As a result, capital controls have been put in place and Greece’s stock market and banks will be closed until after the proposed referendum on July 5. All of this potentially moves Greece closer to a Grexit.
However, much has changed since the last time that Europe faced the possibility of Greece leaving the euro. At the time, Italy, Spain, Portugal, and France to a lesser extent were all facing pressure in bond markets raising concerns that if Greece was forced out of the euro the others might also be forced out perhaps leading to a breakup of the common currency or a much smaller northern core of countries that would remain. Europe has also taken steps such as the development of a banking union to help insulate itself against shocks from a potential Grexit and the economies on the continent are stronger than they were in 2010. There are also good economic reasons why Greece may enter into a short term default on its IMF loans on June 30, but still not leave the Eurozone.
However, this crisis is as much a political crisis as it is an economic crisis, perhaps making the situation more unpredictable. The euro itself was as much a political venture as an economic one with its roots in an effort to build a symbol for a united Europe and to tie Germany more deeply to Europe after its reunification in 1990. So, that political considerations could trump economic considerations in the Eurozone should not be surprising.
Therefore, the unanswered question is not how well Europe has built up its institutions to prevent contagion from Greece to the rest of Europe but what is the damage that would be done to Europe’s institutions? Post-war Europe has been built on a consensus of cooperation and shared opportunities, but how will those institutions be affected at a time when their legitimacy is seen as low across Europe and Greece could be seen in time as a symbol for an over-dominating and ‘unfair’ Europe?
What is the impact on Korea and what are the lessons for East Asia?
For Korea, the potential impact of a Greek default, or Grexit, would not be so much from Greece itself, which only accounts for 0.2 percent of Korea’s exports, but if the crisis were to spread beyond Greece to Europe more broadly. If Europe is able to contain any damage in the coming days from either a Greek default or Grexit, the impact on Korea is likely to be minimal. If the damage does spread early estimates are that economic output could drop by 0.3 percent in Asia as a whole next year. The potential impact more broadly can be seen from the last crisis in 2010 when there were significant drops in exports to some European countries as the crisis developed.
If there is a potential for a small economic slowdown stemming from a slowdown in Europe, there is also a lesson for future political architects in East Asia thinking about their own monetary union. We don’t yet know how Europe’s current crisis will turn out, but the lesson from the 2010 crisis is that monetary unions require a high degree of fiscal and banking unions to provide them with the tools needed to deal with shocks. If the supranational entity overseeing a monetary union is unable to adequately monitor and to some extent limit government spending on the national level without the ability to utilize bonds that all of the member states are accountable for, any Asian Monetary Union would likely run into a problem similar to Greece. At the same time, in the absence of a supranational banking authority there would be no means through which to ensure the stability of the financial system as a whole, while also providing common safety nets and a unified resolution authority for weak and failing banks, as well as successful banks.
Whatever happens in Europe, Asian policy makers should learn from its mistake as they seek to develop more common economic institutions in East Asia.
Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America. The views expressed here are the authors alone.
Photo from Kristoffer Trolle’s photostream on flickr Creative Commons.