Austerity

The saga of financial woe in Greece and several other European countries continues. That saga explains the mercurial exchange rate of the euro that, in turn, explains the erratic behavior of capital markets globally.

Early this week, the Socialist government in Athens barely escaped a no-confidence vote at the parliament. Had it lost that vote, all of Europe might have fallen into financial chaos and the whole world might have revisited the financial meltdown of 2008. That meltdown produced the most severe global recession since the Great Depression of the 1930s.

The relief felt over the outcome of that crucial vote was felt worldwide. In the days preceding that vote, the euro sunk and stock markets shrunk everywhere. After the vote, the euro regained some lost ground and the stock markets recovered somewhat.

But fingers are still crossed on tables where economic managers confer and on the trading floors of stock exchanges everywhere.

The issue that was the subject of the confidence vote is the second package of austerity measures that the Greek government commits to undertake in exchange for a bailout program underwritten by the IMF and wealthier European economies such as France and Germany. The austerity program caused a lot of domestic unrest in the country. The additional austerity package will inflict greater pain on Greek citizens.

Athens painted itself into a corner when it allowed the budget deficit to simply accumulate, financed by borrowing. Today, it needs a bailout desperately to avoid going into default. It will not get that bailout until it demonstrates political will in instilling fiscal discipline in a country unused to it.

The rest of Europe desperately needs Greece to avail of the bailout package. Should Greece default, billions of euros of debt service due all the European banks will not flow in. The banks will be shaken seriously and some might fail. Financial panic could ensue. The euro will come under adverse speculation.

When the dominos start falling, we do not know when the calamity will end. Something worse than 2008 could happen. Greek debt paper increasingly appears like a toxic asset on the books of every major banking institution.

In order to manage its debt servicing, the Greek government has been privatizing like mad, selling off as much state assets as fast and furiously as possible. All the major utilities, such as power and water providers, have been sold off. The cuts on the public payroll have been deep and wages have been adjusted downwards.

If it were at all possible to sell off the Parthenon, the Greek government might have seriously considered that option. What is clear at this point is that Athens has run out of assets to sell. If it must scrounge for more money to keep the country’s finances on even keel, the Greek government must quickly shrink the bloated public sector of the economy.

For the ordinary Greek, what the austerity program means is the loss of subsidies citizens have been used to as well as a sharply rising unemployment rate as government sheds more and more of the public payroll. With Greece’s credit rating rapidly deteriorating, the cost of money rises even more.

This will reflect in both public and private borrowing. Privatized utilities companies, for instance, will pay higher interest rates to keep their operations going. To cover that, they need to charge consumers more for power, water, toll rates and all else.

The Greek consumer is hit from all sides. His wage has been cut even as he now pays more for power and tolls. As public sector payrolls are cut and few private investment ventures into this troubled economy, the prospect for jobs deteriorates from slim to nil. Little wonder the Greeks are rioting in the streets. Those who do, however, offer no alternative to this episode of austerity.

The Socialist Party bears a large responsibility for the financial mess the country must now sort out. This party, supported mainly by the trade unions in both the public and private sectors, allowed wages to rise, the public sector to bloat and subsidies to flow even if all these could not be supported by government revenues. The debt crisis that now afflicts Greece is the outcome of many years of fiscal irresponsibility.

Those many years of fiscal irresponsibility, however, was politically beneficial for the Socialist Party. In election after election, the party disposed towards dole-outs was returned to power by happy voters.

Now it is the Socialist Party that must deal with the financial cleanup. They, more than any other political party on the scene, are best positioned to convince their political base to accept the austerity program, painful as that might be.

With the last vote of confidence, the world will watch anxiously as the Greek government gets to work, restoring fiscal order in a state once overrun by populism and state patronage. Greece may not be too big to fail but the interlinked global financial system is not large enough to absorb a Greek default. The European Union has bent over backwards, despite its tough internal rules on fiscal discipline, to prevent a Greek default.

We have much to learn from the sad experience of Greece. The financial difficulties of that country and the global implications these hold instruct as well about the perils of populist government and the neglect of fiscal discipline.

At the most basic, this experience instructs us well on the futility of buying popularity in the short term by compromising fiscal sustainability over the long term.