Will Greece's Austerity Plan Work?

By: Rab Jafri
In Economics, austerity is defined as a time when a state government reduces its spending and increases user fees to pay back its creditors. This measure is taken when a government’s fiscal deficit is felt to be unsustainable. The Government of Greece has found itself in an identical situation in which wasteful spending has led to a debt to a GDP ratio of over 100 percent.   Due to these circumstances, the government has approved an Austerity package worth 8.4 billion Euros. Additionally, it plans to raise taxes, cut spending by freezing wages and laying off civil servants. The Socialist government has pledged to cut deficit to 8.7% of GDP this year and below EU's 3% limit by 2012.

But is this a realistic goal set forth by Athens?  The world needs to take a look at Greece’s historical finances for a better picture.

Greece’s ability to hit fiscal targets?

The measures taken up by Athens include a freeze on civil wages, a 10% cut on public sector entitlements, a fuel tax increase, and an end to dozens of tax loopholes for certain professions—including some civil servants—who now pay less than their fair share in taxes. They also include an increase in sales tax from 19 percent to 21 percent, as well as increased levies on alcohol, cigarettes, luxury yachts and precious stones.  

Of course, these measures did not come without consequences, as protests have erupted in Athens. The city has come to a halt as flights are being grounded and trains suspended amid a nationwide general strike. As the crises looms, the unemployment rate has increased significantly since the start of the global financial crises (December of 2008).

Unemployment Rate – (1984-2008)

Historical debt level data paints a bleak picture of the Greek’s finances. From 1990 until 2008, Government debt level has been increasing at an astonishing rate.

Government Debt Level

Government debt to GDP (Gross Domestic Product) ratio levels shows a similar story. Historically the ratio has hovered above 90 percent of GDP.

Debt to GDP ratio

For now, Greece’s problem may be quiet as Prime Minister Papandreou travels the world seeking support from his allies and presenting the EU with his country’s fiscal budgets going forward. And, while a sale of 5 billion dollars worth of bonds may look successful by the Greek Government, it still faces more than 20 billion in Euro redemptions in April and May. Eventually, Greece will return to center stage along with Spain, Portugal and Ireland as the combined debt due for all four countries is 404.6 billion Euros.

The austerity plan will ease the Greek’s problems, not end it. Given Greece’s history of fiscal irresponsibility, the world should be cautious of the false promises that Athens is intending to make. Member states such as Germany are strongly opposed to the idea of a “bail out” and German tax payers will certainly not be willing to bail out a foreign government with a history of fiscal disasters. The current situation in Greece will test the very fabric of the European Union, which is best described as a monetary union without a political will.

The downward momentum in the Euro has stabilized. Any Euro gains going forward should be seen as a correction, unless the fundamentals change. The Euro could reach 1.3850-1.4000 before continuing on its downward path.