Germany and Greece Need to Learn How to Tango Together
By Dr. Pierre Canac—Prior to the 2007-2008 financial crisis, cross-countries financial flows triggered global imbalances whereby some countries experienced large current account surpluses (and capital outflows) while others faced large current account deficits (and capital inflows).
Current Account and Capital Flows
A country with a large current account deficit by definition has a large excess of investment over savings, the result of high consumption and investment in plant and equipment. Equivalently, the country with a large current account surplus has a large excess of savings over investment and must find a place to park this excess savings. When the rate of interest at home is very low, capital will flow to other countries which have a current account deficit. These capital flows finance the cost of consumption and investment projects. Inevitably, some of the investments will have poor prospects (i.e., likelihood of success and of repayment of the borrowed capital). This is pretty much what happened in the Eurozone, where large German excess savings flowed to Greece and other southern European countries. These capital flows constituted loans from private investors/lenders. Later, when the Greek economy hit the wall, the German private lenders were bailed out by their government making the German taxpayers the holders of Greek sovereign bonds.
Creditors and Debtors
So who is at fault? You do not have to be Argentinean to know that it takes two to tango, in this case a creditor and a debtor. Why is it that for some reasons we think of creditors as being virtuous and debtors as being sinners? To approach this question, we might ask: was it the German creditors who were looking for potential debtors to park their excess savings or was it the Greek (and Spanish, Irish, and Portuguese) debtors who were desperate to find a lender? A reasonable answer is that the two sides looked for and found each other although perhaps not on the dance floor.
A Different Perspective
However, I would like to offer a somewhat different perspective from the one that seems to prevail in the mainstream news media. The interesting question is whether German money was pulled into southern European countries to finance their spending, as the media seem to assume, or whether it was pushed into those countries in search of investment opportunities. Frankly, it is very hard to believe that all those southern countries would start a spending spree at the same time and would be able to obtain financing from an unwilling Germany at the relatively low interest rates they paid for these loans. As the German current account surplus jumped from about 2% of GDP to 5% in 2005, peaking currently at 7%, it is more likely that German excess savings were desperate to find investment opportunities abroad paying higher rates than the yields prevailing at home. Thus Greek and Spanish individuals and the Greek government were offered such good terms by the German lenders that it would have been unreasonable for them not to borrow at those excessively low rates in spite of the fact that they did not have any productive use for that money (other than consumption and real estate investment). A case can thus be made that the huge flows of capital so eagerly flowing out from Germany destabilized the economies of the southern European countries. Moreover, the larger German current account surplus in 2005 and thereafter was not the result of higher productivity but rather of lower wages in Germany; German business and labor agreed to limit wage growth (the so-called Hartz reforms implemented between 2003 and 2005), thus inflating the incomes of the investor class; it was the German workers who sacrificed in order to finance the flow of capital to southern Europe while it was the German financial institutions that benefited the most. Following the Eurozone debt crisis, these private institutions were bailed out forcing the German taxpayers (workers for the most part) to be called upon to pay the cost of bailing out Greece. Obviously, these taxpayers are now saying enough is enough; clearly they should have objected earlier before their own banks were bailed out by their government behind their back. In the end, both the German and other financial institutions came out winners while the German workers received low wages and Southern European workers lost their jobs.
In addition, German capital outflows fueled inflation in Greece and other periphery countries. The increased inflation lowered the real interest rates in the periphery, thus encouraging even more consumption and real estate investment in Greece and Spain. Those capital flows also were largely responsible for the asset price bubble in southern Europe. Under a flexible exchange rate, the peseta and the drachma would have fallen in value and put a brake on the capital inflows. Instead, the fixed exchange rate system based on the euro blocked the devaluation adjustment mechanism and prevented German investors from realizing that they were taking considerable risk.
Give Greece a Chance!
Thus, to claim that the Germans have no responsibility whatsoever for the Southern European crisis is ludicrous. This is not to say that the Greeks and others should not shoulder part of the blame. However, it is important to denounce the less than accurate statements made by German government officials and echoed by much of the news media that put all the blame on the southern Europeans as if Germany were the innocent victim of a trickery arranged by lazy debtors to secure hard-earned German funds.
Incidentally, the stereotype of the lazy Greek and the hard-working German does not hold up to scrutiny. According to a 2011 study by the Office for National Statistics, the Greek workers put in 42.2 hours per week while the German worker put only 35.6, below the EU average of 37.4. Thus the Greeks who happen to be employed work a lot harder than the Germans while the unemployed ones receive much lower benefits than their German counterparts. These benefits have further been reduced following the imposition of austerity measures on Greece as conditions for receiving bailout funds. According to data from the European Commission, Greece has reduced its non-interest real government spending by more than 20% between 2007 and 2014 while Ireland and Portugal have managed a reduction of about 2% and Spain achieved a small increase. Moreover OECD data show that out of a total of 18 countries, Greece is ranked number one for implementing the most reforms overall between 2007 and 2014.
That’s not all. According to the German economic historian Albrecht Ritschl (Spiegel Online, June 21 2011), Germany defaulted at least three times on its debt during the 20th Century; it defaulted on its WWI debt in the 1930’s; it reaped the benefits of a haircut on its WWII debt at the London Agreement on German External Debts in 1953; and it stopped paying reparations, loans and occupation costs in 1990, including the portion owed to Greece, following its reunification with East Germany.
Given the German resurgence following its defaults, shouldn’t Greece be given the same opportunity to start anew?
Pierre Canac, Ph.D.
Associate Professor of Economics