EC3102 Assignment

Meenachi Rohini D/O Karuppiah

A0071159E
Tutorial group W2

Origins of the crisis

Greece is currently in its fifth year of economic crisis. The crisis started back in 2001 when Greece
joined the Eurozone.
There are several factors that contributed to this economic crisis. A strong currency allowed for very
low interest rates. This led to excessive borrowing by the Greeks to fund their imports, mainly
consumption goods. Another reason is the failure of Eurozone members to check on member
countries' annual budget deficit limits of 3% of GDP. Furthermore, tax evasion in Greece meant a
weak revenue collection and further aggravated the situation. Low productivity stemming from
higher manufacturing costs also resulted in a low income growth.
Furthermore, savings in the economy was low as interest rates were low and loans readily available.
Thus private savings could not meet the level of government expenditure and Greece officials were
forced to borrow from foreign countries. A low savings also meant that investments in the economy
was low thus impeding productivity growth. These factors amounted to a debt of 160% of Greece
GDP.
France, Germany, and IMF have intervened to bailout Greece. Greece has been given two bailout
packages till date. The first was a 109bn bailout and second was a 130bn bailout. However,
these packages include severe austerity measures. These include 15000 job cuts in the public sector,
pension cuts of 15% and wage cuts of 22%. These measures are supposed to ensure that Greeces
debt come down to 120.5 percent of gross domestic product by 2020. Part of the bailout includes a
debt restructuring program as well. For the bondholders the deal means taking losses of as much as
74% on their holdings.

Suggested policy package

Greece should stick to the bailout package and implement the accompanying austerity measures as
they are necessary for running a budget surplus. The required budget surplus, for Greece to attain
solvency, over the next 8 years is 4.4 % of GDP after accounting for debt exchange and buybacks.
In addition, it should avoid a full-fledged default and implement reforms necessary for ensuring
long term growth (Cline, 2011, p1).
Greece could address the prevalent corruption and inefficiency of its tax system. They could
increase taxes and get an external auditing firm, such as foreign tax officials, to come and check on
the tax collection methods to tackle corruption (Tsiantar, 2010).
It should also reform its pension system. In addition to the reforms currently adopted, the Greece
government could consider adopting a fully-funded system to ensure the sustainability of the system
in the long-run (Meghir & Vayanos & Vettas, 2010, p19) . As the individual would be made to save
for his own retirement, the problem of an aging population would be negated. These measures
would reduce the dependence of the aging population on government resources in future.
Greece government could aim to increase productivity of the economy by 20 percent. Investor
confidence declined due to junk Greek bonds and high current account deficits with FDI (Foreign
Direct investment) making up only 1% of the Greece GDP. Thus measures put in place should aim
to increase investor confidence. This could be done by reforming the labour market. Rules that
govern the operation of markets should be modified to allow for easier navigation for foreign
investors who may not be familiar with Greece culture and policies (Tsiantar, 2010). For example,
the government could remove regulations that are an obstacle to fire workers. The severance
payments made to workers when firms fire them could be reduced (Meghir & Vayanos & Vettas,
2010, p26).
Lastly, the private sector of the greece economy could reduce nominal wages and prices of up to 10

percent. Firms could do so by making their workers work harder and longer instead of cutting
wages so that overall unit labour costs are lower. This will reduce nominal prices and hence
increase competitiveness of the economy (Rodrik, 2010, p33).
On further note, despite the shortcomings with staying in eurozone, it should continue to do so as
the consequences of leaving are disastrous.
Possible problems with the policy package
As many of the policies above are targeted at increasing long term growth, they may not address
short term problems such as reducing the debt burden. Furthermore, there are many constraints with
each individual policy as well. For example, a reduction in prices would imply a decrease in
deflation and this may further worsen the recession (Christodoulakis, 2010, p95). And given the low
prospects of doing a business, reducing costs of firing workers may not do much to stimulate
demand for labour in the short term. And, a sudden change in administration could come down hard
on the transitional working population as they will have to keep financing the previous social
security system and contribute to their own pension (Castanheira & Galasso, 2011). The tax and
pension reform may be seen as unfavourable during times of elections as tax evasion is common in
Greece.
There are also many limitations with the policies put in place. For instance, the austerity measures
that accompanied the first bailout package have pushed the economy further into recession.1 In fact,
the economy shrunk by almost 12 percent between 2009 and 2011 and is expected to shrink by up
to 6 percent in 2012.
A bailout is seen by opponents as causing a perpetual dependency of Greece on its foreign lenders.
1When wages are cut, real disposable income of workers decreases. This would then decrease
consumption. And this spelled disaster for Greece economy as consumption of the economy makes
up about 70% of the GDP.

And proponents of a Greece default have argued that the money used to bailout Greece may be
better used elsewhere.
However, research shows that when only net debt is taken into account, Greece stands at a much
better position to repay its debt. Availability of public financial assets, privatization and reduction in
face value of bonds ensure the sustainability of Greek debt (Cline, 2011).
In conclusion, the Greek government should adopt the reforms as described by its creditors and
implement reforms targeted at long-term growth. This would address all individual policy
shortcomings and ensure that Greece economy recovers in the short term and grows in the long run.
(1000 Words)

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