Greek tragedy, but there might be a silver lining

Beware of Greeks bearing gifts? It has been touch and go this past month or so as to whether or not a wooden horse would make a suitable coffin for the euro. The EU itself has been shaken at its very core by a rift between President Sarkozy of France and Germany's Chancellor Angela Merkel when, was been reported, the French President banged his fist on the table and threatened his country would pull out of the euro if Germany did not give its full backing to a rescue/bailout package for Greece and other EU countries under threat from the world's money markets. The package committed the central banks of EU member countries with the European Central Bank (ECB) and the IMF to support Greece through a period of restructuring involving 110 billion euros; support if needed to Portugal, Spain, Italy and Ireland; and a liquidity reserve if required for the euro itself. The total amount: 750 billion euros. The cause of so much upset is the near total bankruptcy of Greece.

Considering Greece's economy is only 2.5 per cent of the total EU economy, its fiscal delinquency over many years and under previous governments has had an effect out of all proportions to what would appear logical but, unfortunately for Greece and the EU in general, its deficit and very large national debt is only seen as the worst case of many countries in a similar position and this has spooked the money markets.

The lack of market confidence in Greece has been noticeable since late last year. The money markets simply did not believe that Greece could service its debt any longer and demanded a premium on Greek government bonds and the faster any remaining confidence ebbed, the higher the premium demanded.

The new government of Prime Minister George Papandreou unsettled the markets further when it was announced that the previous government had not been honest with the Greek public or money markets as to the true scale of the problem with nearly every economic indicator looking bleak. On revising the 2009 deficit upwards from 12.7 to 13.6 per cent of GDP, the credit agency Fitch in late February 2010, downgraded the four largest banks in Greece - Alpha Bank SA, EFG Eurobank, National Bank of Greece and Piraeus Bank SA - to BBB with a negative outlook, this latter sting making them little better than "junk". The country's bonds were heading the same way. In Greece, meanwhile, government auditors and a beefed up tax investigation "police" were going over government returns for the last 15 years and expressing doubts over the figures for 1999.

To try to gain the confidence of the markets once more the Greek government started to implement a package of austerity measures designed to turn the whole economic situation around and reduce the deficit to four per cent over three or four years. A combination of personal and consumption tax rises, pay cuts and freezes, an overhaul of the whole tax system, increase in pension age and cut backs in government programmes have all been rushed through the Greek parliament. Latest government figures from Athens indicate that in 2009 government expenditure amounted to 50.1 per cent of GDP. It is little wonder that thousands of people, especially government workers fearful for their jobs, have taken to the streets in recent weeks and with tragic consequences for three people, including a pregnant woman, burnt to death when a bank in central Athens was set on fire.

The measures taken to date are intended to take the deficit down to about eight per cent of GDP by next year but will this be possible without tearing the state apart?

That Greece is a member of the EU is fine, its GDP per head of about $31,000 makes it a "rich" country but the question must be asked, should it ever have joined the euro. The decision to invite and allow Greece to do so in 2001 (with much German support) was premature, not given sufficient deliberation and bears all the hallmarks of a political and not an economic judgment. It has done neither Greece nor its EU partners any favours although Greece quickly perceived at the time, an economic benefit in being able to borrow much more cheaply than in drachmas.

The borrowing funded projects such as a new airport and motorways for Athens, the 2004 Olympics and the cable-stay bridge near Patra. It also permitted the employment of more government workers at all levels and boosted these workers pay and pensions benefits. Except for the odd year, the deficits just kept on coming and getting bigger until the national debt well exceeded GDP. A proposal now being suggested is that Greece abandons the euro and reverts once again to the drachma. Would this really help? With doubtful confidence in the drachma, the money markets would immediately put pressure on the Greek Central Bank if any of a variety of indices looked unfavourable and the bulk of its debt would now be in "strong" euros. A weak currency making Greek exports attractive? How original, join the long queue of countries aiming to export their way out of their fiscal mess.

Greece's big problem is that it is just so ill prepared for this economic disaster. The deficit in 2009 was 13.6 per cent of GDP and GDP had fallen 2.3 per cent Q1, 2009 - Q1, 2010. Unemployment, which was 9.8 per cent in October 2009 in a workforce of five million, had risen to 12.1 per cent by the end of March 2010 - and the government's austerity programme is just getting started!

An added social problem is the 12.4 per cent still employed in agriculture. This eighth of the workforce contributes less than 3.5 per cent of GDP. Manufacturing's productivity is also found wanting having 22.4 per cent of the labour force but only 20.8 per cent of GDP and so the Greeks are highly paid relative to productivity and have high entitlement expectations. About 20 per cent of the population live below the poverty line.

Greece exports only about one third of the value in goods of what it imports and although there is a large tourist surplus and having the world's largest merchant fleet can in good years cut the trade deficit by some 40 per cent, there still is usually a sizeable deficit on current account.

Undermining any effort to reform such a welter of difficulties has been a serious degree of corruption and widespread tax evasion. On Monday 18 May, Angela Gerekou, a Secretary of State for Culture and Tourism, resigned over her husband's failure to pay some £4.7 million in taxes. Tolis Voskopoulos, a singing star in the 70s and 80s, seemingly hadn't paid tax since 1993. One can understand why Angela Merkel found any rescue package so hard to present to the German electorate.

Hard to see much cheer in all this, yet this bank of clouds does have a silver lining. Firstly, the big package (750 billion euros) has passed the German hurdle and on 18 May, Greece got an initial $18 billion of its share to settle maturing bonds and the remainder - about $100 billion - should take most of the heat off Greece provided steady progress is made on restructuring its finances. The package should allow the country about 18 months to make the necessary reforms and George Papandreou is just the leader Greece requires.

Mr Papandreou is both Prime Minister and Minister of Foreign Affairs and has been leader of the Panhellenic Socialist Party since 2004. Having a famous surname in Greek politics, Mr Papandreou's mother is American and he was born in St Paul, Minnesota. He has degrees from Amherst College, Massachusetts and the LSE. For his considerable body of work, much in international affairs outside Greece, he has received numerous honours, decorations and awards from several countries, including one from Turkey. Apart from Greek and English, he speaks Swedish, French and Spanish fluently. Since coming to power, he has concentrated on a major overhaul of the tax system and tax enforcement authorities and this has already produced very positive results.

Mr Papandreou should be wished all the best on what is likely to be a very long road ahead.