Does the Greek tragedy have lessons for Australia?

Australia and Greece represent the two extremes of how developed nations are faring in the world economy. With low debt, solid growth and falling unemployment, Australia’s timely fiscal response to the 2008-09 crisis has seen us dodge the worst of the downturn. So is there anything we can learn from Greece, now teetering on the edge of the economic abyss?

To begin, let’s take a moment to run through the events that have brought Greece to its current situation. Shortly after their election last October, the new Socialist government announced that their predecessors had fudged the figures, and the 2009 deficit was at least twice as large as had been reported.

Rapid sell-offs of Greek debt followed, and by January the IMF had announced that it would send a team to Athens. Reminiscent of the “technical advisers” that the US sent in the early days of the Vietnam War, this group was described as merely a “technical mission”. But the symbolism of the IMF sending its grey-suited boffins into a member of the Eurozone was lost on no one.

As the risk premium on Greek bonds soared, the credit rating agencies followed what had become conventional wisdom in the markets, and downgraded Greek government bonds to “junk” status. Standard and Poor’s predicted that if the bonds were restructured, investors would get back only 30-50 per cent of their principal.

With unemployment at 11 per cent, street demonstrations were held in Athens at the start of this month. Since emerging from dictatorship in 1974, Greece tends to do mass protests frequently and gracefully. But this time a firebomb thrown into a bank led to the deaths of three people.

In return for a European Union “stabilisation fund” and IMF loan guarantees, Greece has now agreed to a jaw-droppingly tough plan for recovery. Among the austerity measures are public service pay cuts, increases in the pension age, higher tax rates on luxury goods, and reductions in the number of state-owned firms.

If all goes according to plan, 2012-13 will see unemployment peak at 15 per cent and net public debt peak at 149 per cent of GDP. Even the IMF admits that “the scale and frontloading of the adjustment are unprecedented”. Prime Minister George Papandreou has compared the voyage ahead to that of Odysseus (prompting wags to point out that Odysseus took ten years and lost all his companions).

While Greek tragedies are supposed to eschew simple lessons, commentators have been unable to resist drawing moral conclusions from this particular tragedy.

One camp describes this as a lesson about the cost of excessive wage growth and public spending. After a decade in which wages outpaced productivity growth, and spending rose faster than revenue, some regard this as the recession Greece had to have. The solution: gritted teeth and fiscal austerity.

The other view of the crisis is that it shows the problems that arise from big currency areas. Since adopting the Euro in 2001, Greek inflation has outpaced the European average. Unlike a country with its own currency, it cannot devalue. And unlike a province in a larger nation, it cannot hope for substantial fiscal transfers. On his blog, US economist Paul Krugman argues that if Greece stays in the Eurozone, Greek wages need to fall by 20-30 per cent relative to German wages. Assuming this is impossible, an alternative would be for Greece to drop the euro and bring back the drachma.

For Australia, there is something to be learned from both diagnoses. The Greek crisis reminds us of the importance of good fiscal management and sensible microeconomic reforms. Productivity growth is pretty much the only way of securing sustainable increases in living standards.

Greece’s problems also flag a weakness of large currency areas. A perennial proposal in Australia and New Zealand has been the idea of a common currency (former Deputy PM Tim Fischer suggested that it be called “the Zac”). But in the unlikely event that New Zealand got into fiscal strife, would Australian taxpayers be willing to send cash across the Tasman?

Even although New Zealand represent just one-tenth of the combined GDP, the effect of Greece on the Eurozone shows that within a monetary union, contagion is a serious problem. Think hard before joining a currency union, because breaking up is hard to do.