TALLINN - The meltdown in Greece’s finances may have negative implications for Estonia’s attempts to join the euro club next year. Greece’s ‘new standards’ in its fiscal creativity have exposed the flaws in Europe’s hybrid of monetary union and fiscal indiscipline, reports Bloomberg. The crisis engulfing Greece risks extending the euro’s 6 percent slide against the dollar so far this year, its expansion into eastern Europe and its prospects to challenge the dollar as an international reserve currency.
The birthplace of tragedy, Greece presents its own modern day tragedy on the fiscal stage. This “reveals a lot of things that people didn’t want to look at, such as the lack of economic governance of the euro zone,” said Pervenche Beres, a French member of the European Parliament who is sponsoring a resolution calling for tougher financial regulation. “If Greece falls apart, everything would fall apart. Nobody should allow this.”
Harvard University’s Martin Feldstein was among economists who have cautioned, since the currency debuted in 1999, that divergent economies such as are found in the EU couldn’t fit under a “single roof.” The union was led by a Germany that consented to give up its deutsche mark as long as the rest of Europe embraced the German aversion to debt that took hold after two world wars.
Things didn’t turn out this way. Each country, instead, went its own way. Germany, led by companies such as Volkswagen and Siemens, parlayed labor cost caps and the elimination of exchange-rate risks into its economic dominance.
German unit labor costs fell from 2004 through 2006, and rose only 2.2 percent in 2008, the year of the latest Eurostat figures. Labor costs in 2008 jumped 4.3 percent in Spain, 3.9 percent in Greece and 3.4 percent in Portugal.
The outcome was a skewed European economic playing field, with imbalances such as Spain’s current-account deficit of 9.6 percent in 2008 set against Luxembourg’s surplus of 5.5 percent.
Greece, Spain and Portugal, buoyed by European Central Bank interest rates that never rose above 4.75 percent, rode a debt-fueled housing boom that went bust after the Lehman Brothers collapse unleashed a global financial crisis.
The so-called ‘shelter’ the euro provided Greece began to fade. The government in Athens paid as little as 8 basis points (0.08 percentage point) more than Germany to borrow on Feb. 18, 2005. This gap has now increased to 334 basis points.
The euro doesn’t protect an economy from poor governance. Governments must still maintain sound budget principles.
The debate now turns on forcing the Greek government to come up with a workable plan to cut its deficit, and on how the EU will step in to support its massive deficits and contain the fallout.
“The biggest single cleavage in the EU will increasingly be between those that belong to the euro and those that don’t,” said historian Peter Ludlow. This means further expansion of the eurozone, to eastern Europe, could become a potential casualty of the Greek debacle. Already in 2006, Lithuania felt the collateral damage: it was barred from adopting the euro because of 3.5 percent inflation, and was the first euro aspirant to be vetoed.
The next test comes with Estonia in April or May. Once a showcase economy with growth peaking at 10 percent in 2006, the EU’s second-highest rate that year, Estonia’s GDP dropped an estimated 13.7 percent last year. Its bid to join the euro next year hinges on persuading the EU that its current deficit won’t head back up, after dipping to an estimated 2.6 percent last year, and after joining the eurozone.
“It will be more difficult for the potential new members to join,” said emerging-markets strategist at Societe Generale Esther Law, in London. “I expect them to be stricter with all the criteria and also to be stricter with the statistics.”
The EU has a history of weakness and bending the rules. When the European Union predicted in 1997 that Italy’s budget deficit would exceed the threshold to qualify for the single currency, it buried in the fine print the observation that, with “additional measures,” the Italians could pass.
The Italians did pass, thanks to a one-time tax and a yen-denominated swap. This was an early example of the balance-sheet ‘fiddling’ deployed since then by countries eager to share the benefits of a 10 trillion euro common market and lower government borrowing costs, but unwilling to cede control over their budgets, wages and welfare systems.
Without a convergence of political union, along with its monetary union, the crisis in Greece may be just the first in a contagion spreading to Spain and then Portugal, which are running government budget deficits of around 10 percent, and could be a regular occurrence for Europeans into the future.