This week, the debt crisis in Greece has taken the headlines worldwide due to its unprecedented nature – they’re the first developed country to default on its international obligations.
But first, here’s a little backgrounder on what’s going on in Greece.
The debt crisis is generally believed to have begun in end 2009, triggered by the Great Recession. The Greek Ministry of Finance stated that the five main causes for the government debt crisis are its low GDP rates, high government deficits, high government debt-level, poor budget compliance and unreliable data. Eventually, due to Greece’s large budget deficits, the country’s debts began to increase rapidly and emergency bailouts were necessary. Greece sought bailouts from the IMF, European Central Bank and the European Union. On 30 June 2015, Greece failed to make a €1.6 billion loan repayment to the IMF.
Greece will conduct a referendum on Sunday to decide whether to accept the terms of an international bailout deal for the country. The conditions contain a set of austerity measures the country must implement. The country’s Prime Minister has urged citizens to vote “no” and reject the package while economists worldwide and European Union leaders have encouraged Greeks to vote “yes”. The referendum is seen as key to Greece’s continued presence in the Eurozone and the European Union.
What can we learn?
Here’s two lessons.
Firstly, a country needs to balance its budget. A big reason for the Greece sovereign debt problem was its large long-term budget deficits. That is, the government was spending more than it was earning. Consecutive Greek government ran large deficits, spending on the military, pensions, social benefits and public sector jobs to bring their left-leaning citizens into the economic mainstream. Eventually from 1993, the debt-to-GDP ratio was always found to be above 94% and it quickly became unsustainable.
“The fundamental cause of the financial crisis has been people and institutions thinking they are wealthier than they are; this spread to Europe as well and now we are seeing the comeuppance”. – Tyler Cowen
Secondly, just because someone is willing to loan you money does not mean you should borrow it. That’s because the market and other institutions make mistakes and do not have perfect information. After all, not many knew that the previous government had been making up the numbers in its books.