Greece is paying the price of excess spending

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Greece is paying the price of excess spending
Greece is paying the price of excess spending

Photo: (A protester sports the word 'no' in Greek on his forehead as he waves a Greek flag during an anti-austerity demonstration in Syntagma Square in Athens, Greece.)

WHICHEVER way it voted on Sunday, Greece will still be faced with economic pain as the financially embattled country tries to adjust its domestic spending in line with what it can afford.One of the first lessons taught to economics students is that all societies have only limited means available to meet their unlimited wants.

As a result, they must choose to have less of one thing so that they might have more of another.Infamously, Adolf Hitler told the German people that they would have "guns before butter".

As we all know, the costs of this imposed choice were enormous.When economies grow, the overall means available to them increase, and their citizens can consume more of anything.Still, they must select preferred goods and services and their requisite quantities.

The mechanism through which these choices are made is the particular economic system each country adopts.The necessity for such choices is not willingly accepted either by individuals or governments.Greece is just the latest in a long line of countries to have faced the painful consequences of living beyond their means.The consumption of individuals is limited by their income.

They can temporarily consume more than they earn by borrowing.But as debt increases, the interest they must pay also grows — that which is left over to buy necessities decreases.

Eventually, individuals who borrow recklessly may end up worse off than if they had never borrowed at all.In extreme cases, bankrupt households are forced to surrender assets — such as their homes — to their creditors.

The result, as Mr Micawber so poignantly observed in Charles Dickens’s David Copperfield, is "misery".It is no different for countries, except that a country that lives beyond its means must borrow from abroad.If, eventually, a country can no longer afford the growing interest on its debt, the consequences for its citizens are harsh.

The adjustment is especially painful when the government has long lived beyond its means, allocating funds, for example, to social welfare and other spending that exceeds what it collects in tax.

This is the situation Greece now faces. For many years, it hid the true extent of its overspending by publishing false statistics.

It knew lenders would have cut off funds long ago had they known the full extent of its indebtedness and the perilous state of its government finances.

Foreigners are no longer willing to fund Greece’s excess spending.They are demanding that it shows it can balance its future income and spending.This requires painful cutbacks.

It requires that those Greek citizens who have dodged tax for years now pay what is legally owed.

This will reduce household after-tax income, further constraining consumer spending.The government will have to cut welfare and pension benefits, which currently exceed what is affordable.

This means further pain for an economy that is already in severe recession and in which unemployment has soared to levels that rival those in SA.Voters are "between the rock and the hard place" of Greek mythology.

To vote for austerity means accepting further hardship.But it ensures continued membership of the eurozone and access to foreign borrowing, while the necessary domestic adjustments take place.

This is what Spain, Portugal and Ireland did. They are growing again after several years of painful adjustment.Reneging on its debt and leaving the euro offers Greece only short-term relief.

All access to future foreign loans will end, and spending will still have to adjust to what is domestically affordable.Abandoning the euro for what will be a very weak local currency will therefore still have painful consequences.

Greece’s banks, which hold government debt among their assets, may be insolvent. Saving the banks may cost government more than its dishonoured foreign debt.

The euro-denominated debt of Greek companies and some individuals will dramatically increase when expressed in a local currency.There is no easy option.

But the uncertainty that will be caused by rejecting austerity may turn out to be a far worse option than many commentators imagine.


Article by Gavin Keeton


• Keeton is with the economics department at Rhodes