\fRegional Economic Integration Chapter 8 291 The financial crisis had its roots in a decade of free ity, once considered very remote, investors started to move spending by the Greek government, which ran up a high money out of euros, and the value of the euro started to fall level of debt to finance extensive spending in the public on the foreign exchange market. sector. Much of the spending increase could be character- Recognizing that the unthinkable might happen-and ized as an attempt by the government to buy off powerful that without external help, Greece might default on its interest groups in Greek society, from teachers and farm- government debt, pushing the EU and the euro into a ma- ers to public-sector employees, rewarding them with high jor crisis-in May 2010 the euro zone countries, led by pay and extensive benefits. To make matters worse, the Germany, along with the IMF agreed to lend Greece up to government misled the international community about El10 billion. These loans were judged sufficient to cover the level of its indebtedness. In October 2009, a new Greece's financing needs for three years. In exchange, the government took power and quickly announced that the Greek government agreed to implement a series of strict 2009 public-sector deficit, which had been projected to austerity measures. These included tax increases, major be around 5 percent, would actually be 12.7 percent. cuts in public-sector pay, reductions in benefits enjoyed by The previous government had apparently been cooking public-sector employees (e.g., the retirement age was in- the books. creased to 65 from 61, and limits were placed on pensions), This shattered any faith that international investors and reductions in the number of public-sector enterprises might have had in the Greek economy. Interest rates on from 6,000 to 2,000. However, the Greek economy con- Greek government debt quickly surged to 7.1 percent, tracted so fast in 2010 and 201 1 that tax revenues plunged. about 4 percentage points higher than the rate on German By the end of 2011, the Greek economy was almost bonds. Two of the three international rating agencies also 29 percent smaller than it had been in 2005, while unem- cut their ratings on Greek bonds and warned that further ployment approached 20 percent. The contracting tax base downgrades were likely. The main concern now was that limited the ability of the government to pay down debt. By the Greek government might not be able to refinance some 2012, yields on 10-year Greek government debt reached 34 E20 billion of debt that would mature in April or May percent, indicating that many investors now expected 2010. A further concern was that the Greek government Greece to default on its sovereign debt. This forced the might lack the political willpower to make the large cuts in Greek government to seek further aid from the euro zone public spending necessary to bring down the deficit and countries and the IMF. As a condition for a fresh restore investor confidence. E130 billion bailout plan, the Greek government had to Nor was Greece alone in having large public-sector defi- get holders of Greek government bonds to agree to the big- cits. Three other euro zone countries-Spain, Portugal, gest sovereign debt restructuring in history. In effect, bond- and Ireland-also had large debt loads, and interest rates holders agreed to write off 53.5 percent of the debt they on their bonds surged as investors sold out. This raised the held. While the Greek government had not technically specter of financial contagion, with large-scale defaults defaulted on its sovereign debt, to many it seemed as if the among the weaker members of the euro zone. If this did EU and IMF had orchestrated an orderly partial default. occur, the EU and the IMF would most certainly have to Whether that might be enough to stave off a complete step in and rescue the troubled nations. With this possibil default in Greece remains to be seen. 26 Notes 1. "Power Struggles: European Utilities," The Economist, "Free Trade Free for All," The Economist, January 4, 1991, December 2, 2006, p. 74; "Anger Management in Brussels," p. 63. Petroleum Economist, April 2006, pp. 1-3; R. Bream, "Liberal- ization of EU Market Accelerates Deal-making," Financial 5. D. Swann, The Economics of the Common Market, 6th ed. Times, February 28, 2007, p. 4; "Twists and Turns: Energy (London: Penguin Books, 1990). Liberalization in Europe," The Economist, December 8, 2007, 6. See J. Bhagwati, "Regionalism and Multilateralism: An p. 76; and "Better Than Nothing?" The Economist, June 14, Overview," Columbia University Discussion Paper 603, 2008, p. 80. Department of Economics, Columbia University, New York; 2. http://eur-lex.europa.eu/summary/chapter/enlargement. A. de la Torre and M. Kelly, "Regional Trade Arrangements," html Occasional Paper 93, Washington, DC: International Monetary Fund, March 1992; J. Bhagwati, "Fast Track to 3. Ibid. Nowhere," The Economist, October 18, 1997, pp. 21-24; 4. The Andean Pact has been through a number of changes since Jagdish Bhagwati, Free Trade Today (Princeton and Oxford its inception. The latest version was established in 1991. See Princeton University Press, 2002); and B. K. Gordon,Case Discussion Question 1. What was critic's greatest concern regarding the establishment of the euro zone. How did the Greek Sovereign Debt Crisis show this concern to be a reality? 2. What do you think was the fundamental cause of the Greek Sovereign Debt Crisis