Euro Crisis Forces Deep Cuts in Social Benefits
Countries face drastic reductions as debt rises
June 3, 2010
The Greek financial crisis, which has pushed Europe to the brink of economic ruin and ravaged world financial markets,will lead to a fundamental restructuring of the European economy, according to international financial and government experts. But what will this restructuring look like?
Clearly, Europe is on the cusp of huge change. In the coming years, the post-World War II social benefit structure that benefitted Europeans for decades will undergo fundamental adjustments, drastically altering the way Europeans live and work. Three countries that best capture the drama and severity of the crisis are Greece, Germany and Spain. The Fiscal Times reviewed these three pivotal nations to determine how Europeans will likely adjust to the crisis, as well as the likely barriers to change. What we project is a more nationalistic Germany, a Greece where consumers and workers pay heavily for corruption by the government and the wealthy, and a Spanish government trying to prove to the world that the country’s economy can persevere through the crisis.
Pre-bailout: Better known for its corruption than its efficiency, the Greek economy is largely sustained by tourism, which accounts for 15 percent of the country’s annual gross domestic product. However, the public sector drives the Greek economy, accounting for 40 percent of GDP. Public sector workers have received generous salaries, including 13 and 14 months’ bonus pay, an early retirement age and job security. The Greek government estimates approximately 700,000 people — or about 6 percent of the population — work for the federal government, although independent estimates put the number of Greek bureaucrats as high as 1 million.
In recent years, government corruption has been widespread, with Athens awarding sweetheart deals to contractors to build infrastructure for events like the 2006 Summer Olympics. These projects were funded through government bonds (now practically worthless), which led to the government lying about its debt levels, which led to the debt crisis this year. Greek Prime Minister George Papandreou has tried to rein in corruption but brought his own credibility into question when he admitted to understating the extent of his country’s debt.
Corruption is not limited to the Greek government. Private citizens, especially the wealthy, are notorious for their failure to pay taxes. According to a New York Times report, only 324 of 16,974 pool owners in a posh Athens suburb paid taxes on their pool. This same report estimated that as much as $30 billion in taxes went unpaid in Athens last year, an amount large enough to make a dent in Greek debt payments.
Despite endemic corruption, Greeks still live the good life. According to the Economist Intelligence Unit, the Greek standard of living is the 22nd highest in the world.
Post-bailout: While the bailout will have little effect on Greek private industry, it will have a serious impact on Greek civil services. The austerity package recently passed by the government contains dramatic cost-cutting measures, including an increase in the retirement age from 61 to 65, limits on pay bonuses, and salary freezes. Jobs are no longer guaranteed, as the plan allows more freedom in making layoff decisions. In recent weeks public workers have taken to the streets to protest the plan, but with a debt problem as deep as Greece’s, the changes are inevitable.
Post-bailout Greece will also be a different one for consumers. As part of the austerity plan, taxes on alcohol, fuels and luxury goods have increased to 10 percent. Cigarette taxes were also increased to 10 percent, creating a large financial burden in a country where 42 percent of people smoke. This could have a negative impact on tourism, as goods purchased by visitors will be more expensive.
Growing pains: It remains to be seen if post-bailout Greece will be a less corrupt place. Papandreou has promised reforms, but his efforts to date have been inconsistent. Corruption as systemic as Greece’s is hard to root out. Without a concerted effort by both politicians and private citizens, corruption is likely to be a lingering problem.
It also remains unclear if Greek workers are committed to the austerity measures enacted by their governments. So far, strikes and protests have been small in scale. If the protestors gain traction, continued turbulent times for Greece are unavoidable.
Pre-bailout: German economic power is based on its robust manufacturing sector and exports. Since the fall of the Berlin Wall, German companies like Volkswagen and Siemens have gained a worldwide reputation for their reliability and quality. Germany is now the world’s second largest exporter and the economic engine of the European Union. It carries large trade surpluses, while its consumption of goods from elsewhere is stagnant.
German frugality also extends to personal savings. Germans in the baby boomer generation, hardworking and ever mindful of Germany’s turbulent past, are among the most frugal in the world. Credit for purchases other than a home or car is rare. A 2006 report from the Federal Reserve Bank of St. Louis found that German personal savings rates have hovered around 15 percent since the 1970s, second only to Japan and well above the United States.
One of the key reasons Germans have been able to save is because of the generous social benefits programs. Germany’s universal health care system dates back to 1883 and covers everything from prescription drugs to prevention holidays, or trips to German resort towns on the government’s dime. Employment benefits are also generous, including one year of full unemployment insurance, followed by a staggered subsidy if work cannot be found within the first year of losing a job. Housing allowances are also provided to unemployed workers.
Post-bailout: Even without the hundreds of billions Germany is providing for the Greek bailout, German social spending was recognized as unsustainable. In fact, Germany, like Greece, was in violation of EU budgetary restrictions last year – its annual budget deficit was 3.3 percent of its gross domestic product, above the permissible 3 percent level. Germany’s population is aging quickly; soon, baby boomers will retire and begin draining the German national pension coffers.
With a constitutional amendment to balance the budget looming, the German government recognized the need to cut costs and instituted the Hartz IV reform plan. Hartz IV is meant to trim public benefits, including limiting unemployment insurance and placing controls on health care costs. While all reforms have yet to be implemented, it is already clear that before the end of Chancellor Angela Merkel’s term in 2013, big changes are coming to the German social benefit system. In fact, Germany is set to trim $3.75 billion from its budget next month. German Health Minister Philipp Rösler has also announced a sweeping review of the health care system in an effort to cut costs. As German Finance Minister Wolfgang Schaeuble said recently, "We have to adjust our social security systems in a way that they motivate people to accept regular work and do not give counterproductive incentives."
German spending habits must change. In most cases, frugality and limited exposure to credit are rewarded. However, in this case, Germany’s trade imbalances have hurt the euro zone, as Greece has not been able to pay for the goods it purchased from Germany, which has dragged down the value of the currency they share.
Growing pains: Merkel has already felt the sting of the Greek crisis: Her coalition was voted out of power in Germany’s upper house of parliament last month, threatening to derail her political agenda. The Hartz IV reforms she championed are also widely unpopular with Germans, who ask why their benefits are being cut as Germany subsidizes Greece, a country with even more generous social benefits. Lastly, Merkel, once the EU’s go-to head of state, was seen throughout the European Union as indecisive throughout the Greek crisis. She must work to re-establish her place in the EU hierarchy.
There are also fears that Germany could retreat to a more nationalistic stance. Long the champion of European unity, the Greek debt crisis has unnerved both German politicians and the German public. Both groups remain stunned that the bad actions of one EU member could so negatively affect the Euro zone. As Merkel tries to rebound from her recent electoral disappointment, there is growing sentiment in Germany that German, not European, interests, should be Berlin’s top priority.
Pre-bailout: Spain has the inglorious distinction of being the country many believe will soon find itself in a crisis similar to Greece. Yet, until recently, Spain was counted as one of the EU’s success stories, attracting large amounts of foreign investment and economically outpacing fellow euro zone members. It also significantly benefited from the real estate boom, with construction producing 16 percent of Spanish GDP at the peak.
Of course, when the real estate bubble burst, Spain’s economy burst with it. Spaniards borrowed heavily during the real estate boom to take advantage of the market. When home prices fell, many middle-income families could no longer afford their mortgages. Homeowners were also hit by the recession, as Spanish unemployment topped 20 percent.
The Spanish government, on the other hand, spent responsibly during the real estate boom and during the recession. What can derail Spain is a crisis of confidence. Foreign investors hold most of Spain’s debt, and if they get skittish, Madrid will not be able to raise the money it needs to run the country. This led the credit rating company Fitch to downgrade Spain’s debt last week from AAA to AA+, which in turn sent world markets plunging. Portugal, also mentioned as a possible trouble spot, is in a similar situation.
Post-bailout: It is difficult to predict how the Greek crisis will affect Spanish private industry. But Spain’s public sector has already felt a chill. Last week, Spain passed a $19 billion austerity plan of its own, including salary cuts of 5 percent for public workers, the end of inflation adjustments for pension funds, and $1.5 billion in cuts to regional government budgets.
Growing pains: Spain’s federal government might have spending under control and recognize the need for belt-tightening, but the country’s 17 regional governments continue to spend lavishly. A Standard & Poor’s report last week found that regional governments, which provide social services like health care and education, are unlikely to be able to cut spending, sending Spain deeper into the red.
How to Stop the Euro Crisis: Brussels vs. Berlin (Time)
The Greek Debt (and Euro) Crisis Will Drag On and On (Huffington Post)
Fears Intensify that Euro Crisis Could Snowball (New York Times)
Euro Crisis Raising Doubts on Long-Term Stability (Denver Post)