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Did the Euro ruin Greece?
May 29, 2012
   
   
Prior to attending a meeting of European leaders last Wednesday, German chancellor Angela Merkel offered a remarkable insight: "Euro bonds would make no contribution to growth, [a] very tight range of interest rates led to things going awry" This in reference to the convergence of borrowing costs for Euro zone governments after the introduction of the Euro.

With this defense of her stance on Euro bonds, Merkel implied the following: Greek government spending spun out of control starting in 2002, paralleling the decrease in Greek bond yields. GreeceaEUR(TM)s fiscal situation was, if not excellent, at least no cause for alarm prior to the Euro.

Unfortunately for Merkel, the numbers donaEUR(TM)t quite paint the same picture. It is true yields on Greek government bonds dropped significantly - by 18 percent between 2002 and 2006. However, GreeceaEUR(TM)s general government expenditure relative to GDP actually decreased during that period, from 19.4 to a seven-year low of 17 percent. This could still be viewed as high, but if we consider the Greek scenario a spending spree, as Merkel seems to insinuate, then France has been on an outright spending rampage. FranceaEUR(TM)s government expenditures as a percent of GDP has been continuously north of 23 percent for over 15 years. Looking at Germany, the irony really begins to sting. While remaining relatively unfazed by its new currency, GermanyaEUR(TM)s general government expenditure relative to GDP was only once lower than that of Greece before 2009 - lower by only 0.4 percent in 2002.

So how did the Greek get into the mess they are in now? The answer: GreeceaEUR(TM)s government debt has always been alarmingly high. When Greece joined the euro zone in 2002 it stood at 129 percent of GDP. Further contradicting the chancelloraEUR(TM)s observations, the Greek government actually managed to reduce the figure slightly to 128 percent by 2006. Only since the beginning of the current financial crisis has Greek debt taken the fatal leap, increasing to 142% in 2009.

MerkelaEUR(TM)s remarks are indicative of the German Euro-crisis narrative . Perpetuating the myth of the fiscally prodigal periphery, it lends no credit to the structural problems the introduction of the Euro caused. This is demonstrated by the huge divergence in trade. Whereas Greece has never been EuropeaEUR(TM)s workbench, it experienced an average export growth of 7.9 percent between 1992 and 2001. Germany, while always a world leader in export, experienced an average annual increase of 5.9 percent during the same period. From 2002 to 2007 (i.e. omitting the general economic downturn in the wake of the financial crisis), fortunes in Europe reversed. GermanyaEUR(TM)s exports during this period increased 7.7 percent per year on average, while Greek exports only increased by an average of 4.1 percent per year.

This presents an inconvenient truth for Merkel: the introduction of the Euro gave rise to a seismic shift in Euro countriesaEUR(TM) ability to compete. The de facto depreciation of the exchange rate for Germany boosted exports, while the dynamic in reverse made Greek products more costly abroad. This is a crucial example of the structural change in Europe. One last question remains: How can we trust European leaders to agree on the right solution to EuropeaEUR(TM)s problems if we canaEUR(TM)t trust them to tell us what caused them in the first place?

MilkenInstitute