[Opinion] Greece and Spain’s Divergent Paths in Fiscal Crisis

In times of economic crisis, the direction of government policy determines the future of a national economy. After the European sovereign debt crisis, Greece failed to respond early enough to foster economic growth. Spain, by contrast, showed the fastest recovery among the countries that experienced a debt crisis. The difference in the two countries’ recovery rates stemmed from government policies aimed at securing national competitiveness.

The fiscal crisis that began in Greece in 2009 spread into the broader European sovereign debt crisis by 2012. Among the countries affected, the Southern European nations referred to as “PIGS” or “GIIPS” suffered especially severe debt crises. In response, each country adopted its own policy approach. This was also true of Greece, which suffered the most serious blow, and Spain, which recovered the fastest.

Greece’s Syriza government was passive in reforming the public sector and labor market. There were efforts to pursue reforms in line with the demands of the troika (EC, ECB, IMF). However, they lacked effectiveness, as plans were made to abolish measures such as restrictions on rehiring in the public sector after the bailout program ended. In fiscal policy as well, Greece chose tax increases as its solution to the crisis. In a country centered on tourism, it even introduced an additional stay tax on foreign tourists. As a result, domestic demand stagnated and growth potential was constrained.

Spain showed the fastest economic recovery among the “PIGS” countries affected by the European sovereign debt crisis. Among its pro-growth policies, measures to increase labor market flexibility appear to have been especially successful. To secure labor flexibility, Spain implemented structural reforms after the fiscal crisis, including steps to ease the excessive protection of regular workers. As a result, Spain’s labor productivity index at one point exceeded the eurozone average. Alongside the success of these structural reforms, the unemployment rate fell from 24.8% in 2012 to 14.1% in 2019.

Spain also pursued fiscal austerity in various forms. It sought to restrain public-sector spending through measures such as cuts in civil servant wages and pension freezes. Based on austerity policies implemented from 2010 to 2014, Spain achieved economic growth rates in the 3% range over the following three years.

Of course, there were also differences in the intensity of the shocks the two countries experienced and in the industrial foundations of their economies. Nevertheless, the responses of their governments had a meaningful impact on the gap in economic growth rates. After the fiscal crisis, the presence or absence of policies aimed at restoring competitiveness determined the fate of the two countries. The Greek government, focused on political gain, did not push labor market reform forcefully. Spain, by contrast, made substantial efforts to secure labor flexibility. This difference led to the result that Greece’s labor productivity, which had been higher than Spain’s before the financial crisis, fell behind Spain’s after the crisis.

Greece’s decision to raise tax rates to overcome its fiscal difficulties was also a misstep. Higher taxes instead slowed the recovery of domestic demand and further reduced tax revenue. Tax increases are merely a stopgap for resolving immediate fiscal problems. In the long run, they cannot serve as a way to build national competitiveness.

Structural reforms and banking system restructuring aimed at restoring national competitiveness are policies that may provoke public backlash in the short term. Nevertheless, such reforms were necessary to secure competitiveness after the crisis. In the end, the Spanish government’s policies produced results and led to continued economic expansion until the COVID-19 pandemic.

Greece’s economy, which has recently shown signs of recovery, has likewise achieved this through improved competitiveness. In 2019, the Syriza government lost the election, and Kyriakos Mitsotakis was elected Greece’s new prime minister. Since then, Greece has moved away from populism and adopted bold austerity policies and structural reform measures. As a result, the Greek economy is showing dramatic signs of revival. At present, Greece’s sovereign credit rating is on the verge of reaching “investment grade.”

An economy can grow when the government cuts spending and creates a free market environment. Spain after the fiscal crisis and Greece after the COVID-19 pandemic demonstrate this. To overcome an economic crisis and achieve growth, governments must pursue austerity policies and ease restrictions in the market. There is no economic problem that can be solved simply by the government pouring in money. Especially in times of crisis, fiscal spending must be reduced and potential growth must be raised.

Hyungsoo Kim, Intern Researcher, Center for Free Enterprise (CFE)

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Original title: [자유발언대]재정위기에 빠진 그리스와 스페인의 상반된 경로

Author: Hyeong-su Kim

Date: 2023-11-24

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=free_opinion&pn=5&idx=26156