Reforms that were never implemented begin to hurt

Athens : People who lie to join a club may not prove to be very good members. That is one lesson of the current fiscal mess in Greece, where there are — again — fears that the country will be unable to pay its debts.

Those particular worries are almost certainly overdone, at least for the near term. But Greece is suffering mightily from having joined the euro zone — something it was able to do only because it used what could kindly be called creative accounting to get its budget deficits down far enough to qualify a decade ago.

To be sure, there are unquestioned benefits for Greece from the euro. Interest rates are far lower than they would otherwise be, even if they have risen during the financial crisis. Having one currency for much of Europe facilitates tourism and encourages trade.

But Greece, like Italy, has lost competitiveness within the euro zone — so much that two bond rating agencies have reduced the country's rating and a third, Moody's, says it may follow suit. Inflation has been higher than in other parts of the euro zone, and the country finds it hard to match prices of other exporters. Moreover, notes Arnaud Marès, an analyst at Moody's, the country has a reputation for having a slow and expensive bureaucracy that makes it costly and difficult to do business in the country.

Devaluation option

If Greece still had its own currency, it would have chosen, or been forced, to devalue, and thereby gotten a quick boost to competitiveness, albeit at the cost of raising inflation as imported goods would have cost more. But that is not possible within the euro zone.

Some hoped the euro would lead to political union. Others hoped it would force countries like Greece and Italy to keep their fiscal houses in order and to introduce reforms to make their economies more efficient and competitive.

So far, little of that has happened. Germany has sent conflicting signals about whether, in the end, it would bail out a fellow euro country, but since Greek bonds can be used as collateral for loans at the European Central Bank, there is at least some institutional support.

Still, worries about Greece have helped to renew fears of contagion in other parts of Europe where foreign exchange reserves are scarce and debts are high. The comfortable belief that the world weathered the storms of 2008 and is now recovering could be challenged by a new wave of defaults.

At a minimum, we are being reminded that an incredible amount of capital was simply wasted during the late boom and a lot of those losses have yet to be realised. Unfortunately, Greece, like a number of other countries, has proved to be much better at announcing economic reforms than at putting them into effect.

In a major speech last week, the country's new Prime Minister George Papandreou promised economic changes. But as the head of Greece's Socialist Party and the president of Socialist International, a grouping of national socialist parties, he did not follow what has become the standard of comparison for euro countries in trouble: unlike Ireland, he did not promise to cut the pay of civil servants.

Instead, he said he would rely on attrition, hiring only one new civil servant for every five who retired. He promised that civil-service salaries would not be reduced, and that lower-level employees would get raises to offset inflation.

Euro countries are supposed to maintain budget deficits of less than 3 per cent of GDP — something that Greece did not do in the late 1990s but said it did in order to join the euro club. Papandreou promised to meet that goal, but not until 2013. Moody's estimates the deficit will be above 12 per cent in 2010.

"We must change or sink," he said. "Our biggest deficit is the deficit of credibility. Markets want to see action, not words."

Here is a socialist speaking after a world crisis that is generally blamed on capitalist excesses, citing the international market as requiring sacrifices at home.

Doubt in the market

The bond market is again voicing doubt, with Greek bonds trading at a yield premium of more than two percentage points over German bonds. In the heady days of 2005, that margin almost vanished. That costs Greece money when it borrows, and makes it even harder to get the budget under control. As with many countries, it has a public pension system with major problems. But it cannot make a new start by devaluing its currency, and it is unwilling to impose salary cuts.