An economist who was in the middle of the storm recounts Greece’s financial crisis

The Boston Globe

By Jonathan Schlefer
GLOBE CORRESPONDENT  NOVEMBER 01, 2016
When economist George Papaconstantinou returned to Greece after working for a decade at the Organization for Economic Cooperation and Development, he settled into a series of comfortable government and academic jobs. Then, to his surprise, PASOK, the social-democratic party, asked him to run for Parliament. He lost the first time but won in 2007. He also began advising the party leader, George Papandreou, on economic issues. Named PASOK’s press spokesman, he helped give the party a fresh, young image, contributing to its landslide election victory in 2009.
On taking office in October of that year, Papandreou appointed him finance secretary. Papaconstantinou didn’t realize it at the time, but the Greek debt crisis would make it the “hardest job in Europe,” he says.

Papaconstantinou spoke recently with the Globe about his role in the crisis that shook Europe when he was in Boston to promote his book “Game Over: The Inside Story of the Greek Crisis” (Papadopoulos Publishing, Greek and English, 2016).

Q: How many countries have faced anything like what Greece has?

A: Very few countries, I think only five, have had a recession that lasts more than five years. We’re in our seventh year. Our recession is close to the depth of the Great Depression in the United States.

Q: How did you actually discover what trouble Greece was in?

A: October is budget month. You need to know what you’re starting from, so I assembled people from the General Accounting Office, the Revenue Service, the Bank of Greece, and the Statistics Service. I was astonished to realize this had never been done before. They had never had open, frank conversation. It quickly became apparent that the deficit was already 9 percent of GDP, going on 10. Based on that trend, it would end up 12 percent. This quickly became 15.5 percent. We found skeletons in the closet — 1.5 billion euros of public companies’ pension funds weren’t in the budget at all, expenditures were clearly underreported, revenue projections were based on wildly optimistic assumptions about growth, but the economy was already in recession.

Q: The US government prints dollars, so it’s not going bankrupt. The Greek government can’t print euros, so it could go bankrupt. When markets feared it might, they jacked up interest rates, like on a bad credit-card customer. But who really caused the crisis?

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A: Oh, there are so many culprits! Both political parties, including mine. Particularly after 1981, when PASOK came to power, it created a national health care system, increased pensions, lifted people out of poverty — all necessary. The flip side was a rapid increase in debt. And the economy fell increasingly behind in the modernization it requires.

The conservative New Democracy Party could have capitalized on the 2004 Olympic Games in Athens. Greece was in the euro, credit was cheap, its image was fantastic. They ran everything down. Government debt was on a knife edge, hovering around 90 or 100 percent of GDP. They thought they didn’t need to rein it in because the economy was growing so fast — but based on loans and imports. When growth collapsed in 2008, debt shot up to 130 percent of GDP.

The European statistical agency failed to monitor what was going on. But it had asked for auditing powers, which France and Germany had vetoed. The head of the European Commission was in the same political family as New Democracy, so he didn’t want to give it a hard time.

And the markets! They lent at extraordinarily low rates to Greece in the 2000s, completely disregarding what should have been an obvious risk. The same credit-rating agencies that gave Enron AAA ratings until days before it collapsed were happily giving Greece high marks.

Q: May I suggest that when the euro was created, economists didn’t understand the dangers? They had this model about the difficulty of setting interest rates when countries go into recession at different times. But the model had no banks in it, and the euro crisis was a banking crisis.

A: You’re absolutely right, banks were a big part of the problem. In fact, there’s an interesting what-if question. How would the crisis have evolved if not Greece but Ireland had been the first to fall? Because unlike Greece, the Irish crisis was a purely banking crisis.

Q: Ireland had been running budget surpluses.

A: So if it had fallen first, and Greece had held on a bit longer, perhaps the whole thing wouldn’t have been a morality tale of fiscal profligacy.

Q: You disagree with some US economists who have suggested Greece should go off the euro.

A: I have not seen any convincing evidence for doing that beyond the mere statement that there will be a few difficult years but then everything will be all right. How many years, how difficult, who will bear the cost? By the time they said that, Greece had adopted harsh measures to reduce inefficiency. It was running a small budget surplus, not counting interest. Going off the euro might suppress the economy another 20 percent. Practically all our energy is imported, much of our food, a lot of medicine. Where would they come from?

Q: In October 2011, Greece was finally offered an outright debt reduction of 100 billion euros plus a second loan to provide breathing space, in exchange for more harsh measures. Papandreou called a referendum to let the Greek people decide on the package. Why didn’t it happen?

A: The government was facing a crisis of legitimacy. We weren’t elected on wage cuts, pension cuts, tax hikes, but we couldn’t put these policies to the people before the first bailout. We had to avoid bankruptcy. When Papandreou came back to Athens with this second package, he met hostility from every political party. They said we could stay in the eurozone but didn’t need harsh measures. There were riots in the streets. So to break this cycle, he called a referendum. His European peers felt betrayed because the agreement they had just made was up in the air.

Q: The German chancellor and French president said, ‘Oh, no, you don’t.’

A: Especially French President Nicolas Sarkozy. The agreement with Greece was supposed to be the launching pad for his reelection campaign — he had solved the problem, it was a triumph. Papandreou was told if he wanted a referendum, the question had to be in or out of the euro. That was not the thing to do. And he didn’t even have much of his own party’s support. So he backed down. In the end, both large parties were forced to sign the package. This became necessary but raises questions about external imposition on democratically elected governments.

Q: Whereas if you had held a referendum in 2011?

A: There is no doubt in my mind we would have won it. The government was ahead in the polls. We would have had fresh legitimacy to tackle the crisis.

Jonathan Schlefer, author of “The Assumptions Economists Make” (Belknap/Harvard, 2o12), is a research associate at Harvard Business School.