Unconventional business thinking across the board: Debt crisis in Greece - are there lessons to be learnt from the Latin American case?

Recently there have been many debates about the Greek crisis, its causes and potential consequences. With Greece being a member of the European Monetary Union many other countries depend on the situation in Greece. In order to know how to prevent Greece’s default and the potential meltdown of the European financial system there is a need to understand the history and origins of Greece’s debt crisis. As I will attempt to illustrate in this article at the core of the current crisis are fundamental imbalances in the level of consumption and income, which following years of reckless behaviour, brought the European integration project to its knees.

In order to explain the origins of the crisis and provide a basis for the formation of an effective resolution, many lessons can be learned from past debt crises with a view to avoid taking the wrong policy decisions and efficiently work toward the restoration of confidence in sovereign bond and financial markets. I will therefore take a comparative approach and consider the parallels between the Latin American debt crisis of the nineteen eighties and the current debt crisis in Greece.

As this article will set out, while in both the Latin American (1980s) and Greek (late 2000s) case the trigger was an external shock, the key difference between the two is the structure of the total public debt. While Latin American countries affected by the crisis were characterised by a high proportion of short term debt in the total public debt, Greek was characterised by an overall high level of indebtedness, particularly external debt, accumulated over years of excess consumption with limited long term investment.

This article will discuss the differences and similarities of crisis in Greece today and debt crisis in Latin America during the 1980 by analysing key economic indicators. Firstly, I will summarize the beginning of the debt crisis in Latin America (focusing on Argentina, Brazil, Venezuela, and Mexico) and Greece and then compare their respective public debt levels, inflation rates and Gross Domestic Product.

THE BEGINNING OF THE DEBT CRISES IN LATIN AMERICA AND GREECE

As Montiel (2003) pointed out, the problems for Latin American countries started in the 1970s when international inflation was high and nominal interests were relatively low and developing countries experienced rapid growth. These circumstances allowed the Latin American governments to borrow heavily and they accumulated a sizable stock of external debit by the beginning of the eighties. At the very end of the seventies the situation changed rapidly as oil prices increased and consequently in the early 1980s interest rates raised sharply which resulted in developing countries’ growth slowing down. With falling growth Latin American countries had problems in meeting their obligations and making interest repayments (El-Gamal et al, 2009).

The financial crisis that started in the USA in 2007 and spread all over the world has not bypassed Greece. Even though almost every developed country has had heavy problems in resolving the crisis, Greece’s problems were even deeper and date back before 2007; the Greek government’s weak co-ordination and organization, high expenditures in comparison to revenues, corruption, tax evasion, weak welfare system and inflexible employment laws (Muhammad et al, 2011). Before entering the Eurozone, Greece needed to satisfy the criteria set out in the Maastricht Treaty in order to adopt euro as its own currency. Greece entered the Eurozone on 1 January, 2001 and by becoming a member of European Monetary Union (EMU) funds started to flow into the country, mainly German funds (Arghyrou and Tsoukalas, 2010). Markets perceived that the EMU countries had a vested interest in Greek reforms and Greece’s continued participation in the EMU (Arghyrou and Tsoukalas, 2010). After 8 years of entering the Eurozone it surfaced that Greece lied about its circumstances by misrepresenting its monetary and fiscal results (Muhammad et al, 2011). The reason behind the Greece crisis was the behaviour of its institutions, as they behaved dysfunctional which was neither forecasted nor expected (Muhammad et al, 2011).

Latin American countries in the 1980s and Greece today have a common feature high external debt and both Latin America and Greece depended on the economic situation in foreign countries, specifically on the credit inflows from these countries.

PUBLIC DEBT AND GOVERNMENTS’ EXPENDITURES

During the 1980s the largest Latin America debtors were Argentina, Brazil, Mexico and Venezuela (Guidotti and Kummar, 1991) and in Europe today one of the largest debtors is Greece, followed by Portugal, Ireland, Spain and Italy (The Economist, 23 April 2011). This section will compare available data about public debts and governments’ expenditures within the countries and will illustrate how healthy these economies were over the observed period.

Argentina, Brazil, Mexico and Venezuela accumulated their public debt over the years. Graph 1 shows their total and external debt as percentage of GDP between 1976 and 1988. From the graph is visible that there was a constant growth of total debt till the 1987 when total debt started slightly to decrease. The culmination of public debt was in 1986 when it was more than 50 per cent of GDP and external debt was more than 30 % of GDP. From 1976 external borrowing grew steadily till the 1986 when it finally started to decline.

Graph 1: Total public debt and external public debt for Four Largest Debtors, 1976-88 (percentage of GDP)

Source: Guidotti and Kummar (1991)

A key characteristic in the management of public debt is the debt maturity where long-term debts (bonds) are desirable since they help in stabilizing inflation and prevent “credibility crises” (Guidotti and Kummar, 1991). The debt structure of Latin American during the 1980s was heavily geared towards short term debt, as set out in the table below.

	Short-Term Debt/Total Debt
Country	1982-1988	1987-1988
Argentina	63.3	73.7
Brazil	100.0	100.0
Chile	48.3	31.8
Mexico	73.8	71.8

Table 1: Debt Maturities, 1982-88 and 1987-88 (in per cent)

Source: Guidotti and Kummar (1991)

Brazil’s total debt fully consisted of short-term debt while over 50 per cent of total debt was short-term debt in Mexico and Argentina. The reasons for that structure probably lay in the lack of credibility of Latin countries which prevented them from issuing long-term bonds (Guidotti and Kummar, 1991). The exception was Chile which had less than 50 per cent of short-term debt.

As for Greece, it most recently became obvious that Greece lived far beyond its means as illustrated in graphs 2 and 3. Government consumption consistently exceeded total government revenue. Most strikingly, the gap between expenditures and revenues widened in 2009 due to the sharp drop in economic activity and private sector demand. From 2000 Greece’s government expenditures were constantly higher than revenues and in 2009 expenditures reached over 50 per cent of the GDP. The year 2009 was the year when the Greek crisis exploded, when its credibility was shifted down and when it was placed very high for the corruption (Muhammad et al, 2011).