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Greek debt recession and austerity (part 1)

A primer of why Greece is in a tough situation (more in future videos). Created by Sal Khan.

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  • female robot grace style avatar for user Cassandra Hamilton
    Can someone explain how all the countries in the Eurozone are tied together economically?

    Is it possible for the entire Eurozone to go into a depression that pulls the economies of the rest of the world into one also?

    Thank you for your answers so far.
    (125 votes)
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    • piceratops ultimate style avatar for user Kamil Jozwiak
      Yes, if Greece defaults on their debts, devalues its debts or goes back to their old currency and leaves the EZ (Euro Zone), this will cause a ripple effect throughout the financial system.

      Because of this mess, Greece is locked out of the financial markets, basically meaning that no one trusts Greece and expect very high interest on borrowed debt (known as bonds)

      So now that Greece cannot finance itself through selling bonds on the open market (because no one wants them), there are three organizations that are buying bonds to help Greece stay afloat and finance itself:

      - European Commission (EC)
      - International Monetary Fund (IMF)
      - European Central Bank (ECB)

      These organizations collect money by the other countries in the Euro Zone, and they are holding most of Greece's debt (Bonds).

      Once Greece goes belly up, they will basically be stuck with billions of uselss bonds that will never be paid back.. This will affect other countries that are in the euro zone, especially the banking sector.

      Because the banking sector is so intertwined throughout the world, many banks will take some loses.

      The main concern isn't really Greece going bankrupt, its what will happen to other weak countries such as Spain, Italy, Portugal. If these run into more issues, the ripple will be even larger causing more chaos.
      (150 votes)
  • blobby green style avatar for user br.ramaprasad
    Nations are no different than individuals. Lenders knew the risks, took risks and made lots of money when the going was good in Grece. Now Greece cannot pay, the lenders should take the hit. Should they not?
    (44 votes)
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  • male robot hal style avatar for user Melinda Baker
    I wonder why countries are allowed to borrow to 100% of their annual income, but I can get only credit to about 40% unless I want high rate credit cards? As in, why are are countries spending themselves to crisis point?
    (12 votes)
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    • male robot hal style avatar for user Cameron
      When a person has larger, and larger amounts of debt, as compared to their income, they become a credit risk, and the lenders raise the interest rates for borrowing money. The same thing happens to countries. As the countries start to accumulate larger amounts of debt as compared to their potential revenue streams (taxes, government owned corporations, etc.) , they have to payer higher rates of interest on their bonds before investors will buy them.

      As a private individual, you tend to have limited options for generating income, or capital to pay off your debts. What you earn as income from your job tends to be fixed, and the assets that you have (house,car,retirement savings), tends to be limited. Worse even still is people lose their jobs all the time, depriving them of their primary source of income. Private individuals go broke all the time. This makes lenders cautious around private individuals.

      Countries on the other hand have what are typically (but not always) predictable sources of income from taxes, and if they feel like they need more income, they often can raise taxes to generate more income (but this is not always effective). Beyond that, countries often have considerable assets (companies, land, buildings,etc.) that they can sell to pay off their debts. Countries, outside of the third world, rarely default on their debts. This makes lenders more confident that countries will pay them back.

      Why do the countries spend themselves to this crisis point?
      I would suggest that barring an event that suddenly destroys a country's economy, the cause is mostly politics. My rationale for this is below:

      Given 2 politicians:
      Candidate A) says they will provide generous social programs, and makes spending promises for each area of the country, and promise to keep taxes low,
      Candidate B) says that the country needs to tighten their belts and everyone needs to expect to receive less services, the country can't afford to spend money on special projects for each area of the country and on top of that the people need to pay more taxes.

      Candidate A will likely win, and candidate B will likely lose. This gives a huge incentive for politicians to act like candidate A. The consequence of this is countries usually use deficit spending to pay for the promises of candidate A. This results in debt increasing. This is certainly not a phenomenon isolated to Greece, or even Europe.

      Sure, candidate A could take the high road and not make these promises, but it is likely a candidate C would come along who would promise those things, and would then get elected.

      Voters may be unaware that this will result in a problem, or be willfully blind to it. Those who are aware of it may not care to do anything about it since it won't be them that has to deal with the problem, it will instead be the problem for a future generation to deal with.

      And then all of a sudden the future is now.

      This answer, as would any answer to your question, will be endorsed by some, and disputed by others.
      (27 votes)
  • blobby green style avatar for user cwpollock
    Looking at the data at the bottom of the presentation, it looks like Greece was relatively stable for a long period of time. What is it that tipped it into the spiral. It doesn't seem to be a long trend, it seems to be something that's developed over the last several years.
    (5 votes)
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  • male robot hal style avatar for user Faisal
    What would happen in a world without interest?
    (3 votes)
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  • leaf green style avatar for user Luis
    I'm so glad I found this app at the chrome store, and I am thank full to have access to this "digestible" information. In regard Austerity, can the changes made in spending be made in a way in which it puts the money to work back into the economy, given that does paid for will benefit from it? or would this be too much control from the government? and if so, could it be only be done as a transition until the economy in the country balances? I am new to economics, so please bare with me! Thanks!
    (5 votes)
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  • blobby green style avatar for user Renato Tranchesi
    I understand the current situation of Greece, but why they had a high deficit throughout this period, especially in years of economic boom?
    (2 votes)
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    • male robot donald style avatar for user Matthew Drane
      Because they receive very little in taxes, partly due to having there taxes set low and partly due to the problem in Greece of people not paying their taxes. That is a very persistent problem in parts of Europe such as italy but it is probably worse in Greece.

      As well as this they had very generous pension schemes as well as benefits for those sick ect (Not saying this is a bad thing, just very high for their revenue from tax)

      So this low amount of tax coming in and high amount of spending created a large deficit even within the boom period,

      Hope this helps.
      (3 votes)
  • aqualine ultimate style avatar for user Nathan2055
    What actually began the rising of the debt that led to this current crisis?
    (3 votes)
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  • blobby green style avatar for user GTJG88
    When Austerity happens, the economy contracts and does shrink, but wouldn't this be a good thing? It seems that when the government spends money, the economy is running off of artificial money that is not real production.

    My question is, although contraction in the economy caused by austerity hurts in the short run, wouldn't it help in the long run by restructuring the economy to where the demand and production is more "real", rather than artificial?
    (3 votes)
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  • piceratops tree style avatar for user G-dragon freak
    why did they go down in stock?
    (3 votes)
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Video transcript

Greece and the crisis in the European Union has been in the news for some time now, so it's long past due that I did a video on it and just so we have a time context that you might be watching this video far in the future. This video is being done in May, 2012. So we really don't know how all this is going to play out, but I hope over the next few videos to lay out the potential scenarios and what might be the risks and drawbacks, uh, drawbacks of each of them. So this right over here, that is Greece. And so let's just think about it on a very high level, what the situation that they find themselves in. So when you look at this chart right over here the most obvious thing and it actually pops out from this top line right here, their public debt is growing at a dramatic level and their debt to GDP...this is actually the more relevant thing because you might have a huge amount of debt but if your GDP, if the productivity of the country is high, that might not be that big of a problem. What matters is how much you owe relative to how much that you can actually produce. And we see right over here the debt to GDP ratio is a percentage so this debt is a percentage of GDP , it's well over 100%. It is well over 100% for Greece. And you can see a large part of that is because the public revenue, the taxes that the Greek government gets is consistently lower than their public expenditures. So let me write this down. So you have taxes. Taxes are less than spending which lead to deficits...deficit is how much you couldn't afford, or how much, how much spending you have above and beyond your revenues in a given year. And so they have deficit spending on a year by year basis which increases their debt. The debt is the total amount of money that they owe, that's this top line right over here. So this leads to increasing debt, increasing debt right over here. But that's not the only problem. Because as their debt keeps increasing, people start to become more and more suspicious of whether the government is actually good for their I.O.U.'s, whether the government will actually pay back that debt. And so as the government's debt becomes riskier and riskier, people start demanding higher and higher interest rate. So the debt goes up. And as the debt goes up, people think that they're not a good borrower. So they want higher interest, interest goes up. But now that makes things even worse, because we were already running deficits, we were already spending more than we were bringing in taxes, now we have to spend even more on the interest on our debt. So if you were spending 10% on your interest in one year, so if you had $100 billion dollars, you just spend $10 billion, now if the interest rates go to 15%, you have to spend$15 billion on that. So that's going to make your spending on interest go up, so that's going to make the debt go up even more. So Greece finds itself in a situation like this. So you might immediately say "well, you know there's seems to be a fairly straight forward solution here. Why don't they do some combination of increasing taxes?" So why don't they increase taxes? "And maybe even more importantly, why don't they decrease spending? " Why don't they decrease spending? Now the first cut is a political situation. Because this spending right over here, these are for the most part, these are promises to people, these might be government obligations, these might be pensions, there might be retirees that are dependent on this, there could be other types of government programs. So if you decrease that spending, the people who are losing out on those entitlements, they are not going to be too pleased with you. So politically that's probably not the best thing to do. But there might be a brave Greek leader that say "well no, this is what we have to do to save the country, we're willing to cut that spending." But that by itself, even if someone was willing to do it, it still isn't clear whether it's a good idea. Because you might have noticed this other line right over here. This other line, "Real GDP Growth" . Greece right over here is in a fairly severe recession. They have a lot of unemployment, clearly factories aren't producing at the levels that they could actually produce. So if you either do some combination of increasing your taxes, increasing the government revenue, and decreasing spending, that actually will suck air out of the economy. So this combination of things, and you've probably heard this word a lot, this combination of things, and it tends to focus on the decreasing spending in a very significant way, this is referred to as "Austerity." The word "Austere" just generally means someone who doesn't have a lot of frills, they just deal with the most bare necessities they really kind of cut things to the bone. And so when a lot of people say "Hey Greece you have to do Austerity measures" --and there's actually already been a couple of rounds of austerity measures. "you need to decrease your spending in a big way." But the problem is Austerity sucks money out of the economy, and so Austerity leads to the economy slowing further, and if the economy slows further, that actually going to hurt your taxes. So the economy slowing makes your taxes, your actual revenue that you're getting, go down, and that can actually make your deficits even worse! Because now people say "oh my God, their economy is bad, they're even less likely to be able to pay." Interest rates go up, and since the tax revenue goes down, and a lot of the spending isn't tied to the economy, a lot of the spending actually goes up with the economy. It might be unemployment insurance, it might be people retiring, pensions, and so that can actually make things worse. And that's actually what has happened over the last few years. Because, and we'll talk more about this, the Greek's were given some help from the rest of the European Union. In exchange, the rest of the European Union said "well, if we're going to help you, you gotta take some pain. And the pain that you had to take were these Austerity measures right over here." But these Austerity measures actually made the economy do even worse, which made debt as a percentage of GDP even higher, because now the GDP itself was shrinking at a even larger and larger rate. So if you think, just all of these aspects, there was no obvious answer here. You do Austerity, it's kind of a bad situation because that's going to hurt the economy, you're going to become even less productive, at least in the short term. And on top of that it's hugely politically unpopular, to the point to where we have such high unemployment that it's becoming politically unstable. So I'll leave you there, I'll let you mull over this situation, and in the next video I'll talk about what a normal, independent country, truly independent, both fiscally and monetarily independent country, would do in a situation like this, given Greece's situation. And then we'll talk about why Greece kind of can't do it in its current context.