How can problems in Greece’s relatively small economy cause problems for the rest of Europe and even far-away Asia and the United States? Some economists say that international loans and worried investors are among the reasons for the fear of financial contagion.
Economic austerity measures recently sparked riots in Greece as some citizens protested cuts in government spending, services, wages along with tax increases.
The bitter medicine was intended to help the troubled government repay loans that made up the difference between high levels of government spending and low levels of tax revenue.
Stratfor analyst Peter Zeihan says Greece’s economy has too many people working for the government and too little industry.
“The Greek system does not have an industrial base. Its primary business was in shipbuilding and that has been almost completely over taken by the Chinese and the Koreans. All that really leaves is tourism. You cannot support a country Greece’s size on tourism,” Zeihan said.
Stratfor does political and economic analysis for business and governments.
Greece’s lack of economic power makes it harder for it to pay back loans. Richard DeKaser of the Parthenon Group in Boston, says, if the Greek government cannot repay its loans, it will hurt lenders, who in turn will have trouble repaying loans they have taken out from other financial institutions.
"So the worry is that Greece defaults, certain banks take losses, those losses affect counter-party banks, the entire banking system goes into contraction (shrinks)," DeKaser said.
With banks less able and less willing to make loans, economic activity slows or even stalls.
American Enterprise Institute economist John Makin says Greece’s economic and political problems could force it to leave the group of nations that use the euro. He says that makes investors and lenders worry about other euro member nations with heavy debts.
“People start asking, if Greece leaves, what about Spain? They are experiencing some of the same symptoms. What about Portugal?,” Makin said.
Worried investors and lenders will make fewer loans to nations that seem to have Greece’s problems. That perceived increase in risk means borrowers will have to pay higher interest rates to get loans, sharply raising their costs and hurting growth.
Many economists say a Greek default could do serious harm to many economies. But Greece’s problems have been well-known for some time, allowing lenders and others to sell off risky Greek investments, reducing the potential damage.
Richard DeKaser also says a political accommodation might also ease the crisis.
“I think the most likely scenario is that we get another ‘muddle through' compromise,” DeKaser said.
He says protesters and angry voters have sent a message that austerity measures have been too severe and officials may become more flexible as they seek a way out of the crisis.