In this Greek melodrama, everyone is watching Angela Merkel and Alexis Tsipras, the German and Greek political leaders, seemingly racing their cars towards the edge of a cliff, daring each other to jump out first. The face-down is fascinating but if you wanted to know why it is happening you would do better to watch the other euro zone leaders, shuffling in silent embarrassment. They know that Greece is just a prelude to a long-delayed reckoning over how Europe will pay for its overburdened and over-indebted welfare states.
Greece is bust. It has been so for five years, unable to borrow from commercial lenders. The money advanced by the European institutions and the IMF has simply been used to repay other debt. Greece cannot service its borrowings because the economy has shrunk by a fifth and the only solution is some sort of managed default.
Most of the hawkish euro zone politicians, such as Wolfgang Schauble, the German finance minister, know this to be the case. He wants troublesome Greece out of the Euro area so he can get on with the real task of integrating Europe's core economies and imposing financial discipline and reform on bigger basket cases, such as Italy, which has just scraped out from under a three-year recession with government debt 1.4 times its GDP. But Mr. Schauble is at odds with his boss, Ms. Merkel, who continues to do battle with the Athenian rebel, hoping she can pull a rabbit out of a hat and thus avoid the awful continent-wide political confrontation that would follow a Greek default and exit from the euro.
Greece is the fork in the road: If it stays in, the euro zone bumbles along, deferring and delaying economic reform, pension and welfare reform. If Greece cuts itself adrift, the financial markets will pay close attention to weakness elsewhere. This was acknowledged by Alexander Stubb, the Finnish finance minister. He is a harsh critic of Greece and in an interview with the Financial Times, ahead of today's Eurogroup finance meeting he admitted that Finland needed to put its money where its mouth is. "It's quite obvious that Finland is a country right now, that needs to put its house in order."
Yet Finland is hardly the weakest link in a euro zone crippled by a double-digit rate of unemployment, weak economic growth and the financial burden of welfare systems supported by shrinking working age populations. Underlying the poor economic performance is the fundamental challenge of paying for welfare systems established during the post-Second World War economic and population expansion. In a world of zero inflation and static or negative population growth, the burden of supporting an expanding welfare bill gets worse every year. Unfortunately, the institutions of the European welfare state are politically untouchable.
What is being tested is the European consensus about the state's proper role in social spending. Greece has given Europe a terrible fright in allowing its public finances to get ruinously out of control, mainly through overgenerous and unfunded welfare provision to the middle classes. However, most continental European states operate cradle-to-grave welfare systems that provide cash subsidies that are not means tested. Ranked in order of social spending, the top ten nations in the OECD database are Europeans. France leads the field with public social spending representing 32 per cent of GDP. The euro zone states are well ahead of the U.K., Canada and the U.S. which spend at or below the OECD average of 22 per cent.
The biggest part of the burden, unsurprisingly, is state-funded pensions. According to the OECD, cash pension payments represent almost 16 per cent of GDP in Italy. That can be compared with the ratio in Greece of 14.5 per cent, a figure which is at the centre of the demands by Greece's creditors that pensions be cut. Public pension provision represents 6.7 per cent of GDP in the U.S., 5.6 per cent in the U.K. and only 4.5 per cent in Canada, reflecting the big role played by commercial pension providers in the so-called Anglo-Saxon economies.
It is the principle of universality that is under challenge. Very little of state support in the euro countries is targeted just at the poorest – in Italy only 5 per cent of state social spending is subject to means testing while almost a third of the state's cash payouts go to the top fifth of earners. It amounts to a massive subsidy by the state of the Italian middle class.
For many Europeans, (unlike Canada and the U.S. or the U.K.) the notion that the state provides for all is an article of faith. It is not seen (as in Canada, the U.K. and and U.S.) simply as a safety net for the unfortunate, the sick or those who failed to invest wisely in private pensions. The European ideal is that all pay in and therefore all have a right to take out. Greece's financial disaster has exposed the terrible weakness in a system which has been stretched like a rubber band to accommodate more and more welfare recipients while the numbers who pay in to the system dwindle due to low birth rates, unemployment and the black economy.
Greece has been cast as the euro zone's spoiled child caught with its fingers in the cookie jar, yet it is worth remembering that the wider family has much bigger issues to contend with. If Ms. Merkel appears to be mesmerized in her struggle with Mr. Tsipras, it may be because she reckons that she can make a lesson of Greece to her euro zone colleagues.
It's a futile exercise. She should let Greece go. The financial markets have already spotted the Italian and French pension time bombs. They are just waiting to see how the Greek game plays out.
Carl Mortished is a Canadian financial journalist and freelance consultant based in the U.K.