Will U.S. follow Greece’s course?

Instead of rioting in protest of its government, Greeks should be thanking their fellow European Union members for coming to the rescue. The European Union members are coming to the rescue in the form of a $146 billion loan. The hope is that this loan will give Greece time to restructure its debt and make significant internal reforms, and prevent further damage to the Euro.

The Greek debt crisis has little direct impact on the financial future of the United States. Yet U.S. policymakers should be paying close attention to learn from Greece’s mistakes and to prevent our own debt crisis. As House Majority leader Steny Hoyer warned, “It is enough to look across the Atlantic at Greece’s extreme economic crisis and understand: It can happen here. If we don’t change course, it will happen here.”

For years, Greece—like much of the developed world—has been over-spending and promising unaffordable benefits to its citizens. Profligate spending and weak tax returns (Greece has a significant problem with tax compliance) lead to a significant structural deficit and growing public debt. The debt has caused multiple problems.

First, one of the conditions of being a member of the EU is supposed to be that a country must balance its books. Member countries are required to keep budget deficits below three percentage points of GDP, but Greece is expecting to run a one year deficit of more than 12.7 percent—four times the EU limit. Greece’s total debt is roughly $404 billion, more than the value of the country’s entire economy. One of the conditions of the E.U. bailout package is that by 2013, Greece’s deficit must be back in compliance with E.U. standards.

Second, Greece’s growing debt has lead to increased worries that Greece might default on its debt payments, which would thus make borrowing more expensive and the budget problems even worse. The S&P recently downgraded Greece’s credit rating to “junk.” As a result, the interest rate on Greek bonds rose to almost 9 percent—three times the interest rate on a German bond. This means that the Greeks have to spend a great deal on interest payments, a big problem for the already cash-strapped country.

Even with the loan, Greece faces a significant challenge in getting their fiscal house in order. The public continues to protest “austerity” measures designed to reduce public spending. Yet spending cuts are inevitable in such a situation—particularly so since, absent reform, budget pressures are bound to get worse, not better.

Today, 18 percent of the Greek population is over the age of 65. The fertility rate is just 1.4, which means that Greece isn’t producing enough children to sustain its population. By 2030, one-quarter of all Greeks will be over the age of 65. Meanwhile, Greece has one of the most generous (and costly) public pensions systems in the entire E.U. As a result, public pension costs have been rising, and will get worse in the future, growing from about 11.5 percent of GDP today to 24 percent by 2050. Clearly something needs to change.

Andrew Dean, the director of country studies at the Organization for Economic Cooperation and Development (OECD) has said there are many steps Greece could take to avoid insolvency: cut administrative costs, control public-sector wage increases, slim down the public sector, reform state enterprises that operate at a loss, and, most importantly, reform their pension system.