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This convention was started for practical reasons many centuries ago.
In most of the Cycladic islands, houses were painted white to reflect the harsh summer sun. So, it started for let's say "bioclimatic" or "ecological" reasons, to make houses a little more heat resistant, with the knowledge people had at the time. All Cycladic island houses were quite well insulated, although with primitive means -- walls were built with stone (enduring heat and cold very well ) while roofs (vaulted or not) were insulated too, with a combination of wood, mud, hay, and pozolanic (volcanic ash) cement. One thing to note is that walls were not painted with white paint, since white paint was fabricated and mass-produced all around the world,only after 1905 - 1915. Instead, asbestos was used to produce an almost white color. It was also used as a cheap material for many other purposes, like painting tree trunks to kill pests, making the edges of pavements more visible, ornamenting small roads, etc. This was NOT the case in Santorini but in most other Cycladic islands.
Santorini (where some examples are preserved till today) was colorful and vivid. with the use of intense red, brown-red, warm ochre, transparent cyan, a little white, light blue, brown, etc. After many centuries, color has finally become a stylistic issue in Santorini, rather than a practical one. Unfortunately all this changed in Santorini in the 1967 - 1974 period, when a military government was in power in Greece. For clearly political reasons (it brought to mind certain political concepts) all houses had to be re-painted white by law, as were houses elsewhere on the island. In contrast, church domes were already painted blue in most of the cases. So, after some decades, the blue and white combination, along with the preexisting colors of the Greek flag and the preexisting colors in other islands too, became the strongest "trademark" of the Greek Cycladic islands, Santorini included.
Since 1974,all new houses have had to be painted white. This was a common obligation, by law, but sometimes light ochre, pink, and some other light colors have been allowed. Last year, a big debate was re-opened between the Ministry of Culture and other authorities about re-allowing the use of other vivid colors, as in Santorini. This conversation is still in progress.