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Greece: A Contrarian View
June 23, 2010
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Summary
Economic analysts have made up their minds: Greece is doomed to face stagnation, social chaos and eventually default. An alternative scenario will not hurt.
Analysis
Greece can easily make its public deficit target for 2010
Although most people would endorse a claim that any Greek government would understate its deficit, the truth is that this one overstated it. The new administration decided to pay past debts upfront while failing to collect sizeable revenues due for 2009 thus raising the deficit to 13,6% instead of 9,5% of GDP. Although this proved a major tactical blunder, the upshot is that the deficit target of 8,1% for 2010 is hardly a Herculean task. In fact, already legislated measures should reduce the deficit well below that, despite the instability caused by the bailout saga given the inability of the domestic political system to assume leadership. The “unexpected” improvement in public finances should become obvious next fall.
The Greek crisis is different to other EU countries
The large public deficits of debtor economies - like Spain, Ireland, UK, Portugal - are the result of pronounced private sector deleveraging.
The Greek private sector is under-borrowed with private debt at 98% of GDP compared to 136% for the EU average and over 180% for major EU debtor economies. So how did Greece manage to sink its public finances when its economy had been growing at twice the EU average for over a decade?
The culprit is the state sponsored nature of Greek capitalism under the management of a populist and corrupt political establishment. The latter has refrained from observing budgetary constraints and implementing permanent reforms to ensure the sustainability of public finances. That same political system took advantage of cheap credit, after adoption of the Euro, to finance a public sector spending spree raising public debt to 115% of GDP.
Over 2005-09, primary revenues declined by 3,5% and expenses increased by 4,5% of GDP due to the doubling of the public sector wage bill as the government went overboard with wage increases and new hires, heavy subsidization of pension-health funds and a collapse in the tax collection mechanism with (certified) uncollected taxes accumulating to 12% of GDP.
Greece found itself in a similar position in the 1990s when a budget deficit above 11% of GDP was reduced to 3.1% between 1994-99 and quite surprisingly growth averaged at 2,8% during fiscal retrenchment. This occurred despite an exchange rate pegged to the ECU, a real interest rate above 5% and a political establishment that was as complacent as the current one.
Over 1994-2004, Greece has consistently registered primary surpluses averaging at 2,8% of GDP.In reality, the current Greek adjustment program is primarily targeting a return to past trends. However, this time around, the focus is on reforms of permanent nature, over a much shorter period of time and under extremely adverse global circumstances.
Can Greece arrest the decline?
Greece is one of the least institutionally evolved economies in the Eurozone. Postwar Greece leapt from underdevelopment and within a few decades started to resemble a developed economy leaving however a number of unsettled scores in the process.
Greek tax revenues lag the European average by over 7% of GDP, the public sector wage bill absorbs 57% of tax revenues compared to 39% for the EU average and the budget subsidizes insurance funds to the tune of 6% of GDP when most other EU members have mature pension and tax systems in place. The OECD has estimated that public sector inefficiency results in a suboptimal use of public spending reaching 35% of the total. This is an understatement considering that just the public health medical bill is 75% of Spain’s with almost five times the Greek population. The unofficial economy, mostly as tax evasion, accounts for 30% of GDP while there is a large potential from privatization.
Regarding the policies legislated in 2010, a decline in public sector wages by 15% coupled with a wage freeze and a reduction in public employment by 20% over 2010-13 will reverse the recent ballooning of the wage bill. The new tax law will reduce tax evasion significantly e.g. average taxable income declared by middle strata self-employed is 30% below that declared by wage earners. The new pension system linking pensions to contributions and abolishing early retirement will reduce the pension to salary ratio by 25% and raise the average pensionable age from 57 towards the EU average of 64 years. These measures will also help bring a significant share of the unofficial economy to the mainstream. Therefore an increase in revenues by 5% of GDP and an equal fall in spending sustaining a primary surplus of 3,5% of GDP should not be brushed aside as unrealistic.
What about growth and competitiveness?
Analysts claim that growth prospects are non existent given lagging competitiveness. According to latest EU data, Greece’s real exchange rate (measured by unit labour costs) has appreciated by 12% since joining the Euro which is almost half the appreciation incurred by Italy, Spain, Portugal and Ireland. Hence, easy foreign credit and a public administration happy to indulge are better at explaining Greece’s large external deficits instead of a total collapse in competitiveness. Even so, the measures adopted entail a massive real exchange rate depreciation given the pronounced decline in wages.
Pessimism also stems from the presumption that strong growth (1,7% above the EU average) since the mid 1990s has been the result of excessive domestic consumption. Since 1995, with the exception of the past two years, consumption has consistently been rising below GDP growth and in reality it was investment that actually doubled sustaining productivity growth at 2,8%. The strong points regarding Greek growth include the fact that earnings from tourism, shipping and earmarked EU subsidized investment amount to over a fifth of national income and do not depend on domestic demand. Further, given that 55% of consumer spending is made up of imports, any decline in the former implies a positive contribution to growth from net exports. Finally, the retreat of the public sector entails a strong modernizing aspect that will help relieve private sector crowding-out and raise competitiveness (like in the 1990s). Hence the assumption that the Greek economy will be down and out for the foreseeable future could prove unfounded.
What about public debt?
Although real growth should decline by almost 6% over 2009-2011, most analysts predict public debt to exceed 150% of GDP due to pronounced deflation reducing nominal GDP by almost 10%. This assumption ignores that Greece is a small open economy (price taker) implying that nominal growth (which matters for debt/GDP) need not fall dramatically since the large share of imports ensures that inflation will tend to track the EU average. Already the prediction for a 3% decline in nominal GDP this year will probably be revised closer to 1% positive growth. Finally, the EU-IMF program targets public sector savings of 11% of GDP over 2010-13 but the measures already legislated amount to savings of 18% of GDP and should they be partly enforced debt would peak below 135% of GDP.
What could sink the boat?
Unboundedly, a major risk stems from the fact that reforms will actually have to be implemented by a political establishment whose norms are the actual problem. Even Greece’s economic elite is partly state sponsored thus lacking both the willingness and credibility to lead. It is exactly for these reasons that it is the EU-IMF leading the adjustment process, rather than some Greek government.
Obviously, people will have to grow wiser out of this experience and decide to reboot their political system to avoid future crises, albeit at a more convenient time. Greeks already know that they have plenty to lose, so any forthcoming social unrest will mostly result in forcing the government to get its act together in overcoming internal opposition towards the gradual retirement of the current regime.
If the prerequisite for escaping economic ruin was a swift institutional convergence to advanced economy standards then Greece would require something close to a revolution. However and despite the obvious risks, since better housekeeping and long due reforms are likely to prove sufficient, it seems quite premature to preempt the country’s socio-economic demise from within. In fact, the greatest risk for Greece resides abroad.
The unbalanced European economy constitutes the major risk
The current policy mix across Europe, namely, that exports should continue to constitute the growth engine of creditor economies (like Germany) while debtors (like the South Europe) should focus on restrictive fiscal stances is self-defeating. It tends to perpetuate economic stagnation as creditors can’t sell their exports and debtors can’t sustain their economies in the face of inevitable deleveraging. It remains to be seen whether a weak Euro alone will persist long enough to rescue European growth given the unwillingness of Europe’s creditor economies to expand their domestic demand. The latter still hope to free ride economic recovery on the back of Chinese domestic expansion and US deficits putting both European and global recovery at risk. Economic stagnation in Europe would not allow breathing space for Greece to escape the debt trap. Should Europe find itself in such a predicament the surfacing problems will demonstrate that Greece was never the main issue after all.
For an analysis of “European Economic Imbalances” see:
https://councils.glgroup.com/news/Analyses.mvc/Details/46798
https://councils.glgroup.com/news/Analyses.mvc/Details/47361
e siccome l' Iceberg e' la UE e l' euro e minare questa realta' , innescando la miccia Grecia , porterebbe , probabilmente ,il globo a qualche anno di "medioevo" .... non credo faccia piacere ne agl' americanos e ne ai cinesi o chi altro ! Poi le vie della politica sono infinite e se hanno nel cappello una ristrutturazione soft con "Mascherina e Lacrimuccia" che placa tutti gl' animi .... boh !