Thursday, January 20, 2011

Can Greece be saved?

by Katinka Barysch

Will Greece have to restructure its debt? Among most West European economists and investors, this now seems to be a foregone conclusion. The Greeks themselves are not so sure. During a recent visit to Athens, none of the economists and politicians I spoke to thought that restructuring was inevitable or desirable. The Papandreou government looks determined. But to avoid default, Greece would need two things: economic growth and more help from its European neighbours.

Since Greece negotiated its €110 billion financial assistance package with the EU and the IMF last year, it has cut its government deficit by an impressive 6 per cent of GDP. The government has slashed public salaries and pensions, raised VAT and other taxes, and clamped down on ubiquitous tax evasion. Half a dozen big strikes and the occasional outbreak of street fighting notwithstanding, the Greeks have so far remained rather stoic in the face of this unprecedented belt tightening. Most realise that change is needed and hardship inevitable.

The other reason why Greeks have so far stayed calm is that the worst is yet to come. While civil servants, truckers and some other groups felt immediate pain, the population at large has not yet suffered unbearably. After 15 years of rising salaries, most Greeks can cope with an initial drop in income. Those who lose their job or business can usually rely on a tightly knit family network for support.

Greece, however, is not even half way through its deficit cutting programme. The total need for adjustment is 13-15 per cent of GDP. Cutting the first 20 or 30 per cent out of any budget is relatively easy – especially in a budget that contains as much flab as the Greek one. The public sector is overstaffed and, in many places, overpaid; pension entitlements are generous; although 60 per cent of the population lives in the capital, Greece has over 1,000 municipal administrations and 52 regional ones (a new law will cut those numbers by two-thirds); the country’s 150 public hospitals are accounting-free zones, which has contributed to spiralling healthcare costs; public enterprise such as the railways are black holes for government subsidies.

Once the most glaring inefficiencies have been removed, however, further reductions will get a lot harder. After the fat is gone, the government will have to cut bone. Papandreou needs to perform this operation at a time when the economy is in deep recession: by the end of this year, GDP will have contracted by as much as 10 per cent; unemployment is heading towards 15 per cent; among younger people, one in three is out of work; thousands of businesses are closing down every month.

Even if the government managed to stay on track with its plans for budget consolidation, public debt would continue to rise inexorably, to over 150 per cent of GDP by the end of this year. Greece will only stand a chance of generating the revenue needed to service such high debt if it returns to economic growth, and quickly.

The bad news is that in order to regain its competitiveness Greece will require an internal ‘devaluation’ – a fall in real wages relative to its trading partners. Such wage compression will dampen consumption and could even lead to damaging deflation. And it would not even address the deeper problem that Greece makes few things that people in other countries want to buy. Growth since the 1990s was led by consumption and fuelled by cheap foreign credit. To move to a more sustainable growth model, the country requires higher value-added industries and massive foreign investment. Neither will materialise without very thorough economic and institutional reforms. “In terms of institutions, infrastructure and corruption, Greece looks a bit like a third world country”, sighs one Greek fund manager based in London.

The somewhat better news is that Greece’s economy is so inefficient that a series of straightforward changes could kick-start an economic expansion. “In many sectors, our economy resembles Soviet central planning”, explains Yannis Stournaras, who runs the IOBE institute for economic and industrial research. “If we remove stifling regulation and bureaucracy, the economy’s dynamism will be unbound.” IOBE has calculated that liberalisation of the most heavily shackled sectors and professions would lift output by 10 per cent over four years, and probably more once dynamic, growth-boosting effects are taken into account.

Having implemented a first bout of budget-cutting policies, the Papandreou government is now setting to work on structural reforms. If things go according to plan, some 70 ‘closed shop’ professions, from lawyers to pharmacists and civil engineers, will lose many of their privileges and protections. Hiring and firing workers will get easier across the board. State enterprises will be restructured, downsized and sold off. Red tape for businesses will be cut. New incentives will boost investment in green energy, high-end tourism and other potential growth industries.

These plans are already creating fierce opposition from the highly organised groups that will be directly affected. The two main political parties, but Pasok in particular, rely on the trade unions and professional bodies for their core support. “Attacking the closed-shop professions means civil war within Pasok”, predicts Loukas Tsoukalis, head of Eliamep, a think-tank in Athens. Already, some Pasok MPs are grumbling that the reforms are now going too far, too fast. More strikes are inevitable.

Curiously, Greeks tend to sympathise with the plight of even the most molly-coddled public sector workers and privileged professionals. Faced with rising opposition within his own party and public restiveness, Papandreou’s resolve may yet falter.

Even if it does not, Papandreou will face the immovable object of his own state administration. Structural reforms will only boost growth if they are implemented swiftly and effectively. The chances of this happening are slim. A law going back to the post-dictatorship days makes the dismissal of civil servants illegal; even sacking public sector workers who do not strictly speaking enjoy civil service status is considered politically impossible. Each administration since the 1980s has added ‘its’ people to an already outsized state apparatus, often in return for votes and political support. The result is a public sector that is not only hopelessly bloated (roughly 800,000 out of a workforce of five million) but one that is infused with a sense of entitlement, rather than public duty.

Until and unless growth resumes, Greece will struggle to cope with its stifling debt burden. Greeks hope that the EU will step in again to tide the country over until the economy recovers. Many hope that Germany will drop its opposition to joint eurozone bonds, which would help to lower the interest rate at which Greece borrows and refinances its debt. Others suggest that the EU could ‘front-load’ regional aid to boost Greek investment over the next couple of years.

If no further EU help is forthcoming, or the debt burden proves unsustainable, Greece may yet be forced to negotiate a rescheduling or restructuring with its creditors. Since Greek politicians are loath to consider the default option publicly, this would come as a shock to many ordinary Greeks. Many might be directly affected if (as seems likely) a public debt restructuring triggers a crisis within the Greek banking sector and social security funds. Most Greeks would consider default as a terminal blow to the country’s standing inside the EU.

Greeks have traditionally been very pro-EU, and not only because the country has been one of the biggest recipients of EU structural funds since the 1980s. All political parties, with the exception of the Communists, are in favour of more European integration. Remarkably few Greeks have so far blamed the EU (or the IMF for that matter) for the hardship they are going through – although Germans, and Chancellor Merkel in particular, are deeply unpopular for dithering over the bail-out and lecturing the Greeks about their allegedly lazy and lavish ways.

If Greece was forced to restructure, politicians and public opinion could quickly turn against the EU. “The Greeks would say: We’ve been through pain and austerity, and now you drop us”, predicts Panagiotis Ioakeimidis, professor at Athens university and an EU specialist. Some Greeks fear that after default, Greece’s membership in the euro, and the EU itself, may be questioned. That is why the Greeks will hold out fiercely against any pressure to consider restructuring.

Katinka Barysch is deputy director of the Centre for European Reform


Anonymous said...

I agree with all your points to a great extend - the only negative reaction that I have to the goverment is that they'd have involve the wealthy people to these austerity plans - but it looks like nobody can touch them as all politicians are linked very mcuh to the "black money"

Vasilis said...

I do not usually respond in such a manner, but I think that this gentleman has articulated the case of Greece rather accurately. So, I do beg you spare 6 minutes to watch the video.

Speaking with "experts" on the economy and producing economic arguments for the further deterioration of the Greek society is only half the issue! One should also refer to social, political and military experts, in order to realise what has happened and what can be a sustainable solution. For example, asking the majority of people that are earning less than 700 euros a month to accept further salary cuts, will only aggravate the situation. Mass investment, leberalisation of proffessions and high-value industries may produce economic growth, but heavy government investment in armaments will also pluck this flower from its root. Should one want to see what the tax burden of each taxpayer is, he/she should investigate how much of our income goes to taxes already. Property owners are paying something like 20 different taxes, excluding the extraordinary requests for taxes on income and other goods and services. Out of the 1.60 euros pler litre of gas, 1 euro goes straight to the state.
In addittion, Germany, who was nagging about the way Greeks squander their money and do not work, should know about the 2 billion euros spent on German-built submarines. Instead German MPs argue publicly that we should sell several of our islands! Lest we forget the German tanks, other military equipment or the implication of the German colossus, SIEMENS, in bribes of Greek officials in order to get various contracts etc.. Without the lectures, France and the US are at fault all the same.

Honestly, the hypocrisy knows no limits! What I only hope is that the Greeks learn their lesson and will not allow anyone, foreign or domestic, to plunder our coffers and our land anymore.

P.S. I used to be an active pro-european; now I can only see the EU for what it truly is a “wonnabe”. The Constitution case, the way countries in distress are dealt are signs of a weak collective that cannot move into being a powerful union.

Thank you for your time.
Vasilis Gaganis

Antaeus said...

Very interesting article that makes it apparent to all those who lost focus on Greece that the worst is yet to come. Most of the key points in the article are spot on, although I think the piece forgot to attribute much of the high growth Greece enjoyed to massive inflows of EU structural support funds and others (cohesion, agriculture, etc). It was not due to sound, pro-investment Greek economic policy. Finally, although the article talks about the challenges Papandreou faces, it understimates the amount of "creative destruction" needed here in Greece. The gargantuan public sector needs to be substanitally dismantled, and the PASOK Government does't seem ready to accept that philosophy, since its political base derives from the public sector. So the sirens needed to be turned on, the problems are quite substantial, and the Greeks don't seem interested in completing the "reinvention" task required of them now. They do like to make projections and promises, however.

Homes said...

I think that they have good intentions and ARE interested in the reinvention task. I think any nation/Country would be devastated after getting such a "hard hit" and I truly hope Greece comes back hard and strong and actually takes action. They have slowly started with the pension cuts, etc and hopefully soon enough they'll be on the road to recovering their debts. It's sad for the citizens that the government has put them in such a bad situation, hopefully the Papandreou gov't will take action

Anonymous said...

I still do not understand why are we still in Euro??? If we exit Euro we can benefit from several advantages like changing the currency ratio could result in cheap domestic produced products and services. Even the thought of taxing imported goods from EU could be a better idea, simply because the Germans French and other people forget that in the 80ies we sacrificed our own small industry so that Bosh, AEG, Miele could sell their fridges, stoves and other products without taxes. Even worst, we moved on and now Greece is the second buyer in Mercedes and BMW. My opinion is that in a country that cannot afford to pay its depth, such luxury imported goods should be overtaxed simply because the result in money export.

In order to protect the lower income people, there should be established a maximum price for each service or product. This worked in the past (80s). In the same manner, there should be only one intermediate between the producer and the retailer. How ready is a government like those two we have in order to adopt such ideas?

What about dismissal of civil servants? I do not understand why this is so difficult. Now days, the one third of civil servants work under the mean average private employee due to the fact that its post is secured for a life time. On the other hand in cities like Thessaloniki, the unemployed young people reached the 25%.... How 's going to change this PASOK? ND perhaps...?

And what is that with closed professions? Why a pharmacist may pass his shop business as an inheritance to his child and a young graduate is not allowed to open cannot open a new store? Why someone cannot acquire a truck and run a logistic business? Who secures my profession (I am a mathematician/computer analyst)? Why I have to take such people making money on my back? But of course again, I don't see a government capable to brake such chains...

One can tell me why in Greece we have so many company formats like the SA, LTD, INC, Ptn, NPSA, .... while i Cyprus there are only Ltd companies. Perhaps it is time to get rid of all those company formulations and use only two INC and Ltd. In the same idea, simplify the incorporation procedure by eliminating the bureaucracy and company incorporation cost. By the way, why should layers benefit from my company's incorporation, is something I still cannot understand. In other words, why I have to pay those stamps to help their private held security organization? Who pays for mine?

Since no actually company pays a tax around 35% why we still keep it 35% and not downgrade it to 15% but with consequences to the one who is not paying? Why the good tax paying company must pay a-priori a 20% of the fore coming year taxes?

I could easily write more, but I believe the reader already had enough and knows what we have to change. The question still remains: Who is going to do it...

Michael Mountrakis