If you were a Greek MP would you have voted for the austerity package in the Greek Parliament on Sunday evening?
The fate of Greece and perhaps of the euro area was, according to both Greek and EU policymakers, on the line. And despite riots in the streets and resignations from the government, the Greek parliament overwhelmingly said yes.
Sadly, it is increasingly looking as if the real answer is that it actually does not matter. If nothing else changes, Greece is damned if it accepts and damned if it doesnt.
I won’t discuss the latter course in detail here. Default and a disorderly exit from the euro area would bring massive and unpredictable costs. Economic activity in Greece would collapse as would its financial system. Immense hardship would ensue while the system was stabilised and rebuilt. And that’s not all. It would be very hard to build a firewall around Greece: the problem would immediately shift to Portugal and other troubled economies, where national and EU policymakers would face the same unpalatable choices. For that very reason I think (or should that be ‘thought’?) it unlikely.
But what happens if the agreement is implemented?
The package consists of more than 50 pages of measures, listed in excruciating detail. Here’s a taste of what a loss of fiscal sovereignty means:
[the Government must take] further measures to extend in a cost-effective way the current e-prescribing to all doctors, health centres and hospitals. E-prescribing is made compulsory and must include at least 90 percent of all medical acts covered by public … [and introduce] a temporary and cost-effective mechanism (until all doctors are able to use the e-prescription system) which allows for the immediate and continuous monitoring and tracking of all prescriptions not covered by e-prescription.
Cut through such interminable detail and the thrust of the package can be summarised as follows:
- massive cuts in public spending with the aim of achieving a small primary (i.e. before debt service payments) surplus next year and a large one in 2014 (around 1 and 4.5% of GDP),
- a privatisation program that should yield around 7.5% of annual GDP by 2015,
- a clampdown on tax evasion and avoidance,
- an increase in banks’ capital ratios (banks that do not or cannot achieve this are to be ‘resolved’ at the least cost to the state),
- a massive reduction in labour costs (nominal unit labour costs to fall by 15% in two years) brought about by cuts in the minimum wage and public sector pay and strengthening government’s power to set wages,
- and liberalisation of regulations on business, network industries and the professions.
It may be symbolic that the package was approved late in the evening. For looked at by daylight it must be obvious that this package simply will not work.
First, however much Greece needs some of these structural reforms – and this is undoubtedly the case in many areas – the 50-page list of measures could not be implemented in the two-three year period envisaged, not even by a well-run and financed administration. Yet everyone agrees that Greece has a dysfunctional politics and poor administrative system, even in good times. How a demoralised public service facing job and pay cuts is supposed to implement, in a couple of years, a reform package that would challenge a country like Germany over two parliaments is a mystery. (Some may remember the wrangling in Germany about reforming the Meisterordnung. And if you recall Britain’s failures in introducing IT systems in the public administration, you may wonder how likely it is that Hellenic patients will soon enjoy a cost-effective e-prescription system.) Just how long is the queue to buy state assets worth 7.5% of GDP in a country facing – at the very best – another half decade of pain and suffering? One implication of the sheer detail in the program and the immense time pressure is, of course, that at any point in the future the Greek government can be charged with not having fulfilled its commitments and aid risks being withheld.
Second, even to the extent that the structural reforms are actually implemented and do have the purported longer-term positive effects on potential output, given the current state of the economy and the further fiscal austerity measures they will in the short run drive demand and thus output down yet further. (Swiftly raising banks’ capital requirements is a good example: a very sensible policy to implement in a boom.) The package is a recipe for extending and deepening the already severe economic contraction. This will depress investment and lead to labour market withdrawal both of which will damage potential output. But the key point is that Greece’s immediate problem is not so much inadequate potential growth as the massive and widening output gap, i.e. the fact that spending is hugely below any sensible assessment of what the economy could produce even given the myriad distortions and inefficiencies which it undoubtedly has.
Third, conversely, there is virtually nothing in the package that would boost demand and particularly investment. Public investment is to be cut severely. Just why should domestic private investment be expected to fill the gap under current and prospective conditions. What about external support? Well, it seems – this is not yet entirely clear – that the bail-out fund for which the austerity package is a pre-condition will be set up in such a way (escrow fund) that it focuses on debt repayment and not to any substantial extent on reigniting growth and investment. And the other carrot, voluntary participation by the private sector? Supposedly the private sector will accept a haircut of 70% of its claims on the Greek state. Yet, despite the primary surpluses even the official forecasts see Greek debt falling from 160% to just 120% of GDP – and that by 2020! Some carrot.
Fourth, the measures are unbalanced in a number of important regards, undermining public support and increasing the negative impact on demand of (necessary) reforms to improve competitiveness and the fiscal situation. The fiscal consolidation is heavily tilted towards the spending side, rather than focusing on revenue raising, despite the fact that Greek public spending is not particularly high in European comparative terms but its revenues are among the lowest as a share of GDP – see here. Similarly, the focus is very much on driving down wages, whereas measures to reduce prices are much vaguer. Cutting the minimum wage is a great way to maximise the negative demand-side effects.
Fifth and lastly, there is no link between this agreement and a necessary rebalancing within the euro area, more specifically to a parallel commitment on the part of surplus countries to reflate their economies with stimulus packages and faster nominal wage and price increases. (Cue the chief editor of Handelsblatt who has just helpfully told the German labour minister to shut up, after she had voiced sympathy for higher wage increases in the German public sector. Of course he did not mention euro area rebalancing. Rather he is concerned about Tarifautonomie – free collective bargaining.)
If voting down the agreement, presumably followed by default and exit, would bring an immediate calamity, implementing this agreement in full will bring years of senseless pain unless it is associated with genuine commitments to stimulate growth both within Greece itself and in the surplus countries. Unemployment will remain extremely high, investment and growth depressed, living standards will fall, there will be substantial outward migration and the fiscal situation will improve at best slowly. Any pay-off from the structural reforms in terms of higher potential output will take years to materialise and be offset by the squeeze on demand and investment. This would be to repeat the catastrophic errors of the 1920s and 1930s (Versailles, Britain re-adopting the Gold Standard) and of ‘structural adjustment’ in developing countries in the 1980s and 1990s. Maybe worse. IMF-mandated structural adjustment was, in some cases at least, accompanied by World Bank loans and support (and, of course, devaluation). Yet Greece, with no devaluation option, and a member of a club supposedly committed to ‘ever greater union’, is signing up to a radical austerity-cum-‘reform’ strategy without a clear commitment to restart the economy (as opposed to finance debt service payments) and in which other countries, too, are being forced into a race to improve their ‘competitiveness’.
At some point Greek politicians (democrats if we are lucky, populists or worse if we are not) would lead their country out of the euro. The negative consequences of exit will come to pass; they will merely have been postponed. On the other hand, at that point the country will at least regain some policymaking levers (complete default, capital controls, monetary policy autonomy, exchange-rate flexibility) that, if wisely used, can help it slowly recover. Frankly, I can understand those who say, if that is going to happen anyway, let us get it over with. Just to be very clear, I am NOT recommending this strategy, nor do I believe that merely by devaluing against the euro Greece will solve all its problems, not least given the size of its traded goods sector.
The fact remains that, however you turn it, Greece is damned if it does and damned if it does not implement this agreement, unless there is a major shift in other parameters over which it has virtually no control.
The only non-catastrophic scenario for Greece is if it can gain, in return for accepting the package, the two crucial things it needs to emerge from the crisis: externally funded or supported investment in the country to get the economy growing again and reflation of the core economies. Very probably, Greek MPs also know very well that the programme cannot be implemented. They are buying time, and hoping for a change in the parameter. That, too, I can understand. But the odds against such a process have declined very substantially in a short time. For many of those policymakers in the core countries that want Greece out also know that the programme cannot be implemented. They, too, are waiting for their chance.