"Dilemmas and Lessons Stemming from the Greek Economic Crisis: The Day After"
Δευτέρα, 17 Ιανουαρίου 2011 10:24
Presentation at the HSCC Annual Event Presentation at the HSCC Annual event by Mr. Yannis Stournaras, Director General of Foundation for Economic and Industrial Research (IOBE) and Professor of Economics at Athens University
Greece is at the center of the world’s attention regarding its recent economic developments. Following inappropriate policies implemented by previous governments, especially in the period 2007-2009, the new government initially failed to anticipate market reaction and delayed to take corrective measures. At the same time, Eurozone authorities, which are partly to blame for not acting quickly despite the fact that there was ample evidence of a fiscal derailment in Greece as early as 2008, also failed to realize the seriousness of the situation and wasted time swinging between punishment of sinners, self-interest and Eurozone salvation. Financial markets also played a role in the Greek crisis: For a number of years, they totally ignored high and rising current account deficits in Greece and other Eurozone member-states of the European South, providing ample financial resources. Suddenly, they shut the doors of liquidity mainly to Greece, a country with relatively high public sector debt but relatively low private sector debt, taking the view that the former is more toxic than the latter. This seems to be changing now.
In the face of skyrocketing government bond spreads and an imminent risk of default, the new government was forced to ask for a bail-out. Following dramatic negotiations among Heads of States and in the absence of a crisis resolution mechanism, this took the form of an Agreement last May, between Greece and a triumvirate ("troika"), consisting of the European Commission, the ECB and the IMF. According to the Agreement, Greece is receiving tranches of a medium-term loan (initially a 5-year loan, most likely to be turned into an 11-year loan after the latest decision of the Economic and Financial Affairs Council (ECOFIN)) 110 billion euros (almost 50% of Greece’s GDP) under the conditionality of applying a comprehensive, medium-term reform program, encompassing fiscal measures, social security reform, the opening-up of closed professions and markets including the labor-market, as well as the establishment of a 10 billion euros Financial Stability Fund for the re-capitalization of Greek banks. On May 6th 2010 the Greek Parliament voted in favour of the reform program which is now being fully implemented. Among Eurozone member-states, only Slovakia rejected participation in the Greek bail-out scheme.
The Agreement contains policies and reforms which are necessary for restoring fiscal soundness and improving competitiveness, thus establishing conditions for sustainable growth. In a certain way, it provided the Greek economy and society with the necessary remedy which the domestic political system has been unable to offer due to its various commitments towards many interest groups. From this perspective, the present crisis could also be seen as an opportunity to correct past mistakes, mostly related to the creation of a large, unwieldy and inefficient public sector. If left alone, Greece would have defaulted last May, with detrimental effects to its economy and society and, possibly, with (difficult to control) contagion and domino effects in other Eurozone member-states. The loan under the Agreement and the stability of the euro act like an umbrella in rainy weather, under which Greece can apply the reform program and rebalance its economy in an orderly way. Arguments which have been put forward by certain analysts in favor of a voluntary default and exit from the Eurozone are wrong, eccentric, and, if adopted, would put the Eurozone into jeopardy, possibly resulting in serial defaults in the banking system and social havoc.
Despite initial fears by many foreign analysts, the tough fiscal measures, the social security and labour market reforms, the opening-up of closed professions and markets proceed at considerable pace without social unrest. The Greek people have, so far, proved to be more responsible, clever and patient than certain analysts had initially assumed. People are definitely angry with the political system and show their discontent in every opportunity, but have tolerated big cuts in their disposable income which, in certain cases, are as deep as 20 percent in the current year, in the knowledge that there is no alternative. As a result, Greece is on the way of narrowing the general government deficit from about 15.5% of GDP in 2009 (after the inclusion of public enterprises and organisations in the general government) to a forecast 9.5% in 2010.
It should be stressed, however, that the adjustment program is still in its beginning and the remaining distance to the end is, without a doubt, quite considerable. Hence, the critical success factors are endurance, leadership, vision, implementation abilities and good judgement. Endurance is necessary because the program resembles a Marathon rather than a one-hundred meters race. Leadership is needed to resist populist arguments and politicians who try to exploit people’s discontent against austerity before recovery resumes. Vision is needed to inspire people and convince markets that there is light at the end of the tunnel by pointing at new sources of growth and opportunities to reduce public debt which have not yet been considered or priced by market participants. Implementation abilities are needed because most of the tasks resemble management projects that require target setting, follow-up procedures, decentralization and incentives. Good judgement is needed to manage unavoidable crises in the course of events by choosing the right priorities and minimizing mistakes.
The main difficulty in the adjustment program is one of debt and interest payments dynamics: Even if Greece manages to reduce its general government deficit below 3% of GDP and restore the general government primary surplus to a level as high as 6% of GDP by 2014, public debt will continue to rise under the assumptions of the program and will ultimately stabilize at about 155% of GDP (after the recent inclusion of public enterprises’ and organisations’ debts) before it starts declining. This is a level considerably higher compared to the one recorded at the beginning of the adjustment effort. Hence, the crucial question is whether financial markets will be far sighted enough to provide fully reformed Greece with the necessary refinancing of its considerable gross borrowing needs in the crucial period 2013-2015. Although no one can predict the reaction of financial markets in two to three years from now, especially if the targets of the adjustment program are met, it is encouraging that the recent Economic and Financial Affairs Council (ECOFIN) decided, under the condition that fiscal targets will be met, to extend the duration of the 110 billion loan from 5 to 11 years.
Ongoing research in the Foundation for Economic and Industrial Research (IOBE) shows that there are sources of growth, especially on the supply side, which have not been accounted for in official projections. The same applies for opportunities to cut the general government deficit by reducing defense spending in the light of improving Greek-Turkish relations and by containing public health spending with the introduction of accounting books, professional management and software systems in state hospitals. Similarly, public debt can be reduced through extensive privatizations and long-term leases of large and valuable pieces of land, which, for historical reasons, are owned by the state.
By simulating the well-known GIMF model, calibrated for the Greek and the Eurozone economies, we have found that as a result of opening-up markets and professions in the non-traded goods and services sectors as well as the labour market, GDP is expected to increase by 17 percent from the steady-state ante to the steady-state post. Five years from now, GDP is expected to be 10 percent higher. This should not be considered as a surprise taking into account, firstly, the extent of the inefficient state regulation of the Greek economy which produces a 15 percent higher average mark-up in the non-traded goods and services sectors compared to the Eurozone average, and, secondly, the existence of similar results elsewhere.
It should be mentioned that during the 1990’s Greece achieved a budgetary adjustment similar to the one currently required by the Agreement, in roughly the same time-span: The general government deficit stood at 14.5% of GDP in 1993 and fell to 3.1% in 1999. Actually, during this period the real exchange rate of the drachma appreciated by approximately 15%, refuting the arguments of those who believe that the main difference between 1993 and today is the use of currency depreciation. However, GDP growth remained positive and gradually accelerated mainly as a result of three factors: Firstly, the liberalisation of the banking and telecoms sectors. Secondly, the reduction of market interest rates as a consequence of the reduction of both the general government deficit to GDP ratio and inflation, which strengthened market confidence. Thirdly, the co-financing of infrastructure projects by the European Union Structural Funds. It is worth noting that the main driver of growth during this period was business investment.
Similar forces could be elicited today without the appreciation of the real exchange rate, provided that: Firstly, the government proceeds according to the fiscal targets set in the Agreement. Secondly, it deregulates markets and professions, reduces the administrative burden, privatises public companies, sells or leases state land and uses private-public partnerships to attract domestic and foreign capital for infrastructure projects, particularly in transport and energy, while adopting a "fast-track" approach towards all private investments and ESPA (i.e. the National Strategic Reference Framework, or Greece’s share of the European Union’s Structural Funds).
The Greek economic crisis was the first to erupt in the Eurozone, but it is definitely not the only one. In this context, Greece acted as the "midwife of history" in the sense that its problem proved that a monetary union among structurally different member states cannot be preserved without a permanent crisis resolution mechanism. The European Financial Stability Facility (EFSF) which was established in the aftermath of the Greek crisis and, particularly, the decision by the European Council to turn it into a permanent mechanism, an issue which will be discussed in detail in the forthcoming European Council, are steps in the right direction. This permanent mechanism should be in the form of a European Monetary Fund and its architecture should be similar to that of the International Monetary Fund.
Actually, the Eurozone needs its European Monetary Fund. Those who fear that such a mechanism might turn it into a transfer union will be reassured that this will not be the case, through simultaneous changes in the Treaty, and the Stability and Growth Pact. In addition, those who fear that if the crisis is spread to other member-states of the European South there will not be enough resources for their rescue, can also be reassured by the fact that the current account balance of the Eurozone is zero- in other words the deficits of the South are almost equal to the surpluses of the North, while the key Eurozone economic fundamentals are generally healthy.
The establishment of a European Monetary Fund is not sufficient to safeguard financial stability of the Eurozone. If the burden of adjustment falls exclusively on member-states with current account deficits, then the Eurozone will suffer from a permanent deflationary bias. Keynes’ proposals for symmetric bounds in countries with current account deficits and countries with current account surpluses had been ignored by the Americans in Bretton-Woods in 1944, but were adopted by them sixty-six years later in the recent G-20 Summit in South Korea. However, China and Germany did not appear very willing to adopt this proposal. It seems that responding to current account imbalances, both negative and positive, will become inevitable in the world financial system as a minimum coordination requirement. There is no doubt that we need similar arrangements both worldwide (USA-China-Germany) and in the Eurozone (member-states with current account deficits and member-states with current account surpluses).
Today, leading powers in the Eurozone as well as Eurozone institutions are facing the biggest challenge since the creation of the Euro. Financial markets and particularly those who use aggressive trading practices and derivatives that are highly toxic, test the sustainability of the monetary union using all the firepower at their disposal, exploiting the weaknesses of the architecture of the Eurozone. In the short-run, the best reaction of the authorities should be, as mentioned above, the establishment of a European Monetary Fund and the introduction of restrictions in both deficits and surpluses in the current account balances of member-states. In the long-run, however, the sustainability of the Eurozone requires the establishment of a central economic authority, ideally a Ministry of Finance of the Eurozone or, as a second-best, a Public Debt Management Agency, combined with the supervision of banks in the Eurozone by the European Central Bank (ECB). Today, this may sound as blasphemy by many who abhor the creation of stronger federal institutions and believe that economic governance is achieved solely through fiscal discipline. Sooner or later, however, the dilemma will be set: Either more federal Eurozone or collapse of the Euro. I believe that the leaders of the Eurozone, acting rationally, and taking into account one of the cornerstones of their foreign policy after the end of the 50’s, i.e. the increasingly deeper European integration, will choose the first, possibly strengthening Germany’s position in European affairs.
As far as Greece is concerned, I strongly believe that the country will do its duty, reform itself and pay back its entire debt, making use of its significant state-owned property. Today, Greece has intellectually healthy, albeit dispersed, forces which recognise that radical changes should be made to economic policy, to economic structures, institutions, social values and attitudes. These forces will become the catalyst of change, as they have always been in the last several years. Throughout its modern history, which started in 1830 when Greece gained its national independence from the Ottoman Empire, the country has experienced many economic crises that were mostly the consequence of wars, both international and civil, social unrest, national disasters and dictatorships, all of which inflicted not only huge economic but also human pain. However, Greece managed to recover from these difficulties relatively quickly, establish a high quality democratic regime and more than double its share in the world GDP in the last one hundred years. Very few Eurozone member-states have actually achieved this in the same period of time, under much easier political and social conditions.
