The Prodigal Greek

The Greek crisis through a different prism

A tragic common fate looms for Greece, Portugal and Spain

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Even from a Greek perspective, the austerity measures the Spanish government adopted last week were alarming. The cuts to civil servants’ salaries and unemployment benefits, the rises in VAT and the rest triggered the shocking realization that yet another country is about to walk the same treacherous road of abrupt fiscal adjustment that Greece has been stumbling along for the last two-and-a-half years. But it was the sight of riot police clashing with protesting miners and their supporters in Madrid that really drove the chilling reality home. Whereas Greece has been suffering a painful but largely lonely death, Spain seems poised to commit a spectacular mass suicide. The reasons that led the two countries to this point are not exactly the same but it is now clear that the miserable realities they face are absolutely identical.

While Greece’s rotten public finances have pushed its banking system and the country itself to the edge of collapse, it is Spain’s overexposed and undercapitalized financial sector that is threatening to raise public debt to dangerous levels and destabilize the country. Ultimately, taxpayers in both countries are suffering. Spain’s decision to adopt a new round of austerity measures, though, makes it more urgent than ever to answer the question of whether this suffering is part of an effective strategy to exit the crisis.

“These measures will only marginally improve the fiscal situation in Spain in the short term,” wrote the Economist Intelligence Unit (EIU) of the latest decisions by the Spanish government. “The main reasons behind the current level of the budget deficit are the fall in revenue owing to the economic contraction and the rise in spending on social benefits, also a consequence of the poor state of the economy. The measures announced try to tackle these issues, but will in the end harm the economy more than help the public finances.”

For Greece, these are familiar consequences of applying asphyxiating levels of austerity during an economic depression. The latest economic data released by the Greek government last week confirm the pattern that the EIU suggests: The deficit is shrinking but as the life is being squeezed out of the economy, tax hikes can no longer deliver higher returns and in many cases revenues are falling.

The figures for the first half of the year show that although Greece is ahead of its deficit targets due to deferring payments and reduced public investment spending, it is falling short of its goal for tax revenues by 1 billion. The effect of the austerity on revenues has been visible for some time.

In 2011, after two years of draconian austerity and repeated taxation measures, which included increases in all VAT brackets, the reduction of non-taxable income levels (from 12,000 to 5,000 euros) and the controversial emergency property tax levied through electricity bills, Greece’s revenues were marginally lower than in 2009: 88.1 billion euros vs 88.6 billion, according to the Hellenic Statistical Authority (ELSTAT). Taking into consideration that 2009 was the year of the absolute fiscal derailing that forced the country to seek assistance from its eurozone partners, the self-defeating nature of this policy mix is evident.

The argument is often put forward in Greece and abroad that one of the reasons the fiscal adjustment program has failed is because the focus on raising revenues has not been matched by an effort to cut spending. While Greece has yet to tackle some public sector privileges, the assertion that it has not addressed expenditure at all is false. Between 2009 and 2011, Greece cut its primary expenditure by 20 billion euros, a reduction of approximately 18 percent, from 112.7 billion euros to 92.7 billion. The public sector wage bill was reduced from 31 billion euros to 26.1 billion, or 16 percent.

Greece’s primary deficit in 2011 stood at 2.2 percent of GDP compared to 10.4 percent when the fiscal consolidation effort started. This reduction has come at great political and social cost: Greece has had three governments, two tense elections and countless protests, while social services such as education and healthcare have been stretched to breaking point. European officials who are quick to criticize Greece or who believe that fiscal austerity is the only possible answer to the perceived profligacy of the South should consider what kind of effect fiscal adjustments of this magnitude would have on their own societies.

For Greece, the cost of following this course will be that by the end of this year its economy will have contracted by about 20 percent from pre-crisis levels and 15 percent of the labor force will have been forced into unemployment, as the jobless rate closes in on 25 percent.

These figures suggest the country is reaching the limit of what it can do fiscally to address its situation. A fifth year of recession and third of austerity means that although there is still plenty to do in terms of structural reforms, the government has virtually run out of spending and taxation options.

Despite this obvious dead-end, Greece is being asked by the troika to find further savings of 11.5 billion euros over the next two years. While some of this spending rationalization can be achieved through the necessary intervention to reduce public sector waste, the government will eventually be forced to turn to more tax hikes and cuts to wages and pensions in a likely vain attempt to meet its latest targets.

Given the latest economic data, there must be serious doubts about the wisdom of imposing further austerity measures of this magnitude while the economy continues to deteriorate. The pattern of the last couple of years suggests that this will simply lead to Greece running even faster to stand still. The danger that the country will collapse from fiscal exhaustion and social unraveling is looming. It should be of utmost concern that rather than serve as an example for other countries in similar difficulties to avoid, the formula applied in Greece has begun to take root in Portugal and Spain.

From the start of the crisis, Greece has been singled out as a “unique” case. In some ways it was. Perhaps of all the eurozone countries, it was the one that was most prone to a perfect storm caused by public sector overspending, uncontrolled borrowing and a lack of structural reforms. But this does not mean that these, and other, weaknesses were not evident in other members of the single currency. The crisis has been a great leveler in this sense, showing little discrimination for the depth or breadth of problems that existed in each country. Singling Greece out as being completely different to any other euro member meant the problems the country has suffered under its fiscal adjustment program could easily be dismissed as also being “unique.” But what has happened to the Portuguese economy over the last couple of years suggests that the Greek experience, for all its differences, is far from an isolated one.

Just halfway into the year, there are already concerns over Lisbon’s ability to meet the program’s fiscal targets. The worrying signs for Portugal first appeared at the end of last year, when the country had to revert to a one-off transfer of banks’ pension funds to the state in order to meet the 5.9 percent deficit target. The latest budget execution shows revenues stuck at 23.9 billion euros due to lower indirect taxation and lower social insurance contributions for an economy that is expected to shrink by 3 percent this year, according to troika estimates.

This week, the IMF published a broadly positive review on the implementation of the Portuguese program. However, paying closer attention, the review highlights the downside risks, the deeper-than-projected unemployment and the challenges in the budget execution, including the accumulation of arrears (3 percent of GDP at the end of March) driven by local authorities and hospitals.

Portugal’s difficulty in meeting the program targets in exchange for its 78-billion-euro bailout is not because of the country’s unwillingness to bring its public finances back in order. It is because it is facing the same uphill battle of having to adjust fiscally in a shrinking economy while unemployment rises. Portugal is also beginning to go around in circles, like a dog chasing its tail. And, as Greece discovered, the ability to implement a fiscal adjustment program depends on people’s willingness to tolerate it. These programs demand drastic changes in a short period of time and the longer they go without producing results that ease the burden on citizens, the more difficult it is for governments to call on society’s support. While Portugal has not experienced the same social upheaval as Greece, nor does it have the same culture of protest, there are signs of austerity-weariness in the Iberian country, where the fiscal program began a year after Greece. At least 100,000 people protested the measures in Lisbon in February, the country’s largest union CGTP went on strike in March and medical staff walked off the job for 48 hours last week in opposition to health cuts. This suggests Portuguese society is less tolerant of the continued austerity than is sometimes suggested.

The mistakes of Greece and Portugal now look set to be repeated in Spain, where taxpayers are being ushered onto the treadmill of austerity. The cost of a failed financial sector is to be absorbed by a faltering economy which has the highest unemployment rate in the eurozone. It seems it is easier for policymakers to explain and defend this economic anomaly rather than address the decisions made by banks in Spain and other parts of Europe leading up to this crisis.

If the experiences of Greece and Portugal are anything to go by, Spain’s turn to austerity also points to trouble ahead. The Spanish government last week announced fiscal measures amounting to approximately 6.5 percent of the country’s GDP over the next two years in order to meet the conditionality of the bank recapitalization from EFSF/ESM. According to a publication from the IMF, this could translate, in the best-case scenario, into a 0.6 percent reduction in income and a rise of 0.5 percent in unemployment for every percentage point of consolidation effort. The IMF adds that in the absence of aggressive rate cuts from the central bank and when the consolidation effort is happening simultaneously in other partner countries the impact can double. It would be unreasonable to expect the Spanish economy to absorb an added 6 percent of economic contraction and unemployment without suffering long-term structural damage.

“The rise in the VAT rate and the cut in unemployment benefit will hurt households directly,” the EIU says in its report. “Spain is therefore more likely than ever to see renewed social unrest, potentially leading to some disruption to the economy and political stability.”

With Greece, Portugal and Spain heading toward economic dead-ends, there is an urgent need to identify how this downward spiral can be broken before Southern Europe turns into a zombie zone always reliant on the reluctant generosity of its Northern partners. We have reached the point where rather than ask what spending can be cut or what taxes can be raised, we must demand to know where growth will come from.

In Greece, the failure to answer this question has led to the debt crisis becoming a liquidity and credit crisis, which means that even healthy businesses are starved of the funding they need to keep going. There has been a trend over the last few months for policymakers in the EU to talk about growth. Words, though, are not going to be enough to keep businesses from going bust or to create new jobs.

There are a number of ways the troika — which has spent the last few days inspecting Greek finances ahead of talks on a new round of cuts — could help foster some growth in Greece. It has been satisfied to release loans to Athens to meet bond maturities and coupon payments to the European Central Bank, but has not taken any steps to hasten the settling the 6.8 billion euros of arrears the Greek government owes in tax returns and to suppliers. The head of the EU Task Force for Greece, Horst Reichenbach, recently identified that payment of these arrears as being vital in keeping Greek businesses alive. If there is a genuine interest in Greece being in a position to grow — not just cut — its way out of the crisis, its lenders need to show a greater interest in steps that could encourage this.

There also appears to be reluctance from the European Investment Bank to guarantee loans to small and medium-sized Greek enterprises even though an agreement was reached on this several months ago. If Brussels wants to genuinely restore Greece’s competitiveness and growth, then this has to be addressed. The EU could also show further commitment toward projects able to play a role in getting Greece out of its economic rut by reducing the level of co-financing for structural funds. Last year, Brussels reduced Greece’s participation in these schemes to 5 percent but the deterioration in economic conditions means even this is an extra cost the country can barely meet. Scrapping the Greek contribution altogether would make sense at the moment.

Equally, the troika has tolerated delays in the bank recapitalization process — vital for providing the fuel that could help restart the Greek economy — when it is unwilling to put up with procrastination in other areas. And if fiscal sustainability is the overarching objective, it is incomprehensible that there has not been a greater discussion about conducting this recapitalization.

These are all basic steps that can be taken within the current framework to stimulate growth and to show the eurozone is committed to helping countries like Greece work their way out of the crisis based on something more than spending cuts and tax hikes. These steps can be taken before the eurozone decides on more complicated issues, such as a banking union, Eurobonds and a restructuring of official sector debt, which could also help Southern European countries get out of the current dead-end.

There is little doubt that Greece allowed itself to become the weakest link in the euro chain ahead of this crisis. It failed to evolve in a changing economic environment and to adapt to the demands of being in a single currency with much more robust economies. However, it’s now clear that other countries in Southern Europe are suffering the effect of similar weaknesses, even if they were not as pronounced as Greece’s. The response has been to follow similar austerity policies in all these countries. While the need to get public finances under control is a natural reaction to the crisis, the speed and depth with which these cuts are being made is open to question. The results in Greece indicate that the impact of the measures is counterproductive.

Fiscal discipline is an understandable part of moving the eurozone toward closer union and debt mutualization, but the manner in which it is being implemented in Greece, Portugal and Spain is putting the economic viability of these countries and the single currency in doubt. Implementing austerity but not taking measures to encourage growth threatens to lock these countries into a death spiral. The eurozone needs to strike a balance between the structural reforms, the fiscal housekeeping and the growth initiatives that are needed in Southern Europe. As Martin Wolf wrote in the Financial Times last week: “Far too much policymaking and advice neither recognizes the post-crisis challenges nor crafts effective answers. The heart of the matter is accelerating deleveraging, while promoting recovery.”

If this issue is not addressed quickly, Greece will slide past the point of no return. Portugal and Spain could quickly follow. A crisis that has created so much disagreement and division within Europe will leave the people of these countries alone to face the terrible fallout caused by the lack of courage and imagination shown by policymakers who refused to see the signs of impending danger. Our vision of a prosperous, united future would be replaced by the mutual wretchedness of a tragic economic present.

@YiannisMouzakis and @NickMalkoutzis

Written by Yiannis Mouzakis

July 18, 2012 at 4:04 pm

2 Responses

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  1. Good article. but can someone explain to me the difference between private debt and public debt when there is malinvestment from both sides? In both cases, some Spanish people and some Greek people used credit to stoke consumption. in both cases, the money was squandered on bad investment. Why do we put such a premium on distinguishing between private and public debt when private debt eventually becomes public debt? One way or another?

    danallen2

    July 19, 2012 at 1:29 am

  2. Yianni Nick,
    Excellently put. I could add even temporary ceasing of fiscal measures(1-2yrs, with the exception of “gradual” lay offs in the public sector) along with strict enforcement of structural reforms and corruption fighting norms. Bravo guys. Please keep it up

    Peter Lazos

    July 19, 2012 at 1:46 pm


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