Greece, returning to sustainable growth
Last Thursday I had the privilege to participate in a conference in Rome, organised by Friedrich Ebert Stiftung and Fondazione Giacomo Brodolini on the topic of “Keeping Europe Together: Pathways to Growth in Southern Europe”.
Aside from the fact that it is not very often that us Greeks get the chance to be part of a discussion that has Greece and growth in the same sentence, it was enlightening to hear the views of other fellow Europeans, most importantly to get the German view on the crisis that is not necessarily reflected in the rhetoric and decision making of the current German government.
A great experience overall, here is what I said about Greece (first published by the Social Europe Journal).
What follows might seem unconventional for the topic of how to restore growth in an economy that is considered developed and is part of the eurozone.
Greece is going through unprecedented times; the Greek people are experiencing the most debilitating crisis in the country’s modern history, a severe and sharp reduction in standards of living. By the end of next year, Greece is expected to have lost 25% of her economy; this is a quarter of the national income lost in just 5 years.
Unemployment currently stands at 25% and 58% of young Greeks under the age of 25 looking for a job are not able to find one. Even more worryingly, according to OECD data for the first quarter of 2011, 18% of Greek youths are not in employment, education or professional training (NEETs), steadily going down a path of a lost generation being consumed by the crisis.
These are figures that suggest not just a cyclical turn of the economy that will eventually turn a corner once conditions and sentiment improve. These figures indicate a significant structural damage and any discussion on growth needs to take this into consideration and address it accordingly so economic activity is re-built on solid foundations and not on sand.
At the same time, the Greek state for decades has failed to play the fundamental role of centralised government that creates the necessary conditions for sustainable growth. Unless these flaws are adequately addressed, sporadic growth euphoria will only mask the issues that will be exposed with the first challenge. This is exactly what happened during the previous decade, when Greece was reporting the highest growth rate in the eurozone and was praised by the European leaders and institutions that now disparage her.
At the moment, Greece is the European Union country that carries the highest level of country risk. Over the last year, numerous statements from heads of European institutions, heads of European states and policy makers have put the country’s place in the eurozone in doubt. These euro exit statements intensified early in the summer during the double elections period and have subsided recently when more sensible voices prevailed. Still, just two weeks ago the Greek Parliament was once again asked to vote for two bills within five days as a pre-condition for securing Greece’s place in the common currency.
A characteristic example why the euro exit debate and the associated currency risk are impeding any possibility of growth is the site of Athens’s old airport, an area by the sea in the south of the capital. One of the city’s prime pieces of real estate and one of the most promising prospects for the Greek government to attract foreign direct investment, generate much needed revenue and put people back to employment. Citigroup Global Markets is contracted as financial adviser for the privatisation project. While Citigroup is involved in finding the most suitable investment proposition, the research department of the bank until recently was giving a 90% probability for a “Grexit” – as they called it – by early 2013.
No rational investor will place money in a country where there is a probability that the assets he purchases in Euros will soon be valued in a new devalued currency. Nomura recently estimated based on Real Effective Exchange Rate (REER) that a new drachma would have to be devalued by 55%-60%. For what it is worth, Citigroup’s research department still thinks Greece will exit the euro in the next 12 to 18 months.
Another, perhaps extreme, example is the recent BDO annual survey of global opportunities amongst 1,000 CFOs of mid-sized companies. It found that the overall perception is that investing in Greece is riskier than investing in Syria, Libya, Nigeria, Egypt and Yemen, with Iran and Iraq the only investment destinations riskier than Greece.
From bigger investment decisions of local and foreign investors, to smaller decisions of consumers, they are severely impacted by this currency uncertainty.
It is because of this currency risk that the Greek banking sector has seen a dramatic fall in deposits: 83 billion euros have left Greek banks since the crisis started due to a combination of capital flight and depositors looking for safer places for their savings. The loss of faith is so extensive that you hear stories of people burying their money in the ground and storing it in their freezers, something that even shifted criminal activity from bank robberies to house break-ins.
This decline of deposits combined with the estimated 50 billion Euros loss that Greek banks had to take as part of the debt exchange program earlier in the year – known as PSI – has left the country without a functioning banking system and has turned Greece effectively into a cash economy. With the Greek banks cut off from access to financing from the ECB for most of the year – as Greek Government traded securities are not accepted any longer as collateral by the ECB – and no access to inter-bank lending, credit in Greece is nonexistent and the economy is suffocating without liquidity.
Even the ELA – Emergency Liquidity Assistance – which was put in place as an interim financing solution to facilitate liquidity needs through the Bank of Greece has a spread of about 200 basis points above the ECB’s lending rate. Greek businesses are forced to pay interest rates between 8% and 10% for credit, which confirms the complete collapse in Greece of what the ECB calls monetary transmission mechanism. Part of ELA financing is also used by the Greek government to issue short term treasury bills and close financing gaps from the delayed disbursement of troika tranches, in effect crowding out the private sector from the much needed access to liquidity.
Greek government bonds are not the only asset in the Greek banks’ balance sheets that took a major hit. Resulting from the unprecedented reduction of disposable incomes and the rising unemployment, non-performing loans of all types are increasing. Bad loan provisions increased fivefold from approximately 5 billion in 2009 to 25 billion euros, according to the latest data from the Bank of Greece. Although not officially reported, the recent audit of all systemic Greek banks that was undertaken by BlackRock has revealed that 1 in 5 loans in the Greek banking system are not performing.
Greece urgently needs a well functioning and adequately capitalised banking system that will restore the basic function of financial intermediation, which is one of the key drivers of growth. The recapitalisation process should leverage the EU summit decision on June 29th of direct bank recaps from ESM that will not add further to the country’s unsustainable debt burden.
However, any attempt to direct Greece to a path of sustainable growth should not only focus on addressing euro membership uncertainty and the banking sector, the two direct consequences of the country being effectively insolvent since the beginning of 2010.
The Global Competitiveness Indicators (GCI) of the World Economic Forum (WEF) measure the foundations of institutions, policies and factors that determine the level of productivity – and in turn of prosperity – of an economy.
During the crisis years, the country has lost 29 places and now ranks 96th in a list of 144 countries. When looking at the different pillars of competitiveness, Greece has lost 47 places in the basic requirements, 12 places in efficiency enhancers and 27 places in innovation and sophistication. This puts a big question mark next to troika’s recipe of improving Greece’s competitiveness only through the IMF signature ‘internal devaluation’ approach.
The quality of institutions has a very strong influence on competitiveness and growth. Not only do institutions determine the legal and administrative framework in which individuals, firms and the government interact, they also play a key role in defining the ways in which societies distribute wealth and prosperity. Greece’s institutions have dropped a staggering 53 places now ranking 111th. The fact that the country ranks rock bottom in terms of macroeconomic stability highlights many of the aspects that were discussed earlier.
Goods markets operate efficiently when there is minimum disruption from government intervention that could hinder competitiveness through an irregular taxation framework, overly regulated markets or extensive bureaucracy. Greece is ranking 108th in Goods Market Efficiency. In terms of Labour Market Efficiency, although Greece is ranking 133rd, this does not capture the recent developments in the labour market, demanded by the troika, that have extensively changed minimum wage determination, company and individual level wage agreements, notice periods and severance payments, effectively providing the framework that the troika wanted of freedom to ‘fire and hire’. The Financial Market Sophistication ranking reflects the conditions in the banking sector.
For developed economies, business sophistication and innovation are paramount for the determination of competitiveness. Sophisticated business practices determine the levels of efficiency and productivity when basic sources of productivity improvements have been exhausted. Investment in innovation technologies is key to growth sustainability when economies reach the ‘frontier of knowledge’. Since the crisis began, fixed capital formation, which represents the investments that businesses make to improve their production capacity and staff productivity, has shrunk by 40% as a result of the suppressed domestic demand and uncertainty over the future of any potential investment.
The findings of the report are even more alarming when Greece is compared with other countries in the innovation driven stage of development. Innovation driven economies need to compete on new and unique products in order to sustain the standard of living that was gained through the previous stages of development. Many of Greece’s peers in the eurozone are in this innovation stage, which amplifies the need for the country to converge and develop her competitive advantages in order to excel in a monetary union consisting of many value add economies.
The key word for Greece’s return to sustainable growth is ENTREPRENEURSHIP.
The Greek state is behind the majority of the problematic factors for doing business; impeding entrepreneurship and sustainable growth through bureaucracy, policy instability, unstable tax regulations and corruption. The findings are in line with the Ease of Doing Business rankings by the IFC – International Finance Corporation – and the World Bank, where Greece ranks 146th in Starting a Business, 150th in Registering Property, 117th in Investor Protection, 87th in Enforcing Contracts, with an overall ranking of 78 out of 185 countries.
Greece’s political institutions need to redefine their role, moving away from the state that has been abused as a mechanism for political favours and has become inflated, inefficient and far-reaching. It has distorted the economic model by creating a framework where either employment in the state or doing business with the state were two of the main objectives of economic activity. The country’s political institutions must now act as facilitators to entrepreneurship.
Under normal circumstances a growth debate should be focused on industries and sectors with strong growth potential, the country’s competitive advantages, her strategic geographical position, natural resources and human capital skills. However, Greece is facing such structural problems at an institutional and macroeconomic level that any discussion on growth needs to focus first on decisively addressing the issues that prevent it from creating an environment of sustainable growth.
In their book Why Nations Fail, Daron Acemoglu and James Robinson, argue that while economic institutions are critical in determining the level of a country’s prosperity, it is the political institutions that define what economic institutions a country has. Countries differ in their economic success because of the difference between extractive and inclusive economic institutions. Where extractive institutions are designed to extract income from parts of the society to benefit a select, politically connected and privileged subset, inclusive institutions – to quote from their book –
“feature secure private property, an unbiased system of law, and a provision of public services that provides a level playing field in which people can exchange and contract; it also must permit the entry of new businesses and allow people to chose their careers”
This brief sentence summarises the ingredients that can change the future of Greece.