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Lessons from the Greek crisis

Dr. Philippos Sachinidis* 

Over the period 2009 - 2012, I have served under different capacities at the Ministry of Finance in Greece. I would like to share with you the lessons, which we have learned out of this crisis.

Lesson No 1: A wrong diagnosis of the nature of the problem will always result in a wrong prescription.

Lesson No 2: The Euro crisis is the combined result of deficiencies in the institutional framework of the Euro zone -- deficiencies that were known from the time of its inception -- and the failure of the financial markets.

Lesson No 3: Grexit is not the answer to the Greek crisis.

Lesson No 4: Structural changes are necessary to improve growth prospects; but they need time to deliver results.

Lesson No 5: Now that we have almost balanced the primary deficit, it is about time to reconsider the speed of fiscal consolidation in order to give space to the economy to breath and to fight unemployment and rising inequalities.

Let me elaborate on these lessons.

Lesson No 1: A wrong diagnosis of the nature of the problem will always result in a wrong prescription. The dominant view is that the euro crisis is a debt crisis. The truth is that the euro crisis is not a debt sustainability crisis.

The average debt-to-GDP ratio in the Euro-zone is smaller compared to the Japanese or even the USA or the UK debt-to-GDP ratio. Even in major Euro-zone countries, the debt-to-GDP ratios were lower compared to those in the aforementioned countries.

If it had been, one would have expected Belgium or Italy, which entered the crisis with extraordinarily high debts, to request assistance. As it turned out, they made it through without economic adjustment programmes, while Ireland and Spain, which entered the crisis with low levels of sovereign debt, needed bail-outs.

The problem in Europe was one of massive capital flows across borders, which encouraged high levels of private borrowing in the economies that eventually got into trouble. When the global financial crisis -- that started in USA in 2007-2008 and hit Europe via the UK and Ireland -- generated a reversal in those flows, private borrowers and banks got into big trouble. That trouble translated into serious economic downturns and bank failures, both of which led to explosive growth in sovereign debt burdens.

It has been argued that Greek fiscal deficiencies caused the crisis in the Euro zone. However, Greece is a rather small economy and its debt is a very small proportion of the European debt.

It may be correct to argue that Greece has not been a fiscally-responsible country over the years before the crisis. But this was no excuse to punish a country and its citizens with punitive interest rates as happened with lending under the first programme.

Lesson No 2: The Euro crisis is the combined result of deficiencies in the institutional framework of the Euro zone -- deficiencies that were known from the time of its inception -- and the failure of the financial markets.

The absence of a fiscal union, the lack of the a federal agency to supervise European banks, the institutional prohibition of ECB to act as a lender of last resort in order to stabilize bond markets and banking systems, the failure of the European institutions to monitor closely the economies of the euro zone member countries, have among other factors contributed to the emergence of the euro zone crisis. The crisis will be resolved only when European countries will be ready to fully address these deficiencies.

Lesson No 3: Grexit is not the answer to the Greek crisis.

Almost 20 years ago, a significant majority of Greek economists came to the conclusion that it would be to the benefit of Greece to join EMU. Greece would lose the instrument of monetary and exchange rate policy but it was expected to gain in terms of monetary stability and growth prospects.

One can successfully argue that Greece did not, and probably still is not, meeting the theoretical criteria to belong to an optimum currency area (OCA). The theory of OCA was first published by Robert Mundell in 1961. It shows that countries could join a monetary union if the costs of doing so are lower than the benefits. The European Monetary Union (EMU), founded in 1999, is the most prominent example of the OCA theory.

Greek economists and political parties were aware that in a globalized economy Greece had to adapt and make its economy more competitive and outward oriented. They did understand at the time that there was an urgent need to introduce politically-difficult reforms. Their expectation was that by joining the EMU Greece would be keen to introduce the necessary reforms through peer pressure.

Nine years after joining the Euro Area, Greece was trapped in an unsustainable economic path with high fiscal and current account deficits, high debt-to-GDP ratio and a deep recession. The debt problem was initiated by the fiscal irresponsibility of the years before the emergence of the global crisis. In almost every year until 2009, the government was running a deficit. In fact, this was increasing year after year post-2006.

At that period, despite the fact that Greece was enjoying significant positive growth rates, the government debt increased from 180 bn euros in 2004 to 290 bn in 2009. As a result while Greece joined the Eurozone with a debt-to-GDP ratio below 100% and despite the high growth rates in the nine year period 2000-9, the debt-to-GDP ratio rose to 127% in 2009. In that year, the government deficit reached 15.7% of GDP, and not 6% as had been reported by the governing conservative party of New Democracy. The current account deficit in that year was almost 11% of GDP.

In 2009, Greece was in a recession for the second year in a row despite a doubling of the government deficit between 2007 and 2009 from almost 7% to 15.7% of GDP. Against Keynesian theory predictions, fiscal expansion not only failed to prevent recession but the recession deepened as the deficit was increasing. There is a number of studies, showing that fiscal spending under certain conditions might have a negative effect on growth. In Greece, public spending financed through borrowing mainly fed external imbalances.

In spring 2010, Greece experienced a sudden stop: it lost access to capital markets and requested financial support from its European partners. Europe established a special supporting mechanism along with the IMF. Greece accepted to implement an Economic Adjustment Programme in exchange for the financial support.

According to the first programme, Greece had to reduce its deficit below 3% of GDP by 2014, address the lack of competitiveness through major structural reforms and safeguard financial stability.

Over the first three years, the Greek government managed to reduce the fiscal deficit by 7 percentage points of GDP and introduced many substantial reforms, which in the discussions that are taking place these days are neglected or ignored. No surprise that later governments prone to clientelism tried to replace or dilute them.

In 2016, six years after the first programme was signed, Greece is back in recession and has a small primary deficit. This is so despite registering a small but positive growth rate in 2014 and a fiscal primary surplus in 2013 and 2014.

Even the current account deficit swung to a surplus; however mainly as a result of a decline in imports rather than an increase in exports. The elimination of the twin deficits (fiscal and current account) came at the expense of growth and employment. Over the eight years -- the recession started two years before the first programme -- Greece lost almost a quarter of its GDP and unemployment reached 27%.

One could argue that this happened because part of employment was in effect disguised unemployment -- in either the quasi-public sector and/or the non-tradable sector -- financed by borrowing. At the same period, all social indicators worsened.

Over the crisis, some economists, mainly Anglo-Saxons, have argued that a Greek exit from the Eurozone would benefit the growth prospects of the Greek economy. However, there are good reasons to argue that a Grexit will have disastrous consequences for the Greek economy and the living standards of Greeks.

I believe that after eight years of recession, there is an urgent need to be more sensitive on the issue of rising inequalities. And I am arguing that a Grexit, whether coordinated or not, will result in an increase of inequalities.

A Grexit would imply that Greece would default on a large part of its foreign debt. Without defaulting on a substantial part of debt service obligations, the combination of devaluation and recession would push the total external debt to even higher levels. As a result, Greece would have to produce greater and unattainable current account surpluses in order to meet foreign debt repayments. That is why Greece will have no other option but to default on part of its foreign loan obligations.

The argument that Greece’s exit from the Eurozone would enable the country to enhance the competitiveness of its economy through the devaluation of the currency has no real substance. Most of the key export sectors of the Greek economy, as well as a significant part of production intended for domestic consumption, rely on imported raw materials and imports of intermediate and capital goods, which would be difficult to acquire due to the limited access to foreign exchange.

With the country’s transition to the new currency, the living standards of Greeks will fall dramatically as their real income will fall. In distributional terms, the only groups that stand to gain from a Grexit will be wealthy Greeks, whose assets are already denominated in other currencies and reside abroad. The most vulnerable part of the population will be the first victim of a Grexit. That is why we should oppose recommendations for a Grexit or a break from participation in the Eurozone, as suggested by the German Minister of Finance.

Lesson No 4: Structural changes are necessary to improve growth prospects; but they need time to deliver results.

According to the OECD, Greece was among the countries that introduced a lot of structural changes. But in the same period, the recession was becoming deeper. As a result, citizens lost their faith on the effectiveness of the programme to move the Greek economy out of the recession. Therefore, there is a need to reconsider the growth strategy not by just arguing on the need of more structural changes. Returning to positive growth rates will make our fiscal consolidation easier and will change the view of the markets on the debt sustainability.

Lesson No 5: Now that we have almost balanced the primary deficit, it is about time to reconsider the speed of fiscal consolidation in order to give space to the economy to breath and to fight unemployment.

What is imperative for Greece is to put the economy on a path of sustainable growth. That is a pre-condition to help the most vulnerable part of the society by enabling them to get access to the job market.

As negotiations for the first review of the third programme -- that was signed last August -- are at their beginning, Greece needs:

a) to design and implement a National Reform Programme with a stronger growth orientation and

b) a decision for debt relief through lengthening bond maturities to 50-70 years and lowering interest rates.

It is correct that the debt-to-GDP ratio increased over the years of fiscal consolidation despite a substantial nominal haircut that took place by 2012. This was due to the recession but also to the fact that Greece continued to have deficits after the 2009 crisis and up to today.

Greece needs to present its own National Reform Programme to transform its economy to become more efficient and more outward oriented. It is important to be ready to introduce reforms in the pension system, judiciary system, in the functioning of the political system and public administration.

These are the major challenges that the current coalition government and the one before failed to address over the last few years. In reality, what we observed since June 2012 was an effort to re-establish a clientelist state. Even worse, since last year the new coalition government is nurturing the idea of an economy that will mainly be controlled by the state, leaving little room if any to private entrepreneurship.

In the meantime, unemployment rate is well above 25% with youth unemployment at 60%. We cannot accept youth unemployment at such levels as a natural phenomenon. The emergence of an extreme pro-nazi party in Greece is a very clear signal on the problems that might arise if we do not take concrete action to address youth unemployment.

In order for Greece to restore growth and address the issue of unemployment and social inequality, there is an urgent need to attract resources -- i.e. private investment mainly in the tradable sector of the economy. That would allow the Greek economy to revive its productive potential and capacity -- that was ruined during the period of the crisis -- and to restore its competitiveness. Young Greeks deserve a better future and it’s our generation’s duty to set the conditions for that.

 

*Dr. Philippos Sachinidis is Economist, former Minister of Finance. This speech was delivered at the American College of Athens, as part of a trip of 29 Stanford University students and faculty, in collaboration with “Diktio”. Athens 27 January 2016