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24 March 2015

A New Troika: Greece's Three Paths to Economic Salvation

March 23, 2015 

The most remarkable thing about the recent EU-Greek negotiations is how shallow they were, or perhaps it was how shallowly covered they were. Media reports almost universally described them as dividing over questions of austerity, with Europe, primarily the Germans, insisting on tax hikes and cuts in government spending, while the new Greek government resisted in the hopes of relieving recessionary effects on the Greek economy.

The coverage did give voice to arguments on both sides of this divide, pointing to high unemployment and the country’s long recession as perhaps evidence that the austerity was misplaced, but at the same time recognizing that it was unreasonable for Greece to ask its creditors to finance a return to the country’s previous borrow-and-spend ways. Very little of the discussion, however, touched on the fundamental economic and structural reforms also long pressed on Greece by the rest of Europe. This is unfortunate, for it is only through such reforms that Greece, and other members of Europe’s periphery, can address their debt, fiscal and growth problems.

The original deal Europe pressed on Greece had three essential parts. Each meets a critical, political, economic need of one of the parties involved. A lasting remedy for the country’s financial dilemma requires all three.

Part one of the deal included a sizable, low-interest loan of some €240 billion to Greece. This met an ongoing and urgent need for credit and further encourages private creditors to lend to Athens at low enough rates for the country to manage the payments.

Part two involved the much discussed austerity plan. Athens had to manage its budget—raise taxes and cut spending—to meet ever more stringent deficit targets. This demand reassures all lenders—private and public—that Greece would not squander the monies lent to it. It is also essential for the German government, which primarily bankrolled the loan, to gain ongoing support from its own parliament—the Bundestag—which, understandably, sees a primary need to protect the German taxpayer.

Part three pressed fundamental economic reforms on Greece. These took their lead from German reforms of some years ago that successfully increased that economy’s competitiveness, dynamism, and markedly raised its growth potential. Part of those reforms sought flexibility in Greece’s labor market to promote more aggressive hiring and a more effective use of labor. Another part aimed to ease licensing and other product regulations in order to give existing producers the flexibility to respond effectively to customer needs and to make business more dynamic and competitive by encouraging the development of new firms. The suggested reforms also pressed Athens to privatize certain activities, such as the management of ports, where individual companies might run them more efficiently and cost effectively than the government. The pro-growth nature of these reforms should have offset all or part of the adverse economic effects of the necessary budget austerity and reassured creditors that, in time, a more dynamic and larger Greek economy could meet the country’s financial obligations without aid.

Well, Greece embraced the austerity, but dragged its feet on the pro-growth reforms. Taxes shot up (a hated real-estate tax most prominent among them). The government instituted a strenuous program to crack down on tax evasion, a major longtime problem in the country. On the spending side, Athens laid off vast members of government employees and cut the salaries of a greater number of others. Yet, it instituted almost no labor market or regulatory reforms. Privatization efforts moved at a glacial pace. Those sent by the so-called Troika of lenders—the European Union (EU), the International Monetary Fund (IMF) and the European Central Bank (ECB)—to monitor Greek compliance complained of the country’s failures on these fronts. Even the previous government in Athens, considered especially cooperative with the lenders, seemed either unable or unwilling to generate effective reform plans.

An immense planning document it put out last April is indicative of this. For instance, it made no effort to ease constraining labor regulations. Under current arrangements, it is difficult for Greek companies to adjust work schedules or even lay off incompetent workers, as is the case in much of Europe’s periphery. Employers, as a consequence, are reluctant to hire, except on the basis of temporary contracts, making it especially hard for young workers to find permanent work and generally forcing great inefficiencies on business. Yet the most the government plan could do was propose a bigger government bureaucracy for training and job placement.

Those supposedly responsive plans also didn’t make much effort to encourage new business. Evidently, habits were so entrenched that the planners could not even conceive of the kind of reform the economy needed, even with the German model ready to hand. More likely, entrenched interests—unionized and older, well-situated labor and already-established firms that had no interest in new competition—had more political influence certainly than either taxpayers, who saw their rates rise, or lower-level civil servants, who either lost their jobs or suffered pay cuts.

Whatever the reason Greece has refused to implement thoroughgoing economic reform, it is little surprise that the failure allowed austerity alone to create a truly severe recession. During the past three years, the country’s real output of goods and services has declined a cumulative 10 percent. That a modest 0.6 percent rate of growth last year caused such a stir speaks to the depths of the problem. Private consumption has declined a cumulative 14.4 percent, including a 1.8 percent drop last year. Business spending on new equipment, premises and technology has fallen almost 26 percent cumulatively over this time. Overall employment has dropped by more than 11 percent, while unemployment as a percent of the workforce has climbed from an already ugly level in the high teens to around 25 percent of late. Greek poverty rates, recently measured at close to 35 percent of the population, were up significantly from an already high 28 percent at the start of the crisis. Though the austerity has no doubt played a role in creating this mess, it is misleading to blame it alone, as does the new Greek government, and ignore Greece’s failures on economic and administrative reform.

Such an economy can neither serve its people, nor meet its financial obligations. The four months of additional lending agreed upon in early March cannot correct matters. Nor will four years of additional aid. The only answer is the fundamental reform that Greece seems so far either unable or unwilling to make. Without it, Greece and Europe have but three choices—none of them pleasant. One, Greece stumble further along the unsustainable path followed to date, continue austerity as a condition of aid from a Troika that turns a blind eye to the lack of fundamental reform. In such a case, Greece would see at best a stagnant economy, while it costs Europe and the IMF more in aid every year. Two, it can abandon austerity as well as reform, which seems to be the path desired by the new government. In such a case, Greece would lose the official support of the Troika and eventually face unsupportable borrowing costs, leading to debt defaults and probably to the third choice—a break with the common currency, a tremendous loss of wealth in a depreciating drachma and a relapse into a less developed economic status. There are no other options.

Milton Ezrati is senior economist & market strategist for Lord, Abbett & Co. and an affiliate of the Center for the Study of Human Capital at the State University of New York at Buffalo. He writes frequently on economics, finance, and politics. His most recent book, Thirty Tomorrows, on aging demographics, the challenge it presents, and how the world can cope, was recently released by Thomas Dunne Books of Saint Martin’s Press.

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