CONFERENCE IN HONOUR OF MIKE ARTIS Florence 17 June 2016
First of all, I would like to thank the organizers for their invitation to participate in this conference in honour of Mike Artis who supervised my PhD thesis at the University of Manchester in the early 1990s. Mike was a very kind and knowledgeable man. He was also an excellent teacher. I was very lucky to have had him as a PhD supervisor at Manchester.
Today, I would like to share with you my views on the puzzle “why is Greece still under a programme”. After a deep and prolonged depression that started in 2008, real GDP in Greece fell by 26%, unemployment rate is at 25%, pushing many people into poverty and increasing income inequality.
These are clear signs of a failure and although it is hard to consider Greece as a failed state, as it still stands within the group of the 30 most developed nations, there is always the risk of being trapped into a prolonged stagnation and deflation.
This will definitely cause Greece to lose its place among the 30 wealthiest nations and it will trap large segments of its population in chronic unemployment and poverty.
Today, I would like to argue that the economic problems of Greece are the immediate result mainly of an institutional failure.
In order to understand how Greece has been trapped in stagnation as a result of the failure of its institutions, I will try to answer two questions:
1) How did Greece manage in 2009 to be in such an economic mess nine years after joining the European Monetary Union; and
2) Why is Greece the only Eurozone country that is still under a programme and trapped in a recession for more than eight years?
Let me start with the first question.
Almost 20 years ago, a significant majority of Greek economists and the major political parties came to the conclusion that it would be to the benefit of Greece to join Economic and Monetary Union.
While at the time they understood the urgent need to introduce politically difficult structural changes, their expectation was that peer pressure from the Euroarea would lead Greece to adopt these changes. Joining EMU was viewed as a safe way to break the vicious cycle of high wage increases – high inflation that was cursing Greece for two decades.
However, nine years after joining the Eurozone, Greece was trapped in an unsustainable economic path with high twin deficits (specifically fiscal and current account deficits), high debt-to-GDP ratio; and after growing fast for a number of years the economy entered a recession.
The debt problem was the result of the fiscal irresponsibility of the years before the emergence of the global financial crisis.
In almost every year between 2001 and 2009, the government was running a deficit. In fact, a deficit that was increasing year after year post-2006.
As a result, while Greece joined the Eurozone with a debt-to-GDP ratio below 100% and despite an average annual growth rate of around 3.5% and extremely low interest rates in the nine year period 2001-9, the debt-to-GDP ratio stood at 127% in 2009.
In that year, the government deficit reached 15.3% of GDP and the current account deficit was at 12.5% of GDP. A year earlier, in 2008, the current account deficit was at 14.9%.
In the spring of 2010, Greece lost access to capital markets and requested financial support from its European partners.
Europe along with the IMF established a special support mechanism. This was a first – it had never happened before.
And it involved the biggest loan ever given to a country: 110 billion euro.
In return for this financial support, Greece accepted to implement an Economic Adjustment Programme involving tough austerity and structural reforms.
With hindsight, an obvious question would be:
Was there no «alert mechanism» either at the country or at the European Union level to prevent the emergence of these economic imbalances that were not sustainable within a monetary union?
Here is where both institutions and markets failed to prevent these imbalances from emerging.
The major political parties, the economic elite and social partners failed to understand the complexities associated with monetary union membership and the implications of globalization.
To understand why Greece failed to keep its public finances in order, we have to concentrate on the institutional framework for the budgetary process.
The European Commission in 2007 found that Greece had the weakest budgetary procedures among the 18 countries examined.
Before the 2009 crisis, almost a third of the general government revenues and expenditures were outside the budgetary process.
Government ministers acted and spent money as semi-autonomous state agents.
The political parties in their effort to win popular support were ready to introduce new social or investment programmes boosting public spending and introducing tax cuts at the same time, irrespectively of the economic cycle.
This is why Greece experienced deficits even during years of high growth.
Between 2001 and 2009, fiscal deficits were typically at least 70-80% higher than their targets.
Greece’s failure to keep its public finances in order was matched by a failure of European institutions, the very institutions responsible to assess the fiscal stance of Eurozone countries within the context of the Stability and Growth Pact. The fact that Germany and France were the first to break the SGP in the early 2000s without any reprimand gave the wrong signals.
Markets also failed to realize that the economic problems of Greece were severe and structural.
This is clear from the fact that, until 2008, markets were lending Greece at rates close to those of Germany.
It was only after the global financial crisis of 2008 that markets started to question the fiscal position of Greece.
In conclusion, Greek political and economic elites in the 90’s decided that Greece should join EMU in order to address Greece’s institutional failures with the hope that the new challenges Greece would face would bring about the reform of institutions.
However, as the Euro Area institutional framework was itself weak and incomplete, the Eurozone failed to trigger or enforce the transformation of the Greek economic institutions.
At the same time, the two major parties of Greece and the small parties of the left opposed the transformation of the economic institutions that would facilitate the Greek economy to become an outward oriented economy.
Now moving to my second question:
2) Why is Greece the only Eurozone country that is still under a programme and trapped in a recession for more than eight years?
Out of the four Eurozone countries that signed adjustment programmes, Greece is the only country still under a programme, six years after signing the first adjustment programme in 2010.
This is despite the fact that fiscal consolidation was pretty much achieved already by the end of 2014.
Greece has also balanced its chronic current account deficit.
Then how comes Greece didn’t manage to get access to capital markets?
There are economic and political reasons that can explain this failure.
In the case of Greece, the initial macroeconomic imbalances were the worst in the Euro Area.
Greece within 5 years had to cut the fiscal deficit by 12 percentage points of GDP by introducing measures up to 18 percentage points of GDP.
Fiscal policy was extremely restrictive, a lot more than any other program country, in an environment of tight credit.
As a result, recession deepened further and unemployment soared to 27%.
Markets therefore questioned the economy’s ability to grow again in such an environment, and more importantly they questioned the country’s ability to service its debt without growth.
In fact, the debt sustainability issue and the continuing fear of a Grexit were the two most important factors that prevented Greece from regaining market access.
A second reason relates to the structure of the Greek economy, which is a more closed economy, with consumption representing almost 70% of GDP.
Exports were only 20% of GDP and could not carry enough counter-weight to the reduction of domestic aggregate demand.
However, if we want to understand why Greece is still under programme, we have to focus on the constraints the political system imposes on the implementation of the adjustment programme. This is directly related to the important question of why Greece managed to re-access international capital markets only two years after the largest debt restructuring in history – but did not manage to sustain the momentum.
From the very beginning, there was lack of political consensus on the need to correct economic imbalances and address the institutional failures.
Leaders of the opposition parties were “infected” by the “I can do it better” syndrome and\or “There is an Alternative way without memorandums” syndrome.
Hence it is no surprise that within a very short period of time after the signing of the first programme the PASOK government was challenged on a daily basis by demonstrations and members of the government or MPs were humiliated at public appearances. Eventually, MPs from PASOK left the party in the hope that they will survive politically.
This led to a “lack of ownership” of the Programme over the whole 2010-2016 period, even when the center-right New Democracy party came to power after the 2012 elections and currently with the new coalition government between leftist Syriza and populist far right-wing Independent Greeks.
Hence we suffered from a lack of full and timely implementation of the reforms which were voted.
Finally, Greece turned out to be a special case because although its economy was stabilized and began growing in 2014, uncertainty on continued EMU participation was raised again by the political developments in 2015.
The January 2015 elections brought a new coalition government of Syriza and Independent Greeks – which gambled in a protracted stand-off with the EU and wasted precious time in interminable discussions heightening uncertainty.
By August 2015 the SYRIZA government met T.I.N.A. (There is No alternative) as had happened before in late 2012 with A. Samaras, the then Prime Minister and leader of New Democracy.
As a result, in 2015 the economy moved back to stagnation and the government was forced to introduce capital controls in order to prevent the collapse of the Greek banking system.
In conclusion, Greece’s failure was mainly the result of the failure of the major political parties to reach a consensus on an adjustment programme that had to be implemented in order to regain access to capital markets.
Since 2010, Greek political parties are being asked to implement a series of reforms that they themselves hadn’t shown the willingness to introduce in the past.
After the signing of the first programme, opposition parties failed – or were unwilling – to understand the severity of the crisis.
So instead, they accused the PASOK government for agreeing with institutional creditors to sign the “wrong prescription” for the economy, giving too much emphasis on austerity and not on growth.
With regard to the question whether robust growth can resume by 2016 or 2017, I would say that I am rather skeptical, mainly because of the recessionary effects of the new fiscal measures that were introduced a month ago in order to meet by 2018 the target of 3.5% of GDP set for primary surplus.
I would like to argue that now that we have balanced the primary budget, it is about time to reconsider the speed of fiscal consolidation by reducing the target of primary surplus to 1.5-2.5% of GDP in order to give space to the economy to breathe and to fight unemployment.
Given that negotiations for the first review of the third programme have been completed, Greece needs:
- to design and implement a National Reform Programme with a stronger growth orientation and
- a decision for debt relief roadmap that will be fully clarified if not implemented before and not after 2018. So that potential investors can have a clear picture.
Greece needs to present its own National Reform Programme to transform its economy to become more efficient and outward oriented.
It is important to be ready to introduce deep reforms in the judiciary system, in the functioning of the political system and public administration and the product market.
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.
This will allow the Greek economy to revive its productive potential and capacity, which was ruined during the period of the crisis, and restore its competitiveness.
For this to happen, the government has to decisively embrace the idea of opening up the Greek economy and attracting private investment. This is not still the case.
Young Greeks deserve a better future and it’s our generation’s duty to set the conditions for that.
Thank you for your attention.