Monday, September 19, 2011

Greece’s New Property Tax: Beginning of the End?

For the past eighteen months I have believed in three things: (1) that the crisis facing Greece was, above all, a political crisis; (2) that the Greek government was serious in facing down powerful constituencies; and (3) that the aegis of an IMF-led program offered the right mix of carrot and stick for Greece to make these changes. I still believe No. 1 but I increasingly doubt No. 2 and No. 3. In fact, the newly proposed property tax was an inflection point for me: it turned me from an optimist into a pessimist. 

Why an optimist to start with? For two reasons. First, I believed that Greece needed to be in crisis mode for things to change – deep reforms in the country’s political economy would be unthinkable under a “business as usual” scenario. Second, I believed that the troika’s agenda was, more or less, sensible. It demanded cuts where cuts should be made, and it pressed for reforms where reforms should take place. I did have one worry: I recognized that reform and debt repayment were different things and that if pressed to pick, debt repayment would trump reform. 

There was reason to keep being optimist, I think, until just now. In my mind, the Greek program has gone through three phases. The first period came from the signing of the memorandum with the troika in May 2010 to the start of 2011. For about 8-9 months, the government was diligent. It succeeded in cutting the deficit quite impressively, and its deviation from the target could be easily explained by a deeper than expected recession. The government was also resolute in its reform agenda: it faced down truckers, port workers, and others who challenged new laws. It showed a strong commitment to change. 

Then it started to waver. Chiefly, it slowed its commitment to change. The second period lasted from the first quarter of 2011 until the passage of the medium term plan in the summer. The period was marked by four trends: a progressive realization that a deeper than expected recession would make the 2011 fiscal targets hard to meet; a second wave of structural reforms but with feeble implementation; the introduction of a broad set of measures, balanced between higher revenues and lower spending, in the form of the medium term strategy; and finally, an outright mutiny in the ruling party that almost toppled the government but that, instead, led to a cabinet reshuffle. 

By the end of the summer holidays, the government was again in a tough spot. Its fiscal targets were increasingly beyond reach. At that critical juncture, it chose to plug a fiscal hole by introducing an extraordinary levy on property to be paid through the electricity bill (a measure which, amusingly, the current finance minister called absurd and unfair only a few months earlier). The government is also meeting to consider additional measures, but so far, this is it. 

Now, of course, no program goes fully according to plan. It easy to miss targets, to take longer to pass reforms and implement them, to seek consensus by sacrificing expediency. These obstacles are expected. But a politician and a government reveal a lot about themselves by how they handle adversity. Faced with trouble, do they stand on firm principles that will guide them? Do they have a clear purpose and a sense of fairness? Do they know where they want to end up and have some idea of how to get there? Or do they dash for the exit, seeking the path of least resistance, opting for naked opportunism over thoughtful action? 

The property tax was naked opportunism. There is no doubt that a government faces a trade-off between good measures that yield results with time and less good measures that yield results instantly. And yet, this excuse becomes progressively less valid as time goes on. This is particularly so when one considers the alternatives available to the government – one being to set up special courts to expedite the collection of tax arrears, the other being to be more aggressive in cutting jobs and wages in the public sector. Together these two actions would enable a third crucial one: a tax break for consumers. 

These actions would signal both a willingness to tackle vested interests as well as demonstrate a sense of justice. More fundamentally they would reinforce a government message: we are introducing measures, often unjust, because we need to plug in a hole until the structural reforms kick in. But when you keep saying this, and when the structural reforms keep getting pushed back, how on earth can you keep justifying such measures? The truth is that when confronted with a pure grab versus more painful but more just measures, the government went for a grab. And a government with such instincts does not deserve a mandate to rule.

Friday, September 16, 2011

Can Greece Still Avoid Default?

Once again, Greece spent days battling rumors that it is about to default. Realistically, whether and how Greece defaults comes down to a single question: what is Europe’s patience with Greece? Will the ‘troika’ hold back the disbursement of an installment if Greece misses its targets? Or will it look the other way, agree to an exemption and live to fight another day? 

The problem is this: Europe is in no better position to let Greece default now versus 18 months ago. Yet Greece is exhausting the troika’s patience. Mainly this is a dispute about why Greece is missing its targets. According to the Greek side, it is all about the recession, which is bigger than anticipated. Yet the recession does not explain the slow progress in passing reforms or the slow implementation of reforms passed. It does not explain the lack of political will to unsettle constituencies, nor does it explain the political math that politicians engage in when deciding which laws to pass and implement. 

So the Greek government and the troika are speaking past each other. While the Greek side is explaining why it is missing its targets, the troika is saying, “OK. But what about all those other things we’ve talked about?” If Greece made a sincere effort to reform and the weight of the recession somehow derailed the numbers, then it would be easy for the troika to look the other way. But with less progress on reforms, the failure to meet budget targets is harder to oversee, much less to forgive. 

The government also refuses to see how its own actions are making the recession worse. The most recent measure – effectively to levy a new property tax – was particularly depressing. It was depressing because when confronted with the inadequacy of its own measures, the Greek government chose a blatant “grab” measure over an effort to accelerate other changes. 

What changes? For one, it seems inconceivable that there is still so little progress in collecting tax arrears – a mere fraction of those would obviate the need for this latest measure. Second, the government is not moving boldly enough to shrink the public sector wage bill. If the government made progress on those two areas, it could easily lower taxes and boost household income to re-start private consumption. 

Greece is now entering a critical phase: it started with a very sincere effort to reform and an impressive fiscal consolidation in 2010. It then slowed down the reform agenda, provoking an intense reaction from those people who saw that it was shirking from its commitment to change the Greek economy and political system. Over time, the reform agenda has become more ambitious in theory but feebler in practice. 

Now, the government is faced with its own limitations and is looking to merely grab money. I have never believed that Greece’s task is impossible – yet I am increasingly convinced that the government is trying to do just enough to secure the next tranche. Cosmetic change trumps fundamental reform. In that context, the troika may still decide that it cannot afford Greece to fail. But that game will be different – to paraphrase the old Soviet joke, “Greece will pretend to reform and the troika will pretend that Greece is reforming.” The whole point of the program is to provide a framework for change - if it becomes merely a pretext for delaying the inevitable, then what good does it do for Greece?

Friday, September 09, 2011

Distribution of Corporate Tax Arrears in Greece

In a past post, I noted how tax arrears in Greece were both high as well as highly concentrated (here). The General Secretariat for Information Systems (GSIS) has just published a detailed list of the corporate entities that owe more than €150,000 in tax arrears. There are 6,000 companies on the list with arrears of €30.9 bn. There is not much new to say (see my previous post) except to underscore just how skewed the data is: 10 companies alone owe €4.4 bn with train company OSE leading the way; the top 100 companies owe €11.7 bn. Of the 6,000 companies with arrears, 212 make up 50% of the total. No doubt the publication of the names will produce both pressure as well as intense reaction. Will it help with tax collection? We'll see. 

Thursday, September 08, 2011

Greece Needs a Bigger Plan

The Greek economy is in a vicious cycle: the tax increases to close the budget deficit are worsening a sharp economic contraction. That contraction, in turn, is leading budget revenues to come in below targets, which prompts outsiders to call on the government to introduce additional fiscal measures. Those measures further depress economic output and the cycle goes on. In official forecasts, the Greek government assumes that economic growth will somehow emerge by 2012 or – that assumption looks more and more implausible. The problem is that Greece does not have infinite time - Europe has been very patient but its patience is being exhausted. Faced with such reality, the Greek government can either try more of the same or it can try to double down. What it really needs is a bigger plan. 

Greek economic policy has two aims: fiscal consolidation and structural reforms. The former reduces output in the short term, while the latter will increase output in the long term. The question is, how long between the “short term” and the “long term” and what will trigger the inflection point? Right now, there is very little going well for the Greek economy: consumption is down due to higher taxes, lower wages and higher unemployment; investment is down, as it has been over several years; and state spending is down due to the need to lower the budget deficit. Only trade is making a positive contribution to GDP, chiefly because Greece is importing less, which is hardly case for celebration. 

Based on the government’s medium-term strategy, the budget deficit should shrink from 10.4% of GDP in 2010 to 1.1% in 2015. But the consolidation would mostly come from a reduction in spending – in fact, revenues would remain flat as a share of GDP. So the Greek consumer cannot really expect a tax break any time soon. And since reduced private spending is driven by higher taxes, lower wages and lower employment, there is little reason to think that private consumption will rise. This is a vicious cycle with no exit and no obvious inflection point. 

The fiscal calculus assumes a steady but orderly reduction in spending. But that reduction is too slow and perpetuates the vicious cycle in private consumption. The Greek government has thus two options. First, it can place its hope on investment. In theory, structural reforms will yield additional investment. But how soon will this come? Remember that investment peaked in 2007 as a share of GDP so the country faces some deep-seated problems that will not be wiped out overnight. And at just 15% of GDP, it may too small to be a short-term economic driver. 

Its second option is to accelerate fiscal consolidation. The medium term strategy forecasted spending to go from 50% of GDP in 2011 to 44.8% in 2015, while revenues were expected to grow marginally from 42.6% of GDP to 43.2% of GDP in 2015. What is clear is that this “equilibrium” is increasingly implausible – it stabilizes revenues at too high a share of GDP and offers no clear path to a consumption-supported economic recovery. To resolve this problem, the government needs to slash spending faster paired with a fiscal stimulus in the form of a tax break. What this means is a sharp reduction in “less essential” government services that would allow for the government to meet its budget target without having to squeeze consumers so fully. That seems the best way out at the moment.

Monday, September 05, 2011

Why is Greece in a Recession?

Start with two big picture graphs. The first shows real GDP from its Q3 2008 peak to Q1 2011. Several items stand out. First, only imports have made a positive contribution to GDP in this period (meaning imports fell) – all other items lowered GDP. Second, the drop in GDP has been mostly due to a decline in investment with smaller contributions coming from lower exports and from reduced consumption. Little of the decline came from reduced government spending.
That picture, however, aggregates too much information; thus, we need our second big picture graph to investigate further. The reality is that Greece has faced two recessions: the first one, from Q1 2009 to Q1 2010 was driven by a contraction in investment and, to a lesser extent, by a drop in consumption. In that time, government spending and trade both contributed positively to GDP. Then came the second phase from Q2 2010 to Q1 2011: this recession came mostly from reduced consumption and, to a lesser degree, by lower government spending. Investment made a smaller negative contribution, while net trade was positive.
Investment. Lower investment was the major driver of the first recession in 2009 and early 2009. What happened? The drop in investment is, in fact, chronic. Investment in nominal euros kept rising from 2000 to 2007, but when measured as a share of GDP, it peaked at 24.5% in 2003. It then started a steady decline, before registering a sharper fall in 2009 and then reaching just 14.5% of GDP in 2010.

From a sectoral angle, there are several trends. The first is that there was a clear fall in housing investment that started in 2007 – that decline seems steady and does did not accelerate during the current crisis. Instead, the investment-driven recession in 2009 was generated mostly from a fall in metal products and machinery.

Consumption. As I noted above, consumption started to fall in Q2 2010. But why? Households are coping with three main challenges: unemployment, less income and higher prices – which is to blame for lower consumption?

First, unemployment started to rise in Q3 2008 and it grew more or less steadily until Q3 2010, after which it shot up. That trajectory can explain the drop in consumption that started in Q1 2009 but not the acceleration after Q2 2009.
Second, wages were rising throughout 2009 at a time when private consumption was falling – in that period, higher unemployment might have been more to blame for lower consumption than lower wages. In Q2 2010, however, wages did register a drop just when consumption started to fall.
Third, Greek households started to experience significant inflation in Q2 2010 that was driven mostly by tax increases – in fact, when looking at inflation in constant taxes (excluding the impact of tax measures on prices), there was barely an increase. This reality seems best correlated with the drop in private consumption.
Government spending. In 2009, government spending was a boon to GDP, while in 2010 it was a drag. Here it is important to note that, for the national accounts, government spending does not include all government spending – in fact, it includes about half of it in the case of Greece (the rest are payments to households and firms that then consume products and services).

Even so, it may be useful to review some basic parameters of government spending because they link importantly to the recession. Broadly speaking, the government has tried to offset the decline in revenues that are the result of the recession by boosting a number of taxes such VAT, tobacco, fuels and alcohol. These items alone yielded more than €2.5 bn in extra revenue in 2010, more than offsetting the reduction in direct taxes that resulted from lower household and corporate income (minus €1.2 bn). Spending has shown a similar trend: the government is reducing direct spending but is seeing an increase in assistance (unemployment benefits and support for pension funds among others).

Adding this picture to that for households we see the following: households are hit by higher inflation as the government tries to collect more taxes to offset the recession-driven decline in direct taxes. Government spends less but as the recession and unemployment intensify is forced to spend more to support those in need.

Trade. The trade picture is much less clear in part because the data is more opaque and the numbers from the Bank of Greece and ELSTAT are different. Even so, ELSTAT numbers show some important realities. In 2009, the drop in imports (by €13 bn) more than offset the €8.9 bn drop in exports – in other words, trade made a positive contribution to GDP chiefly because, as the recession hit, Greek consumers imported less. In 2010, the picture changed. A reduction in imported goods continued to affect GDP passively, albeit at a slower pace. Exports, by contrast, stopped falling and in fact registered a €1.3 bn rise. But this growth in exports was driven by merely one quarter (Q4 2010).
Conclusions. What does all this mean? First, the Greek economy has suffered from a continuous decline in business investment – the recession merely accelerated the drop in one or two subsectors. Households have started to consume less but, at least initially, their reduced consumption was mostly driven by a hike in taxes and lower wages. Rising unemployment is sure to blame as well, but given government support and other measures of income support (family), there is a weaker correlation between rising unemployment and falling consumption. Finally, trade is making a positive contribution but not in a “good way” – rather than seeing more exports, Greece is mostly just importing less.

Friday, September 02, 2011

The National Interest: Greece Rises Again

News from Greece keeps getting worse. The recession is deeper than expected, social tensions are rising and the government says its 2011 deficit target will be hard to meet. Many analysts surely feel vindicated; they have long argued that Greece’s program will fail. Yet they were and remain wrong. Greece faces a political and economic crisis—debt is only a symptom, and there is no point in treating the symptom but not the disease. For that, Greece needs to keep on its current path.

Read the full version of my article on the National Interest website