Monday, August 29, 2011

Ten Surprising Facts about the Greek Economy

In writing this blog, I have come across several facts about the Greek economy that surprised me. In some cases, it was the fact itself that was the surprise; in others, it was the magnitude of something I already knew about. Here they are, along with links to the relevant posts.

Fact #1. Greek GDP is at 2004 levels, and it will take about a decade to reach pre-crisis levels. Greece’s GDP has been declining since Q4 2008, and is now just above 2004 levels. What is more, the initial program agreed to with the troika forecasted that real GDP would not reach its pre-crisis level until the end of the decade. A greater than anticipated recession means it could take past 2020 for Greece to recover to the income level it had coming into this crisis.

Fact #2. Tourism export revenues have declined 28% since 2000. When analysts discuss how the Greek economy may grow, there is an inevitable emphasis on tourism. But tourism has been in steep decline in the last decade. In 2000, Greece’s tourism revenue was €10 bn (based on customs data). Ten years later, it had fallen to €9.6 bn, a 4.5% drop. But if we factor in inflation, revenues from tourism have dropped 28% since 2000, reflecting the structural flaws in Greece’s tourism industry, which relate, chiefly, to getting more tourists who spend less money.

Fact #3. Net exports from shipping have declined 27% since 2000. Shipping, Greece’s other major export, has performed better than tourism but only marginally so. In 2000, Greece’s revenues from shipping netted €4.6 billion. By 2010, that number had fallen to €4.5 bn. Adding inflation means that the drop has amounted to 27%, although some years were better than others. The chief problem is that from a trade perspective, shipping affects both sides of the equation due to money spent to buy ships and on shipping related services. When we take out the outflow of money, the net effect for Greece has been declining.

Fact #4. Collecting 40% of tax arrears would eliminate the 2011 budget deficit. Weak tax collection forms a big part of Greece’s fiscal problem. In June 2011, the Ministry of Finance reported that tax arrears amounted to €41 bn. Of that number, 90% came from 6,500 people and from 8,200 corporations that owe over €150,000 each. Collecting those arrears would more than cover the projected 2011 budget deficit of less than €17 bn.

Fact #5. Employees in state-owned enterprises (SOEs) earn twice as much as employees in the private sector. One of the recurring themes in Greece’s political economy is the dichotomy between an insulated and well-paid public sector and a low-paid (at least for employees) private sector. According to data released by the ministry of finance, employees at SOEs earned, on average, €38,287 in 2008 – which is twice as high as the €19,147 earned in the private sector. For some SOEs, the gap was much higher.

Fact #6. Greeks are as likely to pay a bribe as Nigerians and Pakistanis. According to Transparency International, 18% of households in Greece reported paying a bribe in the last twelve months, versus an average 5% in Europe. That number puts Greece on par with Nigeria and Pakistan.

Fact #7. When you add private debt, Greece’s overall indebtedness is low in Europe. Everyone knows that Greece’s problem is debt. But it is, in fact, public debt that is the problem. A graph shown in a presentation by the former minister of finance adds public and private debt – when the two are combined, it is clear that Greece is at the low end of the spectrum. What distinguishes Greece is not high debt overall, but high government debt.

Fact #8. Greece’s debt was mostly accumulated in the 1980s and early 1990s. Greek society has yet to have a serious debate about how it got into this mess. What is amazing is to see just how recent this debt accumulation is: in 1980, Greece’s public debt was merely 22% of GDP; by 1993, it was 98% where it stayed (plus or minus) for over a decade before going higher in this crisis. In other words, Greece’s debt problem was mostly created over a 13-year period and it was perpetuated thereafter.

Fact #9: Greece had a relatively small state in 1980. Analysts with an eye to history will always point out that the Greek state has been omnipresent in Greek life since its inception. Yet that fact, while true, disguises the extent to which statism is a post 1980 phenomenon. In 1980, government spending amounted to 24% of GDP; by 1990, that number had risen to 45%. It kept rising, somewhat more modestly to 51% in 2009. The Greek government aims to bring that number back to 45% by 2015.

Fact #10. Greece’s relative standard of living dropped after 1980. In 1978, as Greece was about to join the European Economic Community, its per capita GDP was just 5% below the European average (on a PPP basis). In 2000, the gap was 30%. In retrospect, Greece’s entry into the EEC has been seen as a political gesture, and in many ways it was; but the gap between Greece and Europe was much narrower at the point of entry than ever since. Greece was close to Europe when it joined the EEC; it was only later that Greek living standards stagnated and fell relative to the rest of Europe. Europe moved on and Greece was left behind.

Thursday, August 25, 2011

Lessons from the Latvian Crisis for Greece

As I read this wonderful little book called How Latvia Came through the Financial Crisis by Peterson Institute economist Anders Åslund and the Latvian PM, Valdis Dombrovskis, I could not help but think of what Greece could learn from Latvia. Strictly speaking, the Latvian and the Greek crises are very different. But there is something about how Latvia dealt with its crisis – a combination of competence, clear-headedness and a sense of purpose – that is both humbling and inspiring. The authors offer their own “lessons to the world,” which I recommend reading, but here is what I took away from the book.

First, a disclaimer. Latvia and Greece faced very dissimilar crises. Latvia had a “sound economy” that suffered from a capital-inflow induced bubble. Its politics were center-right and there was a strong commitment, political and public, to markets. Budgets had been balanced and public debt was low. There was also a national consensus in favor of macroeconomic policies that would support the country’s entry into the Eurozone, which served as the end-game “prize.”

By contrast, Greece had an unsound economy with numerous distortions, public and private. Budgets had been chronically imbalanced and public debt had been uncomfortably high for at least 15 years. The electorate has been center-left, at least since 1981, and hostility to markets has been pervasive. And as part of the Eurozone, Greece has so far articulated only negative targets: “avoid default” and “not leave the Eurozone.”

In that sense, the lessons to draw from Latvia are more generic, but are no less valid for that. To begin with, there are economic lessons – these are now almost accepted principles for dealing with a crisis, but they are no less deserving to repeat here. First, better to achieve fiscal consolidation by relying on spending cuts rather than revenue hikes. Second, better to implement reforms sooner rather than later. Third, an international aid package should be big and frontloaded. Besides those narrower economic lessons, I would take away the following.

First, currency “depreciation is an overadvertised cure in current macroeconomic discourse.” As the authors note further, “when a country needs to address underlying structural inefficiencies in the economy, internal devaluation is preferable to exchange rate devaluation, which offers only temporary relief from cost pressures while avoiding long overdue reforms.” This is a view that I subscribe to – as I have written, “A weak currency in itself is a poor foundation for export-led growth. Greece had a free floating drachma before the euro but with no export-driven industries to show for. Just becoming cheaper only gets you so far” (here).

Second, “the international macroeconomic discussion was not useful but even harmful. Whenever a crisis erupts somewhere in the world, a choir of international economists proclaim that it is ‘exactly’ like some other recent crisis - the worse the crisis, the more popular the parallel. Soon, prominent economists led by New York Times columnist Paul Krugman claimed that ‘Latvia is the new Argentina.’ The fundamental problem is their reliance on a brief list of ‘stylized facts,’ never bothering to find out the facts.” 
 
This is a view I also share strongly – hence my post against Nouriel Roubini or against the Argentina analogy as characteristic of how international economists are wrong on Greece. As someone trained in political science and economics, I have always been shocked by how little economists understand of politics. Of course, they understand politics in the abstract, but they fail to connect the political links with the economic dots. In Latvia’s case, they under-estimated just what the politicians were willing to do and the public willing to accept. In Greece, they under-estimate the political economy that has driven Greece to this mess and, as a result, have no appreciation of what needs to change.

Third, equity matters. The Latvian PM, the book’s co-author, spends considerable ink to talk about policies that “might not have saved us much money, but they showed that the government was serious about distributing the cost of the adjustment also to the privileged.” Or, put eloquently by the PM, “we will ensure that the cuts do not apply only to policemen, teachers or the health care sector.” There was also a strong effort to bring in constituencies such as professional associations and unions to enlarge the stakeholder base. 
 
Greece has failed in that task. In April 2011, I noted that the government seemed to be losing support just when it demonstrated a willingness to cushion the effect of the reforms on vested interests: “The PASOK government now faces a fundamental question: will all Greeks be forced to change or will some Greeks have to change more than others? In 2010, the government was saying all Greeks would change. In 2011, it has pulled back from that commitment. This may please some special interests but the silent majority is watching closely. And they are disappointed by what they see” (here). The effort to deal with tax evasion and tax arrears is meant to address that issue, but that may be too little, too late.

Fourth, government competence matters. One Latvian (coalition) government fell months after agreeing to a bailout with the external creditors. The government failed chiefly because it was not up to the task. The shenanigans of the finance minister, Akis Slakteris, are particularly memorable and make Joe Biden seem benign by comparison. His answer to the question, why did had Latvia gotten into this mess (“Nothing special” was the answer) seems to have sealed his fate. But there are other positives too – President Valdis Zalters was relentless in pressing the government to take action and was ready to dissolve parliament when it was failing. As the PM notes on the event of his reelection, “These elections appear to be a textbook example of how a serious and competent government can win elections even with severe austerity policy, if it convinces the voters.”

Fifth, communication matters, as do long-term goals. The Latvian government went out of its way to explain the crisis, what needed to be done, and how its actions would resolve problems. More crucially, it clung to a vision that Latvia should stick to the Maastricht criteria so that it could join the Eurozone by 2014. In Greece that has been a major deficit – almost two years since this government took charge, no politician is  articulating either a strong understanding of what happened or a coherent vision for where Greece needs to go next. Use whatever cliché you want – light in the end of the tunnel, eyes on the prize, the final destination – but Eurozone entry helped keep Latvia focused, while the absence of such goal in Greece shows an inability to galvanize popular support towards something as opposed to merely against something – toward reform rather than mere avoidance of default.

Sunday, August 21, 2011

Greece’s Q2 2011 GDP Puts Country Just above 2004 Levels

Greece’s economy continues to contract at an alarming rate: the Greek Statistical Agency released its flash estimate for GDP growth in Q2 2011, putting it at -6.9% (not seasonally adjusted). Evangelos Venizelos, the finance minister, admitted that GDP this year may fall by over 4.5%, the fourth revision against an initially estimated -3% and higher than the -3.8% assumed in the government’s medium-term strategy. These numbers will test Greece both internally and externally: internally because better days will take longer to come and externally because Greece will likely miss its fiscal targets.

The GDP decline of 6.9% in Q2 marks a slight improvement relative to the 8.8% decline in Q4 2010 and the 8.1% drop in Q1 2011 – but this “improvement” is merely a statistical artifact and reflects the extreme weakness in the comparison quarter (Q2 2010). It is only because it is compared to such a low point, that the decline in Q2 looks “better” than before.
The decline underscores the negative trajectory of the Greek economy: only in one quarter since 2009 has GDP grown, and then only on a non-seasonally adjusted basis. On a seasonally adjusted basis, there has been no growth since Q4 2008. In fact, when looking at performance by quarter, Q1 and Q2 2011 are just 1% above Q1 and Q2 2004, meaning that real GDP is effectively where it was in 2004 (although data revisions means the numbers are not 100% comparable).
What is more, the composition of the GDP drop has changed. In 2009, the GDP contraction was driven chiefly by investment, while government spending and trade contributed positively to GDP. In 2010, the decline was at first driven by investment and later by government spending; it was only in Q4 2010 that there was a significant fall in consumption. Investment, meanwhile, continued to drop but at a much smaller rate. By Q1 2011, however, the decline was more evenly spread, highlighting that no sector has been spared by the recession. The only positive for GDP has been trade where a shrinking current account deficit has boosted GDP. But even there, only half of the gain has been due to rising exports, with the other half coming from lower imports.
What are the implications of this dynamic? First, Greece’s GDP is unlikely to recover to 2008 levels until late in the decade, unless the post-crisis growth turns much better than expected. Second, it means that the period of patience – the period before growth eases political strain – is pushed out further, perhaps into late 2012 or 2013. And third, Europe’s tolerance for Greece will be tested if Greece starts to miss its targets more severely.

Monday, August 15, 2011

Are Eurobonds the Answer?

The case for Eurobonds is simple. Heavily indebted countries on the European periphery are finding it hard to finance their deficits at a time when lenders are demanding higher yields to be compensated for extra risk. By pooling the borrowing needs of the Eurozone, and by falling back on the credit rating of Germany, European countries would raise money more easily. The prospect of extreme borrowing costs triggering a default would almost vanish. But to judge the merits of Eurobonds, we need to ask a deeper question: what kind of a crisis is Europe facing and will Eurobonds resolve it? I would argue that Europe is facing seven interlinked crises.

Crisis #1. Too much debt. Five countries have debt over GDP ratios above 90%. Together they account for 34% of the public debt of the Eurozone at year-end 2010. These countries are also continuing to run budget deficits, meaning that their debt levels are rising. Their ability to repay that debt questionable.

Eurobonds as an answer? Unless paired with a haircut, Eurobonds would do little about debt. After all, Germany's debt ratio is 83% of GDP, and the Eurozone as a whole would have a debt ratio of 85%. Pooling debt together would equalize debt at a high starting point. Even so, Eurobonds would make the debt of the more heavily indebted countries more sustainable.

Crisis #2. High borrowing costs. Markets are increasingly doubtful that the highly indebted countries (and a few others) have credible plans to pay back their debt. Thus, they demand higher returns to be compensated for the extra risk. As borrowing costs rise, fiscal positions deteriorate as projected debt service burdens rise. At an extreme case, when borrowing costs keep climbing, countries either default or need a bailout.

Eurobonds as an answer? Borrowing costs would fall, at least initially. The collapse in spreads would make it easier for countries such as Greece, Italy, Ireland, Portugal and Spain to borrow at lower rates. However, in several countries, their debt may be unsustainable even assuming lower interest rates. Plus, it was lower interest rates (and a convergence in bond yields) that helped fuel this mess to begin with. So without further action to control spending, lower borrowing costs would be a short-lived answer with the seeds for a future crisis.

Crisis #3. Fallout from a default. A default would lead to massive losses in the financial sector. That would lead to (a) a sell-off as banks seek to raise money to meet their collateral needs and (b) significant cash payments and receipts from those institutions holding credit default swaps (which insure against a default). These write-downs would likely mean that banks would need to raise fresh capital, either from the market or (more likely) from governments.

Eurobonds as an answer? Again the impact would depend on whether a Eurobond is paired with restructuring. Without a haircut, the fallout would be zero (for now). A haircut could easily create a re-capitalization need even if there are Eurobonds issued.

Crisis #4. Divergent economic fundamentals. There was no doubt to begin but the crisis has underscored that the German economy and the Greek economy can only belong in a fantasy common grouping in a galaxy far away. Europe faces a deep structural challenge: how to make big parts of the European economy more efficient and more competitive.

Eurobonds as an answer? Technically speaking, the Eurobond, as a financing mechanism, is structural-reform-neutral. In other words, whether it leads to changes in underlying economic policy depends on the political attachments that would accompany the issuing of Eurobonds.

Crisis #5. Uncertainty about German policy. When the market is pricing Greek or Irish debt, it is not clear whether, and to what extent, that debt will be backed by Germany and the richer Eurozone members. Will Germany keep bailing out the indebted countries? Will it demand a haircut (private sector involvement) in exchange for more funds? That uncertainty means that bond yields reflect both the underlying fiscal position of the debtor country as well as a reading of European politics that is changing by the day. Volatility is driven by politics not fundamentals.

Eurobonds as an answer? A Eurobond would be the strongest evidence that Germany will assume Europe's bills. In fact, the volatility driven by political uncertainty would disappear. However, the timeliness of the decision would matter because the reaction of German public opinion would need to be favorable for the country's commitment to remain credible. That brings us to crisis #6.

Crisis #6. Diminishing appetite in Germany for further bailouts. The German people bought into the euro under one condition: that they would not need to bailout the periphery. Ten years later, they have come to do exactly that. European debts become increasingly German debts. To add insult to injury, Germans think of Greeks (and others) as lazy and unproductive. Their desire to send checks to their brethren in the south is even less.

Eurobonds as an answer? Eurobonds fundamentally abrogate the grand bargain that German policymakers made with the German public. By tying all debt together, they effectively make it impossible for Germany to *not* bailout other countries. Whether that is politically possible, in turn, depends on what reassurances the German public can get that it will not become a European ATM.

Crisis #7. Insufficient political levers to manage economic policy. Europe has had no credible levers to force profligate countries to cut their deficits. Right now, it has some muscle through the provision of bailouts – it can force Greece, for example, to make myriad internal changes under the threat that the money will stop coming in and Greece’s economy would plunge further. But it has no permanent institutional measures to control how countries manage their finances (through it is talking about setting up such measures).

Eurobonds as an answer? A Eurobond means that a central authority approves how debt to issue and when, effectively removing fiscal policy from the prerogative of national governments. The best way to think about this problem is to consider a spectrum of options for Europe, given that monetary policy is generated at the European level.

One extreme is that fiscal policy is fully national. This is the pre-2008 approach. Each government manages its finances and issues debt to pay for its deficits. In theory, Europe could censure governments that breached the 3% deficit over GDP limit but, in practice, it never did. The other extreme is that fiscal policy is fully supra-national. A central government (in Brussels) makes decisions and settles on the flow of funds from surplus to deficit regions. National governments have lobbying power but limited spending discretion.

The fully national model has two drawbacks. First, markets did not distinguish between the debt of the different countries. Countries, therefore, borrowed with impunity because the European body politic was unwilling to censure profligate members and the markets were assuming that all debt was the same. The system had neither political nor economic discipline. Drawback two is that the first drawback remains unsolved. Markets know that Greek debt is not the same as German debt. But they are not sure how different they are: will Germany step in and under what conditions? Is there some point at which Germany will refuse to keep disbursing funds? The inability to answer that question is what drives volatility - it is also what is making impossible for markets to function properly by delivering clear signals that will lead to a change in behavior (for example high interest rates leading to a curtailment in spending).

The supra-national model boasts economic simplicity, but it lacks legitimacy. Governments may accept that, in exceptional circumstances, their sovereignty can be curtailed by Brussels. But to accede to a system that delegates, ad infinitum, power away from itself may be too hard to swallow. There are, of course, intermediate steps similar to the American model - there could be a balance between federal and national spending, with (constitutional) limits on the ability of national governments to run deficits. The drawback is that it assumes political deepening that probably does not exist yet. If this crisis has demonstrated anything, it is that Europeans still feel only partly European and easily fall back into national stereotypes and prejudices.

In the tango that is political and economic integration, Eurobonds may be a few steps too far. Given that, the best option for Europe is to modify the pre-2008 system. There is obviously a stronger role for political pressure to limit deficits. But by being clearer on how each member's debts would be treated, and under what conditions a bailout (with a haircut) would be made available, Europe would allow markets to punish the profligate more adequately. Such a system, which has been Germany's chief position for the post 2013 architecture seems best geared to addressing the structural deficiencies of the past system without risking the overreach - and political backlash - that Eurobonds would entail.

Thursday, August 11, 2011

GDW @ 100: Five Reflections on the Greek Crisis

This is post #100 on www.greekdefaultwatch.com, and so a good occasion for some reflections on the Greek crisis.

#1. Debt was the price Greece paid for political normalcy. If one were to believe most outside observers, it seems that the Greek people woke up one day and started to spend money they did not have and started to avoid paying taxes that they owed. But where did that behavior come from? The world often treats Greece as a victim of the financial crisis, but it was only an indirect one. For years, Greece lived precariously, and the 2008 crisis merely edged us over.

Our current debt troubles come from the excessive profligacy of the 1980s and early 1990s, and that profligacy had political rather than economic roots. Debt came from state spending whose intent was to resolve the inherent tensions of the Greek political system after World War II. That system, while it delivered economic growth and prosperity, was deeply unjust, chiefly due to its continued marginalization and outright persecution of the Greek left. Spending brought into the mainstream those previously excluded. But with no effort to raise money to pay for that spending, Greece was left with an excessive debt burden. The political goal succeeded - but the economy suffered as a result.

Why does this matter? A right diagnosis makes a difference. When polls ask Greeks who is to blame for the country’s debt, their answers blend common sense (the “politicians”) with ideological and factual incoherence (speculators, the banks, the Europeans). Without an answer to the question “what went wrong” there is no hope to get right the question “what should be done?” Greece has yet to confront why it got into this mess. The fact that the crisis is rooted in the statism of the 1980s is often understood, but its implications are not: that Greece needs less state and fewer restrictions in the private sector.

#2. Judge Greece by reforms, not its debt. It is easy to pigeonhole Greece into a single metric: debt over GDP. Yet that singular focus is also a mistake. The reason is that debt is a symptom, not the disease, and it merely reflects the underlying political economy of the Greek state. That realization, while in some ways obvious, leads to some non-obvious conclusions. Chiefly, it raises the question of whether to judge Greek efforts by the extent to which they bring about debt sustainability versus the extent to which they create a more robust economy.

Selling off land, for example, might raise money that can pay down debt but it does not change the structural deficiencies of the Greek economy. By contrast, firing public sector employees worsens sustainability by depressing state spending and boosting unemployment benefit outlays, but it can aid the economy in the longer term. That tension - between two metrics for judging the Greek economy – is a main reason I have argued against default. Not because Greek debt is sustainable – it probably is not – but because a default without reform is not good.

#3. Empathize with frustration, ignore protests. A crisis is an incredibly unjust period, hurting those who can least afford to be hurt, and it brings forth solutions that are adopted for expediency rather than justice. In that climate, the protesting masses can easily garner sympathy - who can say that the pensioner who worked for decades and who lives on a subsistence income should face a cut in his pension? There is no justice in such act - just necessity.

Yet to think of Greek protests as the rebellion of the masses against an oppressive government or the IMF is an absurd misrepresentation of reality. Self-interest lies at the heart of that rebellion. It is a self interest that seeks to protect privileges that are indefensible and that seeks to transfer wealth from the population at large to the pockets of the privilege holders. For the most part, the protests of the last 18 months have been protests of privilege - and so the government has been right to ignore them.

#4. Greeks are slowly breaking taboos. Greek political discourse is surprisingly sclerotic. New ideas are hard to penetrate the demos: slogans trump critical thinking; party allegiance stems from favor-granting rather than ideological coherence; established practices gain credibility merely by repetition; stories, however distorted, become myths. The iconoclast is the rarest sight in public debate. Plain truths become heresies. Common sense loses to absurdity.

But in an economic crisis, the sanctity of the old crumbles under the weight of its own failure. Old ideas are discredited. The quest for practical solutions obscures ideological or historical purity. Under such pressure, the Greeks have either embraced or accepted realities they would have found unthinkable a few years ago: support for the market, ending tenure for public sector employees, reforming higher education, to name a few. In that sense, Greece has had a healthier debate than ever before – because the stakes are high and because no subject is off the table.

#5. Greece will emerge stronger from this crisis. This is more a wish than an argument, but I truly believe it. In part it is because my expectations have always been low: when you expect so little, even the smallest change will surprise and please you. So my optimism partly reflects my past pessimism. But it is also an optimism founded on the observation that the Greek state suffocates the economy directly and indirectly. It is an optimism that puts faith in markets, much as they out of vogue these days, and sees the reform effort as strengthening those markets. And it is an optimism that believes that once the shackles are removed, ingenuity (what Greeks call δαιμόνιο) will produce big and positive changes.

Far away, at the end of this journey called austerity, I can imagine a Greece that is fair, just and meritocratic. It is a Greece that is actually worth living in, rather than a Greece that one seeks to escape from by moving to London, Paris or New York. It is not the most likely scenario, I admit; but this is the first time in my lifetime that this has been a scenario at all. And the fact that this is at least remotely possible means that Greece is changing for the better.

Wednesday, August 10, 2011

Greece Meets Revised Budget Target in July 2011

In my last post, I noted how the Greek government was missing its budget deficit targets so far in 2011 and how its accumulation of unpaid bills and the reduction in public investment spending meant the target shortfalls were actually understated. Now the Ministry of Finance has released its new budget figures for July and with it the first numbers on the revised targets that take into account the passage of the Medium-Term Strategy. For the first time since January, the budget deficit is lower than targeted.

First off, the 2011 deficit goal is the same: €19.8 bn. But the path to that target has changed. The government has lowered its revenue goal by €1.5 billion and, to maintain the same overall target, plans to slash spending by €563 million and public investment by €953 million. In other words, the is acknowledging the weakness in revenue collection and will compensate for that by cutting spending further – it also seems to be accepting the de facto lowering of the investment budget that I mentioned in my last post.

Second and most important, the revised budget deficit schedule is extremely frontloaded. Of the final target of €19.8 bn, the goal by end July is €16.4 bn – or 83% of the expected end result. The plan shows a modest increase in the deficit in August, and after that the budget deficit should remain flat. This shows the magnitude of the Medium-Term Strategy’s correction: it is basically aimed to allow for a mere 20% increase in the cumulative annual deficit between July and December 2011.

With these revised figures, the actual deficit of €15.5 bn compares favorably with the target of €16.4 bn for July 2011. In fact, it is the first time since January 2011 that the actual deficit is lower than the target. However, that success is chiefly an accounting artifact. And as long as the government continues to accumulate arrears, it will still offer a slightly distorted picture on the extent of the consolidation achieved. And by frontloading the deficit so much, the government’s margin of error has shrank.

Is Greece Fudging its Deficit Numbers?

Greek statistics have come a long way, and I do not mean to suggest that Greece’s numbers are wrong. Rather I want to focus on a specific question: to what extend are the budget deficit numbers reported by the Ministry of Finance a reliable indicator of how much Greek finances are improving?

In June 2011, Greece’s central government deficit stood at €12.8 bn or 23% higher than the target deficit of €10.4 bn. According to the Greek government, the measures implemented in the medium term strategy should close that gap by year end. Yet these numbers severely under-estimate how off the target the budget truly is: while the deficit is 23% higher, Greece (a) has made severe cuts to public investment and (b) has continued to accumulate significant arrears (overdue bills). With these two pieces the deficit may be more than 50% off target.

First, look at the Budget Execution Monitor published by the Ministry of Finance, which shows that starting in May 2011, budget deficits have become progressively off target: in fact, by June 2011, there is a €2.3 billion gap between the target deficit and the actual deficit. So far so good.

Second, zoom in on the drivers of that gap: compared to the target, revenues are lower by €3.3 bn (13%), while spending is €1.3 bn higher (4%). However, note that the Public Investment Budget is off by €2.2 bn – meaning that the government should have invested €2.2 bn more than it did. The lack of spending counts as a positive for the deficit, but effectively the deficit would have been €14.9 bn had the Greek government not simply choked off funding from public investment to keep its finances in check.

Finally, look at government arrears, which are accumulated bills that the government has not paid. The Ministry of Finance reported those at €5.3 billion in December 2010; by June 2011, they had risen to €6.6 bn, a €1.3 billion rise. Technically many of these expenses are part of the general government budget, rather than the central government budget reported above. Adding them together is only half-right because it ignores all the other parts that turn a central government to a general government budget. Even so, Greece's targets with the IMF and the Europeans are general government targets – so by accumulating these arrears, the government is merely pushing further out expenses for the general government.
If we now add everything together, Greece was targeting a €10.4 bn budget deficit by June 2011. It ended up with €12.8 bn instead. But to accomplish this, it added €1.3 bn to its unpaid bills and it reduced funding for public investment by €2.2 bn. If the Greek government was paying its bills on time (ignoring the accumulated arrears by end 2010) and if public investment were on track, Greece’s budget deficit would be €16.2 bn and hence off by 56% rather than 23%. And that is a completely different picture about how well Greece is doing.

Tuesday, August 09, 2011

The Greek Economy: A 50-year Overview

In the effort to provide a historical context for the current crisis, I thought it would be useful to look at some of the broad economic trends in Greece over the past few decades. My goal is not to highlight something that I have written about before – that the 1980s were an economic black hole – but rather to remind Greeks that it wasn’t too long ago that we had a vibrant economy capable of producing meaningful and sustained economic growth.


Economic growth. In the 1960s and 1970s, growth averaged 8.5% and 5.5%, respectively. Even accounting for population growth, the average Greek person had a real income that was three times larger in 1979 than it was in 1960. Then economic growth stagnated, and real incomes per person were flat in the 1980s. Growth resumed in the 1990s, but at merely 1.1% per capita, it was anemic. It wasn’t until the 2000s that growth returned to high levels – albeit, driven in part by excessive government spending. Real compensation per employee tells an even more dramatic picture: labor saw no real increase in compensation from 1980 to 2000.

Industrial output and productivity. Industrial production growth went from near double-digit increases in the 1960s to a minor slowdown in the 1970s (to 8%) and then started an irreversible decline. Unlike per capita growth, however, there was no real recovery during the 2000s: in fact, industrial production peaked in 2000, underscoring the economy’s overdependence on services. Total factor productivity also went from rapid growth in the 1960s (6%) to high growth in the 1970s (2.5%) to decline in the 1980s and a modest recovery in the 1990s. Effectively by 2000, the economy’s productivity was on par with 1979. Only in the 2000s did Greece started to experience some productivity gains.

Inflation. Inflation was modest in the 1960s but it exploded after the first oil shock (1973-74) and after a modest fall in 1975-1978, it entered a sustained period of high levels. It was not until 1995 that Greece was able to reach single-digit inflation rates. After entering the Eurozone, inflation was at 3.16%, which was still high relative to its peers, slowly eroding the country’s relative competitiveness.

Unemployment. Unemployment followed a slightly different trajectory. Throughout the 1960s, unemployment averaged around 5%, and it then began a significant decline, reaching 2% in 1973. Low unemployment persisted until 1979, after which time it started to rise. The decade-averages, however, conceal some sub-trends. Unemployment rose between 1979 and 1983, but it then steadied; it was only after 1990 that it started to rise until peaking in 1999. After that, there was a 50% reduction (from 12% to 8%) to 2008.

Standard of living. This graphs tells the story of Greece better than any other: it shows Greece’s per capita income on a purchasing power parity basis relative to the EU-15. In 1978, as Greece was negotiating its entry into the European Economic Community, its per capita GDP was just 5% below the European average. Then came a twenty year slide – by 2000, the income gap was 30%. All that Greece accomplished by faster growth in the 1990s was to slow the widening gap. It was not until the 2000s that Greece started to converge, but even that trend was short-lived – by 2004, all the gains has been achieved.

These numbers show that the 1980s and early 1990s produced not just the debt overhang that still plagues Greek finances, but they also strangled what was, until then, a vibrant economy. They did that by introducing an excessive statism, both directly through state spending and indirectly through interference in private industry. Industrial production and productivity both stagnated, leading to a progressive deterioration in living standards. In that sense, the dismantling of statism could potentially energize a dormant private sector in Greece – it was not too long ago that Greece had a strong economy and there is no reason that a new structure cannot produce one again.

Thursday, August 04, 2011

Could the Taxi Strike Be Good for Greece in the Long Run?

Over the past few weeks, Greece has been rocked by a nation-wide taxi strike that has been, at times, comic, tragic, violent, and deeply embarrassing. Yet the battle may turn out to be a good thing. Of course, I do not mean the immense inconvenience that it has caused to thousands of people nor do I have in mind the occasional violence to which taxi drivers have succumbed. Instead, I mean that the country’s political mood needed such an event. Weeks earlier, the government had almost collapsed amidst a highly contentious vote on the “medium term strategy.” By witnessing such a crass and indefensible strike, Greek society may be reminded what this crisis is all about.

In an economic crisis, justice and fairness can be brushed aside for the sake of necessity. Governments do things that are expedient but not necessarily just – they focus on what can be done versus on what should be done. Cutting pensions and raising taxes have been “easy” and they have allowed the Greek government to close a fiscal hole quickly. But these policies are hardly “fair.” They are justified on the basis that they need to happen.

Over time, however, expediency and fairness clash. The people that have borne the burden of the “adjustment” will demand that the pain be more evenly split: others have to pay as well. That anger has manifested itself through demonstrations, and in extremis, violence. It can also be seen in the rising popularity of the (arguably) most populist party (far-right LAOS) as well as by the growing number of people who say they would vote for no one if elections were held today. To sustain political support, the government needs to be seen as fair – going after tax evaders, for example, is important not only because it brings revenue but because it is evidence that everyone is partaking in the pain.

So why might the taxi strike be good for Greece? Because it demonstrates quite vividly what this political and economic crisis is all about: a fight between privilege and non-privilege in the public and private sectors. When the VP of the taxi union in Salonika says that, “you cannot have every unemployed and bitter person get a taxi license,” he’s saying that I have a privilege, and that you, the unemployed, should look elsewhere for work. When 100+ professions say that, of course, where can one really find work anymore?

How the Greek crisis plays out will depend on the answer that Greeks give to this question: how did we end up in this position? Events such as the taxi strike make it more likely that the answer is no longer “because our politicians are corrupt” (which they are) but rather a broader admission that it is “because the state spends too much money and the private sector has too many restrictions.” The restrictions in taxis are just one of many that have to go. By reacting so badly, the taxi drivers have showed how unreasonable those restrictions can be and how they serve no purpose except to enrich the privileged insiders. By demonstrating this to the Greek public, the taxi drivers may end up doing the country a great deal of good.

Monday, August 01, 2011

Banks Remain Greece’s Weak Spot

In the latest stress test conducted by the European Banking Authority, all Greek banks passed the critical threshold of 5% in Core Tier 1 capital versus risk-weighted assets – provided one includes “additional mitigating measures taken or planned” and “generic provisions already accumulated to cover future losses.” But the challenges facing the Greek banking industry have not gone away (see here); in fact, weakness in the banking sector was one of the main reasons that Greece needed to secure additional official financing earlier than 2012 (here).

ECB Funding. After Greece received a bailout in May 2010, Greek banks have stopped relying more on the European Central Bank. December 2010 formed a peak when ECB funding reached €97 bn; it then fell by ~12% to €87 bn. Yet May 2011 shows a reversal with the gains made over the past four months disappearing. Even so, these estimates refer to the liabilities of the banking sector to the Bank of Greece, which is a proxy for ECB funding. As the IMF notes, “Recent ratings downgrades have also led to a decrease of value on Greek collateral by the ECB, necessitating banks to post additional collateral.” So it could be that the addition refers to a change in requirements rather than a change in underlying needs.

Deposit Withdrawals. Deposits peaked in December 2009 and have since seen a steady decline. This is one of the most persistent trends in the Greek banking sector over the past 18 months, despite an apparent hiatus during Q4 2010. Relative to its December 2009 maximum, deposits have shrunk by 19% or €46 bn. Almost 60% of the decline has come from households.

Non-Performing Loans (NPLs). The Bank of Greece has not published detailed NPLs numbers for 2011 yet; but the IMF notes that Q1 NPLs were 11.5% of the total. This marks a continued deterioration in the loan portfolio – even relative to the end of 2010 when the number was 10.4%. So far, there no detailed breakdown on where the NPLs are coming from, but data to end 2010 showed that the deterioration came from all loans: consumer, housing and business.

Inability to grow credit. Credit was expanding rapidly until 2008; then private sector credit grew modestly in 2009, and then not at all in 2010. In early 2011, credit growth has actually turned negative: financing to the private sector has declined by an average 0.5% every month in 2011. The decline is driven by the household sector (housing and consumer loans), while credit to companies keeps growing modestly.

Weaker returns. Since 2009, Greek banks have, on average, posted negative returns on assets and negative returns on equity (after taxes). Meanwhile, equities continue their free-fall, having lost more than 80% of their value relative to 2007.

None of this includes exposure to Greek sovereign debt with credit institutions holding around €60 bn of Greece’s €355 bn debt. A series of privatizations, mergers and capital infusions will be needed to revitalize Greece’s banking sector. As I noted in the past, extra financing for the Financial Stability Fund (SFS) was a key driver for Greece’s higher than expected financing needs; not only does the latest program assume money spent on bank assistance, but it also assumes that “government recovering the resulting equity investment by 2014–15.” Failure to restore health in the banking sector will further deteriorate Greece’s chances to a sustainable debt path.