Wednesday, July 18, 2012

Assessing the New Greek Government: A Month Later

It has been a month since the June 17 election and the subsequent formation of a New Democracy-led coalition government. Where do things stand in Greece?

First, the sense of relief that came on the night of June 17 – as the country recognized that left-wing SYRIZA would end up in second rather than first place – has proven somewhat durable. The country is far from normalcy, of course, and there is a lot to be done. But the near panic that permeated the Greek public at the fear of what a SYRIZA government might do to the country has subsided. In and of itself, this is a good thing.

Second, there has been a marked change in tone. For much of the campaign season, the emphasis had shifted from what Greece can do for itself to what Europe can do for it; as I put it before, “Greece’s new motto is: ask not what you can do for your country; ask what Europe can do for you.” This has now changed. Instead, we now hear about how much Greece has not done, how few of the provisions of the memorandum it has implemented. This is, again, a very good development.

Third, we appreciate a lot better just how much the elections put on hold. There is an intense discussion about the measures that the new government has to take; but these numbers, (€11.9 billion in cuts through 2016) were part of the new bailout agreement and were known since, at least, March 2012. Yet we are just now getting to talk about them. Sad as it is, this fact underscores how much of a wasted opportunity the election season truly was. In three months and two elections we managed to avoid talking about the most important fiscal challenge that the country faced. Pity.

Fourth, the new government is picking the right battles. Instead of focusing on what to renegotiate, it understands that it first needs to restore some credibility. Credibility means a commitment to reforms and it means convincing its partners in Europe and the IMF that it is serious about change. Privatizations and the reform of the public sector are indeed urgent priorities and the government is right to put them front and center in its new agenda.

Fifth, we will know very soon what this government is made of. Gearing up for a fight with the power company’s union will tell us a great deal about the government’s stomach and appetite for change. So far, the government has indeed shown a willingness to fight; but it has also said publically that it will not fire people from the public sector, a non-serious starting point for reforming the state. Therefore, the signals so far are mixed. But they will be unmixed shortly. And that is good news since we will then know whether this government is for real or not

Sunday, July 15, 2012

One European Crisis, Different National Fates

We often use the term “European Crisis,” but not every country in Europe is experiencing the crisis in the same way. In fact, there are several countries that are doing quite well. On a sub-national level, Eurostat reported that unemployment in 2011 ranged from 2.5% in Salzburg and Tirol in Austria to 30.4% in Andalucía in Spain. These three regions are occupying the same economic space only in a very abstract way.

Inspired by that report, I looked at a few more metrics (see table). Of the 502 million people who live in the European Union:
  • 55% live in countries where real GDP was higher in 2011 than in 2007.
  • 95% live in countries where real GDP grew in 2011.
  • 64% live in countries where real GDP is expected to grow in 2012.
  • 71% live in countries whose cost of borrowing has declined relative to pre-crisis August 2008.
  • 46% live in countries where unemployment went down in 2011.

What do these numbers tell us?

First, they are a useful reminder that this is not a “European” crisis at least not in any meaningful sense since a lot of people live in countries that are doing well economically. Given the debate about whether this crisis is due to country-specific problems (corruption, red tape, state intervention, etc.) versus systemic flaws (common currency, European leadership, capitalism, etc.), such variance in outcomes means it is hard to put all the blame on systemic flaws alone.

Second, mobility of capital and of people is insufficient to level outcomes (of course mobility can only okay a role). Eurostat reported that, “In 2011, there were 48.9 million foreign-born people living in the EU27 Member States, with 16.5 million born in another Member State than the one in which they live (3.3% of the EU population) and 32.4 million born in a country outside the EU27 (6.4% of the EU population). In total, foreign-born people accounted for 9.7% of the total population of the EU27.” By contrast, in the United States, the foreign born population was 12.9% in 2010, and the share of people who lived in a state other than the one they were born was 27%. In other words, the “natives” made up 90.3% of each European country while they made up only 58.8% of each US state.

And third, the political economy of the EU remains precarious. For one, such a variance in experiences mocks the idea that this is in fact a “common union.” But more generally, it risks creating a greater backlash in the periphery. People often tell me that Germany does not want to solve this crisis because its economy benefits from it. I do not share that view, but I also recognize that as long as the European economy continues to operate in many tiers, such grumblings will only get louder. And over time, they can only cause harm to the union.

Thursday, July 12, 2012

Should Greece Restructure and Privatize its Power Company?

The New Democracy-led coalition is gearing up for its first big fight against the labor union of the Public Power Corporation (PPC, or ΔΕΗ in Greek). This is good news because we will know soon whether the government has what it takes to implement reforms. Lose this battle, and it will lose the war. Yet amid the bullying and the threats, there is also a quasi-argument brewing: an argument that Greece’s low tariffs for electricity are proof enough that the system is not broken. Is that true?

PPC is right in a very narrow sense. In 2011, Greece’s residential tariffs were the fourth lowest in the European Union and 23% below the EU-27 average (excluding taxes). But that is not the whole story. The state regulates prices, so it’s not hard to mandate that prices remain low. Therefore, the price level itself is not a very useful guide. How should we, instead, think about prices?

First, retail tariffs have not increased according to fuel costs, as they should in a market system. As the International Energy Agency (IEA) notes in its 2011 Country Report on Greece: “The tariff system has caused several distortions in the electricity market. The average wholesale price of electricity tripled from 2004 to 2008, but the regulated end‐user tariffs were increased by only 40% for industrial users and by 25% for households.”

Second, industrial consumers are subsidizing residential consumers. In the EU, tariffs for industry are on average 29% below those for residential consumers, which makes sense it is cheaper to supply bigger consumers in bulk than to supply smaller customers one by one. Yet in Greece, industrial tariffs are almost the same (-2%) as tariffs for the residential sector. Only four EU countries have a bigger discrepancy between residential and industrial prices and none are part of the EU-15. Therefore one reason that the Greek consumer pays so little is that the bill is picked by Greek industry.

Third, the regulated tariff does not cover the cost of electricity production. In a November 2007 strategy presentation, PPC claimed that the gap between the company’s revenues and the real market price for electricity was 25%. So this is another reason to not cheer about low prices: if they cannot cover the cost of production, they are unsustainable.

Fourth, PPC is expensive to run. Take payroll: the company’s staff has fallen from 31,645 in 2000 to 20,821 in 2011, a 34% drop. Yet, its payroll has risen by 23% in the same period – in fact, its payroll had risen by 66% by 2009 before it came down. These numbers mean that real compensation for PPC employees rose by 75% between 2000 and 2009 and by 29% in 2000-2011. By contrast, compensation in the Greek economy as a whole was up 15% and 4% respectively in the same period. PPC employees are doing very well, so why not take that extra cost in salary and give it back to the Greek consumer?

Fifth, the company overall is underperforming. Amazingly, the best benchmarking data to prove this point come from PPC itself. In 2007, return on equity was 1.1% versus 17.1% for the four largest European utilities. Return on capital employed was 2.1% versus 10.1% for six big European utilities. In a number of other metrics – return on sales and capital turnover – the company was lagging its peers. This is no wonder if power prices barely cover costs and staff costs have gone up when the number of employees has declined.

Sixth, it is not clear that the company’s trajectory is sustainable. At times, PPC is cash positive. But in part this is because it is depleting its coal mines – look at the finances of the coal mines by themselves, and they barely make money, which means that PPC is benefiting from investments in coal made a long time ago. But coal production peaked in 2002 and has declined by 21% since then. What is more, as the IEA noted, “In March 2008 … the EU Commission found that PPC’s right to privileged access to lignite violates EU competition rules.” Access to cheap coal is not a sustained competitive advantage.

Seventh and linked to the sixth, is the significant carbon intensity of the Greek economy which is due, in large part, to the heavy dependence on coal for power generation. Greece’s carbon intensity per unit of energy is 25% higher than the EU average. Besides the obvious implication for climate change, this also exposes Greece in general, and coal-fired generation in particular, to significant cash costs to buy emissions permits to keep polluting. As the IEA notes, “lignite‐fired power plants in Greece emitted an average of 1 tonne of CO2 per MWh generated in 2009, whereas the gas‐fired plants emitted 350 kg of CO2 per MWh.” This is again a looming cost for the Greek consumer.

Eighth, PPC does not provide great service. The Council of European Energy Regulators (CEER) conducts a Benchmarking Report on the Quality of Electricity Supply. Its top measure of quality is “unplanned interruptions excluding exceptional events.” Greece had 134 minutes in 2009 (latest data available), putting it 6th from the bottom in a list of 19 countries. Only Portugal, among the EU-15, had a worse number. Relative to the best service (Germany), Greece had ten times more minutes interrupted. That’s not very good.

Ninth, PPC’s dominant position distorts the market for wholesale power and prevents any meaningful competition from emerging. So without a reform of PPC, the power market cannot be reformed in any meaningful and the new investment that the country needs to meet its power needs will always lag what would have been possible if PPC did not have a dominant role.


One of my earliest memories when I went to college in the United States was furiously unplugging my laptop when I heard thunderstorms outside. My roommate looked at me and was puzzled: “what are you doing?” I said I am protecting my computer because we will lose power.” He gave me a perplexed look. It turns out that this is not quite what happens in America.

Deregulating the power sector is a serious debate and one that requires a focus on getting regulation right and on ensuring that we do not replace a public monopoly with a private one. But PPC is intimately connected with lights going out during inclement weather and with the A/C doing down in the midst of the summer heat wave. Sometimes, this happens because the power company cannot do its job. But sometimes it happens because its bullies in the labor union want to send a message to the rest of us. They get paid too much money to be sending those messages and to be bullying anyone. It’s time to end this farce.

Tuesday, July 10, 2012

Should Privatizations Be a Priority for Greece?

Privatizations are once again are at the center of the public debate in Greece. Should privatizations be a priority for Greece? 
Let me start with three observations. First, there is no doubt that the state has legitimate interests which markets will not fulfill on their own. For example, flying regularly to a remote island may not be a profitable proposition and one that the market will not provide at sufficient quantities. Yet a state has an interest in ensuring that all its citizens are connected. This is just one example. Markets will no doubt fail to provide certain goods and services that a state should want provided.

Second, private companies tend to be better managed, but not all state owned enterprises (SOEs) are inefficient – some (but not many) are indeed world class. Nor are private companies perfect – many lose money and engage in harmful or outright criminal behavior. Left unsupervised, private companies can undermine the public interest. We should neither dismiss public companies nor idolize private ones: believing in private or public enterprise should be an empirical, not an ideological position.

Third, the agent-principal problem applies to both public and private companies. Companies are meant to serve their shareholders, but they often serve their managers and employees instead. This happens due to information asymmetries, perverse incentives, and a pure inability to control a company’s day to day operations. Therefore, not every decision will be in the interests of the company’s shareholders, whether these are private investors or the state.

What then distinguishes private from public ownership? The most important difference is the possibility of failure. If a company cannot compete, it will go bankrupt. In private enterprise, this is a constructive force and allows resources to move from unproductive to productive uses. But SOEs rarely go bust. For one, states often own companies because they do not think that profit is their chief function – instead, they are presumed to serve some public interest. Rather than shut down unprofitable SOEs, states recapitalize them and socialize their losses. Even if states want to shut them down, they may not be able to due to social pressures. If a car factory cannot make money, people may protest its closure but there is nothing they can do about it. But they can petition a government – and vote-hungry governments often listen to those petitions. 
Why is this problematic? Three reasons. First, the absence of failure distorts incentives. Without failure an SOE has little incentive to invest, to offer superior services or to keep costs down. Survival depends on political connections. Therefore, the company no longer serves its customers (their view does not matter) or the state in a broader sense. Instead, SOEs need to cater to political interests to keep the money flowing. At a minimum this structure creates bad products and services.

The second problem is that such behavior distorts the markets in which the public company operates. SOEs tend to dislike competition since it underlines their own inferiority. Who wants to work for the company that has crappy 30-year old planes when your competitors have shiny new planes? Competition separates the good from the bad. Thus, state companies tend to lobby the governments for restrictions and regulations in their industry and they can even directly undercut competition by offering very low prices (as losing money is not a problem).

Of course, these efforts are couched in the name of consumers’ or the public interest – they are presented as a concern for prices or reliability in “strategic” sectors. Almost always, these arguments are a sham: instead, state companies want to protect their own privileges and will do anything to do so, including undermine other companies that can deliver the same service more cheaply and reliably. Consumers not only get bad services but they are also likely to be prevented from a chance to get the same service from private providers.

The third problem is that the inability to shut down companies has costs. When the state puts money into SOEs, it does so by either taxing people or borrowing money on their behalf. There is no free lunch: people pay for these companies either directly (by buying their products) or indirectly (by financing the state). A train ticket may cost €15 but if the state-owned railroad company runs a deficit financed by the state, the real price is above €15 – and in fact, people who do not use this service subsidize the people who do.

In that process, however, the state loses sight of costs and benefits. Greek state owned enterprises lost €2 billion in 2011 (before financing from the state). Is what Greece got in return worth €2 billion? Is it worth €2.6 billion (what they lost in 2010)? These questions become very hard to answer. It is easy for me to ask, do I want to pay €150 to fly from Athens to Thessaloniki? But when there are hidden costs, it’s much harder to compare costs and benefits directly. Cost-benefit analysis becomes too opaque.

These critiques prompt a question: can the state safeguard its interests without owning a company? Take the example of the unprofitable flight route mentioned above – clearly there is a state interest and clearly the market will under-provide this service. But the state has many ways to deal with this. It can, on one extreme, own a company so that it can directly provide this service. Or it can merely pay a private provider an amount that will make that provider want to supply this service. In a perfect world, the burden of the two options would be the same. But this is not a perfect world and so the difference ends up being much higher under direct ownership. Or the state can impose regulations on the private sector – make the right to fly contingent on servicing these unprofitable routes. There is a wide spectrum of options and owning a company is an extreme and costly way of getting something done.

So far, this is generic analysis, although given a natural suspicion towards markets, it is never a bad idea to restate the basic principles. Let us now turn to Greece. Most SOEs in Greece lose money – that, in itself, is a case for privatizing them. But financial results should not be the sole factor. Assume that Athens had an amazing metro but the company lost €1 a year; should the company be privatized? Maybe not. Maybe €1 a year is a tolerable subsidy for a perfect metro, even though the private sector could probably better service. At the same time, we ought to ask ourselves, is this result sustainable? Can the company open new stations and invest in new trains if it does not make money? If not, then maybe it should be privatized.

Conversely, let’s assume that a company generated profits – is that an argument against privatization? For one, if it has a monopoly, profits are easy. The company may also be “milking” old assets – it can earn a profit but it does not have enough money to invest. Imagine this: let’s say I own a newspaper and one day all the journalists quit and I replace them with third-rate journalists. For a while, this can remain a profitable company: it will be a while before advertisers pull out and subscribers stop buying the paper. Short-term profits may even go up because costs went down (by hiring cheaper staff). But current profitability masks an inevitable decline.

In Greece, the case for privatizations rests on four pillars. The first and most obvious is financial. Greece cannot afford to subsidize companies. These companies will no longer have funds to carry out their essential duties. In June 2012, for example, the power company secured a set of loans for €525 million with interest rates ranging from 7+ to 11.9%. In this environment, the company’s ability to keep going is severely impaired.

Second, SOEs tend to be inefficient and provide services at a higher cost than private companies could. Even if the state could afford to subsidize SOEs, it shouldn’t. The most glaring evidence comes from data published by the Ministry of Finance showing that salaries at SOEs were twice as high as the average salary in the private sector in 2008. This is hard to justify on productivity or other bases. The taxpayer is paying a lot of money extra for services that tend to be substandard.

Third, privatizations are an essential component of broader market opening and deregulation. The power market is a perfect example again: as long as the power company retains its current form, competitive markets will be nearly impossible to form. It is hard to achieve more competition and lower prices without also changing the ownership of what is usually the biggest or the only company in an industry. What is true for power is true for other sectors.

Fourth, Greece needs to signal its commitment to change. Privatizations tend to be politically tough, especially in countries such as Greece, where skepticism of markets and where the power of labor unions are both high. No wonder many analysts see the looming clash between the government and the power company as the first real test: will the government really stick to reforms? If privatizations are delayed, people will become increasingly doubtful that Greece can actually change.

Experience teaches us three things about how to privatize. First, the process of selling assets should be fair and transparent. Second, privatization needs to be accompanied with a broader market opening – there is no sense in turning a public into a private monopoly. And third, privatizations require regulation: functions that were previously either not needed or performed by SOEs will be now performed by the state. To do this the state needs to upgrade its capacity to regulate these new industries and to ensure that market competition is indeed serving the public interest.

The most serious and perhaps only objection to the case for privatizations is timing. Greece is unlikely to get a great value for its assets; why sell now rather than wait? This is a legitimate concern, even though realistically Greece cannot afford to wait. But there is different way to ask this question: can Greece achieve its economic and political goals without privatizations? Can it reinforce a sense of justice that it is willing to stand up to labor unions; can it put its public debt on a sustainable path; can it open up industries to attract investment; can it communicate domestically and internally a serious willingness to liberalize the economy; can it do these things without privatizations? I think not. And that is the reason privatizations are so essential.

Thursday, July 05, 2012

Repairing Greece's Brand

I’ve been thinking a lot about Greece’s brand lately. In part because I just came back from a trip to Singapore, a country’s which started with so little and yet has developed an impeccable brand around efficiency, cleanliness and connectivity. In part because the British prime minister, David Cameron, hinted that the United Kingdom ought to be ready to shut the door to Greek immigrants, a sure sign that the “Greek” is increasingly seen as a problem in Europe. And in part because it was the Fourth of July yesterday and I inevitably came across continued references to that quintessential brand that is imprinted into the American psyche: “life, liberty and the pursuit of happiness.”

There is no doubt that Greece’s brand has taken a plunge – Peter Economides’ speech is as good as any about the deterioration of Greece’s standing. But what exactly is Greece’s brand, why has it collapsed, and what can we do about it?

At its core, the Greek brand is “history” and “the sea.” Of course, that brand has changed recently, but we’ll get to that shortly. The brand “history” means that since the War of Independence (1821), Greece has counted on Philhellenes for monetary, material and moral support. The allure of ancient Greece, in particular, has created bonds of kinship with peoples and countries around the world, and those bonds have led to economic, political and diplomatic ties. Greek philosophy and literature means that Greece’s name recognition is far above the country’s demographic, territorial or economic weight. This is also a brand that has a strong internal constituency within Greece – not only are the Greek people proud of their history, but Greeks overseas move with a certain confidence that, to borrow Isaac Newton’s phrase, they stand on the shoulders of giants. Even better, this is a self-replenished brand. As long as schools and universities find the “Greeks” to be relevant and include them in their curricula, this brand will keep growing.

The brand “sea” has also served Greece well. It has been the cornerstone of the country’s tourism industry, which is the most important engine of economic development bar none. Combined with the brand history, it has made Greece into a “must-see” destination, a status from which the country has benefited handsomely (though not as much as it could and should). The brand “Greece-History-Sea” has done wonders for the country, but it has also exposed its limits in the current crisis. The reason is that this brand has nothing to do with what Greece is today – it says what Greece used to be and it says also what land Greece inhabits, but it has little to say about the Greek people and who they are.

To understand what I mean, consider America, whose brand can be summed up into “life, liberty and the pursuit of happiness” or the “American dream.” With this brand, America can recover from such events as the Vietnam or the Iraq War. In effect, the bad brand is constantly battling the good brand – America the powerful and the warring versus with America as the land of opportunity. It is this essential clash and ambivalence that allows people to retain an image of America as the land of opportunity while also knowing of wars and inequality and other social and political deficiencies.

If we come back to the case of Greece, the negative stereotypes that have emerged in recent years have no pre-existing brand with which to clash. Therefore, “lazy,” “corrupt” and “entitled” Greece – to pick three stereotypes out there – are perfectly consistent with “Greece-History-Sea.” People can have lots of history and still be lazy. The audience is not required to engage in any mental gymnastics or contradictions: the new, expanded brand is internally consistent.

Why has the Greek brand deteriorated so badly? First and foremost, brands always have semblance to reality. They are not perfect representations of reality, of course – that’s why we call them “brands” rather than “reality.” But they do represent a version of reality, and the truth is that there is a lot that is wrong with Greece. As a result, there is a torrent of news that highlights this or that problem about the country, serving to reinforce Greece’s negative image. Besides creating a negative image, this barrage of news also crowds out any positive stories about the country. Even success stories have an air of disbelief: “how odd that this person is successful in a country that is so inhospitable to success.”

Dealing with this problem requires a three-layered effort. First, the underlying fundamentals have to get better – no branding effort can save us if the country doesn’t correct its chronic ailments. Koh Buck Song in his book “Brand Singapore” notes that, “Singapore has an excellent track record of staying within the boundaries of credibility – never claiming to be too much more than what you really are.” The Greek image reparation has to start with the underlying “truth” and a managed set of expectations for change. The country won’t change overnight but it does not have to.

Second, the branding strategy has to look for positive news around specific critiques. For example, the country tried to make some efforts by publicizing the pace of new company creation under easier company registration rules. And the effort to bring corrupt politicians and tax evaders to justice can be seen under the same branding effort. But this is damage control and little more.

Therein lies the third and more fundamental challenge: that Greece cannot have a strong brand until it knows what the brand has to be. This is not a question of tourism or which slogan will get more foreigners to visit Greece. This is a more fundamental problem of identity and purpose. I am reminded here of the words of Constantine Karamanlis (the elder) who lamented when foreign leaders praised Ancient Greece but had no good words for modern Greece. They reminded him, he said, of the story of Caesar, who returning from Egypt told the Greeks “Till when will you let the glory of your ancestors cover for your failings?” This is an apt way to think about the Greek brand: till when will Greece let the ancients and the natural beauty form the entirety of its brand? Greece needs a brand “beyond history and beyond the sea.”

What might that brand be? If I think about Greece at its purest, most attractive and most seductive, it is a country that can offer an unparalleled work-life balance. Life in Greece can be very good: the problem in the “work-life balance” is the ”work.” Go to any Greek outside of Greece and ask them: if I could offer you the same job and job environment that have you have today in Greece, would you move? My sense is that an overwhelming majority would say yes. The reason is that if you can have a good job, Greece can offer an unbeatable work-life balance – its lifestyle is simply too attractive to match almost anywhere in the world. So if I had to rehabilitate the Greek brand, I would try to do so around the notion of “a place where you can work hard and enjoy the fruits of your labor with a great life.” Or, more simply: “Greece: Work. Life. Balance."