Friday, September 28, 2012

The Endless Tax Squeeze in Greece

My last post discussed how Greece’s “austerity” was not really austerity because first, much of the cut in spending came from lower investment and lower spending on weapons; second, that the cut in spending between 2009 and 2011 has been smaller than the increase in spending from 2006 to 2008; and third, that the state still spends more as a share of GDP than it did in 2000-2005. But since spending is not falling quickly enough, the state has to increase revenues to plug the hole in its budget deficit. This post reviews the main changes that have occurred on the revenue side of budget in recent years.
The first thing that is obvious from the graph is that revenues are not the main problem. I am not denying, of course, that tax evasion is pervasive in Greece; nor do I doubt that the state could collect a lot more in taxes if it functioned better. Rather, I mean that the changes in revenue cannot explain what has occurred recently to the Greek economy.

Government revenues as a share of GDP fell from a high of 43.5% in 2000 to 38.1% in 2004. In part, this drop was the result of the entry into the eurozone. Revenues in 2000 were at a historical high – at no other point in Greek history has the state collected as much money as it did in 2000. Once the country joined the eurozone, its focus and discipline on tax collection weakened. Soon thereafter tax reforms pushed revenues were back to their 1997 level, following an inverted U-path. In other words, it was the 2000 figure that was abnormal, not the drop to 2004. Effectively, the increase in revenues before 2000 was akin to a pre-wedding diet – it worked but it unraveled the day after. That is what happened to revenues in Greece.

From 2004 to 2007, revenues increased somewhat, peaking at 40.8% of GDP in 2007, before falling in 2008 due to the modest contraction in the economy. They then fell by a greater amount in 2009 due to a 3.3% recession and, at 38.2% of GDP, they were almost at the same level as their 2004 low point. But by 2009, the growth in spending had already put the budget completely out of balance – it was spending that was out of control, not revenues, which were at historical averages.

At that point, the state started to practice “austerity,” mostly by cutting spending (as economic practice recommends). But the state also tried to raise more revenue to close the huge fiscal hole with which it ended 2009. It did so mostly by increasing indirect taxes, thus offsetting the decline in revenues that are linked to work, income and profits. This tax hike pushed up prices and squeezed households. Something that cost €100 in 2008 would have cost €109 in 2011 – but in constant taxes, it would have cost €104, meaning that more than half of the increase in prices came from higher taxes.

Besides value added taxes, the government also benefited from an influx of EU funding which rose from a low of €1.8 billion in 2009 to €3.6 billion in 2011. This inflow was, by far, the greatest addition to the Greek budget on the revenue side during this crisis. In fact, 11% of the fiscal adjustment (drop in deficit) between 2009 and 2011 came from higher EU finding for the public investment budget.

What does all this tell us? Greek revenues were a problem from 2000 to 2004 when the gains in tax revenues of the 1990s abated. Soon enough the state was collecting as much in revenue as it was in the late 1990s. Yet through 2006, the weakness in revenue was coupled with a relatively flat primary expenditure profile. It was at that point that spending started to increase and revenues followed suit only modestly in 2007. During the crisis, the government has been able to bring revenues back to their 2001 levels, in part due to higher EU funding and in part due to extraordinary taxation. But if one takes a decade-wide snapshot it is clear that Greece’s problem is that spending spiraled out of control, not that tax evasion became more pervasive or that revenues fell. It is thus on the expenditure side of the equation that the correction ought to focus.

Greek Arithmetic

In my last post, I wrote that Greece has not really practiced austerity. This surprised people. Well, here are some more numbers. If you wonder “what the hell does the troika want from us,” the following table should answer your question.

The top line shows primary government expenditure (data from Eurostat), which covers what the state spends on salaries, benefits, goods and services and investment (but excludes interest). In 2011, primary spending was €92.7 billion, which is €20 billion below the 2009 level. So in a two-year period, the Greek government has cut an enormous amount of spending. If you only look at that number, it seems that Greece has in fact practiced a lot of austerity.

But notice what happened between 2006 and 2009: spending rose by €28.1 billion! In other words, the cuts of 2010 and 2011 barely serve to offset the massive increases of 2007, 2008 and 2009. In fact, as a share of GDP, the amount of spending in 2011 was higher than in 2007 (43.1% versus 42.8%) and much higher than in 2006 (40.5%). Even after cutting €20 billion between 2009 and 2011, the Greek state spent 3.4 percentage points of GDP more than it did in the period from 2000 to 2005. Why?

The first line shows government wages. Here, we see a similar story to the top line number. Between 2009 and 2011, the government cut almost €5 billion in spending. But on an absolute basis, the spending of €26 billion is higher than the spending of €25.5 billion in 2007 and as a share of GDP, government employees took in more than in 2008, before the cuts started. Compared with normal levels in 2000-2005, spending on wages was 1.1 percentage points higher. So yes, the government has made a tremendous effort between 2009 and 2011, but this is not enough to even offset the increase of 2006 to 2009, much less revert spending back to its 2000-2005 levels.

Next comes spending on social benefits, which is mostly health and social protection. Here the reduction is even smaller. Between 2009 and 2011, the government cut €1.9 billion in spending. But from 2006 to 2009, spending rose by €13.3 billion; of that raise, 56% came from higher spending on pensions, 23% from higher spending on health and the rest from other benefits (chiefly sickness, disability, family, unemployment). Relative to GDP, the “welfare state” spends even more than it did in 2009 and it spends 6.3 percentage points more than 2000-2005!

Wages and social benefits made up 79% of primary government spending in 2011 so that’s why they deserve special attention. But their share of total spending was around 67% to 70% from 2000 to 2009, which means that they have declined at a much smaller pace than other spending. In other words, the drop in other spending is disproportionately high to compensate for the modest decline in spending for wages and social services. From the rest of the table, I want to highlight two items.

The first is the drop in the purchase of goods and services. Unfortunately, Eurostat does not have yet detailed information for 2011, but the Budget Bulletins of the Ministry of Finance show that spending on weapons went from €2.4 billion in 2007 to €360 million in 2011, which means that more than a third of the change between 2007 and 2011 in “goods and services” came from reduced spending on defense systems.

The second item to highlight is capital spending. This is mostly the public investment budget and this has been cut severely during the crisis. Here again we need to look at the data from the Ministry of Finance to get a clearer picture of the trends. From 2009 to 2011, the Public Investment Budget declined by €3 billion, which accounts for almost two-thirds of the drop in capital spending. The drop came mainly from reduced spending in transportation, industry and regional development.

These numbers reveal the following. First, the Greek government is cutting spending, but the reductions have yet to make up for the increase from 2006 to 2009, much less to bring the state back to where it was in 2000-2005. Second, the government is cutting spending in defense, infrastructure and development because it cannot reduce wages and benefits quickly enough. And third, tax increases (which I am not covering in this post) are in place to finance the very slow retraction of a state that expanded spending so massively from 2006 to 2009.

The last thing to point out is this. The Greek recession started in Q4 2008 but things really got worse in 2009, when GDP fell by 3.3%. Yet (primary) government spending rose 11.2% in 2008 and 6.3% in 2009. The reason this is important is that there are people out there who seem to think that the recession is due to cuts in government spending and who prescribe more government spending to get out of the recession. But government spending was rising quite rapidly while the economy was shrinking! In fact, when government spending declined by 10.5% in 2010, the economy contracted by just the same amount as it did in 2009 when government spending was rising.

A devout Keynesian (probably not Keynes himself) would say that the increases in government spending were not enough to offset the drop in private activity. But within a three-year period, from 2006 to 2009, state spending as a share of GDP rose by a fifth – Greece had 20% more state in 2009 than in 2006. How can that not be enough? Where was that state? Were the services that the state offered to the Greek citizen 20% better in 2009 relative to 2006? What exactly did that massive increase in spending accomplish besides enrich the people who work in the government and who receive social benefits? What did the taxpayer who was honest then and is honest now get in return? And how is spending more on wages and social benefits as a share of GDP versus 2000-2005 starving “public administration” or crippling the “welfare state?”

These are serious questions. People who are enraged at the corrupt elite should also ask their fellow co-protestors how much money they make relative to 2006 and what they have done to deserve this rise in compensation or benefits. There is plenty of blame to go around but the ideas that the state is either starved or that the solution rests with more “counter-cyclical” government spending are absurd. As Bill Clinton put it recently: Arithmetic, people.

Wednesday, September 26, 2012

What Austerity?

Austerity is killing Greece. Or so we’re told. The politicians and the press have a clear narrative: to please foreign creditors, the Greek government is cutting spending to such low levels that the provision of basic services is being compromised. The Greek people, who suffer under these cuts, are rebelling. That’s the story that one reads on a daily basis and it sounds good. Too bad it’s not true. 

Yes, Greece is cutting spending. But to call what Greece is doing “austerity” is like saying that going from eating five Big Macs a day to four is “a diet.” Reality is more complicated. 

Look at government finances. Basically revenues fell in 2009 but have since held flat. This is due to three forces. First, revenues that depend on work, income and profits have fallen due to more unemployment, lower wages and lower corporate profits. Second, the government has increased value added taxes on consumption, in part because these are easier to collect than direct taxes (where evasion is high). Third, EU financing for investment has increased, providing additional revenue to the treasury. 

These measures have kept revenues flat but since the economy is contracting, the ratio of revenues to GDP is at a ten-year high of almost 41%. So yes, there is tax evasion and revenues could be higher, but the state is taking in as much money as at any point over the last decade. Meanwhile, the increase in indirect taxes has plunged the economy into a deep recession as people have less disposable income. Deposits have fallen by 35% due to capital flight and dissaving. Wealth is evaporating. 

The reason can be seen on the expenditure side of the equation. From 2008 to 2011, the state cut €13.2 billion (-12.5%) in primary spending (excluding interest). But look closer and the “adjustment” evaporates: less public investment accounts for almost half of that drop, while much of the remainder is explained by less spending on defense, meaning the state is building less infrastructure and buying fewer weapons. Meanwhile, social benefits have risen and spending on wages has declined by merely 7%, largely due to retirements by civil servants rather than any rationalization in public administration. 

But consider something else. In 2011, primary spending was at 43.1% of GDP, down from 48.7% in 2009. Yet spending from 2000 to 2006 averaged 40% of GDP. So even today, the state spends three percentage points more than it did earlier in the decade. In fact, once you strip out capital expenditures (to control for the recent drop in investment), the state is spending 5.3% of GDP more in 2011 than it was in 2000-2006. In 2011 terms, that is a €11.5 billion difference, roughly the amount of money that foreign creditors demand that the state cut over the next few years. 

This breeds three big questions: why does the reduction of infrastructure and defense spending so compromise the provision of public services; why is it so outrageous to shrink the state back to its 2000-2006 levels; and why can the state not provide with 43% of GDP the goods and services it could provide with 40% of GDP? 

These are profound questions that go to the core of what is happening in Greece. Taxes are rising so that the government can buy time to shrink the state back to where it was a decade ago (as a share of the economy). The idea that the state is being starved and therefore cannot provide for its citizens is rubbish. Money is not the issue. The state is alive and well – in fact, it is eating better than it was a decade ago. So much for a diet.

Ποια Λιτότητα;

Η λιτότητα σκοτώνει την Ελλάδα. Ή τουλάχιστον έτσι μας λένε. Οι πολιτικοί και ο Τύπος παρουσιάζουν μια σαφή εικόνα: για να ικανοποιήσει τους ξένους πιστωτές, η ελληνική κυβέρνηση μειώνει τις κρατικές δαπάνες σε επίπεδα που θέτουν σε κίνδυνο τη παροχή βασικών υπηρεσιών. Οι πολίτες, που υποφέρουν κάτω από αυτές τις συνθήκες, επαναστατούν. Αυτά διαβάζει κανείς σε καθημερινή βάση. Λογικά ακούγονται. Αλλά δεν είναι αλήθεια. Όντος η Ελλάδα κάνει περικοπές. Αλλά αν αυτό πού κάνει η Ελλάδα είναι «λιτότητα», τότε κάποιος που τρώει τέσσερα χάμπουργκερ την ημέρα αντί για πέντε κάνει δίαιτα. Η πραγματικότητα είναι πιο περίπλοκη. 

Κοιτάξτε τα δημοσιονομικά της χώρας. Τα κρατικά έσοδα μειώθηκαν το 2009, αλλά από τότε έχουν μείνει στάσιμα. Αυτό οφείλεται σε τρεις δυναμικές. Πρώτον, τα έσοδα από την εργασία, το εισόδημα και τα κέρδη έχουν μειωθεί λόγω της ανεργίας, της μείωσης των μισθών και τα χαμηλά εταιρικά κέρδη. Δεύτερον, η κυβέρνηση αύξησε τους φόρους προστιθέμενης αξίας, εν μέρει επειδή είναι πιο εύκολο να τους εισπράξει από τους άμεσους φόρους (όπου υπάρχει φοροδιαφυγή). Τρίτον, η χρηματοδότηση της ΕΕ για τις επενδύσεις αυξήθηκε, παρέχοντας πρόσθετα έσοδα στο δημόσιο ταμείο. 

Τα έσοδα έχουν μείνει σε σταθερά επίπεδα, αλλά επειδή η οικονομία συρρικνώνεται, τα έσοδα ως ποσοστό του ΑΕΠ βρίσκονται στο 41%, το υψηλότερο επίπεδο της τελευταίας δεκαετίας. Οπότε ναι, υπάρχει φοροδιαφυγή και τα έσοδα θα μπορούσαν να είναι υψηλότερα, αλλά το κράτος εισπράττει το μεγαλύτερο μερίδιο χρημάτων της τελευταίας δεκαετίας. Εν τω μεταξύ, η αύξηση των έμμεσων φόρων έχει βυθίσει την οικονομία σε ύφεση, καθώς το διαθέσιμο εισόδημα έχει μειωθεί . Οι καταθέσεις έχουν πέσει κατά 35% λόγω της φυγής κεφαλαίων και της αρνητικής αποταμίευσης. Ο πλούτος εξατμίζεται. 

Το πρόβλημα βρίσκεται στις δαπάνες. Από το 2008 έως το 2011, το κράτος έκοψε € 13,2 δις (-12,5%) από τις πρωτογενείς δαπάνες (εξαιρουμένων των τόκων). Αλλά τι έκοψε; Καταρχάς μείωσε τις δημόσιες επενδύσεις, που αποτελούν το ήμισυ της συνολικής πτώσης. Από το άλλο μισό το μεγαλύτερο κομμάτι είναι η χαμηλότερες αμυντικές δαπάνες. Εν τω μεταξύ, οι κοινωνικές παροχές έχουν αυξηθεί ενώ οι μισθολογικές δαπάνες του κράτους έχουν μειωθεί μόνο κατά 7%, κυρίως λόγω συνταξιοδοτήσεων των δημοσίων υπαλλήλων παρά ενός εξορθολογισμού της δημόσιας διοίκησης. 

Ας δούμε και κάτι άλλο. Το 2011, οι πρωτογενείς δαπάνες ήταν 43,1% του ΑΕΠ (έναντι 48,7% το 2009). Ωστόσο, οι δαπάνες την εποχή 2000 - 2006 ήταν κατά μέσο όρο στο 40%. Ακόμη και σήμερα, το κράτος δαπανά τρεις ποσοστιαίες μονάδες περισσότερο από ό,τι στις αρχές της δεκαετίας. Αν αφαιρέσουμε τις κεφαλαιακές δαπάνες (επειδή η πρόσφατη πτώση των δαπανών οφείλεται στις επενδύσεις), το κράτος δαπανά 5,3% του ΑΕΠ περισσότερο από ό,τι την περίοδο 2000-2006. Αυτό το 5.3% είναι ίσο με €11,5 δις, που είναι σχεδόν τα «μέτρα» που συζητάμε τόσους μήνες. 

Όλα αυτά δημιουργούν τρία μεγάλα ερωτήματα: γιατί η μείωση των δαπανών για τις υποδομές και την άμυνα θέτει σε τέτοιο κίνδυνο την παροχή των δημοσίων υπηρεσιών; Γιατί είναι τόσο εξωφρενικό να κόψουμε τις δαπάνες στο επίπεδο που ήταν την περίοδο 2000-2006; Και γιατί δεν μπορεί να παρέχει το κράτος με 43% του ΑΕΠ τα αγαθά και τις υπηρεσίες που παρείχε με το 40% του ΑΕΠ; 

Αυτά είναι μεγάλα ερωτήματα που βρίσκονται στον επίκεντρο του τι συμβαίνει στην Ελλάδα. Οι φόροι αυξάνονται ώστε η κυβέρνηση να κερδίσει χρόνο για να γυρίσει το κράτος εκεί που ήταν πριν από μια δεκαετία. Η ιδέα ότι το κράτος δεν έχει πόρους για να παρέχει υπηρεσίες δε στέκει. Το θέμα δεν είναι τα χρήματα. Το κράτος ζει και τρώει καλά – μάλιστα τρώει καλύτερα από ό,τι έτρωγε πριν μια δεκαετία. Λιτότητα σου λένε. 

Wednesday, September 19, 2012

Great Expectations in Greece

No one expects much of Greece anymore. Markets expect it neither to repay its debts nor to stay in the Eurozone. Foreign officials doubt that the government has either the will or the capacity to change, and they now merely beg for a faint gasp of reform – any reform. The investor has closed his checkbook, while the rapidly depleting bank balance has turned into a countdown to desperation for the middle class. The unemployed do not expect to find a job, and the employed do not expect to be able to survive through whatever job they have. The infirm have given up on health, the vulnerable on the “safety net,” the parent on education, and the citizen on the police. Fighting tax evasion, selling state assets, reforming the public sector, opening up the private sector – in all, expectations are shrinking faster than the economy. We are almost at zero now. 

Such low expectations make it hard to turn the country around. People often do what you expect of them: if you treat people as if they are unlikely to achieve much, they are unlikely to achieve much. This is a lesson that J. Sterling Livingston captured well in his essay, “Pygmalion in Management,” where he wrote: “The way managers treat their subordinates is subtly influenced by what they expect of them. If managers’ expectations are high, productivity is likely to be excellent. If their expectations are low, productivity is likely to be poor. It is as though there were a law that caused subordinates’ performance to rise or fall to meet managers’ expectations.” The de-motivation of Greek society emerges from a sense that not much can be expected and so not much should be given. 

Yet there is also something refreshing about low expectations. As any underdog will tell you, exceeding expectations is easier when the expectations are low. In Greece’s case, the three main constituencies of the government are its own citizens, its official creditors, and the markets. All three expect little of Greece. They are thus ideal candidates to be surprised. Given the low starting point, it will not take much to replace the current race to the bottom, where one piece of bad news follows another, with a virtuous cycle that can change how people think of Greece. 

Imagine what good news (genuine good news, not propaganda) could do for Greece. Imagine if people believed that reforms were moving forward. Foreign governments would pledge more money and give Greece more time. Investors would sign up for more short-term Greek debt, perhaps even medium and long-term debt. If the Greek people believed in their government and were willing to allocate a share of their savings to finance state spending, the country’s financing needs would be more easily covered. Investment – foreign and domestic, direct or through sold state assets – would rejuvenate the economy and yield revenue to the treasury. And the mental health of the Greek people would rebound from a belief that this endless descent into misery is coming to an end. Good news can do a lot. 

But how to do this? In pondering this question, I have been drawn to a Walter Isaacson article called “The Real Leadership Lessons of Steve Jobs.” Based on Isaacson’s own biography of Steve Jobs, it draws on what one could learn from the founder of Apple and one of the greatest business personalities of our times. The article itself has 14 lessons, but I think five will suffice. 

Focus. “Deciding what not to do is as important as deciding what to do,” Jobs said, a lesson that most leaders will echo. It is easy for the Greek government to find one hundred things that need urgent fixing. And they are all important, politically, economically, ethically, socially. Yet no person, no organization can fix a hundred things at once. And rather than trying, the government would be better served to focus on a few big things. My list would be tax evasion, judicial reform, entrepreneurship, physical security and accountability in the public sector. These are big, broad tasks, of course. But how closer would Greece be in achieving them if it had devoted 90% of its resources to serving these five goals rather than allocating 5% each to 20 goals? Focus means discipline and it means learning to avoid distractions. It is hard work but it means asking every day, “what did I do today to achieve these goals?” 

Simplify. Together with “focus” comes “simplify.” Simplicity, Jobs understood, came from “conquering, rather than merely ignoring, complexity.” Anyone who has interacted with the Greek system knows its immense complexity. No task, however mundane, is truly simple (although I have few complaints about passport issuance). Simplicity requires a return to first principles, to look at each thing and ask “what purpose does this serve” and “do we really need it?” Imagine a serious commitment to simplicity, where the government bureaucracy is pushed to ask “how can I make this task simpler” and where simplification is rewarded by promotion and by pay. What would the Greek system look like then? 

Put Products Before Profits. Jobs said, “My passion has been to build an enduring company where people were motivated to make great products. Everything else was secondary. Sure, it was great to make a profit, because that was what allowed you to make great products. But the products, not the profits, were the motivation.” Greece is not in the profit making business. But Jobs understood that if you focus merely on profits you are no longer focusing on great products. This is the feeling one gets from the Greek government, as if the goal is to create elegant “five-year” plans in the communist style. Pour over the numbers too long and you are missing the point of what governing is about. The goal is not to produce a piece of paper, but to change the country – if the country starts to change, the debt math, the GDP math, the competitiveness math, they will all look immensely better. A country, like a company, needs its priorities straight. 

Don’t be slaves to focus groups. Jobs liked to quote Henry Ford who said “If I’d asked customers what they wanted, they would have told me, ‘A faster horse!’” One of my own favorite dictums comes from Bill Cosby: “I don't know the key to success, but the key to failure is trying to please everybody” In politics, it is hard to ignore constituencies. But with 1.2 million unemployed, with pensioners and wage-earners whose standard of living is shrinking, with the extreme left and the extreme right gaining ground, with such desperation and frustration, it is hard to see how reforms are “bad politics.” Listening to what people want is important but only to a point. There is no way to get out of this crisis while making everyone happy – and in fact, the past few years have shown this to be true. Focus on the big picture not on every constituency. 

When behind, leapfrog. When Apple missed the boat on music, “instead of merely catching up by upgrading the iMac’s CD drive, [Jobs] decided to create an integrated system that would transform the music industry. The result was the combination of iTunes, the iTunes Store, and the iPod, which allowed users to buy, share, manage, store, and play music better than they could with any other devices.” But what does it mean for Greece to leapfrog? It means that Greece is devoting enormous energy to playing catch up. It is trying to adapt, to adopt “best practices,” to close the gap. In some ways that is necessary. But crises are times for bold ideas. Countries have often leapfrogged with innovations such as flat taxes, special economic zones, or industrial clusters. What does leapfrog mean in tourism or shipping? How can the state help turn Piraeus into the premier shipping hub in the world, where owners, charterers, insurance companies, lawyers, and universities gather to shape the future of the shipping industry? Why is that beyond the capacity of the Greek state? In what other ways can Greece leapfrog? I don’t know all the answers, but no one achieved greatness by merely copying others. 

What permeated the Jobs philosophy more fundamentally was a commitment to excellence, a belief that doing great things attracts first-rate people, challenges the human mind and fulfills the human spirit. When asked whether he was rough on people, he said “Look at the results … These are all smart people I work with, and any of them could get a top job at another place if they were truly feeling brutalized. But they don’t. … And we got some amazing things done.” What Jobs brought was a sense of common purpose, a shared journey to a great destination. 

What Greece needs, above all, is someone to believe in its potential for greatness again. It needs a politician who believes that this country can be, as it was a few decades ago, one of the most dynamic and fastest growing in the developed world; who believes that Greece can offer an unmatched tourist product that blends natural beauty, history and modernity; who believes that Greece can be a center for global shipping where young professionals come to build their careers and get ahead; who believes that Greece can be a magnet not merely for refugees and economic migrants but for skilled professionals and for Greeks who no longer feel they need to cross borders and oceans to find opportunities; who believes we can do great things together by getting the little things right – little things like rewarding good work and balancing our rights with our responsibilities to one another. 

This is a paradigm shift and it is what Greece needs not merely to lift itself up, but also to believe that there is something worth lifting itself up for. The expectations are so low, it does not take much to get people thinking differently both in and out of the country. But that change has to come from the top. It can be no other way.