Update: 6/30: A very interesting piece by BrankoMilanovic, made the same point before me
I have been silent on Greece, because scores of excellent economists from all sides commented at length and in real time on the developments of negotiation, and most has been said.
But last week has transformed in certainty what had been a fear since the beginning. The troika, backed by the quasi totality of EU governments, were not interested in finding a solution that would allow Greece to recover while embarking in a fiscally sustainable path. No, they were interested in a complete and public defeat of the “radical” Greek government.
The negotiation has not been one. The two sides were very far in January, as it is and it should be, if two radically different views about the engines of growth confront each other. Syriza wanted the end of austerity, that was much harsher on the country than expected, while failing to bring the promised benefits, even in terms of public finances’ sustainability. And it wanted the burden of debt to be lifted The troika wanted get its money back (well, not all of it; the IMF has always been open to debt restructuring), and more of the policies imposed to Greece since 2010, because, well, “eventually they will work”. (no need for me to remind with whom I have been siding).
But there was a common ground that, had the negotiation been real, could have allowed to reach an agreement, in just a few weeks of discussion. Both sides agreed that the Greek economy is broken, and that it needs radical reform. While Syriza focused on reorganisation of the State, on putting together a functioning tax collection system, at closing inefficiency loopholes, the troika demands were more “classic” and somewhat ideological: pension cuts, labour market reform, and the like. A continuation of the memorandum, in fact.
If we look at the economics of it, Sequencing is crucial: implementing structural reforms in bad times, when the economy is not able to absorb the short run costs of such reforms, imposes excessive disruption and risks hampering the potential long run benefits. This is why the joint implementation of austerity and structural reforms is particularly pernicious. Their short run contractionary effects reinforce each other and may be self-defeating, leading to no improvement in productivity or in public finances’ health. The dire state of Greece’s economy stands as a reminder that such an outcome is all but impossible. Troika reforms and cuts to public spending were doomed to fail since the beginning.
What happened since then? Well, contrary to what is heard in European circles, most of the concessions came from the Greek government. On retirement age, on the size of budget surplus (yes, the Greek government gave up its intention to stop austerity, and just obtained to soften it), on VAT, on privatizations, we are today much closer to the Troika initial positions than to the initial Greek position. Much closer.
The point that the Greek government made repeatedly is that some reforms, like improving the tax collection capacity, actually demanded an increase of resources, and hence of public spending. Reforms need to be disconnected from austerity, to maximize their chance to work. Syriza, precisely like the Papandreou government in 2010 asked for time and possibly money. It got neither.
Tsipras had only two red lines it would and it could not cross: Trying to increase taxes on the rich (most notably large corporations), and not agreeing to further cuts to low pensions. if he crossed those lines, he would become virtually indistinguishable from Samaras and from the policies that led Greece to be a broken State.
What the past week made clear is that this, and only this was the objective of the creditors. This has been since the beginning about politics. Creditors cannot afford that an alternative to policies followed since 2010 in Greece and in the rest of the Eurozone materializes.
Austerity and structural reforms need to be the only way to go. Otherwise people could start asking questions; a risk you don’t want to run a few months before Spanish elections. Syriza needed to be made an example. You cannot survive in Europe, if you don’t embrace the Brussels-Berlin Consensus. Tsipras, like Papandreou, was left with the only option too ask for the Greek people’s opinion, because there has been no negotiation, just a huge smoke screen. Those of us who were discussing pros and cons of the different options on the table, well, we were wasting our time.
And if Greece needs to go down to prove it, so be it. If we transform the euro in a club in which countries come and go, so be it.
The darkest moment for the EU.
I am ready to bet that the latest IMF World Economic Outlook, that was presented today in Washington, will make a certain buzz for a box. It is box 3.5, at page 36 of chapter 3, which has been available on the website for a few days now. In that box, the IMF staff presents
lack of evidence on the relationship between structural reforms and total factor productivity, the proxy for long term growth and competitiveness. (Interestingly enough people at the IMF tend to put their most controversial findings in boxes, as if they wanted to bind them).
What is certainly going to stir controversy is the finding that while long term growth is negatively affected by product market regulation, excessive labour market regulation does not hamper long term performance.
It is not the first time that the IMF surprises us with interesting analysis that goes against its own previous conventional wisdom. I will write more about this shortly. Here I just want to remark how these findings are relevant for our old continent.
imposed to embraced by eurozone crisis countries has taken the shape of expenditure cuts and labour market deregulation, whose magic effects on growth and competitiveness have been sold to reluctant and exhausted populations as the path to a bright future. I already noted, two years ago, that the short-run pain was slowly evolving into long-run pain as well, and that the gain of structural reforms was nowhere to be seen. The IMF tells us, today, that this was to be expected.
The guy who should be happy is Alexis Tsipras; he has been resisting since January pressure from his peers (and the Troika, that includes IMF staff!) to further curb labour market regulations, and recently presented a list of reforms that mostly pledges to reduce crony capitalism, tax evasion and product market rigidities. Exactly what the IMF shows to be effective in boosting growth. Of course, at the opposite, those who spent their political capital to implement labour market reforms are most probably not rejoicing at the IMF findings.
This happens in Washington. Problem is, Greece, and Europe at large, seem to be light years away from the IMF research department. We already saw, for example with the mea culpa on multipliers, that IMF staff in program countries does not necessarily read what is written at home. Let’s see whether the discussion on Greece’s reforms will mark a realignment between the Fund’s research work and the prescriptions they implement/suggest/impose on the ground.
Yesterday, like many, I was appalled by the ECB announcement that it would stop accepting Greek bonds as collateral for loans. The timing, right after Greek finance minister Varoufakis met Draghi, but before he met German finance minister Schauble, seemed a clear signal: the ECB sides with Germany and EU institutions, and the only possible outcome it expects is a complete rolling back of Syriza electoral promises, and a renewed Greek commitment to austerity and troika-style structural reforms (privatizations plus labour market reform, to say it simply). This would of course be terrible news for Europe (these recipes simply did not work, this is acknowledge everywhere from the IMF to the White House, passing by Downing Street). And terrible news for democracy as well. The signal to voters would be “Enjoy your day at the polls. Then we decide in Brussels, Frankfurt and Berlin”.
Appalling, I said. This morning I have read a different, very interesting interpretation by Frances Coppola. Please read the piece. Is wonderfully written. In a few sentences, it says that the ECB move may not be pressure just on Greece, but on both sides involved, i.e. on Germany as well. In a sort of mega game of chess, by weakening Greece, by pushing it closer to the edge of the cliff, the ECB forces both sides to actively look for a deal, in order to avoid the catastrophic effect of Grexit. Coppola mentions the principle of “coercive deficiency” (famously applied to nuclear deterrence): a weaker Greece makes it run out of options, and hence a deal unavoidable.
Boy, I hope Frances is right! The alternative interpretation, United Creditors Against Greece, would mean the end of the Euro. And it is true that the practical implications of yesterday’s decision are in the end limited. But I remain worried, for at least two reasons.
- The first is that if the ECB were trying (in a convoluted way) to set the stage for a deal, it should push Greece closer to the cliff, while at the same time showing at least some willingness to negotiate. Now, it seems that the ECB is not willing even to grant an extension of maturities. This is at odds with the interpretation of the ECB as setting the ground for a deal
- Second, even assuming the ECB were in fact trying to crate the conditions for a deal, the game would be dangerous indeed, because it relies on Germany’s leaders to be good chess players! Leaving metaphors aside, it seems that Angela Merkel and Wolfgang Schauble are trapped in their own narrative of debt as a morality tale, in which punishment of the sinners is by definition impossible. So the question becomes whether they would recognize that pushing Greece off the cliff would entail huge costs for the EU at large. And even if they recognize it, they may be willing to pay the price “to teach the sinners a lesson”
Difficult times ahead. I am not optimist
As I write the Greek people are voting. I was puzzled in the past weeks by the fear (more in the media than in markets, actually) of a “radical” left win. Puzzled, because the radical and ideological policy makers do not seem to live in Greece, today. On January 20 I wrote a piece for the Greek website Macropolis, where I claimed that we should not expect an Armageddon if Syriza wins, but rather some welcome fresh air. I reproduce the piece here:
It is most likely that from the elections of January 25 will emerge a Syriza-led government, the main uncertainty being how large a coalition Alexis Tsipras will have to gather to obtain a comfortable parliamentary majority. This is seen with a fair deal of preoccupation in Europe. A preoccupation that does not seem warranted. Syriza is no longer the radical party of the beginning, which called for the exit from the euro and for a default on Greek public debt. Today it is party whose program can hardly be defined revolutionary, and whose label of “radical” left is justified mostly by the drifting of other social democratic party in Europe (for example in Italy and in France) towards the center of the political spectrum, and towards a de facto acceptance of the European macroeconomic orthodoxy. Syriza’s leader, Tsipras, as the prospects of victory become more concrete, has further softened his tones and is already actively negotiating with the Commission and with the major countries, in view of a compromise on the key points of his program. However, some of the media and some political leaders around Europe continue to present the Greek elections as an incoming Armageddon, and the possibility of a Syriza victory as the beginning of the end for the monetary union.
Let’s see what are the reasons for concern. Regarding Europe, Syriza’s agenda has two key elements. First, in case of victory Tsipras would ask to renegotiate a substantial chunk of Greece’s unbearable public debt, that today is mostly (for around 80%) in the hands of official creditors. Of course, this would mean a loss for creditors to absorb. But, as the Financial Times noted as well, it is difficult to imagine a durable exit from the crisis that has choked Europe since 2008, if at least a part of the debt burden that is stifling the recovery is not removed. The French finance minister has agreed yesterday that some compromise on Greek debt will be have to be found, even if some northern countries are at least as of now inflexible. What seems increasingly evident, in fact is that with the European economy back into deflation the costs, for creditor countries as well as for debtors, of a long stagnation, seem far more important than the loss associated with the debt restructuring. The second key point of Syriza’s electoral agenda is the abandonment of austerity that, albeit less stringent than in previous years, continues to characterize European economic policy In other words, Syriza asks to address the problem of unsustainable debt, so far hidden under the rug, and to finally acknowledge the need for a comprehensive plan to restart the European economy, that goes well beyond the accounting tricks of the Juncker plan. Syriza may seem radical to some German economist. But it is in good company of other well-known extremists such as Paul De Grauwe, the IMF, the US government, and much of the Anglo-Saxon press. The European economy is unbalanced and stuck in a deflationary liquidity trap, Mario Draghi’s faces fierce political opposition, and his arrows are increasingly ineffective; it is therefore increasingly clear that only fiscal policy will be able to get us out of trouble.
On closer inspection, it seems far more radical the position of those who, despite having grossly underestimated the negative effects of austerity, ask for more of the same; of those who insist on advocating supply-side reforms to cope with a chronic lack of demand; and of those who boast having achieved a balanced budget one year ahead of forecasts, when Europe would benefit from a recovery of domestic demand in Germany.
What will happen then, if “radical” Syriza will win the election? Actually not much. Tsipras, comforted by opinion polls among his fellow citizens, does not consider the Grexit option. He will sit at the negotiating table to try to obtain for his country a substantial restructuring of debt, and for Europe change towards a more Keynesian policy. If on the latter objective it is hard to imagine that substantial progress will be made, debt restructuring in some form will probably happen. First, because as we said above, it seems to be an unavoidable event, just waiting for the political conditions to be reunited. And second, because Greece will negotiate from a position of strength. Its primary budget surplus (a proof, if needed, that contrary to widespread beliefs Greece actually did its homework; and painfully so), and the low share of debt held by private investors, around 15%, would allow it not to be subject to market pressures in case of exit and default.
And contrary to some declarations that resemble to pre-electoral tactics (the Greek election game is played in the European arena as well), Greece’s exit from the euro would not arrange its European partners either. First, because it would be accompanied by default, and losses for creditors would be significantly larger than in the case of restructuring. Then, probably more important, because Grexit would have unpredictable contagion effects on other peripheral economies, which not hazardously today look with concern to the increasingly harsh tones used in particular by the German Government. In case of a Syriza victory Angela Merkel will most probably soften the tone and agree to negotiate. It is hard to imagine that orthodoxy will go as far as to push Greece out of the euro.
It goes without saying that the negotiation will be harsh, and that tensions will emerge. But today the ECB is more active in assisting countries in difficulty, and its program OMT, which recently received preliminary clearance by the European Court of Justice, is a good protection against speculative attacks.
To conclude, Europeans should stop worrying and let democracy play its role. A Syriza-led government (possibly forming an alliance with George Papandreou’s To Kinima) would not cause an earthquake. Rather the contrary, it could help stirring things up, and bring within the European debate discussion about measures the need for which is now obvious to all except to those who will not see.
The latest Eurostat release on inflation shows that the Eurozone, and the EU at large, keep flirting with deflation. This happens mostly because peripheral countries have near-zero inflation rates. Strikingly, no EU country had, in January, annual inflation rates above the 2% ECB target (Finland and the UK stood at 1.9%). Deflation is a problem for debtors, who see the real value of their debt increase. It is a problem for macroeconomic policy (in particular monetary policy). But it is also a problem for rebalancing. The imbalances that built over the period 1999-2007 show up in diverging inflation rates and labour costs. Take the former, from Eurostat data: Read More
Last week’s publication of a Lancet article1 on the effect of austerity on Greek public health made a lot of noise (for those who know Italian, I suggest reading the excellent Barbara Spinelli, in La Repubblica).
The Lancet article sets the tone since the abstract, talking of “mounting evidence of a Greek public health tragedy”. It is indeed a tragedy, that highlights how fast social advances may be reversed, even in an advanced economy.
Some time ago (March 2012) I had titled a post “Greek Tragedies“. Mostly for my students, I had collected data on Greek macroeconomic variables. I concluded that austerity was self-defeating, and that at the same time it was imposing extreme hardship on Greek citizens. Of course one needed not be a good economist to know what was going on. It was enough not to work at the Commission or in Germany… But the Lancet article also allows to substantiate another claim I made at the time, i.e. that austerity would also have enormous impact in the long run. It is weird to quote myself, but here is my conclusion at the time:
Even more important, investment (pink line) was cut in half since 2007. This means that Greece is not only going through depressed growth today. But it is doing it in such a way that growth will not resume for years, as its productive capacity is being seriously dented.
What makes it sad, besides scary, is that behind these curves there are people’s lives. And that all this needed not to happen.
I think it is time for an update of the figure on the Greek tragedy. And here it is:
I said in 2012 that investment cut in half spelled future tragedy. Two years later it is down 14 more points, to 36% of 2007 levels. I am unsure the meaning of this is clear to everybody in Brussels and Berlin: when sooner or later growth will resume, the Greek will look at their productive capacity, to discover it melted. They will be unable to produce, even at the modest pre-crisis levels,without running into supply constraints and bottlenecks. I am ready to bet that at that time some very prestigious economist from Brussels will call for structural reforms to “free the Greek economy”. By the way, seven years into the crisis, the OECD keeps forecasting negative growth together with unsustainable (and growing) debt.
I also added unemployment to my personal “Greek Tragedy Watch”: Terrifying absolute numbers (almost 30% unemployment overall, youth unemployment around 60%, more than that for women!). And absolutely no trend reversal in sight. A final consideration, related to the melting of the capital stock. How much of this enormously high unemployment, is evolving into structural? How many of the unemployed will the economy be able to reabsorb, once it starts growing again? Not many, I am afraid, as there is no capital left.
Not bad as an assessment of austerity… And yet, just this morning the German government complained for a very limited softening of austerity demands. Errare umanum est, perseverare autem diabolicum…
1. Kentikelenis, Alexander, Marina Karanikolos, Aaron Reeves, Martin McKee, and David Stuckler. 2014. “Greece’s Health Crisis: From Austerity to Denialism.” The Lancet 383 (9918) (February): 748–753. Back