Dear readers, I know I am beyond apologies for the latest radio silence. I can only explain myself by saying that it has, for the last two months, felt pointless to discuss the realities at home. I have little to add to my main narrative and the fog of war lies thick over the day-to-day developments. I’m not convinced there’s any shortage of economists talking crap in the world, so why add to their number.
There are some core themes that cannot be denied. As I’ve been saying for over a year and a half now, Greece will default. I have hoped against hope that we would do so in an orderly fashion, in whatever little time the bailout money could buy us, and emerge a reformed country with an outside chance of growth in the future. It is clear now that this is not going to happen.
Why now? Because we have proof now that the bailout can never meet its three original objectives. Bear with me while I add updates; this is going to be a long post.
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TEH FAIL NO.1: PRIMARY SURPLUS
Whether one wants Greece to default or to start paying down its debt, maintaining a primary surplus is a necessary condition. As I have documented, for the first year under austerity the primary deficit did in fact fall. Then its trajectory reversed sharply. There are several reasons for this.
Topmost is the fact that the Government and the IMF ignored the latter’s own research which points out that the various means of reducing the deficit can be ranked as follows in terms of outcomes for employment and GDP:
cutting benefits > cutting public spending > increasing direct tax > cutting public investment > increasing indirect taxes.
Ours was a slightly more novel approach. Compare the original plan (Box 3, pg. 11 here) with the plan as of the fourth review (Table 5, pg. 53 here and budget execution bulletins here). If you can’t be bothered, check out my brief summary below. The figures are contributions to the fiscal adjustment in % of GDP, and the 2011 figures are the IMF’s estimates.
Simply put, in the cause of political expediency, our Government delayed cuts to benefits and instead front-loaded the contribution of indirect taxes (remember, the best and worst way to cut the deficit respectively). It then proceeded to more than double the originally intended contribution of the public investment budget, effectively killing whatever recovery might have been possible in the womb. The result was, predictably, a deeper recession than expected, missing the original forecast by 0.6 percentage points in 2010 and by a lot more, possibly 2.5 percentage points, in 2011. Not that anyone can trust the actual figures. And as a result of that the Government missed its target for direct tax revenue by a whopping 2.5% of GDP and its target for indirect tax revenue by 0.9% of GDP, with 2011 accounting for nearly all of the shortfall.
But more than this, it’s important to realize just how ingrained the Greek primary deficit is. In the past decade, it took about 4.8% real growth per annum for Greece to return a balanced primary budget. You heard right. Successive governments built a state that could only. ever. work. in the best case scenario. And they almost got away with it because the combination of EU money, credit expansion and a benign global economy meant that, for a short while, that was the kind of growth we could look forward to. In fact, the real damage seems to have been done from 2003 onwards – when the level of real GDP growth required to balance the primary budget rose to an impossible 7%.
It is, after all, as they say. Once you give up on black, you can’t go back. In case people haven't noticed, the Government's job is to shift the trendline in the graph above upwards so that it crosses the origin - i.e. so that the trend primary balance without growth is zero.
Realising this at last, the Greek government has given up on taxing income, which has the annoying feature of being dependent on growth. Instead it is now signaling that it going to directly tax wealth. By this I do not mean taxing the wealthy, just taxing people for the privilege of having property.
There is a depraved social aspect to this: as I explain here, the median Greek is relatively income-poor but relatively wealth-rich, and while the income distribution in Greece is very unequal by international standards, the distribution of wealth is not. Our government hopes that with the current set of incentives in place the people will start liquidating wealth in order to pay tax. It’s a very dangerous game to play.
The first instalment of this master plan was the now-notorious property tax, to be collected via one’s electricity bill. It has the advantage of not only taxing wealth but also delegating tax collection to the massively unionised Public Electricity Company, whose union has predictably announced its intention to sabotage the new tax. Cue overture to the national anthem of WTFistan.
In the same vein, the Government unveiled its now postponed and possibly aborted plan (more emotional coverage here and here) to penalise any declared income that cannot be matched to consumption on the basis of receipts, to what looks like a ratio of at least 50%. The Greek state’s willingness to outsource tax administration to Joe Bloggs is of course not surprising considering how badly they themselves do it.
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TEH FAIL NO.2: COMPETITIVENESS
The second reason for the bailout was presumably that Greece could, given time, return to a position of international competitiveness which was lost over many years, and increasingly so since the adoption of the Euro.
I cannot stress enough how important this is. The chasm between Greek per capita income (even post-austerity) and the per capita income that can be justified by our competitiveness rankings is massive. According to my much-maligned naive mean reversion model for Greece, Greek per capita income would fall back to developing-country levels if internal devaluation were to be pursued without any further gains in competitiveness.
Benchmarking against 2007 competitiveness rankings, the most likely compromise would be for Greece to target Czech levels of competitiveness and fall to their level of per capita GDP. This would have meant a 13.1% drop in PPP-adjusted per capita GDP (from 2007 levels) against 5.2% experienced so far. In a worse (but not worst) case scenario we would instead converge to Latvia’s per capita GDP, accepting a fall of 39%.
Incidentally, I feel vindicated in promoting this way of thinking about Greece’s internal devaluation: using the quick test I outlined above and data from the latest Global Competitiveness Report by the WEF, the level of per capita income that can be justified by our competitiveness ranking fell by 5.5% in 2010. Very very close to reality.
So if competitiveness is so important, how well are we doing? In summary we’ve fallen another 7 places in the past year, to 90th out of 142. Check pg 188 here for details, or quickly scan the tables below:
First, the professions have yet to be liberalized. In fact, the government has buckled completely before the might of the legal and engineering professions and is still fighting pathetic skirmishes with taxi drivers.
Second, despite a chorus of increasingly demented voices lamenting the selling-off of ‘the entire country’, privatisation and asset sales are proceeding at a snail’s pace because a) demand is abysmally low and b) the Government is committed to raising an amount of money that is simply impossible in a fire sale.
Third, while the Government made some headway on labour market reform, the IMF was forced to note in its fourth review:
…firm-level collective agreements, introduced in late 2010, would allow for wage reductions below sectoral minima (to the nationally-agreed floor) within the formal bargaining framework, thus overcoming this rigidity, but had been used little to date. (pg. 23)
Finally, public sector reform is becoming an irredeemable mess. Already, as discussed above, the balance of public consumption to public investment has been allowed to slip further towards the former. Never a good idea, as the eggheads have proven time and time and time and time again. Public investment builds capital which drives growth, while public consumption inevitably turns to shit. Literally.
To date, not a single civil servant has actually been laid off, although, in fairness, many on contracts have not had these renewed and many retirees have not been replaced. I still think our public sector is overweight to the tune of about 300,000 people, but this is not to say that laying off 300,000 people will solve the problem. We may well need to hire more of some kinds of civil servant and fire even more of some others; there’s simply no way of knowing because the actual skills needs of the civil service and the broad public sector are unknown. Because no one knows or cares what services the public sector is meant to deliver, the question of how many and what staff it needs sounds too much like advanced management speak.
To give you an example, here is a recent announcement of 65 Scientific Specialist vacancies with the Bank of Greece processed centrally by the Greek Supreme Council for Personnel Selection (more on this here). This is not a technical background note to a more user-friendly vacancy ad, by the way. This is the ad. Note how it never once quotes what the actual staff are meant to be doing. This is what we’re up against.
Hence the problem when the Government recently called on its agencies to provide a list of ‘surplus’ staff to be put on its controversial labour reserve scheme (essentially phasing them out of the public payroll gradually). Everyone responded that they were up to their gills with work and needed to hold on to every mammal with at least one working orifice.
Then there are those who have little time for competitiveness through reform anyway, and who are of course calling for a return to the Drachma, or a currency union with other Euro rejects. I realize many Greeks and indeed many of my readers are sympathetic. I can only point out two things: the following two questions are not equivalent, even though people treat them as such.
Would Greece be better off now had we not joined the Eurozone in 2001?
Would Greece be better off leaving the Eurozone now?
And here’s an even scarier thought.
Devaluation is actually possible even within the Euro and I suspect that future Greek governments (which, post-default, will still be lumbered with the euralbatross) will pursue this. The most likely alternative to having our own currency is what is called ‘social VAT’ – basically reducing employee and employer pension contributions and making up the difference to pension fund receipts with VAT. I don’t like this option, not least because it obliterates any hope of a pensions system that isn’t a Ponzi, but I’ve rarely got what I liked from governments in the past either. In fact it’s actually a pretty mild suggestion compared to this one, which would eliminate employers’ contribution altogether.
This will be the final roll of the dice – and if we do default, obliterating the capital of Greek pension funds, it may well be, along with a swap of bad bonds for slightly less bad bonds, the only option we have for recapitalising them in the short term.
