The Greek tragedy: nemesis before catharsis

Posted by Tim Congdon in News Archive | 0 comments

Since 2009 Greece has been a barometer of the Eurozone’s continued viability. The rake’s progress of the four years to early 2009 had been remarkable. It had run current account deficits (relative to GDP) of 7.6% in 2005, 11.4% in 2006, 14.6% in 2007 and 14.9% in 2008 or, over the four years combined, of about 50% of GDP. The big external creditors included international banks, particularly European banks, which had acquired large holdings of Greek government debt and made loans to Greek banks. The extra debt could be serviced in the long run only if Greece reduced its current account deficit substantially. A devaluation against the currencies of its main trading partners was  therefore  sensible,  in  order  to  motivate  the  necessary  switch  of production  towards  exports.  Unfortunately,  as  a  member  of  the  Eurozone single currency area Greece could not devalue. It could leave the Eurozone, but that would shatter the geopolitical dreams of the Eurozone’s architects in Germany and France. For them the single currency area was a permanent structure which foreshadowed ever-increasing economic and political integration in the European Union.

As devaluation within the Eurozone was impossible, the focus of the policy drive to improve Greece’s financial position was on the budget deficit. The Eurozone   sovereign   debt   crisis   escalated   in   early   2010.   Since   then negotiations have been held between international bodies (usually “the troika” of the European Commission, the European Central Bank and the International Monetary Fund) and the Greek authorities, about targets for the reduction of budget  deficits  and  public  debt.  The  Greeks  have  repeatedly  missed  the targets. Fiscal austerity and the implosion of the banking system have been associated with a drop in real GDP of almost a quarter in five years. The GDP decline has further pushed up the debt/GDP ratio. This note examines the latest developments. Although the budget deficit numbers have been better in 2012 than in 2011, the macroeconomic trauma is so severe and unrelenting that Greece must leave the single currency area as soon as possible.

The latest data on the budget deficit

Greece’s public finances have “improved” in 2012 compared with 2011, in that the budget deficit has been running at a lower level. But the apparent improvement is more a sign of desperation than of successful management. The Greek government keeps on drawing down its cash balance to almost nothing, only to find some expedient that allows it remain functional, at least on a day-by-day basis. It cannot borrow from private markets, because it is bust, and it cannot borrow from the European Central bank unless there is some special dispensation, because of the Maastricht Treaty. The occasional replenishment of the cash balance is entirely dependent on international creditors. These creditors know full well that, when they give the Greek government more money to spend, they are in fact playing a long-term game of cat-and-mouse, with the purpose of that game being to minimize the loss on the loans they have already made. In August 2012 Greek government expenditure fell below revenue for the first time since January 2010. Indeed,  month by month the deficit in 2012 has consistently been coming in lower than in 2011.Greek budget deficit - 2011 and 2012 compared

The cumulative 2012 deficit at the end of August stood at €12.6b,, compared with €18.8b. for the corresponding period in 2011. Preliminary figures for September and October 2012 suggest that the deficit continues to run at lower levels than a year earlier. The “better” numbers reflect spending cuts above all, as revenue has been little different this year from last.  While revenue has been above the target for the first 10 months of the year, the total received has been less than 2% higher than in the corresponding period in 2011. The increase has been modest, despite the tax rises demanded by the “troika” as a condition for providing financial aid to the country.

Last week the Greek Parliament voted yet another “austerity” budget, this time for 2013, with further cuts in government spending of €9.4b. Prime Minister Samaras said that this would be the last sacrifice required of the Greek people. In fact, the 2013 reduction is above the €8b. agreed for 2012, while the strain of implementing the cuts will be greater because national income and output have fallen. (The IMF estimates that GDP, which was just under €210 billion in 2008, will be under €165b. in 2013. In short, in a mere two years government spending is being slashed by about 10% of GDP.)

The efforts made by the Greek government to rein in its spending have been very painful, but the beneficial effects on the public finances have been largely negated by the economy’s contraction. The debt/GDP ratio is rising remorselessly. The IMF’s latest view is that the debt-to-GDP ratio will peak at over 190% in 2014. The troika has concocted a rose-tinted macroeconomic scenario in which thereafter a return to economic growth and fiscal restraint bring that 190% figure down to 120% by 2020 Nevertheless, the EU authorities and the IMF seem to be squabbling about whether a 2020 or 2022 target is more realistic for the 120% number. Given the urgency of Greece’s financial disarray, the dispute between the EU and the IMF over a hypothetical outcome almost a decade away is surreal.

Analysis of Greek government expenditure over the first nine months of 2012 shows that interest payments amounted to almost 25% of the total. With three months to go, the figure of €10.7b. is already above 90% of the target for the whole year. Public investment spending has been slashed, down over 20% from the same period last year and less than 40% of the original target for the whole year. Public sector pay and pensions have also been reduced, with a particularly sharp drop in healthcare expenditure. (Fears are being expressed in the media of falls in life expectancy, outbreaks of infectious diseases and such like.)   Most other areas of budget expenditure, apart from military procurement and transfers to the European Union, are also lower than for the corresponding period in (Military procurement is to a considerable extent expenditure on equipment and supplies from German and French companies, i.e., from Greece’s external creditor nations.)

Inspection of the data on tax revenue is also interesting. October’s revenue figure was relatively good, being higher than in October 2011. Tax revenue for the January-September period was a touch lower than for the corresponding period last year. Revenue overall has stagnated despite a new property tax, introduced in December 2011, which has so far yielded an extra €1.7b. (i.e., about 1% of GDP). Personal income tax receipts rose from €6.1b. in the first nine months of 2011 to €6.9b. By contrast, corporation tax revenue was down by almost 40%, and VAT receipts and consumption tax revenues also fell. Fuel duty receipts dropped by over 9%. This drop was larger than an increase in road tax revenue, generated by a doubling of the tax rate.

The latest data on the macroeconomic situation

Fiscal austerity is being imposed on a nation already confronted by severe macroeconomic trauma.  A recent report in the Kathimerini newspaper said that nearly a third of businesses in central Athens had closed in the last three years. Yiannis Stournaras, the finance minister, stated that he expected the Greek economy to have contracted by 25% by 2014, compared with its pre-recession level in 2007, and indeed the data available for 2012 confirm that a decline of over 20% has already occurred. With further  falls  in  demand  and  employment  in  prospect,  and  with  threats  of  intensifying  civil disobedience, tax revenue cannot be raised much in 2013 or 2014, if at all. The only hope of boosting government income lies in reinvigorating the stalled privatisation programme. Since its launch a year ago the programme has yielded a mere €1.6b., less than 10% of the amount the Greek government had originally hoped to raise by 2016.

On 8th  November Elstat (“the Hellenic Statistical Authority”) issued a press release on the August Labour Force Survey. The unemployment rate in August 2012 was 25.4%, compared with 18.4% in August 2011 and 24.8% in July 2012. Employment in August 2012 was 3,726,663 persons, compared with a peak of almost 4,600,000 in 2008. So about a fifth of the 2008 workforce no longer has a job. Since some jobs have been created even in this dreadful period, job losses must have been an even higher proportion of the workforce, probably over a quarter, perhaps even a third. Unemployment among the young is much worse. For those under the age of 25 the unemployment rate was already high at 30.8% in April 2010, but it is now well above 50%.

Bizarre though it may now sound, in the boom period to 2007 Greece saw heavy immigration, much of it illegal, from the Balkans (especially from Albania), the Middle East and Africa. Also surprising is that, until quite recently, the immigration continued. Over one million immigrants arrived in Greece in the two decades to 2010, with much of the explanation being that its land and sea borders with Turkey are notoriously porous. (The population of Greece is under 11½ million.) Small vessels come and go between Greek and Turkish islands in the Aeagean, and tourists and illegal immigrants are difficult to separate. According to Professor Kasimis of the Agricultural University of Athens in a March 2012 paper, Greece “has truly become the gateway to Europe for hundreds of thousands of unauthorized immigrants”. In 2010 nearly 133,000 people were apprehended for unauthorized entry or stay in Greece, although specialized Frontex teams have been trying to check the inflow since October 2010. Not surprisingly, the high ratio of foreign-born workers to the total workforce has exacerbated the social tensions arising from the job losses and heavy unemployment of the last three years.  As  Kasimis  mildly  concludes,  “highly  porous  borders,  growing  xenophobia,  and  [the] ineffective legal and institutional framework for…the integration of immigrants have created a fragile environment for the management of immigration.”The Great Recession in Greece

How much longer can Greece limp along in its present disarray? The country’s economy – or at any at what remains of its once-bloated public sector – remains on a debt-forgiveness life-support machine operated by external creditors. Even as unauthorized immigration continues, the skilled, educated and young are leaving. The departure of much of the nation’s “human capital” reduces its ability to produce and impairs its trend rate of growth.  That impairment is structural and permanent in nature, and implies a long-run deterioration in Greece’s ability to service and repay its debts. (It is also important to realize that these debts consist not just of the public debt of about €350b., but also Greek banks’ borrowings from the Eurosystem [i.e., the ECB] via the target system, which are a further €105b. or so.)

The next €31b. instalment of the second aid package agreed by the troika is urgently needed later this month to prevent the government running out of money. It will probably be granted. But subsequent additional assistance in some form or other will be required, and the conditions attached to that assistance are likely to be tough. The Greek Finance Ministry data analysed in this note indicate that the government has made a genuine attempt to comply with the troika’s austerity measures, although the privatisation programme has been a disappointment. Bail-out fatigue in the northern Eurozone countries may well impede future external cash injections. Meanwhile popular discontent and tensions within the governing left/right coalition in Athens over fiscal retrenchment may derail the 2013 budget,  even  though  it  has  been  formally  approved.  Another  fall  in  GDP,  and  a  climb  in unemployment to almost a third of the workforce, cannot be excluded for 2013. These would be the worst macroeconomic figures to hit an OECD member state since the 1930s.

Greece must leave the Eurozone

The key fact in the last paragraph needs to be reiterated. The unemployment rate in Greece is over a quarter of the workforce and could reach a third. The human waste and suffering are an appalling indictment of the European single currency experiment and of the integrationist ambitions of the EU elite. Greece’s exit from the Eurozone, and a very large devaluation (probably of 25% – 50% within a few days/weeks of the re-introduction of the drachma), have become essential. Sure enough, “Grexit” would create legal and institutional precedents that might lead to the break-up of the Eurozone. But it might also be followed by a move to approximate equilibrium on the current account of Greece’s balance of payments, and a revival in demand, output and employment. Greece needs to run a surplus on its external payments excluding interest payments on its debt, in order that those interest payments can be met without the incurrence of new debt.

If “Grexit” were to result in the reconstitution of the Eurozone, it might well be viewed as the nemesis of European elite’s attempt to forge a European superstate by monetary integration. But it would foreshadow a welcome catharsis. The nation hit by the most deflationary macroeconomic conditions seen anywhere in Europe since the 1930s could at last look forward to a recovery, of sorts.

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