Category Archives: Greece

Greece, the IMF and the Euro

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Talk about possible trade wars with China and the Brexit negotiations has crowded the Greek debt crisis out of the headlines, but a new decision point is approaching. It is possible that this time the beleaguered Greek government will announce a withdrawal from the Eurozone, if only to drive home the point to other European governments that the status quo is not acceptable. But those governments, facing resistance from voters suspicious of foreign engagements, may not offer terms acceptable to the Greek government. Moreover, the IMF does not want to approve the next stage of a bailout agreement that it believes is not credible. Consequently, each side may feel pushed to accept an outcome it knows is not optimal. If that comes to pass, the consequences for the Eurozone will be far-reaching.

Greek economic performance, after years of contraction, has stabilized. The IMF projected that GDP, after stagnating in 2016, would increase in the current year by 2.8%. But the ratio of gross debt to GDP, according to the IMF’s projection in last fall’s Global Stability Report, was 183.4% last year, up from 176.9% in 2015 and 180.1% in 2014. Moreover, a draft report from the Fund projects continuing growth in the debt burden, ultimately reaching a crushing 275% in 2060.

The IMF’s concerns come as European governments are assessing Greek compliance with its current bailout agreement. Greece needs a successful review to qualify for disbursal of about $90 billion, which the government requires for debt repayments. Greece has met its recent fiscal targets, but the agreement calls for a 3.5% primary budget surplus target by 2018. The IMF fears that this is not achievable without a degree of fiscal austerity that would kill off the incipient recovery. Not everyone shares the IMF’s apprehensions, and the agency that administers the European Stability Mechanism has issued a positive assessment. But if the IMF does not approve the next stage of the bailout, at least some European governments will not want to proceed.

George Papaconstantinou in Game Over has provided an insider’s look at the outbreak of the crisis and the course of negotiations in the early years. Papaconstantinou, who earned a Ph.D. in economics at the London School of Economics, served first as Finance Minister and then Minister of Environment, Energy and Climate Change, in the government of Prime Minister George Papandreou from 2009 to 2012. He faced what he calls a “disconnect” between the demands from European ministers that the Greek government close the fiscal deficit and the realization at home what the abrupt change in the government’s fiscal position meant for the economy. There was a continuous refusal on both sides to address the reality of the situation and to temporize in the unfounded hope that the arrival of another day would deliver a solution—or at least delay any decision that would generate voter unhappiness, either at home or in the European electorate. But postponement only raised the cost of what became three bailout agreements. Among the lessons that Papaconstantinou draws: “time is expensive: the more you delay, the more you pay.”

The IMF was also facing challenges in its involvement in the crisis negotiations, as Paul Blustein recounts in Laid Low. The Fund joined the European Central Bank and the European Commission, representing the European Union, in an arrangement known as the “troika.” The IMF, however, was viewed as a “junior partner,” and had to negotiate with its partners as well as with the Greek government. This was a departure from past practice, and placed the IMF in the position of making compromises that it came to regret.

The principal violation of the Fund’s own practices took place early in the crisis when it approved “exceptional access” credit to Greece, i.e., an unusually large amount of credit. Such approval was supposed to be contingent on a high probability that the debt was sustainable. This condition had clearly not been met in 2010, but the IMF gave itself a loophole when it approved exceptional credit if there is a high risk of international systemic spillovers. The insertion of the systemic exception clause violated any notion of the IMF’s evenhandedness when dealing with members who required assistance, and reinforced the image of the Fund as an agency dominated by its richer members.

The IMF subsequently has sought to recover its reputation as an institution that has extensive experience in macro adjustment and is willing to “speak truth to power.” It eliminated the exceptional access provision in 2016. The Fund now admits that the fiscal policies imposed on Greece in the earlier bailout programs were contractionary. And in a statement it issued on Tuesday, the IMF called for more debt relief by the European creditor governments:

“Most Directors considered that, despite Greece’s enormous sacrifices and European partners’ generous support, further relief may well be required to restore debt sustainability.”

But in a highly unusual public statement, the IMF also announced that the Board was split on the feasibility of the new agreement:

“Most Directors agreed that Greece does not require further fiscal consolidation at this time, given the impressive adjustment to date which is expected to bring the medium-term primary fiscal surplus to around 1½ percent of GDP, while some Directors favored a surplus of 3½ percent of GDP by 2018.”

Could there be a better outcome? Joseph Stiglitz of Columbia University argues that the monetary union is inherently flawed in The Euro. He points out that the euro was justified on the premise that a single currency would facilitate trade and financial flows, and “…the resulting economic integration would improve societal welfare everywhere within the Eurozone.” In fact, there were winners and losers, and the latter were not compensated for their losses. Such a redistribution requires political integration, which does not automatically follow the establishment of economic integration.

Stiglitz does not want to abandon what he calls the “European project,” and offers several structural reforms to rescue the euro. But all of these require political resolution as well intellectual flexibility, and these are not qualities rewarded by voters. Upcoming elections in France and Germany will show whether their citizens approve of the attempts to maintain the viability of the euro. If they follow the examples of the U.S. and British electorates, then the days of the euro may be numbered.

Greece’s Missing Drivers of Growth

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Analyses and discussions of Greece’s economic situation usually begin—and often end—with its fiscal policy. The policies mandated by the “troika” of the European Commission, the European Central Bank and the International Monetary Fund have undoubtedly resulted in a severe contraction that will continue for at least this year. But little has been said about the private sectors of the economy, and why they have not offset at least part of the fiscal “austerity.” Consumption spending is linked to income, so there is no relief there. But what about the other sources of spending, investment and net exports?

Investment expenditures provide no counterweight, as they have plunged in the years since the global financial crisis. The same phenomenon took place in other countries in the southern periphery of the European Union, but the change in Greece’s investment/GDP ratio between its pre-crisis 2007 level and that of 2014 was an extraordinary decline of 16 percentage points at a time when GDP itself was falling:

Investment/GDP 2007 2014
Cyprus 24% 12%
Greece 27% 11%
Ireland 28% 17%
Italy 22% 17%
Portugal 23% 15%
Spain 31% 19%

Source: IMF, World Economic Outlook

In view of the scale of the crisis, it is not surprising that investment fell as much as it did in these countries. The parlous state of the banks only reinforced the decline. The particularly severe decrease in Greece reflects the political uncertainty there as well as the calamitous economic conditions.

Net exports of goods and services have continued to record a deficit in Greece while the other periphery countries by 2013 showed small (or in the case of Ireland large) surpluses:

Balance on goodsand services/GDP 2007 2013
Cyprus -5% 2%
Greece -12% -3%
Ireland 9% 21%
Italy 0% 2%
Portugal -8% 1%
Spain -6% 3%

Source: World Bank, World Development Indicators

Although Greece’s balance continued to show a deficit, the turnaround between 2007 and 2013 of 9 percentage points of GDP was only exceeded by the increase in Ireland’s trade balance by 12 percentage points. But this change was due largely to the decline in imports that accompanied the contraction of the economy rather than a growth in exports, as happened in Ireland and Portugal. The lack of Greek export growth has been surprising in view of the decline in unit labor costs. These had soared in the period leading up to the crisis, as had those in the other periphery countries. Since these countries could not devalue their exchange rates, labor costs had to come down to make their exports competitive. But despite the declines in wages, there has been no corresponding expansion in Greek exports.

Explaining the lack of responsiveness of Greek exports to the decline in wages has been the subject of several analyses. A study on macroeconomic adjustment programs in the Eurozone undertaken for the Economic and Monetary Affairs Committee of the European Parliament by a team of authors that included Daniel Gros, Cinzia Alcidi and Alessandro Giovannini of the Centre for European Policy Studies, Ansgar Belke of the University of Duisberg-Essen, and Leonor Coutinho of the Europrism Research Centre claimed: “Greek exports price competitiveness has not improved nearly as much as its cost (and wage) competitiveness…” The report’s authors attribute the rigidity in prices to “structural deficiencies.”

A similar analysis was offered by Uwe Böwer, Vasiliki Michou and Christph Ungerer of the European Commission’s Directorate-General for Economic and Financial Affairs (see also here). They use a gravity model to predict export flows in 56 countries, and compare the predictions of the model with actual exports. Greek exports were 32.6% lower than those predicted by the model, which they label the “puzzle of the missing Greek trade.” They then add measures of institutional quality to their model, and find that these are quite significant. Since Greece’s institutional quality is seen as relatively poor, the authors claim this deficiency contributes to the lack of exports.

In view of all the institutional measures that have already been introduced into the Greek economy, it may seem surprising that more structural reform is seen as necessary. Alessio Terzi of Bruegel has argued that the initial reforms in Greece were slanted towards reform of the public sector rather than the private sector. Some of this shortfall was rectified in the 2012 program, but implementation was slowed by the political climate and economic collapse. A lack of coordination with changes in labor market practices has resulted in a decline in wages that has not been matched by corresponding adjustments in prices. Terzo claims that responsibility for these flaws in program design is a responsibility of the troika as well as of the Greek government.

Designing the optimal composition and pace of structural reforms is always difficult. Antionio Fatás of INSEAD writes about the record of reform in Europe since the 1970s (see also here). He shows that there has been a convergence of policies and institutions over time. He takes particular note of Greece and Portugal’s progress vis-à-vis the record of other OECD countries in business-related reforms, although he also notes that small differences are associated with noticeable differences in productivity and output. Christian Thimann of the Paris School of Economics and AXA Group believes that there is substantial scope for further change.

Can reforms be implemented when fiscal policy is contractionary? Tamim Bayoumi of the IMF admits that the short-run impact of regulatory changes is likely to be disruptive, which only reinforces the impact of the fiscal policy. Under these circumstances, the IMF can play a critical role in providing external financing while reforms are being implemented. But, he writes, “…structural policies need a strong leader and broad agreement across a wide swath of opinion makers about the need to re invigorate the economy.”

Such an agreement is difficult to achieve in the wake of a crisis. Atif Mian of Princeton, Amir Sufi of the Booth School of Business at the University of Chicago and Francesco Trebbi of the Vancouver School of Economics have shown that countries become more polarized after a financial crisis as voters become more ideologically extreme and ruling coalitions become weaker. This makes consensus much harder to achieve.

The latest bailout provides an opportunity to change the structure of Greece’s private sector. Consumer markets are to be liberalized, labor practices to be reviewed and an upgrade of its infrastructure to be taken. Can Prime Minister Alexis Tsipras maintain the popular support needed to implement the reforms? And can these lead to a turnaround in the Greek economy? The private sector must become viable if the country’s continuing economic degradation is to end. It would be ironic if such a turnaround occurred during the administration of a political leader who campaigned on a platform of defying the troika and its programs, including structural reform measures. But “a foolish consistency is the hobglobin of little minds, adored by little statesmen and philosophers and divines…”