In May 2010, the IMF approved a program of 26 billion SDR (about 26 times the Greek quota) despite stating that “risks regarding debt sustainability are undeniably high”. To do so, the IMF amended its “exceptional access framework” by introducing an extra factor: a high risk of international systemic spillovers.
In 2014, the IMF program review stated that debt sustainability “remains a serious concern”. If one looks at the 2010 projections and targets and compares them to data available in 2015, only the deficit-to-GDP ratio behaviour conforms to the original targets (Orphanides, 2015).
- Real GDP has been consistently below the target throughout the crisis, and massively so by 2015;
- Unemployment is about 25% instead of 13%; and
- The debt-to-GDP ratio is about 175% instead of 140% partly because of the disappointing performance of GDP.
Political upheaval and the Greek “red lines”
At the same time, growing popular dissatisfaction with the economic performance of the country and the specific measures implemented has forced a massive transformation of the political landscape in Greece. In the elections held in early 2015, the traditionally strong New Democracy and Pasok parties lost significant part of their power, while a previously small coalition of left-wing groups (Syriza), together with the right-wing party of Independent Greeks, secured more than enough seats to form a government. What brought the two ideologically different parties together was an outright rejection of the “Memorandum”, or loan terms accompanying the support program from the IMF, the Commission, and the ECB (the “Troika”). Further testimony to the protest is the rise of the nationalist party “Golden Dawn” to third position, despite intense investigations of possible criminal activities.
The fact that protest rather than a comparison of well-articulated reform agendas was the key factor in the recent elections has now created an explosive situation. The promise of protest against the past failures has led the Greek government to adopt a very tough negotiation stance with lots of “red lines” that cannot be crossed. The EU reacted with stronger insistence on fulfilling budgetary targets and previous promises. As a result, Greece’s exit from the Eurozone (and possibly from the EU) is being actively considered.
What is really needed: A dynamic, export-oriented productive base
I argue that both sides in this negotiation have failed to focus on the key to fixing the Greek economy in a way that would allow repayment of the debt. The only thing that could provide the basis for debt repayment is a dynamic, export-oriented productive base. This has not been achieved six years into the crisis, and it is even more unlikely to be achieved outside the Eurozone and the EU.
My basic argument is that the adjustment program provided too much ‘stick’ and hardly any ‘carrot’ to the Greek population.
- It focused on measures to reduce the deficit, such as cuts in public expenditure, layoffs of public employees, increases in taxes and introduction of new taxes (notably on illiquid real estate), as well as on cuts in public (and eventually in private) sector salaries and pensions.
- The measures to improve competitiveness and create jobs were internal deflation, reductions in the minimum wage, simplification of layoffs and weakening of trade union bargaining strength.
- The product market measures focused on opening access to specific professions, causing lengthy and politically costly confrontations.
All these looked like ‘stick’.
The ‘carrots’ would be:
- Easing the starting and running of a business;
- Raising investor protection;
- Improving the efficiency of the legal system;
- Linking research to innovation;
- Promoting universities as investment in human capital but also as a potential export industry for Greece; and
- Offering the prospect of higher wages linked to quality and productivity.
These were never presented to the Greek people, even as targets for the medium run.
Yet, the key problem is that the country lacks a broad productive base that could allow export-led growth and import substitution. Both negotiating sides have missed this key point, if not in theory then in negotiating practice. Given this focus in the implementation of the programme, even if not in its design, the programmes economic and political failures are unsurprising.
- The lesson to be drawn is not that Greece is the laggard of the Eurozone that cannot make it and has to get out, but instead that Greece is a country where huge improvement margins have not yet been exploited.
Several of these margins will be illustrated below. It will be a failure of the creditors, but above all of Greek politicians if Greece’s potential for debt repayment and sustainable growth is missed because of a failure to develop a dynamic, innovative, quality-focused productive sector.
By reducing reform pressure and possibilities for the transfer of best international practices, Grexit will become self-fulfilling. After exiting, Greece will be seen to be incapable of reform and production, thus justifying the decision to remove Greece from the Eurozone. Yet a great opportunity will have been missed.
The origins of the fiscal crisis and the lack of a broad productive base
The fiscal crisis in Greece – unlike those in Ireland or Spain – originated in the public sector rather than in the banks.
- The roots of the problem of an inflated and largely unproductive public sector arguably go back in history, all the way to the civil war immediately following the end of World War II.
Communists lost in the civil war, and left-of-centre citizens were effectively and often officially banned from entering public sector jobs. The requirement to be neither leftist nor a sympathizer of the left was formalized through a “certificate of political beliefs” that was often included in the necessary credentials for appointment.
Following restoration of democracy in 1974 and entry to the European Community in 1981, the opportunity arose for a more inclusive approach to public sector appointments. It seems to have been missed by Socialists who came to power and proceeded to interpret public sector appointments as ‘compensation’ for past injustice. This interpretation was a recipe for decoupling public sector appointments from meritocracy, efficiency, and productivity.
- Public sector employees were appointed in large numbers, initially at low pay, without monitoring and meaningful evaluation, and without well-defined objectives.
- Regardless of its own objectives, the right wing opposition had little choice but to follow suit.
The result was a bloated public sector, with employee evaluations that were all “excellent”, horizontal structures for wages and salaries, and lack of incentives to exercise effort and engage in creative thinking about how to improve service to the public and the economy.
The setup of politically motivated appointments was conducive also to the establishment of a clientel-ist state, which allocated funds for public projects on the basis of support to the party rather than on efficiency criteria. Over time, this focus resulted in shrinkage of private sector activities that could not elicit public contracts and exploit party loyalty.
In this way, the Greek private sector gradually became dependent on government funding, instead of orienting itself to export demand and international competition.
- By 2012, one third of Greek exported goods revenues were coming from refined petroleum, obviously with a huge imported input of crude petroleum.
- The next component (packaged medicaments) was one tenth as important in terms of revenue, and it was followed closely by aluminium plating and non-fillet fresh fish.
Not only the composition but also the overall size of foreign trade is very small, even by comparison to other crisis countries. It amounts to about 12% of GDP in Greece, while in Portugal, for example, it amounts to about one third of GDP.
Such a deficient export base cannot yield the quantity expansion necessary for a cost reduction (implemented through internal deflation or even through an exchange rate depreciation upon leaving the euro) to launch an export-led recovery and sustainable growth. This point is often missed by those who advocate exiting the euro in order to improve export revenues and promote import substitution.
- Unlike the tourist services sector – which could benefit from increased cost competitiveness – there is not much of an export sector in Greece that could support an export-led recovery.
Establishing the right conditions for promoting development of such a sector should be the top priority.
The failure of the adjustment programme
A rational approach to dealing with a fiscal crisis is to combine measures that reduce the budget deficit and tidy up finances with other reforms that create prospects for sustainable growth of the taxable base and development of debt repayment potential.
Dealing with a fiscal crisis involves a standard package of curtailing and streamlining public expenditures (possibly through public sector layoffs and cuts in salaries) and increasing tax rates and the size of the tax base (possibly by introducing new types of taxes, such as a real estate tax). The latter should include measures to boost competitiveness, foster entrepreneurship and innovation, and to educate, retain, and attract human capital. Competitiveness can be boosted in different ways, aimed at lowering unit labour cost but also producer prices. This can include cuts in salaries and wages, product market reforms to reduce mark-ups, and labour market reforms to increase flexibility of labour adjustments and link compensation to productivity.
Fiscal-contraction measures are for the most part unpopular, as they typically involve cuts in disposable income and sometimes loss of employment. Supply-side reforms are potentially more varied. Some confront worker or industrialist privileges and can provoke resistance and political unrest. Others are so visibly linked to job creation, improvements in human capital, and promise for the future that they should be easy to defend and could indeed elicit the support of the population at large.
The big failure of the adjustment programme is clear:
- So far, it focused on implementing all the deficit-reduction measures and a range of reforms that generate massive opposition by the public, while failing to stress and implement reforms that would boost entrepreneurship, create jobs, promote quality, and inspire confidence among consumers, investors, and especially young people at early stages in their careers.
The adjustment programme was too slow to improve ease of starting a business (as measured by the World Bank), and failed to ease in any significant way the running of a business, improve investor protection and contract enforcement, or link research, innovation, and entrepreneurship.
This combination of ‘all stick but no carrot’ is responsible for the poor economic outcome and for the lack of political support for the adjustment programme, with one reinforcing the other and leading to today’s impasse.
The failure of supply-side reforms and the wide margins
In this section, I document the poor state of various indicators on the supply-side, almost six years after the start of the fiscal crisis in October of 2009. Although this reflects failure of the adjustment programme to produce better outcomes, it also helps to point out that large margins of improvement do exist and could be exploited through proper reforms in the future.
It is important not to miss this ‘half-empty, half-full’ feature of the data provided. The pessimistic view that nothing can ever change needs to be set against an optimistic view that a lot can be gained with even small but well thought out adjustments. These require, however, the political will of the Greek government and the cooperation and understanding of international partners.
We already have an example of what can be accomplished with rather small corrections. Between 2013 and 2014, in only a single year, Greece improved its rank in the ‘ease of starting a business’ index of the World Bank by 111 places (from 147 to 36). The changes had to do with the required procedures to start a new business, and they were accomplished in one year. However, they took about 4 years to be decided and implemented through the system. This is discouraging, especially given the obvious political appeal of implementing policies that create new jobs and favour good ideas and prospects for the future.
Despite this successful reform, Greece still ranks 72nd in ease of running a business in 2014, having advanced by only 17 positions relative to 2013, despite the massive improvement in the ease of starting a business which enters the index. This lack of progress is also reflected in the opinions of business leaders, captured in the Global Competitiveness Report of 2013-14. These leaders state that the most problematic factors for doing business in Greece include an inefficient government bureaucracy, tax regulations, policy instability, and tax rules, in addition to limited access to financing.
The 2014 Ease of Doing Business Report points further to the poor state of investor protection through the legal system. The average number of days required for contract enforcement through the legal system in Greece is reported to be 1300, while the OECD average is only 539. The potential importance of this factor can be seen from the responses of German financial sector practitioners to the Centre for Financial Studies (CFS) Index Survey of April 2014: 89.8% of German practitioners regarded “legal security” as a “very important” factor for considering investment in any of the southern European crisis countries. This is the factor most widely considered to be important, by a wide margin. The second one (human capital/good educational system) is mentioned as being important by 62.3% of the respondents.
Beyond investor protection, legal security, and ease of doing business, a further important factor is corruption as perceived by potential and actual investors. Transparency International constructs a “Corruption Perceptions Index” for about 175 countries. Greece and Italy share 69th place in increasing level of corruption, but Greece’s score has fallen to this place over the past three years (2012-2014). This new position is shared by Brazil, Bulgaria, Romania, Senegal, and Swaziland, which form the peer group of countries in the eyes of potential investors.
In the 2014-15 Global Competitiveness Report of the World Economic Forum, Greece is ranked 81st out of 144 countries, with a Global Competitiveness Index of 4.0 out of a maximum of 7.0. While it exhibits relatively small distance from the top when it comes to health and primary education, infrastructure, higher education and training, technological readiness, and market size, Greece fares dismally in innovation, financial market development, macroeconomic environment, and institutions. Its peer group in this ranking consists of Guatemala, Algeria, and Uruguay (ranked right above Greece) and Moldova, Iran, and El Salvador (ranked right below). Moreover, Greece’s competitiveness trend is completely flat, not showing signs of improvement during the implementation of the adjustment programme.
A lot is made of the need for internal deflation (cuts in salaries and wages) in order to boost competitiveness under a common currency that prevents devaluations. Indeed, the political difficulties in lowering salaries and wages are often cited as major arguments for a (temporary or permanent) exit from the Eurozone. The ECB publishes a Harmonized Competitiveness Index based on unit labour costs, i.e. the costs paid to labour for producing one unit of output on average. This index is highly relevant for assessing the role of labour costs in overall competitiveness, as it measures how competitive unit labour costs of a country are relative to the other Eurozone countries, but also relative to major countries trading with them.
The change in the index relative to 1999QI shows that, indeed, Greece had experienced one of the greatest losses in unit labour cost competitiveness by the start of the crisis (2009Q4), second to Ireland among the crisis countries. However, already by 2011Q4, Greece ranked third in the Eurozone in terms of improvement in unit labour cost competitiveness, still experiencing a small drop after Germany and Austria that were the only ones experiencing an improvement. By 2012Q2, Greece was not only registering an improvement in unit labour cost competitiveness but had surpassed Austria. By 2013Q3, Greece was the undisputed second to the Champion (Germany), with a highly significant improvement in unit labour cost competitiveness.1
In a recession, unit labour cost figures tend to improve partly through an improvement in competitiveness due to ‘cleansing’ (or elimination) of inefficient industries and companies. As a matter of fact, Greece exhibited a drop in productivity as the crisis worsened, but the cuts in wages were so large as to overcome even this productivity drop.
The sizeable improvements in unit labour cost competitiveness were due to the massive drops in wages and salaries in Greece, which kept being insisted upon by the Troika and by various economists worldwide with a view to improving price competitiveness of Greek exports and import substitutes. Yet, if one looks at the price competitiveness indicators, these did not reflect the improvements in unit labour cost competitiveness. This is because massive wage and salary cuts were implemented before and instead of any serious attempt at implementing reforms that would improve the supply-side indicators reported above.
Given the lack of reforms in product markets, bureaucratic structures, and legal framework and institutions, it is hardly surprising that Greece was the slowest country to rebound in terms of volume of exports of goods following the 2009 crisis among all crisis countries, as well as relative to the average of EU28. Indeed, it is on a much flatter adjustment path than all those, according to the 2014 Adjustment Programme Report of the European Commission. If one looks at the reported volume of exports of services, the situation is even worse: Greece was only at 80% of the 2008 volume by 2014, quite below all other countries examined and without the clear upward trend exhibited by Ireland, Spain, Portugal, and EU28 since 2009. It is also not surprising that most of the improvement in the Greek balance of trade came from reduction in imports rather than from improvements in exports over the period.
The assault on the liquidity buffer
The simultaneous drop in wages, rise in unemployment, rise in VAT, and introduction of real estate taxes constituted a heavy assault on the limited liquidity of Greek households, and was associated with a significant increase in non-performing loans.
The Household Finances and Consumption Survey, coordinated by the ECB but collected by each individual central bank, was first released in March 2013 and reflected data for Greece collected (by coincidence) over the three-month period right before the start of the fiscal crisis. If one considers total assets of each household and computes what percentage of those are financial assets, one finds that Greek households exhibited, on average, the lowest such ratio even before the start of the crisis (of the order of 7%). The average of the 15 Eurozone countries surveyed was of the order of 16%, with Germany exceeding 20%, and Belgium and the Netherlands exceeding 25%.
Looking at the composition of household financial wealth, Greek households had the highest share in bank deposits (slightly more than 80% on average), with Portugal coming second with 70%. Thus, Greek households not only had a rather small liquid buffer, but they were also undiversified in their financial asset holdings. It was this small liquid buffer that was attacked by lower wages and salaries, higher taxes, higher unemployment risk, and increased uncertainty about pensions, and out-of-pocket health expenditures. Moreover, a large part of the increase in taxes concerned real estate taxation. Regardless of its various attractive properties in normal times, this is based on illiquid assets (with a high portfolio share in overall wealth), but it needs to be paid out of the limited and shrinking liquid buffer.
The fraction of non-performing bank loans in overall banks’ loan portfolio, as reported by the World Bank, rose from about 5% in 2008 to about 30% in 2013, indicating that adverse labour market experiences, tax surprises, increased macroeconomic and pension uncertainty were coupled with financial distress on the part of many households and firms.
It is not hard to see how an economic crisis turned into a political crisis and an election shift towards protest parties, regardless of whether they had a well-articulated economic plan to replace the “Memorandum”. This natural tendency, however, was further cultivated, intensified, and exploited by politicians, who drew attention to the negative effects but failed to articulate ways to create jobs and future economic prospects for Greece. Indeed, many politicians focused instead on fostering and accommodating resistance to any reform of the ways that brought Greece to the stage of having to ask for financial assistance in the first place.
What can still be done?
The ways in which the adjustment programme has failed so far to harness the productive potential of the country and to inspire confidence in the future should not be taken as excuses for not undertaking massive reforms. However, these need to focus on creating productive (and debt repayment) potential for the future, and the prospects for access to international markets, financial but also export ones.
The key nexus is finance-entrepreneurship-market demand.
- Working backwards, it makes good economic sense to target export markets as destinations for the products, but also import substitution through quality.
The message of universal internal deflation and horizontal salary cuts is one that discourages those with greater talent and promise for success. Any efficiency wage model can tell us that, if one cuts wages uniformly, one loses the best people who have outside opportunities.
- In developing an export-oriented productive sector, the key message should not be that Greek wages need to fall to the levels of the new entrants to the EU, coming from the former Eastern Europe.
Indeed, German workers face competition from China, but they are not being told to work for the Chinese level of wages. They are told instead that they can earn much more if they produce quality and they manage to justify the difference through the ‘Made in Germany’ label. This is a much more promising message, especially to entrepreneurs and to talented workers and researchers.
Despite a rather poor institutional framework for universities, Greece has pockets of excellence in research that need to be maintained, further nurtured, and linked to industry and applications. Greece’s expenditure on Research and Development as a share of GDP is among the lowest in Europe, under 0.7%, while that for Germany and the Scandinavian countries exceeds 3%. Additionally, the vast majority of such spending in Greece is publicly funded and not undertaken by private companies, a fact that is problematic in a fiscal crisis but quite consistent with the lack of an active productive sector.
It is often argued that pushing R&D spending upwards in peripheral countries is suboptimal and that it undermines labour mobility. There is certainly merit to the argument that R&D should not be wastefully duplicated and that less research-prone countries can always imitate or follow the R&D leaders. Yet, Greece does have a lot of research talent, with several pockets of excellence in its universities and public research centres, and a lot of talent abroad. Ioannidis of Stanford University has estimated that 3% of the highly cited scientists worldwide are Greeks, while the population share of Greece (Greeks) is only 0.15% (0.20%).
The fact that 85% of the highly cited Greek scientists live and work abroad is both testimony to the current lack of institutional framework to attract more to Greece, as well as an indicator of the margins that can be exploited. Indeed, quite apart from developing links of research to innovation, fostering university education can itself have considerable export potential (as evidenced by the success story of the United Kingdom) and it should be among the priorities for export-led growth that need to be considered. Removal of constitutional restrictions to providing private university education should be strongly considered, in combination with strict accreditation procedures for private universities.
Several pockets of excellence in research with potential links to innovation and entrepreneurship have already been identified. The National Council on Research and Technology (ESET for the period 2010-13) published in August 2014 a proposal for a strategic plan 2014-2020, which identified pockets of research excellence after surveying top researchers in Greece. A remarkable set of areas and topics emerged and many of them were difficult to guess a priori.2
A simple, yet powerful, indicator of mismatch between the human capital in the country and the level of R&D expenditure relative to GDP is provided by plotting the population share of scientists and engineers against the R&D share of GDP in 2011 (Press, 2013). Although this follows a more-or-less linear relationship with most countries considered positioned close to the line, Greece appears as a big outlier. Greece has one of the lowest R&D shares but a very high share of scientists/engineers. The Greek R&D share is significantly lower than what other countries with comparable shares of scientists and engineers typically spend.
Dynamic, research-intensive, export-oriented industry needs a lean and efficient public sector to support it, rather than one that hampers its development and productivity by imposing unnecessary bureaucratic impediments. Difficulties in dealing with bureaucracy constitute an important barrier to entry and obstacle to competition that need to be addressed as part of any promising development plan for Greece. Furthermore, optimizing the legal framework with a view to protecting investor rights and contract enforcement is not only deemed crucial by foreign investors and domestic entrepreneurs, but also essential for improving investor confidence and for securing any foreign public funds for investment. Improvements in the legal framework are also very important for resolving the non-performing loan problem in the financial sector (see Haliassos et al., 2015).
Last but not least, establishing sound development policies and ensuring that they do not have adverse social consequences require the presence of active, high-quality economic and social research, independent from industry pressures and party affiliations. Establishment of publicly funded research centres of both types is a priority and not a luxury, especially as they can be designed in a soft form of five-year projects of ‘centres of excellence’. Such calls can be open to universities and existing research centres or groups in the country, in collaboration with centres in the international sphere.
This is a much broader agenda than simply ensuring a target deficit-to-GDP ratio, but one that is necessary to bear fruits and to be accepted by the population at large. While some of the reforms described here will take time to bear fruits, they seem necessary if Greece is ever to get onto a sustainable growth path and avoid its clientel-ist past. The need for some patience in reaching the final destination of this journey should no longer be an excuse for not taking the first step.
Centre for Financial Studies (2014), CFS Index Survey Presentation, April.
European Commission (2014), Greece: Adjustment Programme Report.
Forelle C, P Minczeski and E Bentley “Greece’s Debt Due: What Greece Owes and When”, Wall Street Journal online, Updated May 15, 2015.
Haliassos M, G Hardouvelis, M Tsoutsoura and D Vayanos (2015), “Financial Development and Macroeconomic Stability”. Prepared for an MIT Press volume on reforms in Greece, edited by C Meghir, C Pissarides, D Vayanos and N Vettas.
National Council on Research and Technology (ESET, 2010-2013), National Strategic Framework for Research and Innovation, General Secretariat for Research and Education (Greece), August 2014.
Observatory of Economic Complexity website
Orphanides, A. (2015). “The Crisis in the Euro Area: Greece and the ECB”, slides, May.
Press, William H (2013), “Presidential Address”, Science, 15 November.
Transparency International, Corruption Perceptions Index 2012-2014, available online
World Bank, Ease of Doing Business Report 2014, available online
World Economic Forum, Global Competitiveness Report 2013-2014, available online
2 I mention a few indicatively. In the sector of Energy and Environment, areas with critical mass of excellent researchers included efficient use of energy in buildings, reductions of CO2 emissions, smart grids, treatment of waste water and sold waste, etc. To take another example, the topics for the physical sciences include catalysts, nanostructures, advanced structural materials, graphene, carbon-based nanostructured materials, polymers, colloids and (Nano)composites, etc.
This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.
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Author: Michalis Haliassos is a Professor of Macroeconomics and Finance at Goethe University Frankfurt, Director of the Center for Financial Studies (CFS), and Director of the CEPR Network on Household Finance.
Image: A Greek national flag flutters atop the parliament building in Athens. REUTERS/Alkis Konstantinidis.