By Sebastian Gechert
Macroeconomic Policy Institute (IMK)
Corresponding Author
Groundhog day in Athens: the Greek parliament has decided on yet another round of pension cuts, tax hikes and contingent automatic spending cuts, in order to fulfill the preconditions of Greece’s international creditors for the so called third rescue package that actually serves to reschedule outstanding debt to longer maturities and to convert it from private to public creditors. Alexis Tsipras and his party have come to cross several of their former redlines in order for the Institutions not to pull the plug that keeps the Greek state liquid. But is it worth it?
Clearly, the Greek public finances were on an unsustainable path soon after the financial crisis and still they are ‑ for completely different reasons as I will argue below. Moreover, the costs of an unordered default could be much higher for both Greece and the Euro Area. But is this the only alternative on the negotiators’ table to the full blown austerity that we have witnessed for almost seven years now? My answer would be no.
One has to recognize that Greece has implemented measures of spending cuts and tax increases of about 25 percentage points of its gross domestic product (GDP) since the outbreak of the crisis in 2009. The structural primary balance excluding cyclical components as measured by the European Commission now stands at about 5 percentage points of GDP: wouldn’t Greece be trapped in a deep recession, it would already be running a big primary surplus. This is an unprecedented path of belt tightening, which has virtually destroyed the last anchors of aggregate demand in the midst of a deep recession – a recession that was simultaneously faced by Greece’s trading partners, whose imports from Greece subsequently performed badly as well. During this period, the public primary balance has improved by only about ten percentage points. While this figure is still outstanding compared to other crisis countries, it implies little gain for a lot of pain.
Why did the Greek people’s sacrifice remain largely unrewarded? It is because the negative feedback effects of consolidations are particularly strong in a downturn – a now well-established fact among macroeconomists that has early been spoken out by IMF researchers. Structural reforms like spending cuts and dismantling of employment rights in an economy without a strong export sector and facing a deep depression can make things even worse. Our research shows that a large part of Greece’s extraordinary bad growth path after the financial crisis can be attributed to the austerity measures themselves. With the collapse of economic performance, tax revenues and social spending targets have underperformed – the ultimate reason for the consolidation effect being much weaker than the effort taken. This outcome has been misinterpreted as unwillingness to reform and has been answered by further demands for consolidation measures. Moreover, the loss of more than a quarter of gross domestic product has even impeded lowering the debt ratio back to levels consistent with Euro Area’s fiscal rules. With youth unemployment above fifty percent and thus a huge drag on future growth potential, the situation is unlikely to improve any time soon. Thus frontloading fiscal consolidation has made the repayment of excess Greek government debt even more difficult.
If these basic macroeconomic insights would have been acknowledged early on, and Greece would have been given more time to establish a slower, less growth-retarding, but credible consolidation path, a large part of the depression and its long-term costs could have been avoided. A gradual consolidation path would have allowed the authorities to spend their political capital on necessary reforms like an overhaul of the tax collection system, increasing the efficiency of the jurisprudence or creating a functional social security system that relies less on grandparents’ pensions. It would have likewise been in the interest of other Euro Area governments keen on recuperating their domestic taxpayers’ money. The IMF has learned the lesson to some extent and now advocates a more realistic primary surplus target of 1.5 percentage points of GDP. By contrast, many European politicians and institutions have committed themselves to the narrative that there is no alternative to austerity, thus adding a further act to the Greek macroeconomic tragedy.
*This article is part of a feature regarding the Greek crisis, within the context of a cooperation between "Naftemporiki" and "DIW Berlin". It is based on the research "The Greek crisis: A Greek tragedy?" and expresses the personal opinion of the author.
