The labours of austerity

The international plan to rescue Greece is instead starting to paralyse it

WHEN the ancient Greeks invented the word “crisis” they had in mind a short period of acute stress. The modern Greeks have been experiencing crisis for over a year and no end is in sight. As Portugal this week joined Ireland and Greece in requesting international rescue funds, it would have drawn little comfort from the example in the eastern Mediterranean. The mood in Greece is one of deepening pessimism. A plan drawn up last May to sort out the country’s public finances risks trapping the economy instead.



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At Syntagma, the Athenian square opposite the parliament, taxi-drivers picking up fares report falls of 40% or more in custom. Bar-owners in nearby streets hassle tourists to fill seats in near-empty restaurants. In smart Kolonaki, streets are scarred by the boarded-up premises of failed shops. Tourists snap away at the Parthenon on the Acropolis but the city’s prime attraction is hardly teeming. Nine hotels in the centre have closed in recent months.

The rescue plan was never going to be easy to achieve. In order to get €110 billion ($155 billion) in funding from other euro-area countries and the IMF over three years, the Socialist government led by George Papandreou committed itself to a drastic austerity programme. The project envisaged a two-year stint in the economic workhouse as GDP fell and Greece regained lost competitiveness. At the same time Mr Papandreou promised to carry out a comprehensive repair of the economy’s deep-seated structural flaws.

Some important reforms have certainly been made, in the teeth of protests and demonstrations. Unaffordable promises on pensions, an already high 11.6% of GDP last year, have been slashed: instead of doubling to 24% in 2050, the burden will rise by 2.5 percentage points. The labour market has become slightly more flexible through changes in arbitration arrangements and opt-outs for individual firms from collective-bargaining agreements. The government has also sought to tackle entrenched monopolies such as the trucking industry.

Whether these reforms really measure up to the gravity of Greece’s plight is disputed. Yannis Stournaras, director-general of IOBE, an economic think-tank in Athens, calls the shake-up of the monopolies a qualified success. Stefanos Manos, a finance minister in the early 1990s, thinks that too little has been accomplished. The trucking reform is being phased in over two-and-a-half years. Pharmacists have retained their monopoly and continue to enjoy fat profit margins. Law firms still cannot open branches in different cities.

But the real source of gloom is the shorter-term impact of austerity. A year ago the plan forecast that GDP would shrink by 4% in 2010 and 2.5% in 2011. Instead it fell by 4.5% last year and IOBE predicts it will decline by 3.2% in 2011. The unemployment rate has risen from 9% in mid-2009 to 14.2% in the last quarter of 2010, and is expected to average 15.5% this year (see chart 1).

Misery was inevitable, given sharp spending cuts and big tax rises. Last year’s retrenchment was on an unprecedented scale in recent European history, insists George Papaconstantinou, the finance minister, involving cuts of 15-20% in public-sector workers’ pay, reductions of more than 10% in pensions and painful increases in VAT and other taxes. There is more pain to come: a three-year public-sector pay freeze and the government payroll falling from 800,000 in 2009 to 650,000 by 2013.

Even so, the fiscal figures have come in worse than planned. For one thing, the starting point was even grimmer than realised last May. Late last year the budget deficit for 2009 was revised from 13.6% of GDP to 15.4% and public debt went from 115% of GDP to 127% as a string of loss-making public enterprises were put on the government’s books. For another, progress in cutting the deficit in 2010 was slower than envisaged. Provisional estimates put it at an oppressively high 10.6% of GDP rather than the original target of 8.1%. Debt is now close to 145% of GDP (see chart 2).

Measures to tackle tax evasion, for which Greece is notorious, have obvious potential to lift revenue. Mr Papaconstantinou reels off a host of initiatives, including centralisation of tax collection, which are designed to do just that. They may eventually bear fruit but as Michael Massourakis, chief economist at Alpha Bank, points out, there are no swift gains to be made because the problem is so deeply entrenched.

The fiscal setbacks have made the markets even more wary of Greek debt. Ten-year government-bond yields have climbed to almost 13%. The credit-rating agencies have recently downgraded Greek sovereign debt still further, from junk to junkier. This does not affect the government for the time being, because it can cover its financing needs this year from the rescue funds. But under last May’s plan Greece was scheduled to raise about half of what it will require in 2012 from the markets. Since that looks infeasible, it will need even more official help than the €110 billion already pledged.

Greece’s banks—in contrast to Ireland’s—were not a cause of the country’s difficulties. But they are being poisoned by the toxic public finances, not least because sovereign-debt downgrades hurt their own credit ratings. Cut off from sources of wholesale funding, they have become ever more reliant on liquidity support from the European Central Bank, now equivalent to almost a fifth of their total liabilities. Depositors are skittish and banks are having to offer them higher rates.

Higher funding costs have pushed up lending rates, but the main way that the banks’ difficulties are affecting the economy is through credit rationing. Demand would be anaemic anyway but credit growth to the private sector, which ran at over 21% a year in 2006 and 2007 and a still perky 16% in 2008, has collapsed. Lending fell by 0.2% in the 12 months to January. As banks shrink their balance-sheets the squeeze on business intensifies, which in turn hurts the banks through higher loan losses. Non-performing loans have grown to 10% of the total.

In a sign of the pressures on business, more companies quoted on the Athens stock exchange made losses last year than reported a profit. The economy is stuck in a vicious circle. If it stays weak, that will undermine the government’s ability to achieve additional fiscal retrenchment; that in turn will cause further loss of confidence on the part of the markets, which will continue to lock the banks out of funding sources. Is there a way out of the trap?

The government argues that the exit is in sight and will come, in essence, by sticking to the plan. Just as the darkest hour comes before dawn, so with the Greek economy. Mr Papaconstantinou points to some encouraging signs: a rapid growth in goods exports in recent months, a significant fall in labour costs and indications that tourism will pick up later this year.

But even if Greece is starting to become more competitive, it still has a long way to go. The IMF estimated in March that the country’s costs are 20-30% too high. Bringing them down will take time, and Greece does not have much of that. Dimitri Papalexopoulos, who runs Titan, a cement company, fears that the economy will continue to flag as private investment is stunted by lack of credit and confidence.

Many have argued that restructuring is the only answer. Winning a reprieve from the markets would certainly require something much bolder than a slightly stricter version of the same plan. One option would be to turn the commitment to raise funds through privatisation into a broader opening of the Greek economy. At a summit in March the government promised to raise as much as €50 billion (22% of GDP) by selling assets in return for better terms on its European loans.

There was immediate doubt about the seriousness of its intent, given dissent within government and from trade unions. Facing down such opposition would make full-throttle privatisation even more potent as a way of bolstering confidence.

The bulk of the proceeds would also have to come from land sales, which could call forth another important and long-overdue reform: a land registry. The state owns more property than the private sector but no one can be sure about its precise holdings—and those of private owners—because of the lack of a proper registry except on some islands such as Rhodes (formerly occupied by Italy). Establishing a proper register, says Mr Papalexopoulos, would be “the single most effective way to kick-start growth throughout Greece”.

All this requires firm leadership, however, and Mr Papandreou is, in the eyes of many, failing to provide it. “The oarsmen are rowing back and forward at the same time,” says a business boss. The optimists’ view of Greece is as a giant, sun-kissed development opportunity, Florida minus the swamps. Without decisive political action the harsher judgment of the markets will be the one that prevails.

economist.com