The Fiscal Adjustment Program of Greece: Success or Failure?

PANAGIOTIS LIARGOVASPARLIAMENTARY BUDGET OFFICE

Athens, November 22, 2014

CONTENTS

I. Methodological issues

II. Greece 2008 vs Greece 2013

III. What went wrong?

IV. What remains to be done?

I. METHODOLOGICAL ISSUES (1)

1. Programs are based on forecasts. 2. The program parameters are often subject to

renegotiation.3. Not all policy decisions taken by a country result

from the assistance program.4. Program success is contingent on implementation

by national authorities.5. Program outcomes are affected by spillovers from

other countries.

I. METHODOLOGICAL ISSUES (2)

• Not an assessment based on the fulfillment of the targets set.

• Focus on specific topics of European relevance.

• Starting with the picture of Greece before and after the crisis.

Variables 2008 2013General government primary balance* -4.8 0.8General government balance* -10 -3.2current account balance* -15 0.7inflation** 4.2 -0.9General government gross debt* 113 175People at risk of poverty or social exclusion# 28.1 35.7unemployment rate *** 7.7 27.3GDP per capita**** 21,000 16,500* % GDP, ** percent change, average consumer prices, # percentage of total population, *** percent of total labor force, **** current market prices in €

Source: IMF World Economic Outlook database, October 2014, Eurostat

II. GREECE 2008 vs GREECE 2013 (1)

2008 2009 2010 2011 2012 2013-18-16-14-12-10

-8-6-4-2024

-9.9

-15.6

-11.0-9.6

-6.4

-3.2-4.8

-10.5

-5.1

-2.4-1.3

0.8

-15.0

-11.2-10.3

-9.9

-2.5

0.7

The achievements of the fiscal adjustment (% GDP)

General government balance General government primary balanceCurrent account balance

II. GREECE 2008 vs GREECE 2013 (2)

Source: IMF World Economic Outlook database, October 2014

2008 2009 2010 2011 2012 2013 2014* 2015* 2016*-10

-8

-6

-4

-2

0

2

4

6

-0.4

-4.4-5.4

-8.9

-6.6

-3.9

0.62.9

3.7

GDP growth rates of Greece, 2008- 2016 (ESA 2010)

II. GREECE 2008 vs GREECE 2013 (3)

Source: European Commission, Autumn Forecasts, 2014

2008 2009 2010 2011 2012 20130

20

40

60

80

100

120

140

160

180

200

113130

148

170157

174

Debt as percentage of GDP

II. GREECE 2008 vs GREECE 2013 (4)

Source: IMF World Economic Outlook database, October 2014

III. WHAT WENT WRONG?

•Austerity

•Expectations

•Policy mix

• Institutions

•Fairness

•Exports

AUSTERITYPaul de Grauwe, 2013

Extremely frontloaded and implemented in panic, especially in Greece.

Markets pushed the country into implementing severe austerity (through the increase of bond spreads).

The more severe the austerity was, the deeper the recession of the economy ( → explosion of the debt to GDP ratio).

Combined with severe liquidity constraints (in Greece).

AUSTERITY AND DEBTS

Source: Paul De Grauwe

AUSTERITY AND GDP GROWTH

Source: Financial Times and Datastream

AUSTERITY AND RECESSION

USA, 1929Latvia, 2008

Greece, 2008Argentina, 2001Thailand, 1997

Finland, 1991AVERAGE (ex. Greece)

Malaysia, 1997Korea, 1997

Colombia, 1998Hong- Kong, 1997

Sweden, 1991Philippines, 1997

Norway, 1987Japan, 1992

-35 -30 -25 -20 -15 -10 -5 0 5 10-29

-25.5-24.9 6

Economic crises and lost output

Lost output (% GDP) Duration (years)

Source: IMF, Reinhart & Rogoff (2009), Budget Introductory Report 2012 & 2013, Hellenic Statistical Authority

EXPECTATIONS (1)Giavazzi and Pagano, 1990

The policy choices failed to create positive expectations about the future developments of the Greek economy.

The responsibility lies on both, domestic and foreign factors.

The Greek government sent ambiguous signals to the markets:• Structural reforms lagged constantly behind the program

• Great delays in dismissals of public sector’s employees and privatizations

• Excessive tax increases

• Lack of strong political determination

Inappropriate statements (about “Grexit”) from European officials further fueled uncertainty around the Greek economy (→ investment nosedive, under-consumption, stock market turbulence).

EXPECTATIONS (2)Giavazzi and Pagano, 1990

POLICY MIX (1) Alesina and Perotti, 1997

The Greek adjustment was not sufficiently based on permanent cuts on primary expenditure.

Empirically optimal: (at least) 70% on the expenditures side (except for public investment) and (at most) 30% on revenue side.

Only in 2010 and 2013, this fact was hardly implemented. In the depression years 2011 and 2012 (cumulative loss of

15.5% of GDP), only 45% and 49% respectively were on the expenditures side.

Excessive cuts on the Public Investment Program even in 2015.

Overall the adjustment was:

Unsustainable

Recessionary

Unfavorable for positive expectations

POLICY MIX (2)Alesina and Perotti, 1997

DOMESTIC INSTITUTIONS Daron Acemoglu, 2014

Was the timing wrong?

Institutions should amplify the positive outcomes of the consolidation and not undermine them.

e.g. Tax Administration enhancement should have been prior to the large tax increases in 2011 ( → increased tax revenue).

e.g. Goods market liberalization should have been prior to the private sector’s wage cuts( → reduced prices).

Institutional

Instability

Fragmentation

Divergence

EUROPEAN INSTITUTIONS

Daron Acemoglu, 2014 They did not seem to be ready for a Eurozone member State

debt crisis (→ participation of the IMF).

• Delayed reaction

• Lack of experience

• Insufficient know- how

• Relied on a USA “partner”

• Fragmentation

Eventually, Europe managed to create mechanisms (ESM) for any future cases.

FAIRNESS (1)Kaplanoglou, Rapanos and Bardakas, 2013

The sixth commandment of O. Blanchard and C. Cottarelli.

Fiscal consolidations → serious distributional consequences.

Fairness is crucial for the success of fiscal consolidations.

“Fair fiscal adjustments” may provide the double dividend of enhancing the probability of success of the adjustment and of promoting social cohesion.

Measures like:

• targeted and effective social transfers • higher public expenditure on active labor market programs• decreasing the VAT rate on necessities

In Greece, the consecutive tax increases (combined with the huge tax evasion) levied a disproportionate burden on pensioners and wage earners.

A safety net is only provided by the recently launched pilot program for the Guaranteed Minimum Income (GMI).

FAIRNESS (2)Kaplanoglou, Rapanos and Bardakas, 2013

EXPORTS (1)Daniel Gros, 2014

2008 2009 2010 2011 2012 20130

10

20

30

40

50

24.119.3 22.2 25.1

27.329.126.5 23.9

27.430.8 32.7 34.132.4

2831.3

35.738.7 40.7

Exports of goods and services (% of GDP)

Greece Spain Portugal

Source: Eurostat

Greece seems to have the poorest export performance among the countries of Southern Europe.

Ireland increased its exports to over 100% of GDP in the respective period.

EXPORTS (1)Daniel Gros, 2014

EXPORTS (2)Daniel Gros, 2014

The really important target for any country starting an adjustment program with a double-digit current-account deficit must be export growth.

The Greek economy has remained so distorted (despite any reforms) that it has not responded to changing price signals.

Low international competitiveness, narrow production base.

Except for tourism that skyrockets.

Greece should transform its productive structure based on innovation and technology towards an export orientation.

Sustainability of growth pattern. This depends on:

a) The relief of the public debt

b) The quality and the continuation of the outstanding structural reforms

c) The political stability

d) Any sudden external shocks

IV. WHAT REMAINS TO BE DONE? (1)

IV. WHAT REMAINS TO BE DONE? (2)• The Greek problem is part of a general European problem of

competitiveness and fiscal governance and developments in the EU favor solutions such as: Less austerity, more and deeper structural reforms plus European solidarity (joint initiatives for growth and employment).

• Do not underestimate the potential of a country that faces difficulties to raise funds from the ESM on favorable terms and use the new tools provided by the ECB and the EIB.

Thank you for your attention!