By Marshall Auerback, a portfolio strategist and hedge fund manager, and Rob Parenteau, CFA, sole proprietor of MacroStrategy Edge and a research associate of The Levy Economics Institute
Historically, Greeks have been very good at constructing myths. The rest of the world? Not so great, if the current burst of commentary on the country is anything to go by. Reading the press, one gets the impression of a bunch of lazy Mediterranean scroungers, enjoying one of the highest standards of living in Europe while making the frugal Germans pick up the tab. This is a nonsensical propaganda. As if Greece is the only country ever to cook its books in the European Union! Rather, the heart of the problem is in the antiquated revenue system that supports that state, which results in a budget shortfall consistently about 10% of GDP. The top 20% of the income distribution in Greece pay virtually no taxes at all, the product of a corrupt bargain reached during the days of the junta between the military and Greece’s wealthiest plutocrats. No wonder there is a fiscal crisis!
So it’s not a problem of Greek profligates, or an overly generous welfare state, both of which suggest that the standard IMF style remedies being proposed here are bound to fail, as they are doing right now. In fact, given the non-stop austerity being imposed on Athens (which simply has the effect of deflating the economy further and thereby reducing the ability of the Greeks to hit the fiscal targets imposed on them), the Greeks really are getting close to the point where they may well default and shift the problem back to those imposing the austerity. This surely can’t be much worse than the slow execution they are facing today.
In reality, the Greeks have one of the lowest per capita incomes in Europe (€21,100), much lower than the Eurozone 12 (€27,600) or the German level (€29,400). Further, the Greek social safety nets might seem very generous by US standards but are truly modest compared to the rest of the Europe. On average, for 1998-2007 Greece spent only €3530.47 per capita on social protection benefits–slightly less than Spain’s spending and about €700 more than Portugal’s, which has one of the lowest levels in all of the Eurozone. By contrast, Germany and France spent more than double the Greek level, while the original Eurozone 12 level averaged €6251.78. Even Ireland, which has one of the most neoliberal economies in the euro area, spent more on social protection than the supposedly profligate Greeks.
One would think that if the Greek welfare system was as generous and inefficient as it is usually described, then administrative costs would be higher than that of more disciplined governments such as the German and French. But this is obviously not the case, as Professors Dimitri Papadimitriou, Randy Wray and Yeva Nersisyan illustrate. Even spending on pensions, which is the main target of the neoliberals, is lower than in other European countries.
Furthermore, if one looks at total social spending of select Eurozone countries as a per cent of GDP through 2005 (based on OECD statistics), Greece’s spending lagged behind that of all euro countries except for Ireland, and was below the OECD average. Note also that in spite of all the commentary on early retirement in Greece, its spending on old age programs was in line with the spending in Germany and France.
In fact, Greece has one of the most unequal distributions of income in Europe, and a very high level of poverty, as the following table shows (source: OECD and Papadimitriou, Wray and Nersisyan). The evidence is not consistent with the picture presented in the media of an overly generous welfare state—unless the comparison is made against the situation in the US, which is akin to comparing a French impressionist’s skills with that of a 5 year old finger-painter.
Of course, these facts don’t matter. The prevailing narrative is that Greece is, in the words of the FT’s John Authers, “a country that was truly profligate”, with little in the way of data to support that assertion. The country, however, is truly stuck: they can’t devalue, they can’t pay their own way because they do not have a sovereign currency, and nobody will voluntarily finance them. So they must exit and devalue or drop their domestic prices. The massive default, though inevitable, is just a step along the way.
To make the problem worse, export earnings also seem to face their own structural cap that is consistently exceeded by import spending, which means that the debt that finances the government shortfall is increasingly held abroad. The debt is issued under Greek law, but now it is payable in Euros which Greece, as a user of euros, can’t create, given the surrender of its currency and consequent fiscal sovereignty. In this sense, ironically, the fiscal crisis is a consequence of Greece’s success, after a long preparation, in joining the European Union, and hence giving up its own currency, as Professor Perry Mehrling has noted.
The point is that, if this analysis of the source of the problem is correct, then standard IMF austerity policy is unlikely to do much to help. And, as the increasingly intensifying riots on the streets are vividly demonstrating, the patient might not willingly accept the medicine. Despite attempts to turn the country into an economic colony of the EU, Greece is still, after all, a democracy and if one is to judge from the growing unrest in the country, it is far from clear whether Greece (or any other euro zone member for that matter) is really willing to cut spending and raise taxes rates to any degree which will satisfy the Fiscal Austerians dominating economic policy in the euro zone today without at the same time provoking an ungovernable failed state, right in the middle of the euro zone. As J.M. Keynes noted a lifetime ago in a still widely ignored footnote to Chapter 23 of his General Theory:
Experience since the age of Solon at least, and probably, if we had the statistics for many centuries before that, indicates what a knowledge of human nature would lead us to expect, namely, that there is a steady tendency for the wage unit to rise over long periods of time and it can be reduced only amidst the decay and dissolution of economic society.
Of course, Keynes was not a “Keynesian” and in any case, what did he know that the mathematically “elegant”, well-calibrated, dynamic stochastic general equilibrium models of contemporary Nobel Laureates of today cannot tell us?
Even the “Troika” – the European Commission (EC), the International Monetary Fund (IMF), and the European Central Bank (ECB) – conceded that there might be a slight problem with their Austerian approaches: In a leaked report, from the currently underway EU Summit, and this document will likely form a part of the deliberations in the Greek debt restructuring proposals to be hammered out by Oct. 26th.
On the first page of the document is not only a pretty open and blatant admission that expansionary fiscal consolidation (EFC) has proven to be a contradiction in terms, at least in Greece, but there is also a serious policy incompatibility problem, at least over the intermediate term horizon, with efforts at internal devaluation (ID) – that is, attempting nominal domestic private income deflation in order to improve trade prospects when one has a fixed exchange rate constraint.
While they stop short of recognizing that their demands and the actions they have imposed on Greek policymakers are setting off a Fisher debt deflation implosion of the Greek economy (never mind rupturing any semblance of a social contract, and ripping the social fabric to shreds as well – this is, after all, the jackboot version of neoliberal “reform” designed to stamp out any last vestige of social democracy and organized labor in the eurozone). This is a very large concession for the Troika to have made before the EU itself has taken a “final decision”.
Admitting that EFC is not working, and that pursuing ID will only aggravate matters further, including the ability of Greece to hit fiscal targets, is a fairly large step by the Troika in the recognition of the reality of the situation. This is not something the faith based neoliberal economists in the Troika organizations are often prone to do. It is not what their incentive structures, formal and informal, tend to encourage them to do.
So why pursue it? Well, let’s face it: this has far less at this stage to do with Greece (even as the prevailing mainstream narrative continues to perpetuate the picture of a lazy, unproductive country full of profligates and scroungers), than punishing other potential fiscal deviants and recalcitrants.
Angela Merkel clearly has Italy in her sights. She, and the Troika are scapegoating the Greeks – in order to make sure that should Greece take the rumored “hair cut” on its debt and restructure, the other peripheral countries – especially Italy – won’t get any ideas and be tempted down the same path of forced debt restructuring, but rather will redouble their efforts to achieve arbitrary fiscal targets on an equally arbitrary timeline (and how’s that worked out for Greece?), and learn to “live within their means”, as the Germans always piously lecture the world. This is the strategy to prevent what is euphemistically called the “contagion impact”. In reality, it is also called the principle of collective guilt – destroying the livelihoods of thirteen million people for political or ideological or faith based reasons, which is frankly disgusting and unacceptable. Given their own history, German policy makers should understand this phenomenon. Indeed in many respects, this all too eerily resembles the tangled, twisted mess left by the demands of WWI reparation on Germany – except this time around, Germany is one of the creditor nations imposing their will on the crushed debtors.
If the prevailing mix of fiscal austerity policies continues, there will be spill-over effects to nations that export to Greece. To be sure, Greece is a tiny market in Euroland, but its fiscal problems are by no means unique. As the bigger economies like Spain and Italy also adopt austerity measures, the entire continent can find government revenue collapsing – even Germany, where economic deceleration has become markedly more noticeable in the past few months. As an illustration, consider the ZEW survey results on six month forward expectations for the economy to get a glimpse of where German export momentum may be going. If the historical eight month lead times continue to hold up – and it is certainly tracking right on schedule to date – then the contagion effects on German exports will be utterly devastating by early 2012.
Finally, if austerity succeeds in lowering wages and prices in one nation it can lead to competitive deflation, only compounding the problem as each country tries to gain advantage in order to promote growth through exports. If private debt to GDP ratios did not well exceed public debt to GDP ratios in most eurozone nations, this might not be such a dangerous dynamic to set in motion.
And here we must ask the painfully obvious question: why, pray tell, do all the Fiscal Austerians make a point of ignoring the private debt overhang built up over years of serial asset bubbles in the eurozone? Could it be the faith-based economics that they practice, where fiscal balances express a sort of moral purity, and private decisions are always and everywhere deemed to be optimal and sustainable by definition, a la the magical passes of the Invisible Hand?
What is most remarkable to us is that the largest net exporter, Germany, does not appear to recognize that its insistence on fiscal austerity for all of its neighbors will cook its own golden egg-laying goose. If Germany wants to run a perpetual current account surplus in order to pursue their Asian-like mercantilist, export-led growth strategy, then some other nation, or group of nations must be prepared to run current account deficits ad infinitum. Which means issuing liabilities ad infinitum to the current account surplus nation in order for the current account deficit nations to spend more than they earn on tradeable goods and services. What this means is that default is inevitable unless there is a policy or price mechanism that encourages the current account surplus nation to reinvest the reserves they earn in foreign trade back into productive, income generating capital equipment in the trade deficit nations. This much is elementary international economics, but somehow it completely eludes Berlin.
The German Chancellor and her Finance Minister like to say that no real economic union is possible if one party to the union (Greece) works shorter hours and takes longer holidays than another (Germany). What she should say is that no real economic union is possible if the governing plutocrats of ALL nations (not just the billionaire Greek ship-owners who probably have already moved their money offshore, but also wealthy bankers who have suffered no consequences for their own fraudulent and willfully destructive lending practices) consistently evade their fair share of the cost of that party’s own state expenditure, expecting the union either to pay the bill itself, or to force the bottom 90% to pay it. And there is no real economic union (or any hope of a future political union) if current account surpluses are not properly and sustainably recycled into the trade deficit nations. It would be as absurd as Texas perpetually insisting on running trade surpluses with the other 49 American states.
Greece is not a special case, but rather a case in point of exactly what happens when you impose fiscal consolidation on countries with high private debt to GDP ratios, high desired private net saving rates, and large, stubborn current account deficits. What is needed is a way to redistribute demand toward the trade deficit nations—for example, by having the trade surplus nations spending euros on direct investment in the trade deficit nations. Germany did this with East Germany. Such a mechanism could be set up under the aegis of the European Investment Bank very quickly. Effective incentives to “recycle” current account surpluses in this manner via foreign direct investment, equity flows, foreign aid, or purchases of imports could be easily crafted. If it could be accomplished, it will be a way Greece and the others could become competitive enough to secure their future through higher exports.
Failure to embrace this kind of coordinated, mutually beneficial growth option will ultimately give the Greeks little alternative but to default, leaving the euro zone’s policy makers with an even bigger and costlier mess on their hands. Admittedly, this will not fully solve Greece’s problems as they would like have to leave the euro zone as well and reintroduce the drachma. They would need to reverse fiscal consolidation and place government bonds in their banks as part of their recapitalization efforts. An independent central bank would also have to become a buyer of government bond issuance as foreign demand would likely evaporate for some time. This would entail capital controls, which will cause people to head for the exits (this is, after all, a country with lots of boats) and will require an active mobilization of real resources into public/private initiatives and export enhancement (improved labor productivity, faster product innovation, more R&D, etc. It would not be pretty, it would undoubtedly be painful, but as Iceland is demonstrating today, it is possible to survive and grow and, in any case, is far better than the alternative of starving to death under the guide of the Troika for a decade or more.
In a more dire scenario, a Greek default, would be more akin to a “Sampson moment” for the entire euro zone. Like Sampson in his last days, blinded and beaten by the Philistines, Greece is weakened, blind and bound. Default would represent one last defiant burst of strength with which it “wrecks the temple” (in this case the euro zone) via default and in doing so, it may also take down everybody else.
Myth-making at the expense of the Greeks does not serve anybody’s interests, as there will be a cascade of defaults everywhere, and a Soviet style collapse in incomes, hardly an enticing prospect for the global economy. Not an attractive ending, but this is the kind of outcome which the troika’s self-serving, immoral and cruel policies could lead to before long. The Greeks, and the vast majority of Europe’s citizens, can surely do better than this. The existing policy path is literally bankrupt and bankrupting, and this game of chicken cannot go on for much longer.