Economy’s response to memorandum offers hope


TAGS: Analysis, Economy

Greece’s participation in the Economic and Monetary Union and the favorable conditions this brought led to its economy growing at a rapid pace. This growth was based mainly on domestic demand and consumption was instrumental, being fed by both public and private lending. Thus, new problems compounded the already existing weaknesses of the domestic model of production: unjustifiably expansive fiscal policies, swelling debt, a serious deterioration of competitiveness and a significant increase in the external deficit. The global financial crisis of 2008 turned the spotlight on the problem cases. In Greece, the crisis swiftly turned into a debt crisis and the country was shut out of the international markets in a period when the state’s borrowing requirements were greater than ever before. In 2009, shortly before the outbreak of the debt crisis, the public sector deficit stood above 15 percent of GDP and the current account deficit was at similar levels. No other country in the Organization for Economic Cooperation and Development was experiencing such a toxic combination of “twin” deficits.

We all know what ensued. The memorandum and what came after was nothing more than an effort to deal with these two skyrocketing deficits. The policies implemented were focused on fiscal adjustment while also ensuring the credit needed to avert a bankruptcy. At the same time, reforms were pushed through to cure chronic ailments of the production structure and ease the way toward a new growth model.

The stabilization policies inevitably came at an economic and social cost: additional recession, an increase in unemployment and a reduction in incomes. To a degree, these effects were to be expected and had been observed in almost every stabilization program implemented worldwide. In Greece though, this cost was, according to all estimates, a lot higher. The reasons have been analyzed at length and lie in a string of factors that are less technical than political, such as: weaknesses in program planning and erroneous assessments of the consequences, but more often backpedaling, shifting focus, populism, the hesitation of Greek governments to take ownership of the reforms and to implement the programs with consistency, total denial of reality and a confrontational social and political climate polarized by the absence of government-opposition consensus. Such consensus was achieved in all the other eurozone member-states where similar programs were successful in pulling them out of the crisis.

All of these factors weighed against the consistent implementation of the programs. However, the most important factor that caused the recession to drag on and fed burgeoning unemployment appears to be the inability of a significant part of the political system to deal with a handful of major and many smaller interest groups that resisted the reforms and contributed to the continuation of structural divergence. As a result, the effectiveness of economic policy was restricted, particularly in areas such as taxation, social security, investment, market liberalization and in the consequent strengthening of the healthy forces of competition in the goods and services markets, the modernization of the public sector and, finally, in the strengthening of competition and the rapid reorientation of production toward international markets.

Despite the problems, the high cost of adjustment and the frequent setbacks, the memorandums, i.e. the fiscal and structural adjustment programs, which were implemented from 2010 onward, succeeded to a significant degree in reversing many of the prevalent unfavorable trends and improving the economy’s growth potential. More specifically, the programs achieved:

- Unprecedented fiscal adjustment. In the 2013-16 period, the primary deficit was wiped out and, for the first time since 2001, primary surpluses were recorded in general government accounts. Furthermore, the “structural” primary fiscal balance improved by more than 17 percentage points of potential GDP in the 2009-16 period. So, taking into account the effects of the economic cycle, the fiscal adjustment in Greece was more than double that achieved by other member-states that implemented similar programs.

- Recovery of the large losses in competitiveness in terms of unit labor cost in the 2000-09 period.

- Elimination of the current accounts deficit, which exceeded 15 percent of GDP in 2008.

- An increase in exports from 19 percent of GDP in 2009 to 32 percent today.

- The recapitalization and restructuring of the banking sector, which allowed it to weather the crisis and stem the flight of deposits so that lenders today have the adequate capital, provisions and collateral which are necessary conditions (though not sufficient in themselves) to deal with the major problem of nonperforming loans.

- Structural reforms, particularly in the labor market but also in the product and services market and in public administration.

- An economic rebound in the second and third quarters of 2016, resulting in an expected positive growth rate for the entire year, for the first time since 2014.

- Curbing (and slightly decreasing) the volume of nonperforming loans in the second and third quarters of 2016, for the first time since 2014.

The reforms implemented over the course of the crisis are expected to boost the Greek economy’s growth potential in the long term by increasing productivity and employment. According to the OECD, the reforms implemented in the 2010-2016 period, in combination with those that will still be implemented as part of the program, are expected, ceteris paribus, to increase real GDP by 13 percent over the next decade. This estimate, in fact, is a minimum, in the sense that it is difficult to quantify and therefore assess the effects of reforms such as, for example, improving the justice system, bankruptcy laws and out-of court settlement procedures, modernizing public administration and, more importantly, the effective management of nonperforming loans. The OECD’s estimate is also confirmed by relevant analyses by the Bank of Greece, which have found that the main benefits of reforms concern speedier growth of total factor productivity. More specifically:

- Labor market reforms leading to a 10 percent reduction in employers’ payroll costs on a permanent basis are expected to result, over a decade, in increases of 4.5 percent of real GDP, 3 percent in employment and 4.5 percent in private investments.

- Increasing competition in the goods and services markets by eliminating the obstacles faced by new businesses leads to a reduction of profit margins. A 10 percent reduction of profit margins in non-tradable goods and services is expected over a 10-year period to lead to increases of 4 percent in real GDP, 3.7 percent in employment and 7 percent in actual investments.

Of course, for all of these positive effects on the economy to transpire, all of the agreed reforms need to be implemented without delay. If just two-thirds of the agreed reforms in the goods and services markets are implemented over a five-year period, the cumulative benefits within the first three years of implementation will be about 4 percent of GDP less than they would be if 100 percent of required measures were implemented over five years.

Flexibility key in the long term

Long-term benefits can be significantly increased when structural reforms are paired with fiscal consolidation measures. Structural reforms improve the economy’s growth potential on a permanent basis and the tax base. Therefore, they generate additional fiscal space in the medium and long term, allowing a faster rebound of economic activity.

Indicatively, and again according to Bank of Greece estimates, the long-term additional benefits to real GDP range between 0.5 and 4 percent when the debt-to-GDP ratio declines by 10 percentage points while reforms in the goods and services markets are simultaneously implemented.

The greatest benefits, of about 4 percent of GDP, arise when fiscal space is used to reduce tax rates on business profits, followed by a gain of about 1 percent when fiscal space is used to reduce the tax rate on income from employment.

We are already seeing a significant restructuring of the economy toward a more export-oriented growth model as a result of the changes that have been implemented. Specifically, the prices of tradable goods and services have risen by about 10 percent in the 2010-15 period relative to non-tradables, making production of these goods and services more profitable and increasing their share in the private economy. The relative size of the tradable goods sectors, in terms of gross added value of the whole of the economy, increased by about 12 percent in 2010-15 in constant prices and by about 24 percent in current prices, whereas in terms of employment the increase was about 8 percent. This development is attributed as much to the structural reforms that have already been implemented as to the fact that export-oriented sectors of tradable goods and services have faced a milder recession and were thus able to gradually increase their share in terms of volume and employment. An additional fact that needs to be stressed is that because of the contraction in domestic demand and construction activity in Greece, many dynamic businesses in the construction sector have expanded abroad (Middle East, Balkans), transforming an activity that used to be considered non-tradable into an internationally tradable one.

The reforms are expected to further speed up the recovery and restructuring of the economy to the benefit of tradable goods and services. However, improvements are also needed in the economy’s funding and liquidity. The key condition for that is the effective management of the huge stock of nonperforming loans. This would have a positive effect on economic activity via two conduits: a) increasing bank loan supply, and b) restructuring many sectors of the economy. It is therefore critical for the legislative framework to be completed as soon as possible.

Bank of Greece estimates and studies show that reducing nonperforming loans will contribute to curbing lenders’ financial risk and ease their financing costs, as well as boosting their capital adequacy. As a result, this will lead to a gradual increase in loan supply and a reduction in interest on loans to businesses and households.

At the same time, we expect a reduction in corporate and household credit risk, resulting in a rise in the value of their assets due to greater returns on capital and real estate. Consequently, households and businesses should become more creditworthy, providing higher incentives for investments.

Finally, the process of consolidating nonperforming loans will release productive resources, which, once distributed among the more productive businesses and sectors, will lead to an increase in total factor productivity.

The above-mentioned indications and estimates are encouraging and allow us to make the safe assumption that the Greek economy has every potential to graduate into a new and healthier growth model. They do not, however, justify any relaxation of ongoing efforts. Quite the opposite: What is needed now is greater determination and steadfast consistency, and, more importantly, avoiding the mistakes and backpedaling of the past. The Bank of Greece, therefore, encourages the institutions, Greece’s partners and the Greek government to show the flexibility needed to end any delays in the bailout program review.

* Yannis Stournaras is governor of the Bank of Greece. This analysis was translated from the Greek by Kathimerini English Edition.