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Greece and the troika, dancing in the dark

By Nick Malkoutzis

Finance Minister Yannis Stournaras felt compelled last week to call into a TV news show to deny rumors about imminent property tax hikes for Greeks. He argued there had been a lot of “scaremongering” by the media and politicians relating to the creation of a new property tax, which would unify several levies on real estate that currently exist.

Tax has become an increasingly sensitive issue in Greece. As wages shrink and jobs disappear, nobody is looking forward to the prospect of paying more into public coffers. But anxiety has been spurred by the voting of a new tax bill in January, which increased income and corporate tax and scrapped the tax-free threshold with the aim of raising 2.3 billion euros.

Furthermore, a recent international study by KPMG showed that Greeks pay the second-highest effective income tax and social security contributions at 46.5 percent of their income. Given this burden and the slow progress on ensuring that a sizable minority does not consistently get away without paying its share, it is no surprise that the issue of tax raises hackles in Greece each time it enters the public debate.

While Greeks worry about the practical problems of how tax bills will be paid, analysts have struck up a theoretical debate about whether taxation can play a role in Greece overcoming the crisis. In a recent editorial titled “Greek Tax Insanity”, The Wall Street Journal wondered whether Greece was conducting an experiment to see if it could “tax itself into oblivion.” Bloomberg columnist Josh Barro rebuffed the WSJ’s proposal for a flat tax in Greece as a “really stupid idea”.

Their musings, though, are academic, just as taxpayers’ cries are in vain. Essentially, Greece doesn’t decide its tax and revenues policy. The troika does. While Athens is, to a certain extent, free to choose who it taxes, it doesn’t decide how much to tax them.

Stournaras explained last month that less than a quarter of the 13 billion euros in new savings Greece has to produce this year and next will be derived from extra tax revenues because the troika has reservations about how effectively they can be collected. Stournaras told NET TV that the troika would have preferred all 13 billion euros to be coming from spending cuts because Greece’s lenders find them easier to implement and monitor than tax hikes.

Stournaras's comment is a reminder of the interdependence between Greece and the troika. One side's weakness is the other side's discomfort. In this complex tango for four (Greece, the International Monetary Fund, the European Commission and the European Central Bank), missteps and mistakes have been abundant. There has rarely been harmony or fluidity in the partnership. One side leads at a breakneck speed, while the other is caught between dragging its feet and rushing to keep up. It should not be forgotten that in this dance, which will end either in exhaustion or salvation, the one who leads carries a hefty burden of responsibility when things go awry.

“What technical analysis and the history of crisis management tells us is that you’re better of doing it strong and hard at the beginning in order to enjoy the benefits of the process,” IMF Managing Director Christine Lagarde told the BBC last month by way of defending the dramatic fiscal consolidation that has taken place in Greece since 2010.

Her analysis, though, seems to be in contrast with the findings of a working paper published a few days earlier by the IMF’s chief economist, Olivier Blanchard, and colleague Daniel Leigh. Titled “Growth Forecast Errors and Fiscal Multipliers”, the paper sets out how the Fund made incorrect forecasts about the impact that a rapid fiscal consolidation would have on certain economies, such as Greece’s.

The document is an amplification of the admissions that Blanchard made in the IMF’s World Economic Outlook in October, when he accepted that the Fund had been way off the mark in assessing the recessionary effect austerity would have. Until Blanchard and Leigh carried out their research, the IMF assumed the fiscal multiplier of spending cuts and tax hikes was around 0.5 percent of gross domestic product – in other words, austerity measures equivalent to 1 percent of GDP would produce a 0.5 percent decline in economic activity. The two economists, however, discovered that the real fiscal multiplier was between 0.9 and 1.7 percent of GDP.

In the January paper, Blanchard and Leigh rely on 105 observations rather than the 26 cases they examined for their October findings. “Our results suggest that actual fiscal multipliers have been larger than forecasters assumed,” they write.

Blanchard and Leigh admit that it is futile to try and apply one multiplier to all situations and suggest that it is better to err on the side of caution. “It seems safe for the time being, when thinking about fiscal consolidation, to assume higher multipliers than before the crisis,” they say.

Ever slow on the uptake, politicians in Greece have only just begun tuning in to Blanchard's message. But even so, they have crossed their wires and interpreted the IMF's statement as some kind of blanket admission that austerity has failed. This is not Blanchard and Leigh's intention, nor is it what Greece should be taking away from their research.

Doubts about the accuracy of macroeconomic forecasting are nothing new. In fact, the European Commission published a paper recently admitting that many of its predictions for the 2004-11 period were wide of the mark.

“A significant deterioration of the accuracy of year-ahead projections is found, mainly due to larger forecast errors in the recession year 2009, which by all standards proved exceptional and unanticipated by forecasters,” write the paper’s authors, Laura Gonzalez Cabanillas and Alessio Terzi. They conclude that the Commission’s forecasts are slightly more accurate than the IMF’s but less so than the Organization for Economic Cooperation and Development (OECD).

Where the IMF's “mea culpa" is much more useful is in highlighting the doubts that have been raised about the amount and pace of austerity that should be applied in order to rein in deficits and reduce debt, as well as what factors should be incorporated to calculate targets and to evaluate progress.

“Virtually all advanced economies face the challenge of fiscal adjustment in response to elevated government debt levels and future pressures on public finances from demographic change,” say Blanchard and Leigh. “The short-term effects of fiscal policy on economic activity are only one of the many factors that need to be considered in determining the appropriate pace of fiscal consolidation for any single country.”

In itself, this appears to challenge the “strong and hard at the beginning” theory put forward by Lagarde in her BBC interview. It should be noted that Lagarde herself raised doubts in October about front-loading adjustment programs at a time when many countries are going through fiscal consolidation in an adverse economic climate.

When one looks at the case of Greece in particular, the evidence supports the more cautious approach suggested by Blanchard and Leigh. The contrast between the troika’s forecasts for economic contraction in Greece (4 percent for 2010, 3.5 percent [revised] for 2011 and 2 percent [revised] for 2012) and the actual shrinkage (4.9 percent in 2010, 7.1 percent in 2011 and a likely 6.5 percent in 2012) makes a powerful case against “strong and hard” being applied as a golden rule.

In a paper published last month by the Center for Economic and Policy Research (CEPR), Mark Weisbrot and Helene Jorgensen examine the advice given by the IMF to the 27 European Union member states. The researchers find "a consistent pattern of policy recommendations, which indicates 1) a macroeconomic policy that focuses on reducing spending and shrinking the size of government, in many cases regardless of whether this is appropriate or necessary, or may even exacerbate an economic downturn; and 2) a focus on other policy issues that would tend to reduce social protections for broad sectors of the population, reduce labor's share of national income, and possibly increase poverty, social exclusion, and economic and social inequality as a result."

The message from Blanchard's research and the CEPR report is that while mistakes are unavoidable, they need to be recognized quickly. While incorrect projections can be consigned to history with an admission of blunder followed by a correction, their consequences leave a lasting impact: Human error carries a human cost.

In Greece's case, if the accuracy of forecasts is in doubt, surely so must the attainability of targets. Given that this year's fiscal targets were agreed before the full extent of Blanchard's research was known, isn't there a case for revising the goals? In the wake of the admission over the fiscal multiplier, what is the troika's reasoning behind still favoring a "strong and hard" approach that will see Greece implement some 9 billion euros' worth of measures (approximately 5 percent of GDP) this year?

"I think it's fair to say everyone was a bit too optimistic on forecasting Greece's recovery," IMF spokesman Gerry Rice said last week. “Why? I think... there were a number of reasons. These included the depth and the protracted nature of the European crisis itself, and the political crisis in Greece, which severely affected economic confidence, and delayed the implementation of reforms.

"When it became apparent that the underlying conditions were different to what had been assumed, we certainly moved as fast as we could to update our multiplier assumption."

Rice's explanation, though, simply raises more questions about why just the multiplier was adjusted and not the policy itself. The property tax that Stournaras defended this week seeks to raise 3.2 billion euros, six times what Greeks paid in 2009. Greece's property market is in a state of gradual collapse, construction is on its last legs and consumption is plummeting. Under normal conditions, Stournaras would have rejected out of hand the idea of imposing this level of taxation. But Greece does not find itself in normal circumstances. The tax is not being imposed as part of a recovery plan, it is designed as a tool to help Greece meet the targets agreed with the troika.

A revised midterm fiscal plan submitted to Parliament on Friday sees Greece reducing its public deficit to just 3.2 percent of GDP this year, while producing a small primary surplus of 0.3 percent of GDP, while the economy is expected to shrink further to 183 billion euros. The immediate targets have been made more challenging and in its fifth full year of recession, the coalition government has a fiscal mountain to climb to achieve these goals.

As time has progressed and experts have been able to research the Greek case, these targets begin to look, in the worst case, arbitrary or, in the best case, based on a perfunctory calculation involving money and time: the money the troika is willing to lend and the time Greece has to pay it back. But this process doesn’t take place in a vacuum; there are political and social factors to consider apart from the macroeconomic. Given that Greece has a fragile coalition government, rampant unemployment and substantial social turmoil, it is baffling that the basic criteria of its consolidation program have not been adjusted. After all, the main aim of the program should be to nurse the economy back to recovery to ensure the interests of both lenders and borrower are served.

Speaking in Washington last month, Blanchard outlined that one way of providing relief for countries under a fiscal adjustment program could be to focus on cyclically adjusted data, which factors in the impact of recessions, rather than the nominal fiscal statistics. “We have recommended that countries shift from nominal targets to structural targets,” he said. “Or another way of saying we have suggested that the countries allow automatic stabilizers to work, accepting the fact that fiscal outcome will not be quite what was hoped for.”

Greece’s lenders don’t have to go far to see what impact this switch would have. On page 7 of the IMF’s latest review of the Greek program there is a graph showing that, according to cyclically adjusted data, Greece produced a general government primary balance last year. Basing the program on this method of calculation would ease the pressure on the Greek economy, government and people substantially.

However, as Blanchard acknowledged, it all comes back to the issue of how generous or patient lenders are prepared to be. “The slower you go, the more financing is needed, and there’s not infinite financing,” he said. “And so the financing constraint may force you to go faster than you would want. The results suggest that the pain of going fast may be fairly substantial.”

As Greece attempts to get the program and its economy back on track this year, the warning signs are there that things could go disastrously wrong if all sides persist with the formula that’s been in place since 2010. It was reported this week that state revenues for January were 7 percent below the target and 16 percent lower than last year, as consumption continued to plummet. Perhaps this was just a blip, perhaps improvements in tax collection will overcome this obstacle, but there is a real chance that the recession will leave Greece chasing its tail for another year

In the meantime, though, the question will remain: Is there anyone brave enough to flick the light switch or will the troika and Greece continue to dance in the dark?

[Kathimerini English Edition] , Friday February 8, 2013 (19:31)  
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