Getting the right policy mix in the long term

After Greece signed the first memorandum with the European Union and the International Monetary Fund, the ruling Socialists introduced a policy mix based on across-the-board spending cuts and steep tax hikes. In return, Greece?s international creditors (the EU, IMF and the European Central Bank) promised the debt-choked nation 110 billion euros in bailout loans.

The mix was a reflection of PASOK?s political demands and convictions: maintaining the size and spending levels of the state sector, putting most of the pressure on the private sector and the more privileged classes, and keeping hands off closed-shop professions. Then came the economic meltdown that saw a reduction in the country?s gross domestic product, soaring debt and an insufficient drop in the deficit.

In the camp of the main opposition New Democracy party, the so-called Zappeio II blueprint launched by its leader Antonis Samaras advertised tax cuts as a precondition for long-term growth. The idea made sense: The private sector generates the wealth that feeds the public sector. Overtaxing the private sector will bring it to its knees and, in the long run, also take a toll on the state sector. In the end, both sectors are set to lose out.

However, while the second memorandum commands a large number of state sell-offs, forcing a timid PASOK to plan at least a few privatizations (while increasing taxes further, a criminal mistake), Zappeio II fails to state the obvious: that in order to achieve the necessary fiscal adjustment (the creation of surpluses), any tax reduction must come with a reduction in the size of the state.

Both mainstream parties (and, needless to say, the parties on the left) have failed to see the connection: socialist PASOK because the public sector traditionally constitutes the core of its party base, and New Democracy because it thinks it can gain from uttering fuzzy neologisms like ?standby labor force.? The conservatives should only try to climb back into power on the basis of a clear political platform that would give them the legitimacy to overcome resistance if, at some point, they were to privatize state assets once in government.

However, economic growth requires smaller taxes and a smaller state (and radical reforms in closed professions, private universities, social security and entrepreneurship). Sure, cutting down on state spending (like by laying off some 500,000 staff, abolishing hundreds of unnecessary departments, and bringing monthly pensions down to 1,000 euros) would fuel the recession, but tax breaks and other structural measures would be a boost for the private sector; so in the long term, part of the unemployed could be redirected elsewhere (meanwhile, a tougher policy on immigration would also enforce the trend).

The jobless would of course receive unemployment benefits. But spending 600 euros (plus some other benefits) a month would be no comparison to paying civil servants 1,800 euros/month. In fact, the state could save some 6 million euros a year by doing so. In addition, taxpayers would benefit from the scrapping of property taxes which impact on property values as well as building activity. More savings would come from cost-cutting measures in health and from introducing university fees.

Adding to all these the benefit from staff reductions, privatizations and other spending cuts, while subtracting the increase in unemployment benefits and lower tax revenues (although tax revenues are anyway low under the existing policy), the fiscal gains would be remarkable.

The big difference, however, would come from the fresh momentum of Greece?s economy now paralyzed by the wrong policy mix. Though far from daring, New Democracy?s economic program is in the right direction. The party could win back some credibility among voters who are beginning to see statism as the root cause of the nation?s economic ills if it did away with state sector unionists among its ranks. That would serve as a powerful declaration of the party?s break with statism.

Nicholas Pirounakis is an economics professor at the American College of Greece in Athens.

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