The Baltic countries? example
The Greek government has been very efficient in raising taxes but much less efficient in cutting spending and pushing forward structural reforms. It may be a bit late but both the administration and the so-called troika should pay more attention to the Baltic countries which seem to be coming out of recession by relying on deep spending cuts to cure their fiscal illness.
Back in June when Ricardo Hausmann, Director of the Center for International Development and Professor of the Practice of Economic Development at Harvard University, visited Athens I asked him whether it would have been better for the Greek economy to take a large hit for one year rather than go though a gradual painful process to slash its budget deficit by cutting spending.
He said Greece was both blessed and cursed at the same time because, unlike the debt-ridden South American countries in the past, it had the EU to provide the necessary financing when shut out of the markets. It was a blessing because it soothed and spread the economic and social pain over years but it was also a curse because it would not allow for a large drop in the country?s GDP for one year or more which would allow it to stand up on its feet afterwards.
I thought about this reading John Dizard?s article on the Financial Times last week where he pointed out that Estonia, now a eurozone member, had a growth rate of more than 8.4 percent in the first half of the year, after falling a steep 14.3 percent in 2009. Estonia like Latvia and Lithuania experienced sharp recessions ranging from 14.3 percent to 18 percent in 2009 but were able to stage a recovery by middle last year.
Of course, the economies of the Baltic countries do not have the same characteristics like Greece?s and their population has lived under the harsh Soviet times to be able to withstand a sharp drop in living standards and poverty unlike the vast majority of the Greek population.
Still, their examples show what a country which does not really have its own currency to devalue can do when it has the right economic adjustment program in place.
We have argued all along that the economic adjustment program Greece is undertaking had some major flaws from the beginning. First, it approached the country?s problem as if it faced a liquidity rather than a solvency crisis. This led to giving less emphasis at the start of the program on public asset sales as a means of reducing the stock of public debt and leading to a more efficient allocation of resources by shrinking the public sector and making the economy more competitive.
Second, it tried to boost the economy?s growth prospects by relying on an improvement of external competitiveness via structural reforms and internal devaluation in the form of lower salaries. As we all know by now the most important structural reforms stalled as various vested interests and politicians resisted them. However, even if those reforms were going ahead it would have taken more than one year at best to really bear fruit.
Third, the program rightly targeted a frontloaded reduction in the general government budget deficit but relied heavily on taxes to bring it about although tax hikes undermined to some extent the goal of boosting the economy? competitiveness in our view.
In other words, the policy mix to slash the budget deficit was wrong. Of course, the measures were primarily the choice of the government but nevertheless it reflects on the program as a whole. Especially, in the eyes of the average Greek citizen who sees the deterioration in his living standards but no light at the end of the tunnel, undercutting the program?s social acceptance.
We also suspect that the planners may have not paid much attention to the fact the Greek economy was a relatively closed one. This meant fiscal policy would have had a bigger impact than in Ireland which has a more open economy. So, the impact of fiscal austerity on Greek economic growth would have been bigger than in Ireland.
Moreover, fiscal austerity would have had a bigger impact on countries such as Greece and Portugal which have a lower private sector saving ratios than in Ireland and Italy. Given the large size of austerity measures in Greece, the effect on the economy turned out to be quite big, leading to a deep and protracted recession, undermining in turn fiscal consolidation efforts and creating a vicious cycle.
At this point, the government is trying another go on producing a primary budget surplus next year by relying once again on tax revenues in an economy mired in recession because it cannot really cut public sector spending as much as the Baltic countries did.
Despite all the hoopla in the local and foreign press about spending cuts, a simple calculation shows the latest package of austerity measures worth some 6.6 billion euros or about 3 percent of GDP is made up of more than 5 billion euros in new tax revenues and the rest in cuts in expenditures.
This is hardly good news for Greece?s embattled private sector and the economy in general which will most likely not be able to follow the successful examples of the Baltic countries, bringing closer the unpleasant phase many in Greece would have liked to avoid.
