The probability of a Greek default is higher now than in 2009, although the successful completion of the private sector involvement (PSI) plan will significantly decrease the probability of default and a euro exit for the country. However, it will not be the final answer unless the economy stabilizes and this requires a reversal of the collapse of private investment spending experienced in the last few years.
Contrary to what many pundits in the European Union and elsewhere may think, Greece has adhered to austerity pledges but not to reform pledges. In so doing, it has seen the general government budget deficit fall to about 9.3 percent of GDP last year from more than 15 percent in 2009. Even more impressively, the primary budget deficit, which excludes interest payments on public debt, narrowed to about 5.3 billion euros in 2011 from 24 billion in 2009.
By relying more on taxes and less on spending cuts to close the budget gap in a bid to preserve the sacred cow of the Greek economy and of politicians, namely the public sector, it has hurt the healthy private sector, paving the way for a deeper and more protracted recession.
The accumulated output loss in 2010-11 exceeds 10 percent and is likely to reach 14 percent when this year is over with some 1 million unemployed from the private sector.
Also, by failing to frontload privatizations and other structural reforms, Greece did not gain market confidence and saw its probability of default in the CDS (credit default swap) market skyrocket ahead of countries such as Argentina.
It is an irony that excessive private and public consumption spending thought to be behind the country?s twin deficits, namely the budget gap and the current account deficit, accounted for around 90 percent of GDP last year despite two years of cuts.
It is noted that total Greek consumption has been the highest in the eurozone for years. It stood at around 89 percent of GDP on average in the previous decade, about 90 percent in the 1990s, 84 percent in the 80s and 76-77 percent in the 1970s and 60s, according to database AMECO.
It is known that to minimize output losses when a country applies an austerity program, investment spending and exports have to rise to take up the slack as consumption spending drops.
Since Greece has a small, relatively closed economy, exports could not assume this role even if they posted double-digit growth as they did last year and were accompanied by a drop in imports to make negative net exports (exports minus imports) less of a drag on the economy. It is once again ironic that tens of billions of euros in EU subsidies over the last few decades ended up eroding the competitiveness of Greek agriculture as the country imports agricultural products worth 4 billion euros nowadays.
However, what really made things worse was the collapse of private investment spending to around 16 percent of GDP in 2011 from about 24 percent in 2007 and more than 23 percent in the previous decade. It should be noted that investment spending stood slightly below 20 percent of GDP on average in the 1990s, around 22 percent in the 80s, about 26 percent in the 70s and around 21 percent of GDP in the 1960s.
The sharp drop in investment spending has not just contributed to the large GDP contraction and therefore undermined fiscal efforts. Even more worryingly, it undercuts the country?s potential GDP growth in the years to come by limiting or even shrinking the accumulation of capital stock.
Reversing this sharp drop is not going to be easy. It requires a significant decrease in the probability of default and Greece?s exit from the euro. The successful completion of PSI should contribute to a large extent. The attainment of a primary budget surplus will also play an important role to this extent.
It also requires the recapitalization of the Greek banking system to be able to loan companies with viable investment projects. Greece never really relied on foreign direct investment in the last few decades so one should not have high expectations of this. However, public real estate asset sales and privatizations could help revitalize private investment spending by foreigners in the medium term.
Greek politics could also play a significant role. This would be so if the old and new political parties of the center-left and center-right embraced a more pro-business attitude after the next national elections, which are likely to mark a new era in local politics as a hung parliament looks more and more likely.
It is also important for the business community and others to feel that the social situation will not get much worse, which is directly linked to new doses of austerity, and that there is light at the end of the tunnel.
It may also be a good idea for Greek political leaders and the business community to work out a national plan to reverse the collapse of investment spending that unfortunate economic policies brought about in the last few years, making the recession deeper and more protracted and even undermining the economy?s growth potential in the future.