The Greek political elite is doing its best to protect the public sector from a much needed overhaul and other vested private interests are striving to safeguard their privileges while the country?s international creditors continue to press for more austerity to meet the agreed budget deficit targets. At the same time, the number of analysts and others who think the austerity being applied to Greece is excessive and self-defeating is growing. Obviously, both sides cannot be right.
First, some facts. At the start of the Greek adjustment program back in May 2010, the troika — the representatives of the European Union, the European Central Bank and the International Monetary Fund — demanded the country take austerity measures to the tune of 41 billion euros or about 18 percent of GDP for the 2010-14 period.
The bulk of the measures, equal to about 28 billion euros, were to be taken in the first two years, namely 2010-11, with the rest spread out between 2012 and 2014.
Realizing the budget deficit target was not going to be met in 2011, the troika asked the Greek side to take additional austerity measures, bringing the total amount to about 36 billion euros in 2010-11 or some 8 billion more than initially projected.
The extra measures did not stop Greece from missing the fiscal target last year but they did at least help to close the budget gap. The Greek side largely attributed this failure to the bigger-than-expected recession induced by the fiscal tightening while the creditors blamed it mainly on the Greek authorities? inability and/or unwillingness to implement a series of structural reforms set out in the first memorandum.
In the above case, both sides are right. The strong dose of austerity measures undoubtedly contributed to the greater-than-anticipated loss of output and the failure to meet the budget deficit target. However, the mix of the austerity package, favoring taxes over spending cuts, adopted by the PASOK government and blessed by the troika may have played a bigger role in hurting the economy and limiting the fiscal effectiveness of the package.
Moreover, the government?s inability and/or unwillingness, along with the incompetence of the civil service to implement the agreed structural reforms, hurt the country?s credibility abroad and weakened the chances of an economic recovery. The troika and EU officials have singled out delays in reforms as the most important factor behind the failure of the first memorandum. They argue the delays deprived the economy of a much needed competitiveness boost to counter the drag from the fiscal side.
Although the very limited progress in implementing structural economic changes has done little to boost competitiveness, the biggest damage has been inflicted to the local economy in another form, since in our view structural measures bear fruit with a time-lag of a few years.
It has raised the chances of a euro exit in the minds of investors, resulting in a free fall in private investment spending and hindering privatizations. The same notion has been reinforced by persistent statements made by high-ranking government officials in Germany and elsewhere favoring or implying a Greek exit.
But the size of the Greek austerity package foreseen in the first memorandum fades in significance compared to the second memorandum signed last March. The austerity measures cited in the second memorandum revise the total amount to a bit more than 65 billion euros for the 2010-14 period, compared to about 41 billion in May 2010.
The fiscal tightening of 65 billion euros or 30 percent of GDP is unprecedented by any standard in such a relatively short period of time, and is almost double the 2009 record budget deficit gap of 36 billion euros and was aimed at bring the deficit down to 6 billion in 2014. This may partly explain resistance to reforms outside directly affected vested interests because it has increased the adjustment fatigue with a larger portion of the population viewing the troika with enmity.
Of course, it would be ironic if Greece gives up the effort now while only measures equal to about 16 billion euros, including the carry-over, remain to be implemented in 2013 and 2014 under the current fiscal program. Still, the chances are the drag to the weak economy of frontloading austerity measures of about 8 billion euros in 2013 will deeply hurt the economy further, undermining the attainment of next year?s deficit target.
This is more so since the coalition government wants to increase the share of taxes in the austerity package of 13.5 billion euros discussed with the troika. Readers are reminded that the initial mix called for 11.5 billion euros in spending cuts and other savings from the reorganization of the public sector and 2 billion in new taxes. But the government does not want to lay off employees in the public sector and cut further the benefits of special interest groups to satisfy the troika?s demands for more concrete measures to replace hard-to-justify savings from overhauling the public sector. So it opts instead for more tax revenues to make up the slack, assuming the troika consents.
This is not surprising given the Greek political elite?s — especially the left?s — strong ties to the greater public sector. But, once again, it forces the private sector to bear a bigger-than-projected portion of the fiscal adjustment, undermining its effectiveness.
All in all, the unprecedented size and poor mix of the Greek austerity package since the program started has hurt the economy. In so doing, it has made fiscal consolidation harder and dug Greece deeper into the debt trap of rising debt-to-GDP ratio as the economy continues to contract. Some argue Greece should be given more time to meet the goals of its fiscal program, but even this may not be enough if the strong dose of austerity is not reduced or at least supplemented by debt reduction measures at the same time that structural reforms are being implemented.