Private sector forced to bail out state

The economic adjustment program appears to be back on track, but in reality it is seriously threatened by the protracted recession and the inability and unwillingness of the political elite to overhaul the public sector.

In contrast to popular belief both in Greece and abroad, the general government spent a bit more as a percentage of gross domestic product in 2012 than it did in 2009, the year before Athens asked for a bailout from the eurozone and International Monetary Fund, according to European Commission data. By committing to meet the budget deficit targets without sufficiently cutting public expenditure, the authorities focus on revenues, flirting with taxing the middle class into oblivion.

The popular myth, which has been actively promoted by local politicians, who have little or no interest whatsoever in restructuring the huge public sector, would have it that a shortfall in revenues is mainly responsible for the Greek fiscal mess. The politicians’ stance is easily explained by their unwillingness to sufficiently cut spending, which would have meant doing away with numerous organizations and councils that provide jobs and perks to their voters and party faithful. This is more prevalent in the center-left parties, but even the conservative New Democracy party excelled in this metric last time it was in power.

One would have expected the figures to back up the local politicians’ and some analysts’ claim that the budget hole is mainly the result of insufficient revenues. However, numbers do not lie. A look at the European Commission’s AMECO database on general government, last updated on February 22, shows total revenues went up to 43.8 percent of GDP last year from 38.3 percent in 2009. This is an increase of five percentage points of GDP in revenues despite the continuing contraction of the economy over the same period.

However, what is really amazing is something else: The general government’s total expenditure reached 54.1 percent of GDP in 2012 compared to 54 percent in 2009, the highest ever previously recorded. To be fair, one should note that total expenditure is projected to fall to 51.8 percent of GDP this year, but even so it is still too high for a country which came close to bankruptcy because of its huge public debt.

Even if one excludes interest payments on public debt and focuses on the so-called primary spending, the conclusion does not change. Primary expenditure reached 49 percent of GDP in 2012 compared to 48.8 percent in 2009, according to the same database. This is despite a sharp drop in public investment spending both in nominal terms and as a percentage of GDP. In other words, the decrease in general government spending in nominal terms lagged behind the drop in GDP over the same period, taking the spending-to-GDP ratio to new record highs in 2012.

This confirms that fiscal policies have penalize the private sectord more than the public sector, which is the main culprit for the country’s debt crisis. This in turn may explain more convincingly why the economy has been mired in recession for such a long time. By channeling more and more funds from the private sector into the unproductive public sector over time, the economy was bound to falter.

Of course, one may point to double-digit wage and pension cuts in the civil service over the last few years to illustrate how spending has been severely constrained. Although significant cuts have been implemented, one should note that the structure of the public sector is mostly intact and also take into account some other factors. First, productivity – the major determinant of wages – is much lower than in the private sector. Even after the cuts, salaries in the public sector remain higher, generally speaking. This does not mean across the board cuts, which hurt productivity, are justified. Second, all public sector employees are paid on time, unlike many of their counterparts in the private sector.

Third, there is job protection in the public sector for tenured employees, so far at least. It is true a few public sector entities have been shut down or merged with others over the last couple of years, but voluntary retirement schemes have been employed to reduce the headcount. This comes in sharp contrast with the private sector, where more than 1.3 million people have lost their jobs and tens of thousands join the ranks of the unemployed every month, a factor which has pushed the unemployment rate to 27 percent.

As far as pensions are concerned, one should note that the Greek main pension system is based on the pay-as-you-go principle, meaning the current employees’ social contributions finance the pensions. With the population aging and unemployment up sharply, contributions were bound to fall, entailing an adjustment in pensions in the absence of other funding. This was more so in some “noble” pension funds where sizable increases had been granted in the last 10 years or more with the support of the political elite. These excessive pension hikes were funded with loans which added to the public debt.

Although general government expenditure reached an all-time high at 54.1 percent of GDP last year and revenues have increased by five percentage points of GDP since 2009, the government appears to be focusing on tax collection to produce a small primary budget surplus in 2013. In doing so, it is playing with fire, since there are increasing signs the private sector and the middle class in particular may not be able to shoulder the burden of higher income and property taxes.

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