New policy needs time

The newly elected Greek conservative government, like its socialist predecessor, has been aiming for high GDP growth rates at 5.0 percent or higher, to help create more jobs and generate more revenues to fund social programs, shrink the budget deficit and help reduce the country’s huge public debt-to-GDP ratio. It should be clear to everybody, though, that this goal is no panacea given the structure of the Greek economy, because it may perpetuate the country’s comparable disadvantage over inflation vis-a-vis the rest of the EU, hurting competitiveness and undermining future livings standards. According to the new Finance Minister Giorgos Alogoskoufis, the Greek economy grew by 4.2 percent last year, much lower than the initial estimate of 4.7 percent hailed by the Socialists. On another note, Alogoskoufis said the general government budget deficit touched 2.7 percent of GDP last year versus a formerly revised estimate of 1.7 percent. Pundits in fact claim last year’s budget deficit may even exceed the 3.0 percent of GDP threshold when the auditing of public finances, ordered by the conservatives, is over. Of course, this is not good news. When a country’s economic turbines worked at full speed to meet deadlines related to the Olympics and fiscal policy was expansionary to help pave the ground for the expected general elections, it takes no Ph.D to understand that achieving GDP growth rates of 5.0 percent or higher in the future is very challenging to say the least. This is all the more so when the country’s general government deficit-to-GDP ratio has come close to 3.0 percent for two consecutive years, attracting the interest of the European Commission. The latter means the government will have no choice but to take measures to contain the budget deficit in 2005, making it difficult to deliver on some of its pre-election promises before the next year. It is understood that taking such measures will have an adverse effect on growth and will likely render the 5.0 percent GDP growth goal unattainable. Alogoskoufis has repeatedly stressed the potential for huge savings from the rationalization of the public sector and the elimination of waste. Although all analysts agree with this assessment, few expect these savings to be realized in a short period of time because they are linked to the overhaul of the civil service and the greater public sector. The latter is not an easy task. It takes time to bear fruit even if one finds competent managers and others willing to get involved in an ambitious, risky project whose success runs contrary to the wishes of entrenched special interests, such as trade unions, suppliers, etc. The chances are there will be some savings but they will not be as high as government officials think. Accelerating the inflows from the EU is another promising area, as the most painless and effective solution to the budget jitters. Still, it is not sure whether the current mechanisms in place can guarantee this result. The bottom line is the government may be forced to take other measures. Reducing the public investment budget is the most obvious and easiest target from a political, though not economic point of view. Raising tax revenues by increasing indirect taxation is another option. Restricting the growth of primary expenditure is a must. Hard choices All in all, fiscal policy should be a neutral contributor to GDP growth at best, making the 5.0 percent GDP growth rate more difficult to attain. Although there is no sign or evidence of a vicious economic cycle, tighter fiscal policies lower GDP growth rates, producing in turn lower tax revenues, leading to a larger budget deficit and so on. The risks to growth are easy to spot. Even if attaining such high growth rates in the post-Olympics era is a hard task, achieving them in the classic way may be prove detrimental to the economy’s long-term prospects. It is known that comparatively higher GDP growth rates partially account for Greece’s higher inflation rate vis-a-vis most of its EU partners. Although there is no general agreement, it is estimated the Greek economy has the potential to grow by 2.5 to 3.5 percent without rekindling inflation. This in turn means economic growth rates in excess of 5.0 percent or even lower may aggravate the inflation problem, driving many Greek products and services out of international markets and hurting employment. Moreover, GDP growth rates of 2.5 to 3.5 percent, which are regarded as compatible with low, stable inflation, are not compatible with reducing the budget deficit and bringing down the huge pubic debt currently in excess of 100 percent of GDP. The only apparent solution to the problem lies in the adoption of an economic policy mix which stresses fiscal orthodoxy and the reinvigoration of the economy through supply-side measures. This kind of policy, however, needs time to work and may well produce tangible results after a three-to-four year period. In the meantime, it will meet all kinds of resistance, and perhaps the unwillingness of government officials to push forward with reforms, knowing the ensuing high political cost as was the case with meaningful pension reforms. The government’s apparent decision to tackle first other, short-term pressing problems, such as the Cyprus issue and the Olympic Games, means that it will lose precious time in attaining and reconciling higher growth rates with price stability. This in turn means the attainment of growth rates in excess of 5.0 percent is likely to come through the classic routes of stronger aggregate demand and this may not prove a blessing after all. Unfortunately, supply-side measures such as the overhaul of the public sector, liberalizing markets and privatizing state-controlled companies, among others, take time to work and a four-year time span is the minimum.