Belt-tightening ahead

As more and more voices in the European Union call for a major revision of the European Union Stability and Growth Pact, Greece finds itself, along with Italy, on the brink of joining the club of EU members which have violated the 3.0 percent of GDP rule for their budget deficit. Unlike the other violators, but in keeping with Italy, Greece has a high public debt-to-GDP ratio. This means a likely revision of the pact, linking fiscal consolidation to the level of the budget deficit and public debt, as is sought by some key EU officials. This is sure to make Greece’s fiscal adjustment even more painful than it is projected to be at present. This, along with pessimistic forecasts about the impact of adverse demographics on public debt, should convince Greek officials to impose fiscal discipline sooner rather than later to deal with potential output losses in the next few years. Greece’s budget deficit may reach and even exceed the 3.0 percent of GDP threshold in 2003 and 2004, nearly dashing earlier hopes that the public debt ratio would fall below 100 percent of GDP this year. This development comes some nine months after former finance minister Nikos Christodoulakis criticized Germany and France for running a budget deficit in excess of 3.0 percent of GDP. At the time, Christodoulakis came out defending the pact, saying doing away with it would create problems in the large and the small EU countries, in contrast to Romano Prodi, chairman of the European Commission, who had called the pact «rigid» and «stupid» in the fall of 2002. Christodoulakis was not heeded. The pact was more or less pronounced dead by the major violators who chose to ignore it and continued to run larger deficits in a bid to breathe some fresh life into their sluggish economies. Pact revision inevitable The majority of analysts and other market participants seem to agree that the pact in its current form is not likely to survive and that the expiration of the term of the current European Commission this year provides the large EU states with the opportunity to push forward their agenda in a more forceful way. Moreover, it is clear by now that the latter want to make fiscal policy bite during good economic times and boost the economy during bad times. Even though one is right to criticize the large EU countries for using political muscle to violate the rules they helped to write without being penalized, it is also correct to say any reform of the Stability and Growth Pact along these lines represents sound economics. It is also correct to say that revising the pact in a way that takes progress in reduction of the debt ratio into consideration is also sound economics. No matter what happens, Greece will be counted among the losers and has nobody to blame but itself. Although the Greek economy has been growing at satisfactory rates, well above the EU average since 1996, it has failed to produce tangible results, both in the reduction of the budget deficit and public debt as a percent of GDP. Instead, it followed the earlier lead of other EU states in using creative accounting to hide the true magnitude of the budget deficit and public debt problems. The securitization of future proceeds from lotteries, CSF funds and others, and the issuance of exchangeable bonds into shares of state-controlled companies slated for privatization were just some of the techniques used. Minimizing political cost Unlike other EU states which are taking measures to reform their public pension systems, Greece did its best to tackle the problem in a way that minimized political cost, that is, with securing funding for the main pension fund’s projected future deficits. Heading into elections and fully aware of the implications, the previous Socialist government also passed laws that are bound to increase the pension bill, including early retirement for certain categories of public sector employees. This took place despite the fact that the country runs the risk of encountering a pension crisis of unprecedented proportions in the long term which will adversely impact public finances. A study, written last week by the credit agency Standard & Poor’s (S&P) pointed to the potential effect aging populations may have on fiscal accounts. S&P warned that pressure from age-related spending is bound to rise gradually, starting from about the year 2015, giving rise to budget deficits in excess of 4.0 percent of GDP by the mid-2020s in a typical case. The interest on the additional borrowing will increase public spending further, producing even larger deficits and debt burdens. Unless structural reforms are taken and fiscal consolidation is sped up, S&P projected Greece’s general government-to-GDP ratio to reach 275 percent in 2050, compared to 278 percent in Portugal, 307 percent in Germany and 260 percent in France. Decisions deferred Having to cope with spending overruns related to preparations for the Olympic Games, the current Greek government has said it will make its fiscal program more explicit in the fall after an ongoing audit of public finances has been completed. In addition, it has not signaled whether reforming the country’s ailing social security system will be a priority. High-level government officials, assuming they are still in power four years from now, have said in the past and in private that would be a task to be taken up by the conservatives in their second term. This is good politics but not good economics. The sooner Greece faces up to the task of taking advantage of still high GDP growth rates to close the budget gap and overhaul its pay-as-you-go public pension system, the better. It will definitely not be an easy task as it will entail sacrifices on the part of the public and high political costs on the part of the government. Greece, however, cannot wait. The likely revision of the Stability and Growth Pact will make things even tougher than they already are and result in greater sacrifices in output and income in things left unchecked given the country’s high debt ratio.

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