Barring a few forward-looking market participants, it was not clear a year or so ago that Greece’s medium-term economic growth prospects were mainly threatened by fiscal imbalances. This is not certainly the case now, as the fiscal auditing undertaken by the conservative administration and the unfolding economic slowdown have made the threat much more evident. Although tackling the huge budget deficit and maintaining a high GDP growth rate is a top priority for policymakers, it may well turn out to be a very difficult task, bordering on the impossible in 2005. This will be so if they fail to realize that it will take more than the traditional policy means to make fiscal consolidation compatible with high growth and low inflation in the medium-to-long run. It will require a redefinition of the role of the state in the economy and the subsequent downsizing of the public sector via privatizations and other means. Growth slowing down All data and market evidence point to a deceleration of GDP growth in the fourth quarter of 2004, seen extending into the first quarter of 2005 amid signs that the general government budget deficit may have reached and even exceeded 6.0 percent of GDP last year. These developments obviously contrast sharply with the current government’s forecasts calling for a budget-to-GDP ratio of 2.8 percent and economic growth of 3.9 percent in 2005. Fully aware of the Portuguese experience and the potential negative impact of raising taxes on growth, the conservative administration appears determined to go as far as it can in reducing the budget deficit without resorting to sizeable expenditure cuts or tax revenue-enhancing measures in line with its commitment to the so-called economic policy of «mild adjustment.» In other words, the government will most likely choose a budget deficit in excess of 3.0 percent of GDP and criticism from EU authorities instead of a lower deficit and a political backlash accompanied by even slower growth at home. Given the fact that the 2005 budget gap will anyway be much smaller than in 2004, it will be able to claim more convincingly to EU authorities that the deficit will drop below the 3.0-percent-of-GDP threshold in 2006. This way it can also buy time to see if there will be any major revisions to the present EU Growth Stability Pact working in its favor. The latter should not be ruled out and may even take place in the first half of 2005. Fiscal vulnerability Even if against all odds Greece is able to bring its budget deficit below 3.0 percent of GDP and grow by a respectable 3.0 percent or more this year, it will still be vulnerable to a severe deterioration in its public finances in the years to come. So, instead of constantly fighting this fiscal trend underpinned by a high public-debt-to-GDP ratio and an aging population, which puts greater strains on the country’s social security system, Greece should try to permanently change the trend. This requires the role of the state in the economy to be rethought and new lines between the private and the public sector to be drawn. The fact that forces from the Left, the Right and the center of the political spectrum agree on this, forging even a loose consensus on this should be much easier than before. Despite considerable progress made in the last 15 years or so in deregulating and liberalizing markets and even privatizing a few pubic sector companies, the state continues to play a much bigger role in the Greek economy than in any other in the old EU15. To some extent, this is the result of the three rounds of nationalizations the country has gone through since World War II. The most recent period was in the 1980-1985 period under the Socialist government of Andreas Papandreou, while the two previous episodes took place under mostly conservative governments. This situation, however, has undermined the economy’s growth potential and increased the fiscal burden, as costly and ineffective social policies tailored to the demands of politicians and various interest groups were adopted. No wonder entrepreneurship took the back seat to statism and private sector firms along with individuals became dependent on the state for survival, growth and jobs. Greece’s quest to enter the eurozone in the 1990s helped reverse some of the above excesses despite the fact that the majority of the population, spanning the entire political spectrum, continued to favor pro-state solutions to economic problems. In the pursuit of convergence, the previous, Socialist government under Costas Simitis proceeded with the privatization of some state-controlled companies, part-floated others giving away the management, and signed long-term leases with private sector companies. In addition, it went ahead with BOT (Build-Operate-Transfer) infrastructure projects but mostly sought to raise money via the part-flotation of state-controlled entities while retaining the management. It is estimated that it raised more than 10 billion euros in the process, but even this amount was not enough to have a significant positive impact on public finances. So, the current government faces a tougher challenge. In a world where globalization rules and competitiveness among firms is the name of the game, Greece cannot afford to be left behind. Implementing a large-scale privatization program requiring the transfer of management and sizeable equity stakes in state-controlled entities in various sectors, such as telecommunications, energy, lottery, transportation (ports, highways, air carriers, railways), even the defense industry, to qualified private investors is a good first step toward strengthening the economy via a more efficient allocation of resources at the expense of the public sector. Increasing the number of BOT projects would also strengthen the private economy and help save public funds at a time of tight budgetary requirements. State-private sector partnerships would also work to that extent, mobilizing the private sector while producing some savings for the budget. Even ensuring that state-controlled organizations and companies are run by teams of competent managers recruited from the market to minimize political favors would be another step in the direction of adopting prudent fiscal policies and enhancing economic growth. It would be wishful thinking for anybody to assume that the current government or any other one which takes into account the political cost factor can deliver on all of the above. Nevertheless, it is reasonable to expect that some steps can be taken in 2005 to alleviate the burden on the budget and revive economic momentum and a dialogue on the role of the state in the economy is being initiated. After all, creating the conditions for the Greek private economy to thrive, including the downsizing of the public sector, may be the best way to correct the fiscal imbalances and unleash dormant economic forces, boosting the economy’s growth potential.