More tough decisions needed for the country’s finances
Greece will have to tackle its budget deficit in order to send a clear message to its international creditors about its commitment to fiscal consolidation, while also maintaining social cohesion and keeping the economy growing. However, it is equally important that policies aimed at propping up the economy in the short-run do not undermine its long-term potential growth. According to the latest European Commission forecasts, Greece will grow by 0.2 percent year-on-year in 2009 and 0.7 percent in 2010, compared to -1.9 percent and 0.4 percent in the eurozone, respectively. This is quite a hard landing when one takes into account that the country grew by almost 4 percent per year on average from 1996 through 2008, outpacing its eurozone peers: The average annual growth rate in the eurozone was 2.2 percent during the same period. This outperformance helped bring Greek gross domestic product (GDP) to 88.9 percent of the EU-15 at the end of 2008, according to Alpha Bank’s economists. During this time, the Greek financial sector was liberalized. The main state-controlled nonfinancial companies, such as OTE telecom and OPAP, were listed on the Athens bourse and became transparent. This is the brighter side to the Greek economic story since the restoration of democracy in 1974 in its birthplace. Nevertheless, there is a dark side to the post-1974 story as well: From 1981 to 1996, the Greek average annual growth rate stood at less than 1 percent compared to 2.2 percent in the eurozone. This drove the country’s GDP down to 70.8 percent of the eurozone average in 1996 from 88.2 percent in 1980. During the 1981-1996 period, Greece turned to an expansive fiscal policy to boost its growth and ended up piling up a huge chunk of public debt. In 2009, the country is finding itself in a tough position because it did not do more to cut its budget deficit, reduce its public debt, shore up its ailing social security system and improve international competitiveness during the good times. This happened because the public was not made aware of the medium-to-long-term risks and the political parties in power were more interested in votes than voicing the unpleasant truth and taking unpopular measures. It is no secret that many bankers, analysts and businessmen have predicted that the Greek economy may slide into a recession this year for the first time since 1993 if the tourist industry declines by more than 15 percent compared to a year earlier. This will translate into a bigger hole in the budget because a recession or stagnation are linked with tax revenue shortages and more spending. With Greece paying some 260 basis points over Germany when it borrows for 10 years, it does not want to give the impression on the international markets that its public finances are out of control, although it looks set to satisfy this year’s borrowing requirements of about 44 billion euros or more. Bowing to pressure by the European Commission to bring this year’s budget deficit to below 3 percent of GDP, the government appears to have accepted that it cannot do so by relying solely on spending control. It has to raise taxes as well. This is a realistic assessment based on the history of Greek public finances and the composition of Greek budget spending, where salaries and pensions for civil servants and pensioners, along with interest payments on public debt, account for a huge portion of total expenditures. Therefore, some Finance Ministry officials have suggested that the state impose a one-off tax on profitable corporations and individuals earning more than 50,000 or 70,000 euros per year or even impose a higher tax rate on people earning more than 100,000 euros a year. The fact that this tax measure would help to dent consumer and business confidence further, without bringing in permanent revenues has not apparently been very seriously taken into account. Nor has the state understood the negative implications of the tax on work, productivity and the fostering of tax evasion. Of course, this is not the only tax measure the state is looking at adopting. An increase in the main VAT rate to 21 percent from 19 percent is also being considered at the suggestion of the European Commission. Other tax measures include the pardoning of some form of tax evasion and illegal building. However, the criteria for increasing different types of taxes have more to do with narrowing the budget gap, limiting political cost and giving the impression that the tax burden is shared in a more equitable fashion than in protecting the long-term potential growth of the economy. In doing so, Greece risks entering another era of sluggish economic growth.