Sacred cows of Greek political system need to be sacrificed

The government has no choice but to sacrifice some of the benefits of the sacred cows of the political system, that is, the employees of the public sector, if it wants to win over the markets, cut the budget deficit and put the economy on a sustainable path toward growth. Even so, it has to do it fast and in a concise way rather than taking the piecemeal approach. The much-awaited speech by Prime Minister George Papandreou a week ago disappointed the capital markets, as evidenced by their subsequent reaction, namely the widening of Greek spreads over those of Germany and the drop on the Athens Exchange. It is true that the premier’s speech was long on generalities and short on specifics. Even so, it could have been received more positively by the markets had he chosen to highlight some of the few specifics in his speech on fiscal policy rather than the 90 percent tax on the bonuses earned by executives and others at private banks. The positive reaction by markets to Finance Minister Giorgos Papaconstantinou’s clarification of the 10 percent reduction in public servants’ fringe benefits and the revision of the 2010 budget deficit target to 8.7 percent of gross domestic product from 9.1 percent earlier proved this point. Yet both references were in the prime minister’s speech but few in the market paid attention, since even the downward revision of the budget deficit goal was not stated explicitly. Details may make the difference but these kind of mistakes by the premier in a major speech awaited by the markets should have been avoided in the first place. Still, these mistakes could have been forgotten had the government not continued to repeat the old ones. First, the government is announcing one economic measure at a time when the markets want to hear the entire package for how it aims to achieve ambitious budget deficit targets in 2010 and beyond. It is obvious that the government’s piecemeal approach is weakening the effectiveness of its economic policy. Second, the new government appears to be insistent about plugging the budget hole by increasing taxes and fighting tax evasion rather than limiting expenditures. From the viewpoint of any independent observer, the government seems to be sending the signal that it wants to cut the budget deficit by relying on higher tax revenues than on cutting expenditures. While this is due to internal strife, the political cost and concerns about the strong reaction of the labor unions is not clear. Perhaps all of the above factors have played a role in its adoption of this approach. It is a high-stakes approach, because on one hand, it may alienate the markets and, on the other hand, it risks crowding out the more productive private sector, making the recession deeper and longer lasting. It is understood the political cost of reducing the pay of more than 500,000 public servants would be high for any government, especially a socialist one. But it should also be taken into account that the majority of these people displaced others because of their political connections and party affiliation who may have been more qualified. Moreover, a large number of civil servants appear to get paid more than they deserve, based on productivity. Last but not least, most are guaranteed lifetime employment, financed, to a large degree, by taxes paid by employees in the private sector whose jobs are always at risk. So, from the ethical and economic point of view, the public sector should have shouldered the brunt of fiscal adjustment along with the tax evaders. We should not forget that the wage and pension bill in the 2009 budget bill increased by 11 percent between 2008 and 2009. A similar increase was recorded in the last eight years. Although part of this increase is due to the imprudent policy of more hirings in the public sector, it still points to hefty pay increase with a minimal rise in productivity. It is clear that the markets have smelled blood and will keep up the pressure on Greek bonds unless the country comes up with a satisfactory set of budget deficit-reduction measures based on spending cuts that are fully backed by the EU. Alternatively, the country needs to find some buyers for the bonds to be issued next year, giving it time to prove the fiscal policy works. Still, it would be to the benefit of the country for the government to choose the fast lane with an ambitious deficit reduction plan where the sacred cows of the political system bear the biggest burden.