The Greek government is committed to implementing a whole raft of structural reforms simply to pass the first review of the new bailout program. However, a number of analysts and others doubt whether the additional reforms required under the program will address the country’s fundamental economic problem, which is competitiveness. This will be more so if some key reforms like the social security overhaul are compromised for political reasons.
The government and the mission chiefs of the European Commission, IMF, ECB and ESM are to begin negotiations this week over the second set of 13 prior actions to unlock the subtranche of 1 billion euros. The reforms need to be legislated and approved by the Eurogroup well before Christmas to secure the release of the installment before year-end.
Eurozone finance ministers are scheduled today to discuss the recapitalization of Greek banks and the implementation of the 13 prior actions. Informed sources suggest three out of the 13 milestones will be especially tricky and an agreement could be achieved in time if all three or some were removed to be re-examined later on in the context of the first review of the bailout program. It will not be the first time this happens with the consent of the Commission, which seems to be the most accommodating of the four institutions when obstacles are insurmountable and negotiations require more time.
Although economic analysts and political commentators pay a lot of attention to these developments, financial markets continue to shrug them off. It is no coincidence that the 10-year Greek bond yield climbed recently above 8 percent, a level seen in early October, after falling close to 7 percent at the time the local banks were winding up their private placements with foreign and Greek investors. Obviously the markets were not impressed by the bank recapitalization, unlike high-level Eurozone officials such as Jeroen Dijsselbloem. The same holds true of the agreement between Greece and its lenders on the first list of prior actions, which resulted in the release of 2 billion euros by the ESM.
We think that doubts regarding whether these bailout reforms can bring meaningful economic recovery are behind this behavior. Of course, other factors, like geopolitical risks and the immigration issue, weigh in as well. Even though fiscal discipline is important for a highly indebted country like Greece, it is international competitiveness that will make the difference. Government officials and analysts often point to the country’s improved current account position, which has turned from a deficit equal to about 15 percent of GDP in 2008 to an estimated surplus in excess of 1 percent of GDP this year, to suggest there has been an improvement in competitiveness. As we all know by now, this is largely due to the large contraction of imports on the back of successive years of austerity.
They also point to the sharp drop in unit labor costs, another indicator of competitiveness. The fall has improved the country’s position against core and peripheral eurozone countries, bringing the real exchange rate based on unit labor costs down to levels seen at the time the country joined the euro in 2001. However, a look at the export price deflator, perhaps a more meaningful measure of competitiveness, shows Greek export prices have declined but they are still about 40 percent higher than in 2000 and comparatively more than in other peripheral counties over the same time span. In other words, Greek exports are still expensive.
The fact that wages have fallen sharply but export prices have failed to follow suit should be of great interest because it shows the areas where reforms are needed the most to restore the country’s international cost competitiveness. Increasing competition in certain input and product markets, high taxes, high energy costs and the non-wage bill are some of them. The non-wage bill component has taken center stage again as the Greek authorities seek to increase social security contributions paid by employers and potentially employees. They want to do so to make up for some of the 1.8 billion euros in savings needed over the 2015-2016 to meet budget targets and avoid deeper pension cuts. The required cumulative savings from pension reforms amount to 3.2 billion euros over 2015-2018.
One can understand why the authorities want to avoid the imposition of deeper pension cuts but increasing the social security contributions and therefore the non-wage bill is bound to backfire. This is because it will hurt employment and undermine the competitiveness of Greek exports. Therefore, an increase in social security contributions, just a couple of years after they were decreased, has to be avoided in our opinion. Perhaps, people who retired early and other retirees who benefited from court decisions should be asked to pay more to close the gap. Let’s not forget that there are hundreds of thousands of retirees who received pensions in their 40s or 50s after working for just 15, 20 or 25 years. This is more so if one takes into account the fact that many of them, if not all of them, paid social contributions in drachmas and are now getting paid in euros.
The Greek economy will have to become more competitive to return to a sustainable growth path. However, this will not be the case if important reforms, such as the overhaul of the pension system, are watered down to accommodate goals other than enhancing the competitiveness of the Greek economy.
[Kathimerini English Edition]