Primary surplus targets hurt economy

Primary surplus targets hurt economy

The country’s creditors may want to err on the side of caution, but Greece is already paying a high price in lost output and jobs by delivering record primary surpluses. So, either the scope and mix of the fiscal policy will have to change soon to give the economy some more breathing room, or taxpayers will have to be shielded from a bigger tax burden in coming years if the surplus target is missed in the post-bailout period.

Ever since the first rescue program in 2010, Greece’s creditors have failed systematically to correctly forecast economic outcomes. It is therefore reasonable to wonder how it is possible to design the proper reforms when relying on inaccurate predictions about their impact on the economy. Unfortunately, the tactic of trial and error continues with the record primary surpluses.

Greece’s official creditors are demanding that new pension cuts are implemented from 2019 and that the personal income tax exemption be curtailed further from the start of 2020 at the latest. Their goal is to reduce pension spending and broaden the tax base in order to attain large primary surpluses to the tune of 3.5 percent of gross domestic product to help service the public debt. The latter exceeded 180 percent of GDP at the end of last year.

International Monetary Fund officials had cited “temporary factors” in the past to explain the large discrepancies between fiscal forecasts and actual outcomes in particular. Although temporary factors play a role, the consistent delivery of record primary surpluses points more to policy measures as the root of outperformance.

Greece produced a primary surplus equal to 4.2 percent of GDP in 2017, compared to a 1.75 percent of GDP target, even after accounting for the redistribution of more than 1 billion euros, or 0.8 percent of GDP, last December.

The country also exceeded the budget surplus before interest payments by a big margin in 2016, producing a primary surplus of 3.9 percent compared to a 0.5 percent goal.

Year-to-date fiscal data show that Greece is on its way to outperform the official target of 3.5 percent of GDP again this year by a comfortable margin.

The large primary surpluses explain to a significant extent why the performance of the economy has been lackluster and GDP growth rates have turned lower than the initial official forecasts.

The Greek economy grew 1.4 percent last year after stagnating in 2016. It was the highest reading since 2007 but the lowest in the eurozone last year, and well below the projections for over 2 percent growth of the 2017 budget.

Given the additional restrictive measures legislated by the government for next year and beyond, it is possible that fiscal policy becomes a bigger drag on growth and even contribute to gross domestic product stagnation, undermining fiscal policy in turn.

One would expect the creditors to allow for tax relief measures to bring the record surplus closer to the target and help boost economic activity. However, this is not the case. The institutions prefer to play it safe and have the excess amount distributed by the government ex post although it is known that this policy fosters dependency and helps sustain the Greek clientelist system of benefits for votes.

In this regard, it is important that the parameters of the fiscal policy are recalibrated so that the surplus is closer to the targets, putting less pressure on the economy.

If this is not possible, the second best choice would be to use the record surpluses to form a buffer in order to avoid instituting additional austerity measures through 2022 if the surplus target is missed. This way, taxpayers will be shielded from new tax measures and the buffer could also be used to repay debt after 2022 to lighten the burden on future generations.

Dimitris Kontogiannis ([email protected]) holds a PhD in macroeconomics and international finance. He has written and reported for Reuters, The Financial Times and Kathimerini English Edition, among others. He is currently working for Greece’s public broadcaster, ERT.

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