MacroPolis

The summer month of August is a good moment to sit back and reflect on the broader underlying events in our daily lives.[1] This also holds true for thinking about the macroeconomy of Greece. We can ponder and look at developments from a certain vantage point to ascertain what developments are probably transient and passing, and which ones are more durable and structural. It is the latter that do not always get the attention they deserve; certainly not in a political system that is extraordinarily preoccupied with “the next election.” Daily life is full of ups and downs that consume our energy, and in this turbulence,  we still need to try and filter out what is important for the longer run.

Greece was emerging from the deep crisis of the 2010s when, in 2020, the Covid-19 pandemic hit. It has been the challenge of the day. The Greek economy has suffered from this large adverse shock that particularly affected tourism, hospitality, and travelling. The government has taken quick and effective measures to limit the blow to economic activity and employment, but Greece still suffered another sharp decline in real GDP in 2020 and the first quarter of 2021. This adverse shock has led to even more public debt, disruption of daily life through extended lockdowns, and is still working its way through the economy. Even though the fiscal measures are costly, we need to see through the temporary Covid-19 impact on the economy and calibrate policies for the long run.

There is an accepted rule in macroeconomic management that, if you face a temporary adverse shock, the government needs to support households and businesses to avoid this setback from permanently destroying viable productive capacity. And so it is with Covid-19. Both the European Commission in its evaluation reports on Greece, and the regular staff reports from the IMF have recommended that the Greek government judiciously scales down its substantial support for the economy. The ECB, meanwhile, is doing its part to provide liquidity and flexible conditions to the European economy, in general, and the European fiscal authorities have suspended the Maastricht conditions on debt and deficits--while being mindful that current conditions cannot remain in place much longer.

A new facility has been created at the European level--the European Recovery Fund. This is seen by some as a “breakthrough” of fiscal federalism in Europe. We rather believe, for now, that it reflects the impact of the so-called “symmetric shock” that Covid-19 constitutes--all countries were affected at once and at the same time. These adverse conditions made the recovery fund possible. If the shock had been asymmetrical, the difficulties for Greece would have been much more testing.

As things stand, Greece is, proportionately, one of the largest recipients of this new funding facility, with over 30 billion euros in potential grants and loans. The government of Greece, in turn, has presented a recovery plan that has been met with approval and support, and funds will soon start flowing to help Greece make further progress in emerging from the Covid-19 pandemic. If executed according to plan it can bolster the longer run structural underpinnings of the economy. The detailed proposal and projects are good on paper, the money is available. The only thing in the future is timely, transparent implementation.

Implementation has been, of course, the Achilles’ Heel in Greek macroeconomic management in the past. Greece has tended to accept full ownership of the disbursements of money for adjustment programs, but not the policies that were attached to these disbursements. Whether the country’s political system and acumen have changed to reverse this trend remains to be seen. Since politics in Greece is adversarial and not cooperative, we will only become convinced once we see the effective results in the future. One or two years of good growth does not qualify as light at the end of the tunnel, because the economy is poised to bounce back, as on an elastic string, after the difficult period of Covid-19.

So, let us keep our eyes on the issues that count for the long run--what are some of the crucial ones that we believe Greece should keep tracking?

Demographics: the loss of population is continuing. Partly, this reflects very low birthrates, well below replacement. But it also reflects many Greeks seeking their fortunes abroad with net emigration. This reflects a lack of trust in the political system to turn the ship around. The government has made noises about providing “incentives” for people to stay or to repatriate them to Greece. If the newspapers are to be believed, these musings include special tax rates for those who come back, subsidies of various sorts, and special rules for those who want to invest in Greece. Quite frankly, we view these ideas with concern, because the policies are likely ineffective, discriminatory, set up a new clientele (of which Greece is already overflowing), and pit one Greek against another with differential tax rates, etc. Not once have we heard that the politics of Greece is at the root of distrust from its own population. Giving tax breaks to favor special groups will only continue to expand accumulated debt.

Labor markets: participation has declined during Covid-19, and the unemployment rate has been kept artificially down by various support schemes. These are unviable in the long run because of the costs involved. If we compute the unemployment rate at a maintained higher participation rate as in the past, then the data suggest to us that the underlying unemployment rate is around 20 percent, not in the 16 percent range. Thus, we may expect that as the support programs are phased out, that unemployment may be sticky for a while in Greece, as, indeed, they may be in some other countries as well.

Pension reform: The government has initiated an important pension/labor reform in 2021, intended to set up funded retirement schemes and thus to diversify away to some extent from the pay-as-you-go system that is the dominant pillar in Greece today. There are good reasons for this reform, including to provide better connection between work experience and saving for your days of retirement, and to improve incentives for participation in the labor market. In other countries, experience with this type of reform has shown that it causes a shift of funding away from the public sector to the (private) capitalized systems. This creates an important transition problem related to how the government is going to absorb this transition cost toward a new system. The government will receive less in social security receipts and thus will incur a larger deficit. We understand that the EU Commission has raised this very issue recently, because the fiscal costs are substantial and Greece already has too much debt. We are not aware of explicit plans to address this challenge and how this fits in scenarios for Greece’s long-run deficit and debt plans. More long-run visibility is needed.

Productivity: We have spent no less than 4 out of 7 previous blogs emphasizing the importance of productivity growth as the key determinant of Greece’s economic well-being in the future (the workforce is shrinking, so productivity is the only driver of per-capita growth).

The data are sobering: since the early 2000s, productivity growth has averaged precisely zero percent per year (including the boom years through 2009 and the crisis thereafter). Covid-19 has depressed productivity for obvious reason, but even if we stop the time series at the end of 2019 (pre-Covid), annual labor productivity growth is only around ¼ percent a year--far removed from an aspirational objective of around 1½ percent a year (see our blogs 5, 6, and 7 for more details).

With demographics shrinking the labor force over time, employment growth on trend will be negative. This means that under current conditions, real GDP may be expected to stagnate after the recovery from Covid-19. The IMF has potential growth at 1 percent a year, and the EU Commission is a bit above (because they assume EU convergence in their models without evidence that this is taking place). We consider, for now, these projections to be too optimistic. Potential growth in Greece is likely to be less than 1 percent a year, and may be closer to zero if productivity does not rebound strongly.

Why is productivity growth so weak in Greece? Our research suggests that the public sector actually destroys productivity by hiring people at a faster pace than they contribute to output (this happens irrespective of what political party is in office). Further, since the business world is a powerful clientelistic actor, output market reforms do not get (fully) implemented (they rather lobby for tax cuts) and thus, the domestic business economy is made up of concentric circles of special interests that maintain closed shops, inhibit competition, and tolerate inefficiency; i.e. low productivity even in the private sector (tourism is a labor-intensive services sector, and therefore, structurally, not highly productive or scale-efficient).

One of the items in the 2020 Pissarides report refers to Greece lacking businesses of scale. The government has picked up on this theme, and, again if the newspapers are to be believed, plans are being developed to “create larger corporations” or at least to support mergers and acquisitions in the business sector to create more efficient scale. What are some of the plans? The media report four: selective tax cuts for merged entities; subsidies for mergers; low interest rate loans to support mergers; and regulatory relief. Again, we come away with a sense of concern at reading this news. In a country where operating profits take up a much higher share of national income than in the EU-19, why does the government believe it needs to subsidize businesses to get bigger? Who is going to police these policies? Why is this fair in respect of the factor labor (which has incurred reforms and saw its wages fall)? We hope that we are simply mistaken about these policy impressions created by Greek newspapers…

External balance: We also see evidence of the structural shortcomings in productivity and competitiveness in the external sector. Even though the economy has now been depressed for a decade and longer, and even though a large reservoir of workers is unemployed and wages and prices have come down in Greece, the domestic productive system is still not able to meet this depressed domestic demand--the current account is constantly in deficit, building up debt abroad. If the private sector were efficient and productive, it could easily supply the (slow) domestic economy with goods and services that are demanded, and have spare capacity for (net) exports. But this does not happen. It has nothing to do with the tax burden on capital; it reflects inefficient markets and protected clients. Reforms in these areas have not delivered.

Fiscal policy and debt: Due to Covid-19, another 25 percent of GDP has been piled onto the debt stock of pre-Covid--now amounting to some 210 percent of GDP. Some increase was inevitable and, as said, the government was correct in trying to dampen the effect of this shock on the economy. But just prior to Covid-19, and up into the first quarter of 2020, the interest rates on Greek funding dropped considerably. A chorus of high-placed Greek policy makers, the EU Commission, and the ESM, expressed their conviction that the “problem of high debt” was resolved, because with lower interest rates, Greece could afford more spending and a lower primary surplus to “stimulate development.” But this optimism was articulated with debt at 185 percent of GDP!

Further, the increase in debt may be a substantial underestimate, because it does not include government guaranteed debt (guarantees are “off-budget”). Guarantee programs have ballooned during Covid, and the citizens do not see these in the fiscal statistics, unless one knows where to look (e.g. the Hercules program to sell underperforming assets in Greek banks leans on government guarantees to sweeten the deal). The IMF recommends that governments not only report on debt, but also debt + government guaranteed debt (of the private sector) to see what public sector exposures truly are. The “underlying” liabilities of the Greek state are bigger than 210 percent of GDP.

In a recent medium-term fiscal plan, the government of Greece has expressed its ambition to return to a primary surplus of around 3½ percent of GDP. This is a welcome development, because the interest bill on the debt is around 3 percent of GDP (depressed with super low interest rates), and thus this objective would deliver roughly a balanced budget for the general government (only if interest rates stay low).

The second SYRIZA government in fact did deliver a balanced general government budget during its term in office until 2019. When the conservative ND government took over, the chorus claimed that fiscal policy was much too tight, and thus tax cuts were rapidly developed and implemented, already prior to Covid-19. One wonders what has led to the change of heart in the recent medium-term fiscal plan?

The IMF forecasts, based on current and likely prospective policies, that the primary balance will amount to some 1 percent of GDP with a zero output gap (i.e. a structural primary surplus of 1 percent of GDP). This is not high enough to pay interest and thus, a balanced budget does not look in the offing based on current policies. It is further unclear whether the IMF has considered the implementation of the pension reform (not discussed in the staff report), so that the underlying shortfall to the government’s objective is likely even larger. In other words, the future plans and underlying policies leave much transparency and explanation to be desired.

Conclusion: Where does this short panorama leave us regarding the Greek macroeconomy and its prospects? The tragedy of Covid has interrupted the recovery of the domestic economy. Covid is not over until the world has been properly vaccinated and the specter of new mutations duly removed from the radar screen. Unfortunately, there is no time for relaxation on the health front. But underlying policies for the long run do matter as to how Greece emerges from this additional challenge. We are unconvinced by the promises of new reforms until we see productivity improving on trend. Any short-term result will reflect Keynesian spending to boost aggregate demand; this guarantees nothing about the productive capacity of the Greek economy itself.

The biggest risk to Greece remains the domestic political system and its internal adversarial stance. If trust in politics can be improved, Greeks will return without the need for being offered special tax rates or subsidies. In the meantime, the country depends on ECB monetary conditions remaining ultra-favorable, because, so far, the debt ratio has only risen further.

Our proposal: It would be helpful for the government to present to the public, once-a-year, a long-run scenario that it considers feasible and adequate. This should contain information about long-run real GDP growth; how many will be employed along this path, and their annual productivity. Together with a view on desirable inflation, this provides a long-run path for nominal GDP. In turn, this nominal GDP path can serve for the baseline scenario of general government revenue and expenditure, its primary balance path, and the objective for slow but steady reduction in the public debt. Such a scenario would not serve as a projection, but rather as a guideline for monitoring progress in rebuilding the Greek economy. The country can then have an ongoing discussion about what constitutes such reasonable long-run objectives. This would be a powerful instrument for Greece’s political system to build trust with the public.