Crisis management policy: the sad lesson of the Greek case
The Greeks have given our civilization much, including tragedies such as Sophocles’ Antigone, where everyone eventually dies. Unfortunately, we are now witnessing a different kind of tragedy: the unnecessary sacrifice and hardship inflicted on the Greek people by the wrong economic crisis policy. The Greeks have been hit twice as much and twice as long as necessary.
The Greeks themselves are first and foremost responsible for the severe economic crisis in their country. But the medicine prescribed has been so wrong in its composition that the economic crisis has been much longer and much worse than necessary. This is particularly evident in relation to the 2015 agreement, which was reached after a dramatic negotiation process. : It's our opinion, also based on our interviews in Athens in the first half of May, that due to the way the 2015 agreement was designed, the Greeks will have to bear both excessive and unnecessary costs. This will affect not only the Greeks, but should also challenge the way economic policy and especially economic crisis management is pursued in the EU.
Background to the 2009/2010 crisis
A few figures demonstrate how untenable the situation that Greece had established for itself had become when the crisis unfolded in 2009/10. The current account deficit was over 10 percent of GDP each year from 2006 to 2009, the deficit in public finances turned out to be above 15 percent in 2009, and the gross public debt was over 120 percent of GDP in 2009, with an outlook for a pronounced increase given the substantial government deficit. Greece had not utilised the significant reduction in interest rates and, accordingly, interest payments on the public debt, which was the result of euro membership from 2001, to consolidate public budgets. On the contrary, this opportunity was instead missed and the public deficit problem was even aggravated by pursuing an irresponsible economic policy as the public deficit was substantially increased in the following years. This was despite the fact that Greece, following euro membership, achieved a very high economic growth, averaging four percent a year up to the outbreak of the financial crisis – a growth rate about twice as high as in the eurozone in general.
It was inevitable, therefore, that the EU and IMF, together with the European Central Bank, which was given responsibility for the external crisis management as Greece sought external assistance to avoid bankruptcy, required very substantial fiscal tightening. And so it was: no other OECD country has ever implemented such harsh austerity measures as Greece. The fiscal intervention was especially huge in the May 2010 programme, equivalent to 10 percent of GDP, but also the second and third programmes, respectively, agreed in March 2012 and July/August 2015, included significant fiscal tightening.
The situation at the start of the second programme in early 2012
As the second programme was completed in March 2012, the troika estimated that the 2010 programme would ensure a structural balance by as early as 2013. It was also clear that the unemployment problem had been vastly underestimated, as the effect on economic activity of the implemented fiscal tightening in the 2010 programme had been clearly undervalued. Therefore, already in 2012 a more balanced crisis management policy with an emphasis on structural reforms should have been implemented to improve prospects for growth. But fiscal tightening was continued, as the 2012 programme introduced new measures equivalent to two percent of GDP. As mentioned earlier, early in 2012 the troika estimated that the 2010 programme would ensure a structural balance from 2013 if the Greek economy entered a growth path that would lead to full employment. The high and increasing unemployment had already and would further improve competitiveness. As such, the foundation to establish a steady growth track through the implementations of better structures, which Greece had ample room to obtain, was created. Supported by an upswing in 2014 – albeit moderate – it must have been deemed obtainable.
Accordingly, the 2012 programme should have been focused on improving the structures of the Greek economy, promoting exports, investment, growth and employment. Obviously, for a few years Greece would need more loans and/or easier debt terms to pay interest and principal on its old loans.
It should also have been clear and taken into account that the additional fiscal tightening in the 2012 programme would force Greek economy further to its knees, with significant risk of social and political unrest. It so happened. Unemployment rose to 25 percent and the lifetime of governments became shorter and shorter. This development contributed to a political impasse, blocking the implementation of the 2012 programme during the fall of 2014.
The troika did not have good experiences with successive governments’ implementation of the structural reforms included in both the 2010 and in the 2012 programme. But the troika should have realised that governments, when tasked with implementing tax increases and expenditure cuts of historical dimensions, can hardly simultaneously manage to improve old and unhealthy economic structures. Had the troika better grasped and understood the Greek situation, and fiscal tightening been put on hold, there would have been good opportunities to restore the track to growth in the Greek economy. It would have led to better public finances because revenues would increase and costs decrease.
If, in a few years, economic growth had been more firmly established and unemployment put on a clearly decreasing path, modest fiscal tightening, if proved necessary, could have been implemented until a surplus in public finances was obtained and debt adjustments made until the debt outlook was in accordance with the IMF’s sustainability requirements. Such a more balanced crisis management policy would most likely have brought Greece out of the bailout period after five or six years, which means today.
Emphasis on economic recovery in a balanced economic crisis policy
In a balanced crises management policy, it is essential to implement the necessary fiscal tightening in the beginning of the bailout period in order to restore confidence in a recovery. In the case of Greece, a realistic goal in the beginning of the bailout period could have been that an economic recovery should occur in 2012/13.
Such recovery presupposes that there is sufficient liquidity in the banking system. This is rarely the case in a crisis situation, however, and was certainly not the case in Greece. Liquidity was very tight because of a growing number of non-performing loans and a decrease in deposits. Therefore, there was a pronounced need to increase bank liquidity. In a more balanced crises management policy with a focus on recovery, a comprehensive policy to remove barriers on better liquidity must be implemented and may usually include a professional handling of non-performance loans. This has yet to be put in place in Greece.
If confidence in an economic recovery in Greece had occurred earlier, it would also have been possible to take initiatives to attract foreign investment, and it would have been possible to combine the strategic privatisation of public assets with further foreign investment. One interesting idea tabled early on in the bailout period called for debt relief to correspond with the value of the assets sold. It could have stimulated both privatisation and improved the liquidity position of the banks.
Initiatives to strengthen bank liquidity and growth in exports and investment were not taken or were taken only to a limited extent.
The large Greek deficit on the balance of payments was a clear signal that the Greek competitive position was poor, due to out-dated economic structures. This applies all the way around – both in product markets, the labour market and in the public sector. Greece had simply not taken part in the healthy EU competition to modernise the economy and to achieve a stronger competitive position. It is absolutely necessary that the real economy in the EU countries converge if the economic and monetary union is to be sustainable in the long run. Therefore, the troika should have made it absolutely clear right from the beginning of the bailout period that Greece should participate in the healthy competition between EU countries in regard to good economic structures. However, it was only expressed with the necessary strength in the 2015 agreement.
The 2015 programme and the first review
Unfortunately, fiscal tightening is also an essential part of the 2015 agreement. The fiscal tightening in the 2015 agreement has been designed with a view to achieve a primary surplus in the public finances of 3.5 percent of GDP from 2018 and the following years. The European Commission believed further fiscal tightening of three percent of GDP was necessary from this point of departure, while the IMF now estimates that this will require a tightening of five percent of GDP. However, IMF prefers to obtain sustainability through a fiscal tightening of three percent of GDP. As this is estimated to result in a primary surplus of only 1.5 percent from 2018 onwards, the IMF wants to obtain sustainability through simultaneously agreed lenient interest and redemption terms on the debt in the first review of the 2015 programme.
While fiscal tightening in 2010 was inevitable, as described above, no matter how unpleasant the economic and social consequences may be, the agreed fiscal tightening in the 2012 and, especially, in the 2015 agreements should be questioned. Ahead of the conclusion of the first review of the 2015 agreement, a structural general government surplus of 6–7 percent of GDP in 2016 was forecasted. Calculated figures for a structural surplus are hypothetical figures that can only be estimated by model simulations. As such, there is great uncertainty associated with the estimates thereof. However, there is no reason to believe that the 6–7 percent could be reduced to lower than 4 percent. Therefore, fiscal tightening in the 2015 agreement is not justified by the need to achieve structural surpluses for debt repayment. But it could be argued that it would be possible to achieve a more rapid debt reduction thereby than otherwise. But this is unfortunately very doubtful. For this fiscal tightening will in a Greek context clearly reduce the growth prospects for the coming years. Growth is essential for Greece to emerge from the crisis. Therefore, the positive growth impulses emanating from better structures and better competitiveness (unit labour costs have been reduced by 25 percent since the outbreak of the crisis, and are now relatively lower compared to other euro countries since Greece joined the euro) should not unnecessarily neutralised or reduced. This could very easily be the result of the 2015 agreement, as the fiscal tightening herein will reduce growth potential by about three percent – on average of one percent a year – in the three year period from 2016 to 2018. Accordingly, there is an obvious risk that optimistic EU growth scenarios of 2–3 percent per annum could be too optimistic. And growth rates of around one percent or less is all too little in an economy with such high unemployment as Greece.
This will not only hurt the Greeks; it will also hurt lenders. They have, of course, in the short term to grant more loans than otherwise, but after a few years it would be different. Embarking on a clear growth path – which would be possible if additional fiscal tightening were not implemented – will, after a while, automatically produce more public revenue through higher direct and indirect taxes and through lower spending on unemployment benefits and social programmes.
Designing a crisis management policy of a country that is on the verge of bankruptcy can start from two different starting points. One is to start by finding out how big a surplus is needed to pay off all the debt, the second point is to find the crisis management policy that both creates the least political and social unrest and ensures a maximum payback for lenders. We do not know what considerations have guided the troika crisis management policy, but the result has not been good.
The troika has demanded such severe fiscal austerity that it is overshooting, as shown by calculations for the structural balance, which now represent more than four percent of GDP. There has been too little emphasis on creating an economic recovery in the Greek economy, which could help to improve government finances, and not least minimise social distress and political unrest, which unfortunately is an inevitable companion to economic crisis policy.
It is a strategically crucial choice to what extent crisis management policy must be based on fiscal tightening or rapid recovery. A good way to make the choice could be how creditors get as much money back as possible. They do so through a balanced crisis management policy, which immediately implements the necessary fiscal austerity and unavoidable debt relief, and then by focusing on economy recovery and growth to create a surplus in government finances, so debt can be repaid.
Obviously, it is very important for an economic community such as the EU that members who face or meet grave economic problems and are teetering on the brink of bankruptcy also pay back their borrowings. There must not be any benefits for irresponsible policy. But it is our assessment that the lenders get most money back through a more balanced economic crisis policy. The EU has chosen a crisis management policy in Greece with an unfortunate balance between fiscal tightening and growth policies.
This unfortunate balance also characterises economic policy in Europe and the economic coordination mechanism in the EU. The economic growth in the EU has for several decades been distressed and it is due to the wrong economic philosophy and a badly composed policy.
*Christen Sørensen and Jørgen Rosted are two Danish economists who recently visited Athens to gather information for a study on EU crisis policy.
Christen Sørensen is a professor emeritus and former chairman of the Danish Economic Council as well as the boards of the Copenhagen Stock Exchange, Lawyers and Economists Pension Fund and Business Councils of the Labour Movement.
Jørgen Rosted is former director of the economic department in the Danish Finance Ministry, a member of the EU Committee that prepared the Maastricht criteria, Permanent Secretary in the Business Affairs Ministry and chairman of the OECD Committee for Innovation and Entrepreneurship.
My previous comment was cut short. I should have finished as follows:
I can only remember two entrepreneurial visions which were ever put on the table. Interestingly, both back in 2011. One was the EURECA-project proposed by the consulting firm Roland Berger and the other one was McKinsey’s „Greece Ten Years Ahead Report“. Both would have had, in my opinion, a tremendous positive effect on the Greek economy and both would have tremendously increased ‚Greece’s capacity to pay‘ its creditors.
I think the role of the Troika was mistaken by many from the start, particularly by Greece. The Troika was and is, notwithstanding all the talk about ‚helping Greece‘, a representation of creditors’ interests. Period. Creditors are rarely entrepreneurs who have the vision that, in order to eventually get more money back, one first has to put out more money. Creditors generally want their money back without putting out any more money, or at least as little as possible. For the simple reason that no creditor ever wants to be asked why he foolishly threw more good money after bad money.
The question to be analyzed is why there was not any entrepreneurial vision anywhere, neither at the level of individual European leaders, nor at the level of the EU nor at the level of the IMF. And certainly not at the level of Greece.
One doesn’t have to fake social romanticism about trying „to find the crisis management policy that both creates the least political and social unrest and ensures a maximum payback for lenders“. It would suffice to be brutally capitalistic and state that „the only way to get money back from a weak borrower is by first making the borrower strong again“.
I truly don’t think that this is an issue of austerity, yes or no. Austerity only affects the state as an economic agent, albeit by far the largest economic agent. One entrepreneurial vision could have been (or still could be): „We’ll starve the beast called ‚the state‘ to death but we will more than compensate for that with investments in the private sector“. Obviously, if there is only state austerity without offsetting compensation in the private sector, one gets the mess which we see today.
I can only remember two entrepreneurial visions which were ever put on the table. Interestingly, both back in 2011. One was the EURECA-project proposed by the consulting firm Roland Berger and the other one was McKinsey’s „Greece Ten Years Ahead Report“. Both would have had, in my opinion, a tremendous