Friday, 12 February 2010

Strucutral weakness behind woes in Greece

UNTIL A few days ago, the key question investors were asking themselves about Greece was whether it can dig itself out of debt. Greece had said it could do so. It submitted a Stability Plan to the European Commission, and just got approval on February 2nd, albeit with caveats about contingency planning.

Many of the austerity measures contained in that plan are still being legislated. They are still a way from being implemented, and even further off from bearing fruit. Prime minister Yiorgos Papandreou confessed that they will only have an effect next year. Until then, markets may not give Greece a chance to keep refinancing roughly €300 billion in debt, forecast at 125 per cent of GDP this year – hence the extra lines of credit under discussion in Brussels.

The Greek plan contains austerity measures that would have been unthinkable before the international economic crisis. For instance, Wednesday’s strike by civil servants was occasioned by a 10 per cent cut in their benefits, which can add between 30 and 90 per cent of nominal salary over again. That amounts to a 4 per cent cut in the public payroll, a significant sum, given that a million out of Greece’s 4.5 million-strong workforce is on the public payroll. But it also dims the socialist party’s election message of hope. Papandreou had promised to raise civil service salaries, which he did initially by 1.5 per cent, only to undermine them. He had also poured scorn on the incumbent conservative warning of a wage and hiring freeze in the public sector. Last week he adopted them, too.

To be sure, it is nothing to Ireland’s 20 per cent cut in civil service salaries, but the Greek public sector is traditionally a milk-fed reserve of party appointees not subject to the hardships of the real economy.

The private sector is bearing its share of the pain, too. Finance minister Yiorgos Papakonstantinou hopes to raise €4.5 billion more than he did last year – a 9 per cent rise, despite a 0.3 per cent drop in GDP, from direct and indirect taxation. He is recalibrating the tax scale to penalise higher earners, and abolishing flat taxes on certain professions and bringing them onto the sliding scale. Fuel, alcohol and tobacco are also going up. However, Papakonstantinou is being careful to leave untouched taxes that might affect the poor, such as tax on heating oil, VAT and electricity rates.

Still, with all this in place, he hopes to raise only €54 billion this year to counter expenditures of €70 billion, borrowing €16 billion in new money, and that’s if things go according to plan.

So why did things spiral so badly out of control? After all, Greece earned membership of the euro zone in 2001 on the basis of three good budgets.

One problem is that Greece’s loss of credibility is partly Papakonstantinou’s own doing. He shocked his euro zone partners when they met for the first time last year. The outgoing conservatives had sent figures a few days before the October 4th election to the effect of a 5.7 per cent deficit for 2008 and a 6 per cent outlook for 2009. Papakonstantinou’s revision was for 6.5 per cent for 2008 and 12.7 per cent for 2009. It was the second time in six years that an incoming finance minister rubbished his predecessor’s figures. Tired of being lied to, the EU demanded that Papakonstantinou make the National Statistic Service politically independent. Legislation for this is under way.

Another reason for Greece’s predicament is that the international financial crisis has revealed structural weaknesses in the economy. It’s not just that the cost of government is too high. It is also that development has been stalled for years because of Greek conservatism, so government revenues have been falling despite a 4 per cent average growth rate from 2000 to 2007. For instance, Greece is paying daily fines of €15,000 since the beginning of the year for ignoring a directive (and European court conviction) on recognising degrees issued by other EU universities. Apart from the social injustice involved to Greek graduates of non-state universities, this is directly tied to a lack of investment in private tertiary education at home. It is also tied to stagnant research and development.

Greece has also forestalled liberalisation of its electricity market, worth about 10 per cent of GDP. This is because of pressure from the Public Power Corporations union, which fears that private generators will lead to attrition in the state sector and render their social security fund insolvent. The implications run deep in this sun-soaked, windswept archipelago. Renewable energy investments and micro-generation have been stymied as a result, and a growth industry kept in the wings.

Other key areas remain effectively locked to private investment. Take transport. Taxis and road freight are closed professions. Non-Greek flagged cruise shipping may not use the Athens port of Piraeus as a base, depriving the islands of much of the benefit of powerful Italian and Norwegian operators. The Hellenic Railways Organisation, a state monopoly, is responsible for about €700 million in state debt each year. All this is against the letter and the spirit of European antitrust and competition directives.

Where Greece did liberalise, notably in banking and telecommunications, the results were spectacular. These areas saw growth, foreign investment and new jobs in the last 15 years, helping to drive much of the economy. For instance, all three of Greece’s mobile telecom licences have traded upwards to be owned by foreign interests (Germany, the UK and Egypt). Some of its banks are strategically partnered with interests in Germany, France and the United Arab Emirates or have themselves acquired targets in the region.

These signs of competitiveness are all too rare in other areas of the economy. Last September Greece dropped in the World Economic Forum’s Global Competitiveness Index from 67th to 71st place among 133 countries, and has been dropping for years. It performs poorly in Transparency International’s Corruption Perception Index, coming well behind the EU15 and even some eastern European members which have been independent nations, free market democracies and EU members for far shorter periods.

The socialist government has shown that it appreciates the deep-rooted nature of the problems Greece suffers from. For now, the government has a fairly free hand. Public opinion polls recently showed themselves in favour of the austerity package by a ratio of two to one. Wednesday’s protest was feeble, given that it came from one of the two largest union umbrella organisations. The other represents private sector labour and is scheduled to hold a one-day strike on February 24th. If the General Confederation of Labour fares similarly, this may be a signal that the reactionary unionism that has for a decade stifled attempts at economic restructuring may be dead.

You can also view this analysis by John Psaropoulos as published today by the Irish Times. To see today's news update on European support for Greece please scroll down to the next post.

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