On June 22, at three o’clock in the morning, officials in Brussels declared a victory for the Eurozone’s last intensive care patient after eight years of public spending cuts, and cleared Greece to borrow from markets after August 20.
Austerity has brought some important results. Greece balanced its budget, so it is living within its means. Its exports are rising, so it is bringing in much-needed foreign revenue. The assurance of creditworthiness from the International Monetary Fund and the European Stability Mechanism – the sovereign distress fund that now owns most of Greece’s debt - is an important signal to markets. It should mean that Greece can start to rebuild its credit history and refinance its debt.
Other aspects of the deal are less reassuring. Supervision of public spending will persist for the next 40 years, so Greece hasn’t really graduated - it’s on probation. During those two generations, Greece must set aside an average of 2.2 percent of its economy to repay its creditors. This means that it will remain belaboured by austerity policies that presently include uncompetitively high taxes.
Most economists agree that it is unlikely that Greece can achieve high rates of growth under such circumstances. They also agree that the most effective way to reassure markets about the manageability of its debt is to dwarf the debt through a fast-growing economy. When Greece was forced out of markets, its debt was about 130 percent of its economy. Today it stands at 177 Percent, because austerity caused its economy to shrink by a quarter – the worst depression in any developed postwar economy. Unless that process is reversed, some economsists say, Greece could go bankrupt again in under a decade.
The challenge of growth brings into focus all of Greece’s present structural problems. Unfortunately the Eurozone’s austerity medicine, as administered by Greek governments, not only did not fix these, but often made them worse as it became apparent that reform was no-one’s top priority: that distinction went to liquidity, with which to keep the government functioning and repay debt that other European taxpayers had bought, thus minimising the political risk to their governments.
Europe’s austerity policy has left enormous challenges that Greek governments now have to address, and markets will be watching how, and if, they do it.
Over-taxation making up for under-reporting
Greece had to produce the same amount of annual tax revenue throughout the crisis despite the loss of a quarter of its economy. This was done by constantly shifting the tax focus. As unemployment rose and revenue from personal and corporate income tax slipped, governments raised consumption taxes. As consumption and sales fell after 2011, new taxes were introduced on labour and property.
Greeks survived all this partly by tightening their belts, partly by spending their savings (bank deposits have fallen by 60 percent during the crisis) and partly by working and trading in an extensive black economy.
It is this last aspect of Greek survival that has encouraged hardline creditors to keep pushing for higher taxes, evidently believing that what looks unreasonable on paper works in practice thanks to the unregulated economy. Just as the government overtaxes the Greeks to the extent that it feels they are tax evading, the Greeks are tax evading to the extent that they feel the government is overtaxing them. Each is now fighting for solvency and survival at the expense of the other. It is incumbent on the government to fix this sick relationship by removing the presumption of guilt. By assuming dishonesty, it is turning it into a prerequisite for survival.
Shrinking society and tax base
Greece’s ageing demographic will tend to increase overtaxation. Its labour force is just 4.8 million in a population of 11 million, and only 3.8 million of those people are in work. Again, the crisis has made this worse. Hundreds of thousands of public servants in their late fifties and early sixties have rushed to retire, rightly judging that the retirement age would rise (it is now 68).
At the same time the birth rate has plummeted by a fifth, as young people shrink from the cost of a second child. In 2011, it dropped below the death rate. Measured together with the emigration of young people to healthier job markets, Greece is losing an average of 75,000 people a year – 0.7 percent of its population. Both the rush to retirement and the loss of new blood mean a narrowing tax base.
The third structural problem made worse by the crisis is the lack of transparency and meritocracy in the Greek state. Greek political parties are hardly unique in awarding public jobs to loyalists, but this client base stands as an obstacle to reforms that would make the economy more competitive. Prime Minister George Papandreou (2009-11) started the process of putting government online. None of his successors continued this. Shifting loyalties in the civil servants’ union, the country’s largest and best-organised, are believed to be largely responsible for the fall of Papandreou and the rise of Syriza.
The result of this internal power struggle is evident from Greece’s competitiveness rankings. Despite lowering its labour costs dramatically, Greece still ranks below all its EU partners for productivity in the World Economic Forum’s competitiveness survey. It beats only Romania, Bulgaria and Hungary in Transparency International’s corruption perception index. In short, after eight years of unprecedented reform and belt-tightening for a developed economy, Greece underperforms countries that have had the benefits of democracy, market economies and EU membership for a fraction of the time Greece has had them.
A spectacular feat of economic growth now requires egg-breaking reforms. For example, Greece refuses to break a state monopoly on higher education, even though doing so could create an enormous export industry. The Greeks clearly believe in education. Figures show that they are the most over-educated and overqualified workforce in the EU in relation to their economy. After investing millions of dollars in stellar educations for its children, often overseas, Greece has nowhere to employ them, and sends them abroad again.
Likewise, Greece refuses to break a state monopoly on social security, even after it bankrupted the system by borrowing people’s contributions and replacing them with Greek government bonds. The government was entitled to help itself to this money because it is also the system’s ultimate guarantor. This is now its biggest liability. Last year social security contributions raised 8.7bn euros. The government topped them up with another 21.1bn euros.
Stephanos Manos, a former trade minister, suggested abolishing all social security contributions and offering a €700 state pension funded solely through income tax. The freed up capital would generate employment and a new industry in individual retirement accounts. Nobody took him seriously, partly because the state pension he suggested was considered low. It now appears optimistically large, but there is still no public discussion about changing the system because it would cost public sector jobs and break a political taboo in Greece’s left-leaning culture.
Smashing certain state monopolies carries a double benefit of creating private sector growth and depriving politicians of tradeable inducements to constituents. This ought now to seem like an obvious choice. Yet true liberalisation and reform seem more elusive than they did at the height of the crisis, because the Greek political system has found a way to survive and balance the books without the liberalisation, accountability, transparency and meritocracy that would make it competitive, and it has done this with the blessings of the European Union and the IMF. Celebration at Greece’s graduation is therefore premature. The current state of affairs should not be seen as a victory, but as a second chance for Greece to begin its own, radical reform process. There are encouraging indications that the Greeks are finally ready for smaller and more responsible government, and a more liberalised private sector. Hopeful prime ministers must grasp this opportunity. If they do not, they will simply be asking the unborn to solve the problems of the living.