Simple truths about Greece

Via Tyler Cowen from Ricardo Hausmann:

Greece will have to bring its current account deficit down to zero at some point.

This can happen in two ways: either Greece exports more or spends less. Adjusting the current account by spending less would require an additional fall in GDP of 25 per cent, given that in Greece only one in four US dollars of spending cuts goes abroad. This is clearly not a pretty picture. But adjusting by raising exports would require they increase by 50 per cent, not an easy feat. Achieving it through tourism alone would require the industry to triple in size – an unlikely prospect.

And this:

Here’s the bad news for Greece: in our sample of 128 countries, it had the biggest gap between its current recorded level of income and the knowledge content of its exports. Greece owes its income to borrowed foreign spending it cannot pay back. It produces no machines, no electronics and no chemicals. Of every 10 US dollars of worldwide trade in information technology, it accounts for one cent.

This problem cannot be addressed by fiscal Keynesian stimulus, by bland trade facilitation or by paying lip-service to structural adjustment as the November International Monetary Fund agreement implicitly assumes.

Greece: now what?

The Greeks know they are being lent money just so they can work very hard for lower wages and higher taxes in order to pay it back at great cost. This arrangement is in place because of the second thing the Indignati know well, the fact that the outstanding Greek debt is mainly owned by French and German banks.

In the London Review of Books John Lanchester, author of Whoops!, offers an appraisal of how the Greek default will unwind into a Euro bustup. I agree with Lanchester that the empirical evidence is that “you can’t cut your way to growth”. So the new Plan A is not going to work.

The middle class “Indignati” want Greece to default. The EU wants to protect the on-paper solvency of their banks. Lanchester’s worry is that the Greek default will domino through Ireland and Portugal to Spain. I agree that would be seriously unpredictable and chaotic – but I don’t see why it is a sure thing that Spain goes down too. But if the German voters decide they are done with shouldering the burden, then the Euro is finished.

(…) I speak of the Greek default as a sure thing because it is: the markets are pricing Greek government debt as if it has already defaulted. This in itself is a huge deal, because the euro was built on the assumption that no country in it would ever default, and as a result there is no precedent and, more important still, no mechanism for what is about to happen. The prospective default could come in any one of several different flavours. From everybody’s perspective, the best of them would be what is known as a ‘voluntary rollover’. In that scenario, the institutions that are owed money by the Greek government will swallow heavily and, when their loan is due to be repaid, will permit their borrowings to be rolled over into another long loan. There is a gun-to-the-side-of-the-head aspect to this ‘voluntary’ deal, since the relevant institutions are under enormous governmental pressure to comply and are also faced with the fact that if they say no, they will have triggered a proper default, which means their loans will plummet in value and they’ll end up worse off. The deal on offer is: lend us more money, or lose most of the money you’ve already lent.

This is, at the moment, the best-case scenario and the current plan A. It reflects the failure of the original plan A, which involved lending the government of George Papandreou €110 billion in May last year in return for a promise to cut government spending and increase tax revenue, both by unprecedented amounts. The joint European Central Bank-EU-IMF loan was necessary because, in the aftermath of the financial crisis of 2008, Greece was exposed as having an economy based on phoney data and cheap credit. The cheap credit had now dried up, and Greece was faced by the simplest and worst economic predicament of any government: it couldn’t pay its debts.

There is a good moment in one of the otherwise terrible Star Trek movies, in which Spock quotes an ancient Vulcan proverb: ‘Only Nixon could go to China.’ Similarly, it is probably true that only George Papandreou could confront the fundamental economic structure of the modern Greek state, since his father Andreas did more than anyone else to build it. Andreas Papandreou took Greece into the EEC in 1981, and subsequently the Greek government created a client state in which direct subsidies and transfers from the EEC were supplemented by easy loans from Western European banks. Money poured into Greece, and was used to fund a huge boom in public-sector jobs, most of them linked to political patronage. Various forms of corruption permeated the system, where cash gifts in fakelaki or ‘little envelopes’ were a fact of life, and where, crucially, the rich regarded paying tax as something that only the poor and stupid would ever choose to do. This latter fact meant that Greece was in certain vital respects a country without a functioning version of the social contract. To outside observers, all this was largely familiar, but the younger Papandreou, on becoming prime minister in 2009, was the first prominent Greek politician to admit it and promise to challenge it head-on. ‘Corruption, cronyism, clientelistic politics; a lot of money was wasted basically through these types of practices.’ Papandreou’s admission was jaw-dropping: everyone knew it was true, but since when do prominent politicians say very unpopular things which everyone knows to be true? The EU lent Greece the money to fund Papandreou through his programme of cuts and crossed its fingers that this would buy enough time for the deficit to narrow – the deficit being the gap between what Greece was spending and what it was raising in tax.

That was the old plan A, and it didn’t work. Papandreou made deep cuts across public-sector spending, but two things went wrong. One, the Greek economy kept crashing. Economists have varying theories about the practical effects of ‘austerity’, meaning sharp cuts in public spending. To an outsider, it’s a little alarming how they differ about something so big and basic as the effect of large public spending cuts. But if you ignore the economics and look at the history, it seems to be the case that you can’t simply cut your way to growth. (There are a couple of contentious counter-examples, but this is the broad rule.) Holding public spending flat while other parts of the economy grow is historically a more valid model – and, by the way, holding public spending flat is in itself a huge struggle, being roughly what Mrs Thatcher did in the UK. So the first problem was that the Greek cuts led to a worsening of the Greek predicament: the economy kept contracting, and unemployment hit a record high of 16.2 per cent. The second problem was that those richer Greeks who had never fancied paying their taxes showed no increased desire to do so, and, much worse, the state showed no new ability or desire to make them. Without the ability to raise more tax, the old plan A was invalid.

So this is the new plan A: the Greeks borrow another €120 billion, the bondholders allow their debt to be rolled over, Papandreou’s government introduces further austerity measures and privatisations, rich Greeks start paying their taxes, the Greek economy recovers, and by the time the next huge chunks of debt repayment are due – from mid-2012 – Greece can afford to pay back its lenders and the crisis is over.

Does that sound plausible? It shouldn’t. This scenario is somewhere on the spectrum of unlikely to impossible, because while nobody questions Papandreou’s intentions – he is the only politician I’ve ever known to tell his electorate so consistently things they don’t want to hear – the Greeks are showing clear signs that they are unwilling to submit to the programme. Protests against the measures began with furious far-left agitations of a sort with which ordinary Greeks are weary, and which consequently may even have helped Papandreou, but the protesters now include the ‘Indignati’, middle-class Greeks who have had enough austerity already, thanks, and who take a Dario Fo attitude to Greek debt: can’t pay, won’t pay. The vote on the latest round of austerity measures took place in the middle of a 48-hour general strike.

(…)  This feeling, which is strong enough in Ireland and Iceland, and which will grow steadily stronger in the UK, is so strong in Greece that the country is heading for a default whose likeliest outcome, by far, is a decade of misery for ordinary Greeks.

There is one country in particular where this disconnection between the political, the personal and the economic poses an acute threat to the world economic order. That country is Germany. The economists speak of ‘macro-economic imbalances’, the fact that German interests and, say, Greek or Irish or Spanish interests are not in alignment. The German economy is too big and too powerful for the health of its neighbours, unless European monetary policy is somehow ameliorated to help the smaller, weaker countries stay in step.[*] Interest rates which, during the first decade of the euro’s existence, suited German manufacturers, caused toxic credit bubbles to grow in Greece and Ireland and Spain. The consequences of those credit bubbles could take another decade to unwind, ten years of hard times for the citizens of those countries, who will spend most of it sweating to earn the tax money to pay back the German banks whose lending fuelled their bubble. German savings go to German banks to lend to other countries so that they can buy German goods from German companies who then save their earnings in German banks who lend it to . . . and so on.

This system is not elegant but it is probably sustainable, as long as German taxpayers are willing to pay for the busts and bailouts which will inevitably ensue. (…) The downmarket German press has been asking why Germans should work until 69 to fund the retirement of Greek public sector workers who knock off at 55.

Read the whole thing »