Aus­ter­ity is not Greece’s prob­lem

Financial Mirror (Cyprus) - - FRONT PAGE -

When look­ing out a win­dow, it is easy to be fooled by your own re­flec­tion and see more of your­self than the out­side world. This seems to be the case when US ob­servers, in­flu­enced by their own coun­try’s fis­cal de­bate, look at Greece.

For ex­am­ple, Joseph Stiglitz re­gards aus­ter­ity in Greece as a mat­ter of ide­o­log­i­cal choice or bad eco­nomics, just like in the US. Ac­cord­ing to this view, those who favour aus­ter­ity must be ob­sessed with the the­ory, given the avail­abil­ity of a kin­der, gen­tler al­ter­na­tive. Why would you ever vote for aus­ter­ity when par­ties like Greece’s Syriza or Spain’s Pode­mos of­fer a pain-free path?

The ques­tion re­flects a lam­en­ta­ble ten­dency to con­flate two very dif­fer­ent sit­u­a­tions. In the US, the is­sue was whether a gov­ern­ment that could bor­row at record-low in­ter­est rates, in the mid­dle of a re­ces­sion, should do so. By con­trast, Greece piled up an enor­mous fis­cal and ex­ter­nal debt in boom times, un­til mar­kets said “enough” in 2009.

Greece was then given un­prece­dented amounts of highly sub­sidised fi­nance to en­able it to re­duce grad­u­ally its ex­ces­sive spend­ing. But now, af­ter so much Euro­pean and global gen­eros­ity, Stiglitz and other econ­o­mists ar­gue that some of Greece’s debt must be for­given to make room for more spend­ing.

But the truth is that the re­ces­sion in Greece has lit­tle to do with an ex­ces­sive debt bur­den. Un­til 2014, the coun­try did not pay, in net terms, a sin­gle euro in in­ter­est: it bor­rowed enough from of­fi­cial sources at sub­sidised rates to pay 100% of its in­ter­est bill and then some. This sit­u­a­tion sup­pos­edly changed a bit in 2014, the first year that the coun­try made a small con­tri­bu­tion to its in­ter­est bill, hav­ing run a pri­mary sur­plus of barely 0.8% of GDP (or 0.5% of its debt of 170% of GDP).

Greece’s ex­pe­ri­ence high­lights a truth about macroe­co­nomic pol­icy that is too of­ten over­looked: the world is not dom­i­nated by aus­te­ri­ans; on the con­trary, most coun­tries have trou­ble bal­anc­ing their books.

Re­cent ad­vances in be­havioural eco­nomics show that we all have enor­mous prob­lems with self-con­trol. And game the­ory ex­plains why we act even more ir­re­spon­si­bly when mak­ing group de­ci­sions (ow­ing to the so-called com­mon pool prob­lem). Fis­cal deficits, like un­wanted preg­nan­cies, are the un­in­tended con­se­quence of ac­tions taken by more than one per­son who had other ob­jec­tives in mind. And lack of fis­cal con­trol is what got Greece into trou­ble in the first place.

So the prob­lem is not that aus­ter­ity was tried and failed in Greece. It is that, de­spite un­prece­dented in­ter­na­tional gen­eros­ity, fis­cal pol­icy was com­pletely out of con­trol and needed ma­jor ad­just­ments. In­suf­fi­cient spend­ing was never an is­sue. From 1998 to 2007, Greece’s an­nual per capita GDP growth av­er­aged 3.8%, the sec­ond fastest in West­ern Europe, be­hind only Ire­land. But by 2007, Greece was spend­ing more than 14% of GDP in ex­cess of what it was pro­duc­ing, the largest such gap in Europe – more than twice that of Spain and 55% higher than Ire­land’s. In Spain and Ire­land, though, the gap re­flected a con­struc­tion boom; euro ac­ces­sion sud­denly gave peo­ple ac­cess to much cheaper mort­gages. In Greece, by con­trast, the gap was mostly fis­cal and used for con­sump­tion, not in­vest­ment.

Un­sus­tain­able growth paths of­ten end in a sud­den stop of cap­i­tal in­flows, forc­ing coun­tries to bring their spend­ing back in line with pro­duc­tion. In Greece, how­ever, of­fi­cial lenders’ un­prece­dented mu­nif­i­cence made the ad­just­ment more grad­ual than in, say, Latvia or Ire­land. In fact, even af­ter the so­called Greek De­pres­sion, its econ­omy has grown more in per capita terms since 1998 than Cyprus, Den­mark, Italy, and Por­tu­gal.

Sud­den stops are al­ways painful: eco­nomics has not dis­cov­ered a han­gover cure. But the way to min­imise the pain is to cut spend­ing with­out cut­ting out­put, which re­quires sell­ing to oth­ers what res­i­dents can no longer af­ford. In other words, un­less Greece boosts ex­ports, spend­ing cuts will am­plify the out­put loss in the same way that Key­ne­sian mul­ti­pli­ers am­pli­fied the out­put gain from bor­row­ing.

The prob­lem is that Greece pro­duces very lit­tle of what the world wants to con­sume. Its ex­ports of goods com­prise mainly fruits, olive oil, raw cot­ton, tobacco, and some re­fined petroleum prod­ucts. Ger­many, which many ar­gue should spend more, im­ports just 0.2% of its goods from Greece. Tourism is a ma­ture in­dus­try with plenty of re­gional com­peti­tors. The coun­try pro­duces no ma­chines, elec­tron­ics, or chem­i­cals. Of ev­ery $10 of world trade in in­for­ma­tion tech­nol­ogy, Greece ac­counts for $0.01.

Greece never had the pro­duc­tive struc­ture to be as rich as it was: its in­come was in­flated by mas­sive amounts of bor­rowed money that was not used to up­grade its pro­duc­tive ca­pac­ity. Ac­cord­ing to the At­las of Eco­nomic Com­plex­ity, which I coau­thored, in 2008 the gap be­tween Greece’s in­come and the knowl­edge con­tent of its ex­ports was the largest among a sam­ple of 128 coun­tries.

Too much of the de­bate since then has fo­cused on what Ger­many, the EU, or the In­ter­na­tional Mon­e­tary Fund must do. But the bot­tom line is that Greece needs to de­velop its pro­duc­tive ca­pa­bil­i­ties if it wants to grow. The un­fo­cused set of struc­tural re­forms pre­scribed by its cur­rent fi­nanc­ing agree­ment will not do that. In­stead, Greece should con­cen­trate on ac­tivist poli­cies that at­tract glob­ally com­pet­i­tive firms, an area where Ire­land has much to teach – and where Stiglitz has sen­si­ble things to say.

Un­for­tu­nately, this is not what many Greeks (or Spa­niards) be­lieve. A large plu­ral­ity of them voted for Syriza, which wants to re­al­lo­cate re­sources to wage in­creases and sub­si­dies and does not even men­tion ex­ports in its growth strat­egy. They would be wise to re­mem­ber that hav­ing Stiglitz as a cheer­leader and Pode­mos as ad­vis­ers did not save Venezuela from its cur­rent hy­per-in­fla­tion­ary catas­tro­phe.

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