Austerity is not Greece’s problem
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.