In search of a clean break with the past
Despite the rule violations, the Eurogroup decided to relax the key “no bail-out” rule and begin the provision of massive financial support to Greece, averting bankruptcy. This decision was based on fear of ‘contagion’ – the spreading of the crisis to similarly vulnerable economies in the Eurozone. While a key objective of the Greek bail-out was to avert a financial crisis in Europe, it also provided financing for a primary deficit in the transition to a balanced budget. This was done on condition that Greece would agree to a tough adjustment programme of fiscal consolidation and structural reforms, negotiated and overseen by the Troika of creditors – the EU, the ECB and the IMF. It was, of course, known that fiscal austerity is contractionary on living standards for the majority of the population; but there was also widespread acceptance of a strong hypothesis that fiscal consolidation when accompanied by broader economic and structural reform can improve confidence and competitiveness and lead to growth.
The design of the first two adjustment programmes was balanced in its equal emphasis on spending cuts and tax increases on the one hand, and structural reforms on the other. However, the actual implementation of meaningful structural reforms to encourage private sector investment, including foreign direct investment, an essential element of a strategy for growth, employment creation and debt sustainability lagged far behind.
A budget deficit of 15% of GDP was impressively virtually eliminated, but relatively little was done to implement the privatisation agenda, reduce bureaucratic impediments to private sector initiatives while combating corruption, improve the efficiency of the public sector, liberalise markets and professions, pursue active labour market policies and restructure education to improve the quality of outcomes and employment prospects. Most of these areas are being revisited in the third Memorandum of Understanding (MOU) agreed this year with the creditors.
As structural reforms are not only politically more difficult to implement, they also typically take a long time to bear fruit, delaying their implementation has dealt a serious blow to the success prospects of the Greek programme. Worse, as people lost hope that the good days would resume any time soon, they turned towards the populism of the left and the xenophobic extremism of the right.
While failure to implement key agreed reforms was central to the poor performance of the Greek economy `ivity (known as the fiscal multipliers) in a structurally distorted, consumption-driven and relatively closed economy proved much larger than anticipated. Furthermore, the common belief that public debt was unsustainable discouraged foreign and domestic private sector investment impacting negatively employment and growth.
Finally, the legendary malfunctioning of the Greek public sector, led to giving priority to civil service reform, which takes time to produce results, at the expense of product market and tax reforms which normally have a quicker impact on output. A different sequencing of policy reform with emphasis on quick-impact measures, a less dogmatic and moralist lender stance on early debt relief that would have reduced uncertainty, and a more gradual fiscal adjustment would probably, with hindsight, have been more conducive to Greek recovery; but jumpstarting economic growth required gamechanging and politically demanding structural reforms which were not implemented.
Central to the failure to implement reform is a continuing consensus across the full range of the political landscape and most mass communication media that the agreements with the lenders are responsible for the problems of the Greek economy. This anti-Troika consensus includes successive governments which criticised heavily the reform agenda whilst in opposition and, once in office, failed to take real “ownership” of the programme and provide leadership to the society at large.
While implementation capacity limitations have played a part, experience with World Bank/IMF supported structural adjustment operations strongly suggests that politically demanding reform agendas, confronting vested interests, are always difficult to implement but are almost impossible without ownership. The challenges in Greece are of course homegrown and pre-existing and the opposition to reform is strong despite the fact that the proposed reforms ultimately benefit the more numerous under-privileged citizens.
The privileged classes, which are state-fed and are benefiting from distortions, monopolistic practices and corruption, are strongly represented in all political parties, which in turn, champion their interest. This is where the Troika failed to communicate, to respond to the accusations of those interests during the implementation of the first two program agreements. They have not made a serious effort to explain the rationale of the reform programme through a more active engagement with civil society, and they have also done a disservice to the Greek people by not pushing much harder on the implementation of key structural reforms, while at the same time over emphasising and applauding fiscal austerity.
During the Eurogroup discussions that eventually led to a third programme agreement for Greece, the Greek side argued that the shortcomings in the monetary union that allowed excessive borrowing in Greece and elsewhere in the periphery were as much to blame for the origins of the crisis as the more frequently discussed narrative of policy failures at the national level. They also argued that the mismanagement of the crisis by the Eurozone leadership, which failed to address the problem of debt sustainability upfront, put more weight on bailing-out European banks and, to enable Greece to service this debt, imposed an exceptionally harsh austerity programme on the Greek people, contributed heavily to the failure of the first two programs.
There is a lot of truth in this alternative narrative which identifies challenges that need to be urgently addressed, but reforming the Eurozone’s architecture and even reducing Greece’s debt burden will not by itself improve Greece’s competitiveness and growth prospects. Implementing farreaching structural reforms to make it attractive for private enterprise to employ, produce and export should be the key concern of policy makers and the wish of the vast majority of the Greek people.
As the Greeks finally choose to own, and stay on, the road to reform, the country will also benefit from EU initiatives to alleviate the debt burden for successful programme countries and will be able to argue for more room for fiscal expansion. Monetary stimulus by the ECB, structural reform and room for fiscal expansion could be the trilogy of simultaneous action to strengthen both aggregate demand and supply and open the way to faster growth. The challenge going forward is, therefore, less on the outcome of the September 20 elections and more on the forging of a strong social consensus to implement an aggressive structural reform programme to maximise growth prospects. In parallel, any remaining fiscal adjustment should be gradual, rely less on tax increases, and put emphasis on pro-growth public expenditure restructuring. This will be the supreme test for the political leadership that emerges from the upcoming elections.
This year marks the fifth anniversary of the acrimonious period in the Eurozone when Greece’s admission of gross violation of the agreed fiscal discipline rules marked the beginning of the Eurozone crisis.