Greece needs growth, not aus­ter­ity

The Pak Banker - - Front Page - Costas Meghir

GROSS do­mes­tic prod­uct has de­clined more than 20 per­cent since 2008. The un­em­ploy­ment rate has tripled, and now stands at 25 per­cent, with job­less­ness among youth at twice that level. Crime is on the rise, as are racist in­ci­dents, and ide­olo­gies of the ex­treme right and left are gain­ing sig­nif­i­cant sup­port.

Worse, cur­rent poli­cies aren't stem­ming the eco­nomic de­cline. The new three-party gov­ern­ment elected in June has fo­cused its en­er­gies on ne­go­ti­at­ing a new pack­age of aus­ter­ity mea­sures to meet the con­di­tions set by the so-called troika (the Euro­pean Cen­tral Bank, the Euro­pean Com­mis­sion and the In­ter­na­tional Mone­tary Fund) for the dis­burse­ment of the next tranche of the bailout loan.

The re­forms that are the only path­ways to growth, such as build­ing a well-func­tion­ing pub­lic ad­min­is­tra­tion and lib­er­al­iz­ing mar­kets, are re­sisted by Greek politi­cians and vested in­ter­ests. They are also greatly un­der­em­pha­sized by the troika's push for aus­ter­ity. Un­less there is a change of course, Greece is headed for dis­as­ter: fur­ther de­clines in GDP, a pos­si­ble chaotic de­fault on its debt, ex­trem­ist po­lit­i­cal par­ties in power, and iso­la­tion from Europe. The Euro­pean Union also stands to lose be­cause a Greek melt­down would re­verse the decades-long process of in­te­gra­tion and un­der­mine the cred­i­bil­ity of the sin­gle cur­rency. And Greece's cred­i­tors won't get any of their money back.

To avoid such an out­come, which could oc­cur soon, Greece's Euro­pean part­ners should de­vise a long-term strat­egy with two mu­tu­ally re­in­forc­ing ob­jec­tives: a dras­tic re­duc­tion of Greece's debt and a thor­ough over­haul of the coun­try's dys­func­tional econ­omy.

Greece's debt is pro­jected to rise to 189 per­cent of GDP next year, from 129 per­cent in 2009. This is de­spite the re­struc­tur­ing of pri­vately held debt and se­vere aus­ter­ity mea­sures that have al­most wiped out the gov­ern­ment's pri­mary deficit.

Most of the in­crease in the debt-toGDP ra­tio can be at­trib­uted to the large de­cline in GDP. Fur­ther aus­ter­ity mea­sures, de­signed to gen­er­ate the large pri­mary sur­plus nec­es­sary to be­gin re­duc­ing the debt, will cause GDP to fall fur­ther, mak­ing the debt-to-GDP ra­tio even larger. This will make it im­pos­si­ble for Greece to ever re­pay its debt in full. Its Euro­pean part­ners should rec­og­nize this state of af­fairs and write off a sig­nif­i­cant frac­tion of the debt. This would al­low Greece to grow and re­pay the rest.

Writ­ing off Greece's debt can be done in a way that pre­serves, and even pro­motes, in­cen­tives for re­form. A por­tion of the of­fi­cially held debt -- 50 per­cent or more -should be set aside to be writ­ten off grad­u­ally over the next five years or so, on the con­di­tion that Greece com­pletes a set of in­sti­tu­tional and mar­ket changes. The steps in­clude mak­ing the pub­lic ad­min­is­tra­tion more ef­fi­cient, speed­ing ju­di­cial pro­ceed­ings, re­duc­ing cor­rup­tion and lib­er­al­iz­ing mar­kets. Achieve­ment of these mile­stones could be mon­i­tored us­ing ex­ist­ing in­dexes de­signed by in­sti­tu­tions such as the World Bank and the IMF. Such a sys­tem would not only pro­mote re­form, but would put Greece's debt, which can­not be re­paid in full in any case, to good use.

More gen­er­ally, the troika should em­pha­size struc­tural changes rather than the rapid ac­cu­mu­la­tion of a pri­mary sur­plus. The ini­tial em­pha­sis on re­duc­ing the deficit was ap­pro­pri­ate given the un­sus­tain­ably large bud­get short­fall.

How­ever, con­tin­ued aus­ter­ity will be coun­ter­pro­duc­tive be­cause it un­der­mines re­form. For ex­am­ple, deep salary cuts in the pub­lic ad­min­is­tra­tion are caus­ing tal­ented per­son­nel to leave, thus im­pair­ing an al­ready weak sys­tem and wors­en­ing the core prob­lem of low pub­lic-sec­tor pro­duc­tiv­ity.

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