Commission exhortation for Greece fails to convince

On April 18th, the Commission released a communication, entitled Growth for Greece against the background of a country in its fourth year of severely negative growth during which unemployment has more than doubled to over 20% and wages and pensions have been cut by around 30%. Greece needs growth as much as a starving man needs food but the implicit suggestion that the Commission and other EU institutions like the European Investment Bank may be offering the country the chance of growth as it approaches a general election on May 6th could be a mirage. The economy has slumped because of the need to cut the government deficit from a staggering 15.7% of GDP in 2009 towards balance. The tax rises and expenditure cuts have reduced all elements of domestic demand and with no upturn in exports have therefore cut GDP. Since Greece has not completed the task of deficit reduction (the 2011 deficit was 9.25% of GDP), since severe cuts in the 2012 budget are contributing to an expected GDP decline of 5% or more this year and since further cuts are being requested in subsequent years, prima facie the communication’s title looks like an offer of an illusion. The reader of the title wonders what there might be in the document, which could offer a way to reverse the existing trend.

The fact that the communication was launched by President Barroso does indicate at least that Greece has not been forgotten in Brussels and that its predicament is being taken seriously. However, the content of Mr Barroso’s speech does not inspire confidence. He claims that the EU is in some way providing financial help of 177% of Greece’s GDP, a meaningless figure which includes both the €100bn write-down of private sector debt and new loans which are intended to be repaid with interest. These sums cannot alter the dynamics of the Greek economy. The only part of the financial flows to which Mr Barroso refers that might stimulate growth is that which could go towards boosting such businesses as might start exporting, increase exports from companies already exporting or take domestic market share away from imports. These are primarily from €20bn of structural funds in the 2007-13 Community Support Framework programme which provide non-repayable grants , of which–according to the Communication–half has so far been spent. With half to spend in the last two out of the seven years, there could be a relatively big boost to provision but obstacles to the money being well spent are still large. Although the proportion going to businesses is supposed to increase, the majority of the funding still goes to infrastructure, which cannot directly support business expansion or boost exports. An important but unanswered question is whether there have been any successful business investments which could provide examples for others to follow.

How different is Portugal from Greece?

Greece has rightly tended since the beginning of the euro zone crisis to attract as much or more attention than any other euro zone economy as the weakest link in the chain. Portugal has of the vulnerable countries attracted much less attention except at the time when its financial rescue programme was being negotiated and elections were held in the first half of 2011. This reflects the fact that Portugal’s sovereign debt burden, though rising steadily, still significantly less than that of Greece (even after the latter has seen private sector debt written down). And Portugal’s government deficit has been a perennial problem rather than, as in the case of Greece, one which suddenly shocked financial markets by the revelation in 2009 that previous deficits had been dramatically under-estimated.

Portugal does however have some similarities to Greece. Its population at 10.6m in 2011 is almost exactly the same as Greece’s estimated 10.8m. The two countries’ GDP at purchasing power parities are both at the bottom of EU and euro zone countries other than those taken in from the enlargement of the EU in 2004 and the more recent enlargements of the euro zone to include Estonia, Slovakia and Slovenia. In 2010 Greek GDP per head at purchasing power parities (PPPs) was €21,900 and Portugal’s €19,600, compared with a euro zone average of €26,400, according to Eurostat figures. As Greece’s GDP fell much more than that of Portugal in 2011 and is likely to do so again in 2012, the two countries’ GDPs this year are likely to be close to each other.

Both countries have been running high external current account deficits in recent years although Greece’s has been the higher of the two. These deficits should be given as much attention as fiscal deficits since they measure the viability of the countries’ economies as a whole, not just the public sector. In the case of Ireland, which, despite continuing major problems with its banks and public sector, remains a much richer country, the current account deficit has already been eliminated. Current account deficits can be reduced mainly by two methods, reducing imports of goods and services or raising exports. As long as there are free economic exchanges, a decline in imports in the short term mainly requires that domestic demand falls. There is also the longer term possibility of substituting for imports with domestically produced goods and services, but unless protectionist measures are introduced, this implies the gaining or regaining of market share in turn implying improved competitiveness. Such improvements could in theory be through either higher quality or lower prices but in practice with incomes constrained are more likely to occur through cutting prices.

Raising exports would be the ideal way out of recession. The difficulty of vulnerable south European member states raising exports is intertwined with the difficulty of coming out of the vicious circle whereby attempts to reduce public and private sector deficits and debt weaken overall demand and tax revenue, thereby negating much of the impact of deficit reduction measures. If exports could be increased, they could offset declines in the domestic economy, and furthermore export earnings should feed through into the domestic economy.

One problem is that with the EU in recession, demand for exports is weak but the more fundamental problem is the export potential of the countries concerned due to the limited diversification of the economies and lack of brand recognition of most Greek and Portuguese merchandise products. Portugal and Greece are both well known as tourist destinations. There are however capacity limits at the more favoured tourist destinations during the peak season so expanding demand for holidays in Greece and Portugal would require increasing the range of favoured destinations and attracting visitors outside the peak season. While value for money is important a sharp reduction in prices would not necessarily boost demand by more than the loss of income from lower prices. Greece also has large earnings from shipping but much of these do not reach the domestic economy and the competitiveness of the Greek shipping industry is only to a limited extent dependent on conditions inside Greece.

The performance of exports of goods and services in the last few years puts Portugal in a much better light than Greece. Portugal has seen its exports rise in the last three years to €67.3bn from €60.7bn in 2008 while those of Greece have fallen €56.2 to €51.7bn. The increase for Portugal game mainly from goods while the fall in Greece’s case was entirely of services, though the latter still accounted for half of the country’s exports compared with just over a quarter in the case of Portugal. Judging from recent performance the opportunities for goods exports look better for both countries than for services.

The political situation is also hugely better in Portugal than that in Greece. It has a majority government and main opposition both committed to complying with the EU/IMF conditions in the financial rescue programme. Indeed the government in some respects wants to go further and certainly gives the impression in for example planned reforms of commercial law, competition and bankruptcy law—all currently major weaknesses—that it is taking the initiative rather than just doing what it is told to.

Nevertheless Portugal still has a long road to climb, which will not be helped by the impact on exports of recession across much of the EU this year.  Public debt continues to rise rapidly and the nominal government deficit of 4.2% of GDP in 2011 was highly misleading and would have been 7.7% without a credit being given by the state adding substantially to its pension liabilities. Portugal also has a longstanding overhang of private sector debt (higher than Greece’s)  which is a worry for its banking sector and there is little possibility that the Greek government could help the banking sector without making itself insolvent. EU negotiators have insisted that the write-down of private sector Greek government debt held by the private sector in the financial rescue package for the country, that was finalised in March 2012, was unique. Though Portugal is in a somewhat better position than Greece, it is not yet certain that it can pull through and get on top of its debt without any write-down.

Greek elections: democracy where options are limited

Greece is to have a general election on May 6th. From the point of view of tackling the problems of the Greek economy, the election is not helpful. It will largely consist of politicians claiming that there is a less painful alternative to the Memorandum of Understanding that the present coalition government has agreed with its euro zone partners, the European Commission, the European Central Bank and the IMF. All the seven or so parties which are not in the current government of national unity but have enough support to be likely to gain parliamentary representation will openly oppose the Memorandum. Antonis Samaras, the leader of the centre-right New Democracy, whose support appears to be slipping in latest opinion polls but is nevertheless likely to emerge as the largest party, will base his campaign on calls to renegotiate aspects of the Memorandum, despite the fact that he has been forced to sign it as part of a temporary government of national unity since November 2011. Only the centre-left Pasok, which for two years from October 2009 to November 2011 imposed a drastic austerity programme, which was the key condition of receiving fiscal support from the EU and IMF, is currently willing to support the Memorandum, without which the Greek state would be bankrupt; and it is likely that during the campaign Pasok campaigners will try to distance themselves from the most unpopular measures being taken, whether salary or pension cuts, or tax rises.

Yet as far as the measures so far enacted which include cuts of 30% or more in salaries and pension, and a range of tax rises affecting all income bands, there is no room for manoeuvre since the Greek state is still running a primary deficit which means it is receiving less in tax than it is paying in salaries and pensions irrespective of the government’s huge debt. A unilateral break with Greece’s creditors would at best force salaries and pensions to be cut further. At worst, it could lead to Greece’s exit from the euro so salaries and pensions would be paid in a new currency, which would be likely to depreciate steeply in value in relation to the euro.

That is not to say that there are no options at all for promoting growth and recovery and Greek parties would be right to debate with Greece’s creditors who are effectively sharing in the running of its economy, on how to achieve a recovery. But if as proposed by ND there should be a cut in company tax with the aim of boosting private investment, the money lost would have to be compensated for by even higher taxes of other kinds. In effect there are no options which can ease the unprecedented economic pain being suffered by Greeks in the short to medium term.

Political parties will therefore be more likely than not to propose policies that if they participate in a government they will not be able to enact, which could lead to an even deeper popular disenchantment on the part of the Greek public with their politicians than already exists.

With 30% of the electorate undecided according to opinion polls, the result of the election is wide open. As noted, ND is likely to be the largest party and Mr Samaras can therefore expect to be asked to try to form a government. He is at present saying that he will not agree to a coalition but as it does not look likely that ND will obtain nearly the approximately 36% of the popular vote which could give it a majority in the 200-seat parliament, he will either have to change his mind or not attempt to form a government. Moreover, despite his insistence on renegotiating the Memorandum prescribing policy guidelines agreed with Greece’s creditors Mr Samaras will probably not want to precipitate the economic chaos which would result from breaking the agreement. This means that only Pasok of the multiple other parties is likely to be a suitable coalition candidate since all the others are completely rejecting the Memorandum. A new ND-Pasok coalition would require that the two parties obtain between them at least 36% of the vote which is more than the Public Issue opinion poll released on April 12th that gave ND 19% and Pasok 14.5%. There is a chance that the Greek public may decide that the options being offered by all the other parties would by resulting in a full break with Greece’s euro zone partners, be in practice even worse than the existing situation and come round to giving the two traditional parties enough support to form a government, despite the fact that they are blamed for the country’s predicament. If they do not it is difficult to see any scenario providing for political stability. It is just possible that three parties to the left of Pasok, the Communists, a coalition called Syriza and the Democratic Left could obtain enough seats to form a government but they are themselves bitterly divided.

Is Spain on the right track?

While Italy looks less close to disaster than it did six months ago (an improvement which could easily be reversed) market perceptions of Spain have deteriorated.

Despite a much lower public debt than Italy’s, and after a 2012 budget which was just been presented on March 30th and is described as the harshest since Spain became a democracy, with swinging cuts averaging 17%, and up to 54%, on all ministries, rates on Spanish ten-year bonds on March 30th remained distinctly higher than those on Italian bonds, with both over 5% and more than 300 points above German equivalent bonds.

Although the amount available in rescue funds is likely to be increased gradually to around €700bn (€500bn from the proposed European Stability Mechanism (ESM) plus funds earmarked for Greece, Portugal and Ireland) European policy makers will be earnestly hoping that this does not have to be used to rescue Spain, given the likely contagion effect on Italy and other countries.

There are three main reasons for increased concern over Spain. The first is the considerably worse than expected outturn of the general government budget in 2011 when the deficit amounted to 8.5% of GDP, after already two years of severe austerity under the previous Socialist government. The worse than expected outcome cannot be blamed primarily on the Socialists since the principle cause was higher regional deficits. The harsh 2012 budget aims to reduce the deficit to 5.3% of GDP. The second reason is concern over Spain’s banks, particularly its savings banks, which are being called on to realize their capital losses from the collapse in Spain’s property market since 2008, and raise €50bn in new capital. They will be forced to sell property into a weakening property market, with prices continuing to decline after already falling about 30%. The third reason is the continuing weakness of the Spanish economy with unemployment at 23% the highest in the EU and only weak signs of a pick-up in exports. The austerity measures though necessary are likely to further weaken the economy.

The political situation in Spain should be favourable. In December 2011 a newly elected centre-right Popular Party government, led by Mariano Rajoy, took office committed to a combination of the necessary fiscal austerity and economic reforms to boost employment and growth. However, although the government has consistently pursued its policies, it has made presentational mistakes. These include delaying the 2012 budget even more than it had already been delayed by the general election and change of government, in order to allow regional elections to take place in the misplaced hope that delaying the bad news would help the PP in these elections. This gave the impression that at a time when the government should having its four year term ahead have been free from party political considerations, it was giving priority to political maneuvering over tackling Spain’s economic problems.

A second presentational mistake was in the course of discussion over the reasonable request to revise the 2012 budget target in view of the 2011 overshoot, Mr Rajoy talked about Spain’s “sovereign” right to decide its own budget. In reality he should recognize that a vulnerable country like Spain has sovereignty limited by the need to convince investors to buy Spanish debt and that as a member of the euro zone it also has to consider the impact of its own policies on the rest of the euro zone. However, despite such criticisms the budget itself is as good an effort as is possible in unfavourable circumstances to tackle the budget deficit. Policy actions are more important than presentation and at present these seem to be in the right direction.  But the mountain to climb remains formidable.

Euro zone crisis

Aim of website

This website provides an ongoing analysis of the attempts of the euro zone to pull itself out of its crisis. It starts from a premise of support for the EU and euro projects, but recognises that the euro project is proving more risky than seemed to be the case in its early years and an ignominious collapse of the euro zone would not only entail a severe financial crisis in the euro zone but also put at risk the earlier achievements of the EU, including its single market.

Background

There are several aspects to the crisis.

1)   The first aspect of the crisis of the euro is a sovereign debt crisis. In this respect it is part of a wider sovereign debt crisis affecting all the main mature economies in the world. Not only most of the euro zone but also the UK, US and Japan have built up too much sovereign debt, and are running too high deficits, partly as a result of poor management of their public finances over a long period, and partly owing to the unexpected impact of the 2008-09 global financial crisis, which led to heavy costs rescuing banks and a severe decline in revenue as economies went into deep recession. In fact the overall debt/deficit predicament of the US, UK and Japan are all worse than the overall position in the euro zone.

2)   An equally perhaps more important aspect of the crisis is that of external current account imbalances. These may overlap with fiscal imbalances implying that a fiscal deficit is largely funded externally. But there have also been severe private sector imbalances and accumulated private sector debt in Ireland, Spain and Portugal. In the first two cases the sovereign debt/deficit problems only arose because of the severe domestic economic effects of these private sector imbalances trying to resolve themselves.

3)   A third aspect is a banking crisis. Banks have been weakened by poor lending practices which in some countries, notably, are the prime cause of the problems. In other countries, such as Greece, the difficulties that banks are experiencing are mainly a result of the impact of the sovereign debt crisis. The banking crisis affects almost all countries in the euro zone, including stronger economies, such as Germany and the Netherlands.

4)   A fourth aspect is competitiveness. The external current account imbalances have resulted from some countries being more inclined to save and others more inclined to borrow. After a time borrowers have to repay their debts which requires increasing exports but this task is only possible if companies are able to produce goods or services of a quality and cost able to competed in foreign markets. Lack of competitiveness impedes the closing of current account deficits.

5)   A fifth aspect is economic growth or its opposite, economic decline. In Greece and Portugal the severity of economic decline is causing severe hardship for large parts of the population. Other countries, Ireland and Italy are overall still wealthy countries but lack of growth (in Italy over a long period) raises their unemployment rates weakens their ability to manage public finances. The vulnerable countries are all struggling to emerge from a vicious circle, in which economic decline reduces revenues and so increases government deficits while austerity measures—expenditure cuts or tax increases—further weaken their economies and so undermine the efforts to close the deficits.

Can competitiveness of weaker countries be restored within the euro zone? This is the crucial question, which is likely to be decisive for whether the euro zone survives intact in the longer term. Currency depreciations are a possible way to restore competitiveness which is denied to weaker members of the euro zone. Such depreciations are not an easy option since they can only work if not eroded by inflation which means that wages need to be held down rather than allowed to compensate for higher prices resulting from the depreciations. But they may appear to be less painful than the alternative which is large actual falls in nominal wages. Greece has gone down this route most dramatically as symbolized by a 22% cut in the minimum wage in early 2012. This has only been politically possible because of the manifold and desperate crisis of the economy. The result should help the economy but how much is uncertain. Greece lacks a substantial manufacturing sector and it is far from clear that a mere improvement in cost competitiveness could create the conditions to create one. Other vulnerable economies have lost parts of the manufacturing to emerging economies. If they can lower their wage costs they can lower their prices but wages would inevitably remain well above those in their competitors so they would still only succeed if they can also compete on quality and innovation.

Risks of break-up.  Another problem of euro area membership now comes from the threat of leaving the euro area. Membership was supposed to be permanent and therefore to reduce risk but since the possibility that a country or countries might be forced to leave has come to be seen as real threat, euro area membership has actually increased risk perceptions, because leaving would be associated both as cause and effect with a breakdown of the country’s financial system, with chain reaction effects on other countries, to an extent which could easily get out of control.