A plea for the right kind of austerity!

It is shocking to see how the expressions “overspending” and “austerity” are thrown around without the least effort of defining/explaining what they mean (or should mean). Overspending is what got Greece into trouble and austerity is causing the pains now. But overspending of what and austerity for what?

When a family gets into financial trouble, they need to reduce their expenses wherever they can and start living “within their means”. If they continue to spend more than they earn, they need to find someone to lend them money. If no one lends them money, they have no choice but to stop spending.

The government (state) does not function like a family. Where the family has to save in times of financial trouble, the government needs to spend in order not to damage its revenue base. It really isn’t government overspending which got Greece into trouble because Greece’s government spending, as percentage of GDP, is by far not at the top of the Eurozone (Greece: 50%; France: 56%). What got the Greek government into trouble is that the revenue base was far too low for that kind of spending. Also, the public sector in general absorbed a huge portion of national resources without generating an adequate level of value. While some austerity was undoubtedly necessary, the real austerity should have been applied elsewhere.

The country functions exactly like a family. When a country spends more abroad (for imports, services, interest) than it earns abroad (through exports, tourism, etc.), it is overspending. The gap is closed by funding from abroad. When that funding no longer flows freely, the country must do the same thing as a family: radically curtail spending abroad; radically increase revenues from abroad; or a combination of both.

When a family has a monthly income of 1.000 EUR and spends 1.400 EUR every month, it’s obvious what will happen once the bank stops making loans. From 2001-10, Greece spent 1.400 EUR abroad for every 1.000 EUR which she earned abroad. Until about 2008/09, foreign banks were happy to provide the funding for that. Since then, the funding had to be provided through recue and/or ECB-loans.

Since the peak overspending in 2008 (1.530 EUR spending for every 1.000 EUR earned abroad!), several things have improved: exports increased quite impressively and the growth in imports could be slowed.

Nevertheless: as late as 2011, the 3^rd full year of the crisis, Greece still spent 1.372 EUR abroad for every 1.000 EUR earned abroad! (that is overspending to the tune of 37%!).

Now, picture that those were the figures of a family and that you were that family’s banker. Imagine what you might say to that family? How would you communicate your feelings that, over 2 years ago, you had told them to stop overspending and you had repeated your warnings every quarter, only to now see that they were happily overspending as though nothing had happened?

It is inconceivable to me why Greece as a country would have done nothing to reduce the enormous level over overspending abroad. The first step would have had to be a “buy-Greek drive”. The second step would have had to be to promote domestic production of those products which should no longer be imported (thereby providing a stimulus for economic activity). And, probably, one couldn’t have avoided implementing some form of special taxes on selective imports to make them more expensive.

In short, the much needed austerity would have had to be applied to spending abroad! Instead, Greece continued to spend money abroad as though nothing had happened. The most ridiculous point is that Greece, a country which should drastically reduce spending abroad and which should import only those products which can definitely not be produced domestically, well, that such a country whose most important sector is still agriculture would import even agricultural products, and not in a small way!

How long will it take until people come to senses? That Greece as a country simply won’t be able to spend other people’s money forever?

From 2001-11, in only 10 years, Greece has received funding from foreign lenders to the tune of roughly 400 BN EUR! There was additional funding from EU-grants and foreign investments. There is simply no way that another 400 BN EUR of funding will come in the next 10 years for the purposes of overspending and capital flight! (there are no facts to support this argument; just common sense).

Why is it not obvious that Greece has to apply the greatest austerity imaginable to spending abroad? Even if it means controlling imports! And if import substitution is handled well, it would significantly add to domestic economic activity!



UPDATE PER 20.03.2012
In near disbelief I just saw the January figures. Unbelievably, the current account deficit had declined to 1,5 BN EUR from 2,8 BN EUR a year ago. Exports had increased and imports declined. All other categories improved, too.

Was this a "lucky month" or could it be the beginning of a change in trend? The next months will show. Mind you, if the January-trend were maintained throughout 2012, the annual deficit would still be about 10 BN EUR, a large figure but almost peanuts compared with the 35 BN EUR oof 2008.

http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_20/03/2012_433802

UPDATE PER 22.03.2012

Clarification from the Bank of Greece: "The improvement means absolutely nothing since it is a result of the recession both home and abroad. Unless we embark on structural reforms the weaknesses of the Greek BOP will be there to stay. However: Lower deficit means FDI. FDI means structural reforms. Structural reforms means less state interference, less politics, less corrupt politicians. In view of the forthcoming elections this looks too good to be true".