Wednesday, August 22, 2018

"The Rescue Is Over" - Reviewing 7 Years Of Blogging

"Greece - The Rescue is Over" titled the online portal of Austria's national broadcaster on August 20. The European media were full of self-congratulatory statements by EU elites. Yes, the Greek people had to go through severe hardships in the last 8 years but now that chapter is closed and the stage is set for a prosperous future. Provided, of course, that Greece continues successfully on the reform path of the last years. Etc., etc. This blog has accompanied the Greek crisis since June 2011. In this elaborate essay I will reflect on the observations I have made and the opinions I have expressed over the years.

In early 2009, and in preparation for my upcoming retirement, my Greek wife and I started looking for an apartment in the Thessaloniki area where we planned to spend a good portion of our retired life. We had lived in Munich at the time, one of Germany's most expensive cities, and we expected a life in a less expensive environment. We quickly found an optimal apartment in Kalamaria and in April of 2009, we flew to Thessaloniki with the purpose of getting the apartment in shape, i. e. furniture, etc.

Germany at that time had been hit hard by the financial crisis. At one point, Chancellor Angela Merkel and her Finance Minister had to go on TV to assure the public that all German bank deposits were guaranteed by the state. This against the background that a bankrun was feared. In my banking job, I was responsible for corporate banking in Southern Germany, the home of the German Mittelstand. Every day we received new panic reports from our customers.

As the taxi drove us from the Thessaloniki airport to our hotel (there was no furniture in the apartment yet), we passed an impressive looking furniture store. That, I said to my wife, would be our first stop the next day. I was looking forward to the opportunity of buying top quality furniture at low prices. The first living room arrangement which they showed us (2 sofas and a chair) went for 10.000 Euros. I expressed shock at the price. The sales lady looked at us with the expression on her face: "If you can't afford our furniture, don't waste my time." We decided not to waste her time.

From then on, one surprise was followed by the next. There was an unbelievable number of large furniture stores. At IKEA it was difficult to find a place in their huge parking lot. Downtown Thessaloniki was exploding with economic activity. In short, wherever I looked, I saw shops, people shopping and the prices were high. In several instances (like supermarkets) higher than in Munich.

Through my wife's cousin, a very well connected man around 50, we made our first friends. They were either rentiers or retirees even though none of them was over 60. The cousin had sold his small business (a t-shirt manufacture) when he was 45 and he was looking at about 5.000 Euros in monthly rental income and real estate properties which he valued at 1,5 MEUR. His best friend told us that he had collected a severance package from OTE in his early fifties and was now receiving a monthly pension of almost 3.000 Euros net per month. I asked him what he had done at OTE and he proudly said 'nothing'. He would come to the office in the morning, leave his jacket on his chair and go out to the beaches. Another friend had taken early retirement from a public sector company where he had been a big shot in the union. He was just completing a new mansion which I thought would be worth at least 2 MEUR. On the side, he was pursuing projects with EU subsidies and we learned through the grapevine that a good portion of those subsidies found their way into his private pocket. A neighbor told us that he was collecting 12.000 Euros net per month in the form of pensions from 3 management positions in the public sector. Our real estate agent, a former policewoman in her mid-fifties, told us that she had retired at 48, collected a pension of 1.800 Euros net per month and now earned substantial income as a broker.

In a relatively short time, we had built up a circle of friends of over a dozen people. Only one of them was over 60 (the former public sector manager) but none of them was in a working relationship, either employed or self-employed. There were either rentiers and/or early retirees.

Around that time, I read an analysis of Greece's economic situation by a reputable international institution. Regrettably, I did not keep it and I don't remember the name of the institution. The gist of the analysis was that Greece would probably remain unharmed by the financial crisis because its banks were not involved in international speculation. If anything, Greece had a good chance of coming out of it as a winner.

Upon returning to Munich later in the spring of 2009, I happened to attend a presentation by the well-known economist Michael Huether. He was talking about the financial crisis in Eastern Europe and how the banks had to put together a rescue package. And then he said: "Mind you, before the crisis is over, we will also have to put together a rescue package for Southern Europe." I thought the man was dreaming. A rescue package for Greece? Didn't he know that Greece was a booming place and that analysts predicted a glorious future for the economy?

Around that time, I happened to read "The Battle of Bretton Woods" by Benn Steil. It was the battle between the British John Maynard Keynes and the American Harry White. Keynes had one predominant objective: to assure that the new monetary order would control imbalances in the current accounts. He proposed a new reference currency ("Bancor") in which surpluses/deficits would be settled. Over a certain level, a surplus country would have to pay into the Bancor and the deficit countries would receive them. A perfect recycling mechanism. Keynes' counterpart White also had a predominant objective and it was diametrically opposed to that of Keynes: to establish the predominance of the USD in the new monetary order. The dollar would be fixed against gold and the other currencies would be kept in a trading range versus the USD. Responsible conduct of the US would assure that world-wide imbalances would he held in check. White prevailed.

In 1971, Keynes was posthumously proved correct. The US had not displayed responsible conduct, had accumulated large external deficits and there was no longer enough gold to cover the USD in circulation. In a short TV speech, President Nixon surprised the world with the news that the USD would no longer be convertible into gold at a fixed price. In practice, it was a haircut of all USD claims held by the rest of the world. The age of fiat money had begun.

I came away from reading that book with the conviction that the most important factor in international financial stability was a country's current account, that it was a country's balance of payments that had to be checked, and that conviction shaped almost everything which I would write about Greece's financial crisis later.

When the Greek financial crisis erupted in late 2009 and until the first rescue package of May 2010, it felt to me like a déjà-vu. I had witnessed, as local country manager of a large American bank, the economic turn-around in Chile in the late 1970s/early 1980s. Since then, Chile has become the prototype for me as regards how to overcome an economic crisis. When I arrived in Chile in 1980, the economy was booming. Only 7 years earlier, Chile had been in total economic chaos caused by the policies of Salvatore Allende: Chile in 1973 was what Venezuela is today. How could a totally bankrupt economy be turned around into a booming economy in only a few years?

Two very simple factors: a very competent economic management team (the "Chicago Boys" in Chile) and a political leadership which could give that management team air cover to implement their policies. In Chile, that political leadership was the dictatorship of Augusto Pinochet, rightly blamed for atrocious human rights violations. However, without such air cover it would have been unlikely for the economic management team to succeed owing to the enormous adjustment pains which came along with the new policies. It was a shock treatment like changing traffic from left to right overnight. I often wondered whether a democracy could survive such a shock treatment. In Greece, I thought the shock treatment could work IF there were a competent economic management team and IF there were a strong, unified government supporting it.

The most important factor for the success of the Chicago Boys was that they had a plan and consistently and unwaveringly pursued it. It was nothing but applied common sense: increase exports, reduce imports, apply efficiency criteria to the huge public sector, create market conditions for the private sector and create an economic framework which would attract foreign capital. The Chicago Boys committed one major mistake which eventually caused their downfall and the external payments crisis of the early 1980s: they fixed the exchange rate to the USD 'forever'. With Chilean interest rates much higher than USD interest rates and with no perceived foreign exchange risk, foreign capital flowed into Chile like there was no tomorrow. When the bubble exploded, the Chileans eliminated the fixed exchange rate and the economy stabilized relatively quickly. Chile's luck was that they had only fixed the exchange rate instead of joining a currency union with the USD. The rest of the model of the Chicago Boys remained in place, resulting in Chile's becoming one of the most successful economies in Latin America to this day.

Later in the 1980s, I was transferred to Argentina where my bank was one of the largest foreign creditors of the country. In 1983, Argentina hit the then largest external financing crisis ever with American banks being by far the largest creditors. It was the American Citibank which headed up the crisis management. Its principal negotiator, Bill Rhodes, literally personally developed the model for handling Argentina's external financing crisis, a model which became the standard for handling the dozens of external financing crises throughout the world since then. Its components, again, were quite simple: negotiations had to be carried out directly between Argentina and its private creditors; official institutions (the Fed, the US government) only quarterbacked behind the scenes; private creditors had to maintain their Argentine exposures, i. e. loans and trade credit ("risk takers must remain risk carriers"); and the IMF assumed responsibility for providing fresh money and negotiating economic measures ("memorandum") with the Argentine government. The banks agreed subject to the involvement of the IMF, the IMF committed subject to the agreement of the banks. The mutual dependency between private creditors and the IMF was born. No bank was bailed out. Instead, their benefit was that they could keep their existing exposures on performing status instead of having to write them down.

Given the above experiences, I thought by late 2009 that Greece's problems would be solved rather quickly. As regards reforming the economy, I thought they would copy the Chileans: put in place a competent economic management team and have a unified government provide it with air cover. And as regards the external financing crisis, I thought the EU would consult with Citibank, by then the world's premier expert in how to handle external financing crises. The EU refused to consult the experts. Bill Rhodes later said in interviews that he had offered his advice to the EU as well as to the then Prime Minister George Papandreou. He was told by all parties that the experience with emerging countries would serve no purpose because the EU and, particularly, the Eurozone were completely different animals. The trouble was that the EU had zero experience with the handling of external financing crises of a country.

By early 2010, I was baffled with the events unfolding in the Eurozone. Instead of consulting experts, Angela Merkel consulted with the CEO of one of Greece's largest creditors, Joseph Ackermann of Deutsche Bank! Ackermann, as his job required, defended the interests of his institution and argued with Merkel that not only the Euro and the Eurozone but the entire world-wide financial system would fall into chaos if Greece were not bailed out. At the peak of those dramatic developments, Merkel coined a phrase which may go down into history as the most expensive phrase ever: "If Greece falls, the Euro falls and if the Euro falls, the EU will fall!" That misinterpretation was the source of every other problem which followed subsequently.

What should Merkel & Co. have said to the bankers pleading for a bail-out of Greece? Something like this: "We realize that you have a problem with Greece but, truly, this is a problem between you the creditors and Greece as your borrower. You will have to negotiate a restructuring of your claims directly with your borrower. We are on standby when it comes to financing Greece's new financial needs going forward and for negotiating economic measures with Greece but first you have to restructure your claims. Should you fail to do so, you correctly say that your institutions may fail. You need not worry about that because we already have protective measures in place. We have already put in place successor vehicles for each of your institutions. If you declare bankruptcy in the morning, our successor companies will take over your operations in the afternoon and your shareholders will be wiped out. At some point in the future, your successor companies will again be privatized and we will hopefully recover much if not most our our investment. The tax payers will not lose everything, which is what would happen if we bailed you out via Greece. Mind you, if you do not follow our advice and if your shareholders are wiped out, you may become personally liable for any damage suffered by your shareholders because you had the opportunity to avoid that damage and you chose not to use it."

The utter misinterpretation of EU elites was that, in a major financial crisis, it was the banks which had the power and the governments which were 'alternativlos'. The opposite is the case. In any major financial crisis, it is the creditworthy governments which have the power and the banks are dependent on them for the simple reason that governments have time and the capacity to raise money. If a bank falls below equity requirements, it needs to file for bankruptcy immediately, as Lehmen had shown. A creditworthy government can provide the time for an orderly bank restructuring and/or liquidation and the liquidity required. The US government had demonstrated how this is done. When the world's largest insurance company, the giant AIG, faced bankruptcy because a couple of hundred employees in London had engaged in reckless credit default swaps, the US government stepped in and it demanded its pound of flesh: 90% of shareholdings were wiped out. Only a few years later, the US government successfully exited the restructured AIG and took a huge profit on the exercise. AIG's largest former shareholder sued the government for damages to the tune of 30 BUSD. The law suit failed on the grounds that not only profits are for private shareholders but losses as well.

As I explained above, a first memorandum could not have been avoided even if the EU had handled the Greek crisis correctly: no creditor would have agreed to keep his exposures if there was no commitment for reform measures. What puzzled me during visits to Greece throughout 2010 was that life had hardly changed: Greeks were still buying imported goods like there was no tomorrow. Under normal situations, when a country loses access to foreign financing, its current account needs to be balanced literally overnight. Imports are drastically reduced. The entire population feels that there is a problem. Greece, however, continued to run very high current account deficits. In the spring of 2011, Prof. Hans-Werner Sinn provided the explanation when he introduced the world to the marvels of Target2, the ECB's cash management system. By then, the Bundesbank had accumulated Target2 claims of 324 BEUR and Sinn prophesized the demise of Germany (today they are close to 1 trillion Euros).

One can make intellectual arguments whether Target2 is the key component of a currency union or whether it is an unlimited credit card. In practice, Target2 allows a domestic banking sector to pay for imports, for deposit flight and for capital flight even if it has lost access to foreign funding. Without Target2, the Greek banking sector would have become illiquid in 2010. In June 2011, I started this blog and one of my first articles was about Target2. My argument was that Target2 was the principal reason why there was no crisis awareness among the Greek population. As long as one can buy imported goods, withdraw savings from banks and transfer capital abroad, it is hard to convince the general public that there is a crisis.

As I studied the first memorandum, I couldn't help to think that it was a bookkeeper's approach to solving financial problems: increase tax revenues and cut costs. What I was looking for was a long-term economic development plan à la Chile which would aim to drastically restructure the Greek economy so that it could stand on its own without funding/subsidies from abroad. A plan which would have a 10-20 years time frame. In the first month of this blog I proposed such a plan. To summarize the content: "If Greece cannot make it with the Euro but if a Grexit is the worst of all evils, Greece should hold on to the Euro but temporarily simulate a situation as though it had returned to the Drachma: import controls and substitution with the focus on 'infant industry protection and development'; export promotion; attraction of foreign investment AND, finally, a shock treatment for the public sector. Instead of attempting to change the entire economy at once, Special Economic Zones should be established where the new economic framework could be gradually spread through the country." I later referred to it as the "4 obsessions" which would have to be fostered throughout the Greek economy and population: an obsession with import substitution, with exports, with attracting foreign investment and with making the public sector efficient. To this date, I have not seen such a plan.

Soon after I started this blog, I became aware of Yanis Varoufakis and his blog and other publications. His 'Modest Proposal' had caught my attention because it was a most ingenius proposal to solve the Eurozone's problems. It was certainly better than everything I had heard from EU elites on the subject. The only problem I had with it was that it was a solution for the Eurozone's problems and not a solution for Greece's problems. My dialogue with Varoufakis began at that time. It continued throughout the years and became extremely intensive in the weeks prior to the election of January 2015. Only a few weeks after his appointment as Finance Minister and after observing his conduct on the international scene, I discontinued the contact.

My early critique of Varoufakis was as follows: "Why do you use all your intellectual brilliance, your competency, your eloquence and your charisma to solve other people's problems (i. e. the Eurozone's problems) and don't focus at all on solutions for the problems which Greece could provide on its own?" Varoufakis' standard reply was that, during the American depression in the 1930s, there was nothing which the state of Ohio could have done on its own because it was a systemic crisis. My standard answer was: as long as Greece ranked as the least attractive country for doing business in the entire EU (World Bank) and as the most corrupt country (Transparency International), there is no one other than Greeks who can solve these two problems.

Still, I remained optimistic throughout 2011 that, eventually, the Greek government would take its fate into it own hands (instead of focusing on the victim's role), that it would come up with a long-term economic development plan and implement it. I saw enormous potential in the Greek economy given that its problems were so obvious, could quickly be identified and attacked as long as there was the political will to do it and I also thought that the economy not only had great catch-up potential but also new opportunities as a regional economic hub. At one point, I even dreamed that Greece could become the economic power center of the Eastern Mediterranean.

Two things happened in the fall of 2011 which enormously encouraged my optimistic thinking: the EU Task Force for Greece (TFGR) was established and the Athens office of McKinsey published its economic plan titled "Greece 10 Years Ahead". McKinsey proposed how 500.000 new jobs could be created over a period of 10 years and 50 BEUR added to Greece's GDP and the TFGR proposed "to be at the disposal of the Greek authorities as they seek to build a modern and prosperous Greece: a Greece characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos."

All of this seemed so easy: a unified government would take the McKinsey plan and implement it and it would mandate the TFGR to implement the modernization of Greece in a hurry. Animal spirits would start flowing and foreign investors would take note. Instead of rescue funding from the EU, Greece would receive voluntary funding from private investors. After all, that's how it had happened in Chile.

I had initially been quite enthusiastic about Prime Minister Papandreou. He struck me like a polished individual who seemed competent, was saying the right things and seemed to have a will. By the fall of 2011, I had developed serious doubts. There simply did not seem to be much of a backbone. More of a diplomat than an executive. In early November 2011, I knew that there would be a moment of truth: would Papandreou prove himself as a Margaret Thatcher ("I want my money back!") or only as the son of his father. Regrettably, he showed himself only as the son of his father.

When Papandreou surprised the EU by announcing a referendum, I thought that this was an ingenius plot. Obviously, not to really hold a referendum but only to use it as a negotiating instrument versus the EU. I expected the Nice conference to become a showdown: when the French President lost his nerve, exploded and pounded the table, I expected Papandreou to remain quite relaxed and say to the President: "Look, there is no reason to get so excited; there is an easy way out. All I ask is that you do this and that for Greece and I will call off the referendum. Otherwise, the will of the Greek population will count and I am afraid you may not like the result." Given that discussions had already been in the 3-digit billion Euro sphere, a demand for, say, 10-20 BEUR in the form of additional investments in Greece's private sector would have been like the icing on the cake, a satisfactory 'this and that'.

Papandreou caved in, the political opposition behaved irresponsibly and all my hope for ever seeing a solid solution for Greece evaporated. With the benefit of hindsight, I would say that the period of 2010-12 was the crucial period where Greece 's future was determined: would Greece become the country which the TFGR envisioned or would it remain an underdeveloped economy with totally unequal distribution of wealth, income and burdens? Too geopolitically important to be allowed to fail completely but a far cry from utilizing its potential?

The cynical celebrations about 'Greece's success story' are offset by more balanced critiques of what really happened in Greece since 2010. The celebrators claim that they saved Greece, the more balanced commentators say that Greece saved the banks and the Eurozone but not itself. Very little in-depth analysis is being made as to why Greece really ended up in 2010 where it ended up. Was it unavoidable that the Euro-dominos would fall and Greece was simply the first one to fall? Was the rescue program satisfactory or were mistakes made? If mistakes were made, who is to blame? Greece or the creditors?

I have always maintained that there were 2 crises in Greece: an economic crisis and a financial one. The economic crisis, I argued consistently, began with the assumption of power by Prime Minister Andreas Papandreou and his PASOK in 1981 and the nearly simultaneous admission of Greece to the EU. The financial crisis began when 30 years of reckless mismanagement culminated in a 'sudden stop' of external financing in early 2010.

In his book "The 13th Labor of Hercules", Yiannis Palaiologos gives an account of the reckless mismanagement referred to above. In essence, PASOK managed to change Greece's political and economic climate in only a few years: a bloated welfare state with stifling interventions and overregulation; welfare populism, cronyism, statism, nepotism, protectionism and paternalism. And worst of all, the opposition, Nea Demokratia, when in power, did its best to copy PASOK instead of correcting their policies. There no longer were checks and balances. Aristides Hatzis described this as follows: "Today's result is the outcome of a disastrous competition between the parties to offer patronage, welfare populism and predatory statism to their constituencies." The responsibility can be assigned equally to both parties: if it was PASOK who initially embarked Greece on this disastrous path, the last chapter in the story "how to ruin a country" was provided by ND when, during their term from 2004-09, they drove the public sector out of control.

Was it the Euro which caused the demise of the Greek economy? Not really. When one visits Greek industrial parks today, many are more reminiscent of industrial cemeteries. Most of those industrial failures date back to the 1980s and 1990s when Greek competitiveness was essentially blown out of the water. In 1993, a young Greek professor teaching at an Australian university was asked, in a TV interview, his opinion of the state of the Greek economy. The professor stated that the Greek economy was in a state of terminal decline. His name was Yanis Varoufakis. In 1997, the so-called Spraos Report about Greece's pension system recommended urgent reforms lest the system fail. The President of all unions criticized the report for suggesting that the pension system would collapse by 2010 if corrective measures were not taken. That, the President prophetically ridiculed the authors, would assume that the Greek state would go bankrupt by 2010 (his assumption being that the Greek state could never go bankrupt).

No, the Euro did not cause the demise of the Greek economy. The stage for that was set during the 1980s and 1990s, facilitated by the wave of foreign capital flows after EU membership. The Euro only added a turbo to that process, a giant turbo to be sure, and the wave of foreign capital flows turned into a tsunami during the 2000s.

The economic crisis turned into a financial crisis during 2008. The sub-prime crisis had made lenders very risk-aware and cautious and many of Greece's lenders, previously unanimously enthusiastic, had begun looking more carefully at Greece's numbers. New lending to the Greek banking sector dried out and some existing loans were called back. This is evidenced by the rise in Greece's Target2 liabilities which began during 2008 (before then, Greece's Target2 was rather balanced). In 2009, the outflow of capital accelerated and once the new PASOK government revealed the true dimensions of Greece's deficits, 'sudden stop' was only a natural consequence. I once read an analysis which pointed out that there have been about 70 'sudden stops' world-wide since 1945. As a result, there was nothing new or unusual about Greece's 'sudden stop'. What was new about Greece's 'sudden stop' was the inadequate, if not irresponsible, EU's handling of it. Any 'sudden stop' triggers a major domestic crisis, particularly when an economy has become totally dependent on foreign capital. Thus, the question is not whether the suffering of the Greek population could have been avoided. Instead, the questions are: Could the suffering have been less? Could it have been for a shorter period of time? And, above all, did the suffering serve any constructive long-term purpose?

Anyone who argues that the post-2010 rescue programs intended 'to save Greece' is disavowing reality. As long as the mantra was "If Greece falls, the Euro falls and if the Euro falls, the EU will fall!", the obvious conclusion is that the purpose of the post-2010 rescue was to save the Euro and the EU. The only thing that Greece was saved from was a default on its external liabilities, something which doomsayers dramatically referred to as 'the bankruptcy of Greece'. The Chief Economist of Citibank reacted to this as follows: "What the Europeans did not know was that sovereign defaults have been the most ordinary thing in the world of finance in recent decades." When the threat of a default appears on the horizon (or when it has already occurred), countries - like private or corporate borrowers - need to sit down with their creditors to discuss a restructuring of the debt. Never before in the history of finance have private lenders been let so easily off the hook as in the case of Greece!

Only self-centered dreamers can have the nerve to call a rescue program which still leaves the country in shambles after 8 years a success. "Never let a serious crisis go to waste", the saying goes. The Greek crisis went to waste. No Greek parent can tell his children that "yes, we really had to suffer for a long time but we did it for you because you now live in a better country!" What went wrong?

It is much easier to identify responsibility for the failure on the Greek side instead of elsewhere. Yes, 'ALL Greeks had eaten the lunch', as a Greek politician once said, and, therefore, all Greeks should now pay for it. Yes, the Greek side never left the impression that it assumed ownership of the problem but always left the impression that reforms were undertaken only unwillingly, only under severe pressure from the Troika and then only haphazardly. Yes, the Greek side always focused on the victim's role and sought to put blame elsewhere. Etc., etc.

But the most important point is missing! What if a country is not yet quite ready for the framework of a highly developed EU, particularly for a complicated currency union? What if a country is not yet quite ready for the free movement of products, services and capital? What if a country had joined the EU and the Eurozone in the expectation that it would find help in its development?

Looking back, I would argue that the resource allocation over the last 8 years was at best 10% for assisting Greece "to build a modern and prosperous Greece: a Greece characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos" and at least 90% for debt issues. What if it had been the other way around? A debt problem, however large, can be solved by a group of people in a conference room as long as they agree. To 'build a modern and prosperous Greece: a Greece characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos' is a project for a generation and it requires the best brains not only of Greece but of the EU in general.

As Greece exits the program, its debt is now more or less regularized: much of the interest burden has been deferred, most of the debt maturities have been extended way into the future and a cash reserve has been built up. Here is the million-dollar-question: Why could that not have been accomplished within the first year of the rescue, thereby allowing resources to be allocated to more constructive purposes?

In 2009, Greece had a primary deficit of 24 BEUR: before paying enormous amounts of interest, the Greek state spent 24 BEUR more than it had revenues. A staggering figure by all accounts. Naturally, that can be viewed as an example of extreme profligacy and, naturally, that can quickly be turned into an emotional issue: the profligacy of the Greeks must be stopped; the primary balance must be brought to zero as quickly as possible! So far, so good.

But anyone who has attended Economics 101 in college knows that national income is the sum of private sector and public sector income. If one of the two is cut drastically, the other one must increase if a destruction of national income is to be avoided. The problem is much greater than the 24 BEUR because when the state, as by far the largest economic agent in any country, cuts dramatically, there will be a multiplier effect throughout the economy. With the benefit of hindsight, one can debate whether the multiplier effect was calculated correctly or not. My point is that one doesn't really need a calculator. When one takes 24 BEUR out of an economy the size of about 220 BEUR, one knows that there will be shockwaves. Unless...

Unless one accompanies the (necessary) austerity with growth measures elsewhere to ameliorate the damage. Granted, no one could reasonably have been expected to give the Greek state a fresh 24 BEUR for growth measures given the Greek state's history of misspending funds. But it should not have been too difficult for EU experts to design ways to steer 24 BEUR into the private sector for growth projects. After all, the Chinese company Cosco steered millions of investments into their Greek subsidiary in the midst of the crisis and they are today very happy about that. Why could the EU not have accomplished with the country what a Chinese company accomplished with its subsidiary?

Many have argued that Greece should have been given a major haircut back in 2010 to get back on its feet. That is an illusion! Greece did not achieve a primary surplus until 2016. In other words, debt service (interest) did not burden the budget until 2016. Instead, all interest which was paid until then had first to be lent to Greece (and increased the debt). What would have mattered much more is if Greece had been given the interest terms back in 2010 which it has now (or better yet: an immediate interest moratorium for, say, 10 years). The example of Germany, half of whose debt had been haircut back in 1953, was often cited. With the benefit of hindsight, one can question whether that was a good decision. What if the debt which Germany was forgiven had been replaced with a 50-year bond including deferred interest? Would Germany in 2003 have been able to service that debt? Of course it would have and it would have been fairer to those parties who had to finance Germany's haircut back in 1953.

In short, true help for Greece would have looked something like this back in 2010: extending all loan maturities out into the future, say 25-50 years; an interest moratorium for at least 10 years; fresh money to finance the primary deficit with the proviso of achieving a surplus within 5 years; a commitment to maintain the stability of Greece's banking sector; and fresh money of at least 20 BEUR for growth measures in the private sector. All except the last point would have been quite easy to do as long as reasonable people came to an agreement in a conference room. The last point would have required true brainpower.

With that kind of an offer of 'help for Greece', the EU would have acquired a legitimate claim to put 'demands' to Greece in exchange. Those 'demands' would have consisted of the standard measures of a memorandum, albeit it in a more intelligent way than it was done. But most importantly, the 'demands' would have had to address the 'hot potatoes' of the Greek public and private sector, all those structural weaknesses that everyone knows of but no one dares to touch. Above all, the 'demands' would have had to assure that the 20 BEUR for growth measures would not go to waste.

What if the Greek side had not accepted this? What if the Greek side had interpreted this as an interference with national sovereignty? What if there could not have been accomplished consensus in the Greek government?

Well, it's like the above mentioned conversation with Joseph Ackermann: "We offer you help but it's up to you to accept it. If you don't accept it, you have to live with the consequences!"

Having written all that, it begs the question: Where are we today? Can there still be prosperity for Greeks in the foreseeable future?

At this point, there is no prosperity for the Greek population in toto in sight. Of course, the upper third of the Greek population (or so) will continue to do well to very well, as they have done in the past, even during the crisis, and they may even profit from the current situation. The middle-third (the former middle-class) will struggle to survive. And the lower-third will continue to suffer. All those Greek friends who are telling me that 'Greece will never change' are really saying that it will be this way for a very long time.

However, when I put myself back into the idealistically optimistic mode which I was in back in 2010-12, I envisage the formation of a competent economic management team and a unified government which provides it with air cover. If that were ever to happen, one could realistically hope that the day will come when Greece is 'a modern and prosperous country: a country characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos."

PS: reviewing what I have written above at great length, the thought comes to mind that I have said everything there is to say and that, perhaps, this is a good time to close this blog. I will ponder this.

Friday, August 17, 2018

Long-Run GDP Growth Prospects Are Poor

Last month, the IMF pubslished its 2018 Article IV Report on Greece and it was widely commented in the media. I have now read the full 80+ pages and can only recommend others to read the full report. It can be found under this link (under the caption Electronic Access, click on Free Full Text).

I focus here on Annex VI about Greece’s Long-Term Growth Potential and I reproduce it below. A summery statement would be: "Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades. Labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output). Long-run GDP growth prospects are thus poor, absent a major change in policies. Structural reforms to raise TFP growth and employment are therefore the only option to achieve higher long-term output growth."

Below is the Annex VI about Greece's Long-Term Growth Potential.

1. Greece is set to experience dramatic population aging over the next several decades. In its 2018 Aging Report, the EC projects Greece’s working age population to fall by about 35 percent between 2020 and 2060 due to a shrinking and rapidly aging population. This is among the largest such declines in the Euro Area, and three times the average fall for the Euro Area. Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades.

2. Greece’s productivity growth has historically been poor. Greece’s underperformance relative to peers is often associated with relatively low openness of the economy and a high share of labor allocated to non-tradable sectors. Total factor productivity (TFP) growth over the last 47 years averaged just ¼ percent annually, by far the lowest in the Euro Area. Assuming this historical average TFP growth rate going forward, labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output).

3. A pickup in investment could provide a short-run boost to growth, but productivity and demographics will dominate in the longer run. Investment is bound to recover from its highly depressed level once Greece emerges from the crisis, but the growth effect of this will wane once the capital stock returns to its long-run level. Staff’s medium-term projections already assume a temporary boost to GDP growth from higher investment (with real GDP growth rates averaging close to 2 percent during the investment recovery). Once the transition to the new, higher capital ratio is completed, however, the impact of increased investment will fade and growth dynamics will be determined by the evolution of output per worker and of the number of workers.

4. Long-run GDP growth prospects are thus poor, absent a major change in policies. As a starting point, combining the historical growth in output per worker of 0.4 percent with expected growth in the number of workers of -1.1 percent would imply long-term annual growth of -0.7 percent. This simple result is broadly similar to other recent findings in the literature, which estimate Greece’s baseline growth rate (before the effect of reforms) at -0.4 percent during 2024–2043.

5. Structural reforms to raise TFP growth and employment are therefore the only option to achieve higher long-term output growth. Estimating the gains from structural reforms is technically difficult, and results are necessarily imprecise. The empirical evidence suggests that the GDP growth gains from reforms are somewhat modest and transitory: while studies have documented an impact on output levels of 3 to 13 percent over the initial decade, the impact of reforms on growth tends to fizzle out afterwards.

 • The 2016 WEO estimates the GDP level gain from past episodes of product market deregulation in 26 advanced economies over 1970–2013 at about 3 percent on average, with gains accruing over a period of eight years, suggesting a GDP growth gain of about 0.4 percentage points per year during the eight-year period.
• Adhikari et al. (2016) looks at case studies of major past reformers in both labor and product markets—Australia, Denmark, Ireland, Netherlands, and New Zealand in the 1990s, Germany in the 2000s—and finds that the GDP effect of reforms ranged between 0 and 34 percent over a period of 5 years. Excluding Ireland, which is a clear outlier, the average impact was 0.6 percentage points per year over the five-year period, and in two out of six cases, there were no significant gains. Permanently raising growth would require a period of reform implementation that exceeds in both ambition and duration what Greece has achieved so far. While Greece has initiated numerous structural reforms in the context of its adjustment programs—from labor markets to energy, judicial reforms, closed professions, and others—implementation has sometimes lagged. The country’s key accomplishment has been a cornerstone labor market reform adopted in 2011, but this is set to be partially reversed after the current program. Other legislated reforms have faltered at the implementation stage. For example, numerous attempts at privatizing state monopolies in the energy sector are yet to reduce significantly the state’s share in this sector; judicial reforms have been slow moving, with continued high court backlogs; reforms to liberalize close professions have fall short from expectations in terms of both pace and scope; and; the investment licensing reform, which started in 2011, is still not fully completed. Given demographics, the impact of structural reforms will need to be substantial to achieve an overall long-term GDP growth rate of 1 percent over the next half century. Lifting long-term growth from its baseline of –0.7 percent to 1 percent requires reforms to add 1.7 percentage points to growth per year for the next decades. The OECD (2016) estimates that full implementation of a broad menu of structural reforms could raise Greece’s output by about 7.8 percent over a 10-year horizon, which translates into an increase in annual growth of some 0.8 percentage points for about a decade. Bourles et al. (2013) estimate this gain to be slightly higher, at about 0.9 percentage points per year, while Daude (2016) finds that reforms focused on product markets and improving the business environment in Greece could boost growth by about 1.3 percentage points per year for a decade.

9. In conclusion, achieving staff’s assumption of 1 percent growth in the face of adverse demographics and historically weak productivity growth will require that the Greek authorities and people commit to an extended period of profound structural reform. Implicitly, the 1 percent growth projection presumes that Greece would manage to increase labor force participation to levels that exceed the Euro Area average (to offset the significant projected decline in Greece’s working age population) and that would generate TFP growth rates permanently far above Greece’s historical average. This underscores the importance of rapid and decisive action on the part of the authorities to tackle the many bottlenecks that constrain growth and limit the country’s ability to prosper in the Euro Area.