Who's to Blame for Greece?

Austerity in Charge of Saving a Broken Economy

Theodore Pelagidis, Michael Mitsopoulos

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137549204
• Topic: Économie
• Subtopic: Macroéconomie

Greece's economy symbolizes in many ways the Eurozone's economic problems and divergent interests as it amasses most of the economic disadvantages characterizing the Eurozone's economy itself. This book presents the economic and political challenges to Greece and the EU member states.

1

Introduction

The strategic failures in the approach to deal with the problems of the Greek economy, namely the disproportionate internal devaluation of the private sector and the tax base with respect to the milder internal devaluation of the government expenditure, has certainly taken place in the context of a country that was asked to undertake one of the most difficult adjustments made by any country and through a deal that appeared to be ignoring important warning signs (Mitsopoulos and Pelagidis, 2011, 2012; Pelagidis and Mitsopoulos, 2014). Essentially, the 2010 and onward sequential deals amounted to agreeing with the political leadership and the administration of an economy that has been turned by the former into a quasi-soviet economy at the fringes of free markets that they will tear down the bureaucracy that has been established for over 30 years, while being offered the cash and support to keep operating largely in a “business as usual” environment.

It is within such a context that there were few apparent efforts to shift the balances in favor of the productive sector of the economy as a necessary precondition for success. The lack of such an effort has been paired, after 2010, with a number of other unfortunate policy choices, both by the Greek government and by the creditors – the IMF, ECB, and the European Commission. These have further burdened the prospects of the private sector even as they kept the profligate state on life-support for at least three years. In particular, these are (a) the gradual entrenchment of macroeconomic imbalances as a permanent situation, (b) the delayed PSI, and the large PSI of October 2011, as outlined in the respective Euro Area Summits statements, and (c) the uncertainty that stems from tying the European prospects of the whole of Greece with the insufficient willingness of the government to implement the agreed program. Overall, the above have managed to add to the private sector of the economy, in addition to the burden of persisting fiscal problems and competitiveness deficit, the impact of a full-blown liquidity crisis. So, the question that springs in mind after all this policy failure is identical with the title of this book: Who’s to Blame for Greece, and, more importantly, what lessons for the future can we learn from the failures of the past?

In this context, the first part of the book sets the theoretical context in which Greek policymakers, politicians, and the public opinion matured the decision to adhere to the single currency. In this setting, in Chapter 2, we briefly present the relevant debate in the literature concerning the costs and benefits of joining a currency union. This is necessary to examine the impact of the fundamental discussion that took place 20 years ago in the country, on the costs and benefits of getting rid of the drachma and join the euro area as well as to understand both the constraints and the opportunities that Greece’s economy has faced since 2010.

In Chapter 3, we elaborate and analyze for the very first time in the relevant literature, material that reviews what economic theories and narrative shaped the understanding of Greek policymakers and politicians about costs and benefits for Greece to join the single currency. We then match this narrative with the declared policy strategy, and its implementation, by the government that introduced the Maastricht Treaty for ratification, in order to investigate the extent to which its conviction that Greece could succeed to enter on equal terms as a constructive member country was well-founded.

In Chapter 4, we examine the IMF Director’s, and supporting staff, reports on Greece from 1990 on, as well as the European Council recommendations to Greece and the preceding European Commission recommendations to the Council. We present these in order to place them in context with the key issues raised in Chapter 3, as well as with the recent developments in Europe and the country.

The central aim of the second part and originally of Chapter 5 is to reconsider the troika period, focusing especially on the first three years of the program, where the adopted policy is supposed either to have failed or/and faced significant headwinds. We initially focus on the Greek public finances and debt. We analyze conditions that led to the first Memorandum of Understanding (MoU) and we present an analysis on what it initially provided. We follow the implementation of the MoU and the fiscal strategy involved in it. We focus in particular on the equilibrium between the opposition to reform and the nexus of state sponsored privileges in the country. In the end, this analysis, and the supporting facts, are contrasted with the criticalities emerging from the ex post analysis of surveillance reports done by international organizations and the other material of Chapters 3–4.

In Chapter 6 we assess the intentions of the government that ratified the Maastricht Treaty in view of the current developments and place the developments in Greece within a broader context of European policies and approaches. In particular, we assess the experience of Greece, and other European countries, that implemented at the same time structural and fiscal reforms, and compare them with the impact of the one-sided implementation of the conditionality program in Greece after 2010. We also attempt a preliminary assessment of where this one-sided implementation has led the country, and what can be done from now on.

In the third part of the book, Chapter 7 assesses the results on the critical domain of exports. In particular it explains the reasons that the internal devaluation failed to kick-start an export led growth. It focuses on employment and wage earnings and reveals the real costs that made exports to grow albeit at an insufficient pace.

Chapter 8 analyzes the financial conditions needed for Greece to recover at a rate that would make not only the debt fraction to GDP sustainable but also increase significantly employment. The section deals with the financial sector and more specifically with the conditions needed to finance the private sector.

Chapter 9 addresses the issue of institutional reforms for the euro area itself, elaborating on the notion and a project for a closer and more democratic union to heal economic asymmetries. This is critical for the southern euro area member states and especially for the weakest economy among them, Greece, if it is to get its economy back on track and recover.

Finally, in Chapter 10, we conclude.

In Afterwords, we focus on the rise of Syriza to power and the consequences to the economy.

References

Mitsopoulos, M. and T. Pelagidis (2011), Understanding the Crisis in Greece, London: Palgrave Macmillan.

Mitsopoulos, M. and T. Pelagidis (2012), Understanding the Crisis in Greece. From Boom to Bust, London, Palgrave Macmillan, 2nd edition.

Pelagidis, T. and M. Mitsopoulos (2014), Greece. From Exit to Recovery?, Washington, DC: Brookings Institution Publ.

Part I

The “Party Period” before the Crisis

2

The Costs and Benefits for Joining a Common Currency with Emphasis on Weaker Member States: The Pre-Crisis Debate

2.1 Potential sources of conflicts/costs: de-synchronization of business cycles

Long before the crisis, the dominant theory of an Optimum Currency Area (OCA) was that there are necessary conditions or properties for success (Mundell, 1961; McKinnon, 1963; Kenen, 1969). The basic premise was that the fundamental requirement for a successful currency area is wage/price flexibility and mobility of factors of production as well as harmonization of economic and political institutions. This injects sufficient flexibility in the system to hedge against the so-called “asymmetric demand shocks/disturbances”. Asymmetric shocks are demand shocks or disturbances that hit two or more regions or countries with a common currency. When shocks are asymmetric, business cycles between two countries – let us assume Greece and Germany – are de-synchronized. De-synchronization of business cycles means that Greece experiences, for example, a negative growth rate along with relatively low inflation, while Germany experiences, at the same time, a high growth that goes with low unemployment. Then, the two countries need different monetary stabilization policies. Greece needs some accommodation through decreasing interest rates in order to stimulate economic activity, while Germany needs some contraction to fight an excessive inflation rate. Then, the dilemma that the European Central Bank (ECB) faces has to do with the diversified stabilization prescriptions the two aforementioned economies require.

What it is important to recognize is that the incidence and magnitude of demand shocks or disturbances ultimately depend on the output mix and degree of specialization across countries and regions. These factors can in turn undermine the OCA. The European Monetary Union (EMU) process itself tends to create some convergence (Rose and Stanley, 2005) but at the same time it also tends to, ironically, deepen the market integration that increases the degree of sector specialization and reinforces differences in the structure of production and demand (Baldwin, 2006). The greater the differences in the structure of production, the greater will be the asymmetric incidence and magnitude of demand shocks on individual countries and regions. Institutional divergences in wage setting, for example, may lead in particular to divergent wages and employment tendencies and worsen adjustment problems, and differences in economic and financial practices¹ may also lead to the various national financial markets working differently across the euro area.

Furthermore, the greater the difference in the structure of production, the greater the incidence and the magnitude of the demand shocks that individual countries and/or peripheries experience and, thus, the lower their speed of adjustment, if any, in the case of the labor markets remaining rigid.² Eichengreen (1997) provided evidence that the countries at the center of the EMU (Germany, France, the Netherlands, etc.) experience very different supply shocks from those affecting other member states, such as Italy, Portugal, Spain, Ireland, and Greece.

In the case of multiple countries and currencies, governments are able to use demand management policies to face idiosyncratic shocks, namely succeed in adjustment by applying accommodating monetary policies and using the exchange rate instrument to correct external disequilibrium (amid inflationary pressures). Currency can depreciate to lower relative prices and underpin demand or it can devalue. The greater the asymmetric shock, the higher the option value of independent domestic monetary and exchange rate policy. However, EMU, by definition, involves the sacrifice of the monetary autonomy, and in the euro area authority for the implementation of a single and non-differentiated monetary policy now belongs to the ECB. As economic integration proceeds and diversity of production structures deepens across the euro area, a negative aggregate demand shock is expected to have different, heterogeneous impact on member states and regions. In this case, the cost of adjustment within the euro area depends on the size and incidence of asymmetric real shocks, as well as on the efficacy of the alternative adjustment mechanisms, namely, labor market mobility/flexibility and fiscal policies (Obstfeld, 1997). Otherwise, the country hit by shock must deflate internally by lowering its wages through a policy of “internal devaluation,” accepting unemployment and economic recession.

Empirical evidence has shown that asymmetries in the EMU between core and peripheral countries were persisting well before the crisis (Bayoumi and Eichengreen, 1992a,b; Bordo and Jonung, 1999; Krueger, 2000; Obstfeld, 2000; Dunn, 2001; Baldwin, 2006) and that they coincide with non-synchronized business cycles among member states. An assessment which culminated in 2003 of the case for the UK joining the EMU by HM Treasury was in general agnostic. Regarding the specific issue of business-cycle synchronization, however, the assessment failed to uncover strong evidence in support of such synchronization. Therefore, as the asymmetry of demand shocks raises regional unemployment by destroying industries and jobs, there is a need for monetary accommodation (i.e., increase of money supply and lower interest rates) to offset fluctuations and restore growth and employment. For example, in the case where Greece suffers a permanent fall in GDP or in exports, output contracts and unemployment rises as currency depreciation is excluded from policy tools, and wages and prices are rarely flexible enough to react to economic slumps without causing a severe rise in unemployment. The possible refusal of ECB to implement an expansionary monetary policy in order to avoid recession in Greece had some people being afraid that such an attitude may cause continuing dissatisfaction among the Greeks and other EMU public.

On the other hand, a decision by the ECB to implement monetary accommodation by lowering the rate of interest may cause continuing dissatisfaction among the anti-inflationary countries, such as Germany (Feldstein, 1997). Economic disagreement over monetary policy may then cause general environment distrust among member states and, as a consequence, could very possibly bring about political disputes and instability. The ECB, thus, may face pressures that cannot all be dealt with (e.g., see Frieden, 1998).

The critical role of a central bank is also confirmed by Cooper and Kempf (2004). In an economy with monetary policy alone, they confirm the presence of the Mandellian trade-off (between unification and monetary autonomy) and find that, indeed, a monetary union will not be welfare improving if the correlation of national shocks is too low. However, the authors find that fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results with welfare improving for any correlation of shocks. Similarly, Beetsma and Giuliodori (2010) emphasize the complications that a monetary union poses for fiscal policymaking as governments policy objectives for a high and stable level of economic activity may come at odds with ECB’s goal of stabilizing inflation at a level below 2%. That, according to Dixit and Lambertini (2001, 2003) may...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Figures and Tables
• About the Authors
• Chapter: 1 Introduction
• Part I The “Party Period” before the Crisis
• Part II Greece’s Free Fall 2010–2013
• Part III Looking Ahead
• Afterword
• Author Index
• Subject Index