Greek Crisis: No End in Sight

Europe’s political leadership keeps trumpeting out that their austerity policies actually worked. They are closely backed by their media outlets. Alas, the following story in the EU Observer:

Cash-strapped Greece recorded its first primary budget surplus in a generation last year, according to data released by Eurostat on Wednesday (23 April). Excluding interest on its debt repayments and a number of one-off measures to prop up its banks, Athens recorded a surplus of €1.5 billion, worth the equivalent of 0.8% of its economic output in 2013. Despite this, Greece still recorded an overall deficit figure of 12.7 percent, up by 4 percent on the previous year as the crisis-hit country endured a sixth straight year of recession.

As always, it is completely wrong to use the government budget as some sort of health indicator for how an economy is performing. To illustrate how dicey that can be, let us go over some numbers on the Greek economy.

First, GDP growth, measured as growth over the same quarter in the previous year:

Greece 2 1

If economic growth was any indicator, the jury would still be out on the Greek economy. It is somewhat of a relief that the contraction of the economy (“negative growth”) is slowing down – the figure for the last quarter of 2013 was -2.3 percent – but there were also two “spikes” of improvement during the ongoing recession, one in late 2009 and one in 2011.

The slowdown of the contraction that began in 2012 is still ongoing, though, which could mean that the Greek economy may actually start growing again some time in 2014. The question is what is behind this improvement. Since austerity policies are still being enforced, fiscal policy is suppressing domestic spending. Therefore, a good bet is that the “leveling out” of the long decline in Greek GDP is driven by an improvement in exports. Not surprisingly, Eurostat data show that Greek exports increased three quarters in a row during 2013. This is the longest period of improvement in exports since 2010.

If activity is improving in the exports industry, it would naturally translate into better GDP numbers, albeit limited compared to a sustained recovery in private consumption. QED. It would also translate into an improvement of government finances, as tax revenue would rise from growing corporate income. However, this improvement is probably not going to be strong enough to lift the Greek government budget to balance, thus it won’t help them end austerity.

So what, then, do Greek government finances actually look like?

Greece 3 1

If amplitude is a measure of stability, things do not look good for the Greek government. However, what the European press and its political leaders are raving about is the improvement of the budget deficit displayed as the very last data point in the chart above. There, the consolidated government budget is in a deficit of “only” 2.86 percent of GDP.  If this came on top of the weak but visible trend of smaller deficits from 2009 and on, there would be a reason to believe in a recovery. However, two variables call for a reality check: first, the exceptional dip in the second quarter, plunging the deficit into 30.4 percent of GDP; secondly, and much more importantly, the fact that the Greek GDP is still shrinking.

If the deficit improves as a ratio of a shrinking GDP, it means that tax revenues are shrinking as you improve your deficit ratio. This in turn means that you are making very drastic changes to tax rates as well as spending: tax rates have to go up and spending has to decline.

In other words, the only way to accomplish an improvement in the Greek deficit is to keep austerity in place. This in turn keeps the depression lid on domestic economic activity. So long as that lid is in place there is no chance for an improvement in overall economic activity.

In addition to GDP growth there is one variable that mercilessly tells the true story of how an economy is actually doing:

Greece 1 1

If the Greek GDP is indeed nearing a point where it will no longer shrink, and if the reason is a surge in exports, then the leveling out of the employment ratio is the best the Greeks are going to see for the foreseeable future. Their exports industry cannot pull the economy out of the recession anymore than it could pull Denmark out of its very deep recession in the late ’80s, or Sweden in the mid-’90s. So long as austerity remains in place, depression will still keep its tight grip on the Greek economy.

But just to make it worse… even if austerity was lifted, the Greeks would have little reason to expect a rapid return to better days. To see why, let us return to the EU Observer story:

The surplus [in the Greek budget], which was achieved a year ahead of the schedule set out in Greece’s rescue programme, means that it is entitled to further debt relief on its €240 billion bailout. Talks on debt relief, which is likely to involve lengthening the maturity of Greece’s loans to up to 50 years, will start among eurozone finance ministers following May’s European elections.

All the EU is doing here is kicking the can down the road. They are extending the Greek welfare state’s credit line over and over again. All the bailout programs really achieve is a recalibration of the welfare state, with higher taxes, lower spending and overall a more intrusive government that takes more from the private sector – at a lower level of private-sector activity.

And this is precisely the point here. The goal with austerity policies in Greece is to balance the Greek government’s budget. The goal is not to restore full employment; the goal is not to return to high levels of GDP growth; the goal is not to reduce the ranks of welfare and unemployment benefit recipients. No, the goal is to balance the budget. If the Greek government accomplishes that, they will be rewarded by the EU with more, longer-maturity loans.

In a “normal” welfare state the budget balances at something akin to full employment. However, that changes once a welfare state ratchets down into the depths of a protracted recession, such as the one Sweden experienced in the early ’90s and Europe has been struggling with since 2009. Austerity raises the tax ratio on GDP in order to make sure that government can pay for its spending obligations; spending cuts mitigate some of those tax increases. As taxes go up and spending shrinks, the government budget eventually clears, but at a GDP that provides much fewer jobs than before. In other words, after a long period of austerity, government can pay for its expenses without having as many taxpayers as before.

Once the economy starts improving, tax revenues will go up earlier in the recovery than they otherwise would. Since spending has been adjusted downward, this means in effect that government will begin over-taxing the economy way before it reaches full employment. In the Greek case, if austerity actually works the consolidated government will find itself running a surplus at an employment ratio 10-12 percentage points below what it was before the recession. 

Excess taxation thwarts private economic activity. Taxes themselves discourage productive investments and spending, but so long as government spends the tax money there is at least some return that mitigates the loss to the private sector. Taxation for a budget surplus, however, means that literally nothing is coming back into the economy. Every tax dollar is a full loss of economic activity, meaning that the budget surplus indiscriminately prevents the creation of new jobs.

The economy gets stuck at a low rate of employment. This is a perspective on the Greek economy that nobody outside of this blog is pointing to. Yet there is ample evidence that this is exactly what will happen – unless the Greek government replaces austerity with a long series of permanent, well-designed tax cuts.

There is historic experience to show that such policies could work very well. There is also historic experience to show that if you do not cut taxes, you perpetuate the depression you are in. For more on this, please be patient and wait for my book Industrial Poverty, out in late August.

One comment

  1. Pingback: EU confirms Greek economic rebound forecasts for 2014-2015 - Crash Magazine Online