“Every stone you turn here, there are regulations,” commented one Greek economist when asked about his country’s economy. Ever since its out-of-control deficits sparked the European sovereign debt crisis, Greece has been pushed by the EU to reform its economy through a series of austerity packages which would cut the deficit and prevent a default. Two years later, however, those policies have clearly failed; even with the recent 53.5% write-down on its debt, Greece’s debt-to-GDP ratio is still projected to be 120% of GDP in 2020. Clearly, Greece is as bankrupt as ever.
While Keynesian economists like Paul Krugman argue that excessive spending cuts caused the failure of the reform program, that is simply not true. The Greek austerity program failed largely because there are components of it that haven’t been tried at all. There were three major components of Greece’s reform program: spending cuts, tax increases, and structural reforms. With the exception of tax increases, the Greek government failed to sufficiently carry through any of these measures. Spending has barely fallen and structural reforms have lagged, if they were even implemented at all. Without sufficient structural reforms and spending cuts, the Greek government was forced to increase taxes dramatically, depressing the economy even further. Not surprisingly, this led to Greece’s impending default on its debts. If the other indebted PIIGS countries do not learn from Greece’s failures, a similar fate certainly awaits them.
Although the Greek government took steps toward spending cuts, such as reducing pensions, cutting public sector pay and even firing state workers (who are guaranteed lifetime employment by the constitution), its efforts weren’t enough. Even by its own estimates, the Greek government’s spending remains at 50% of GDP, much higher than pre-crisis levels. Worse yet, government spending in 2011 actually trended higher than that of 2010 and its deficit in 2011 is estimated to be above 9% of GDP. In terms of spending cuts, the Greek government’s “austerity” is hardly visible.
Had the Greek state actually looked to cut waste dramatically, it wouldn’t have spent long looking. Greece’s public sector is ranked as one of the most inefficient in the developed world. The average government job in Greece pays three times as much as that in the private sector, and the real wage bill of government workers have doubled in the past decade. The Greek public school system, one of the lowest ranked in Europe, hired four times as many teachers per capita as Finland, the highest ranked. Prior to the reforms, many “arduous professions” such as hairstylists, cashiers and maids could retire at 55 with a full pension; cameramen and cheese-makers are still classified as “arduous” and can retire at 60.
A policy that truly aimed to turn Greece’s desperate fiscal situation around would have required deep spending cuts to drastically reduce the scope of the Greek state; unfortunately, the cuts that actually occurred were too little and too late.
Even before the crisis, Greek taxes were quite high, with a top income tax of 45% and a VAT of 21%. Since 2009, the Greek government has raised taxes dramatically; in addition to increasing VAT rates from 21% to 23%, it has also increased income taxes on high-income households and raised “sin taxes” on alcohol, fuel, luxury cars and tobacco by 10 percent or more. However, Greek tax revenues in 2011 actually trended below those of 2010; rather than raising revenues, the tax increases likely penalized economic activity further and pushed more people to join Greece’s underground economy, largely formed by those seeking to escape the state’s high taxes and burdensome regulations. Without reforming the fundamental issues that cause people to evade taxes in the first place, tax increases will not solve Greece’s fiscal problems.
Greece’s economy has always been plagued by a massive regulatory burden. State regulations greatly restricted labour-market flexibility; until recently, no company could fire more than 2% of its employees per month and had to give 24 months’ warning to do so. Regulations also placed high barriers to entry and licensing requirements on many “closed professions” and added significantly to the cost of business. As a result, nearly a quarter of the Greek economy has gone underground to escape these costs. Greece’s state-run enterprises were also greatly in need of reform, as they were incurring huge losses that had to be borne by the government. One such enterprise, the Greek national railway company, had 100 million euros in revenue to cover 700 million euros in expenses.
The Greek government’s structural reforms, however, have been inadequate. The privatization program is vastly behind schedule; it has raised just 1.6 billion out of the 50 billion euros it should have raised. In addition, the government’s attempt to open up entry to closed professions has been met with repeated delays; although an initial bill was passed in January 2011, it was so watered down that the Greek parliament had to pass a second bill in 2012 to liberalize these professions. Labour market reforms such as cutting the minimum wage and relaxing limits on dismissals were not carried out until recently.
If the Greek government had carried out its structural reforms rapidly and vigorously, it could have spurred economic growth and even counteracted the effect of its contractionary fiscal policy. Unfortunately, structural reforms were implemented slowly and incompletely, significantly reducing the positive effect they could have had on the economy.
The Greek experience is a very illuminating one for other indebted countries seeking to avoid bankruptcy. The main problem with the reform program was not excessive spending cuts, but the very opposite; instead of executing a sound reform program of drastically cutting spending and reducing growth-killing regulations, the Greek government’s focus on tax increases and failure to control spending or adopt structural reforms have led to disaster. Investors should use the lessons of the Greek experience to evaluate other PIIGS countries’ reform programs; if they make the same mistakes, we will surely see another Greek tragedy.