Faced with an unenviable choice between more austerity and a Grexit from the Euro the Greek Government after six months of resistance caved in and reluctantly opted for more austerity. Two weeks ago in the recent elections the Greek people endorsed that choice, although the record low voter turn-out suggests with little enthusiasm and much political weariness. On the other hand, the Euro-zone authorities are no doubt breathing a sigh of relief. But what can Greece (and its creditors) expect from this deal.
The popular image of Greece portrayed by its creditors is of past profligacy which the Greeks must now pay for. There is some truth in this presentation as the Greek government financial deficit in the good years represented as much as 7.5 per cent of GDP in 2004 and still amounted to an excessive 6.7 per cent of GDP on the eve of the Global Financial Crisis (GFC) in 2007.
What seems to have largely escaped attention, however, is the extent to which Greece has already tightened its belt since the GFC. In fact, the amount of this fiscal tightening far outranks that undertaken by other major countries which are lecturing to Greece.
When making any such comparative assessment it if of course necessary to extract the impact of economic growth on each country’s fiscal position. Indeed, the restoration of many countries’ fiscal positions since the GFC owes as much or even more to the automatic improvement in tax revenues as economic growth recovers.
Consequently, there is a need to strike a balance between discretionary fiscal tightening on the one hand, and avoiding too much counter-productive contraction on the other. Unfortunately it is very likely that Greece has already erred on the side of too much discretionary fiscal tightening, and this is one reason why the overall rate of reduction in its fiscal deficit has been disappointing.
The table below shows the change in the general government underlying fiscal balance between the low point following the GFC, 2009, and the present year, 2015; along with the change in the normally reported nominal fiscal balance over the same time period. It is the change in the underlying balance which portrays the extent of discretionary fiscal action, as it excludes the effect of the business cycle and any one-offs.
Change in General Government Balances
Contraction (+) Easing (-) as per cent of GDP
|Actual Balance||Underlying Balance|
Source: OECD Economic Outlook June 2015
The results reported in this table clearly substantiate that:
- Greece has taken far more discretionary action to reduce its fiscal deficit than the other major countries shown. Thus the fiscal consequences of the discretionary measures taken by Greece over the period 2009-15 in total amounted to a very large 18.7 per cent of GDP. By comparison similar discretionary fiscal action by Germany only amounted to the equivalent of 1.4 per cent of GDP. Even in the US, which had the next largest discretionary fiscal contraction, the size of the package was only just over one third the size of the Greek package.
- The reduction in the fiscal balance actually achieved by Greece has been less than the size of the discretionary measures introduced. This is clear evidence that contractionary impact on the economy significantly reduced the amount of deficit reduction which Greece was able to achieve. By contrast in the other three countries shown, the actual size of budget turn around was greater than the total of the discretionary measures. Instead for these countries increasing economic growth made a major contribution to deficit reduction, and in the case of Germany and the UK, the positive effect of economic growth accounted for more than half of the reduction in the deficit actually achieved.
In the light of this experience, it must be asked whether the imposition of further austerity does not risk again being counter-productive.
Right now in 2015 Greece has an unemployment rate of 25 per cent. Its GDP has declined by 26 per cent from its previous peak in 2007, and according to the OECD, even its potential output has declined by 6.5 per cent since the GFC. This is a worse situation than most countries, including Greece, experienced in the Great Depression in the 1930s.
The experience so far clearly shows that further contraction of the economy will not help fix the budget. As I have argued previously, the much better alternative would be for Greece to exit the Euro and thus reverse the massive deterioration in its competitiveness (see posting 8 July). Otherwise it is difficult to see how the Greek economy will ever start to grow strongly over at least another ten years. Certainly more austerity will not help, and without strong economic growth it is equally difficult to see how Greece can make serious inroads into reducing its debt.
Dr Michael Keating AC is former Secretary of the Department of Finance and Secretary, Department of Prime Minister and Cabinet.