Sunday, July 19, 2015

Act your size

By Invitation

David Skilling

Jul 18, 2015,

A small-country perspective on the Greek crisis

The Greek crisis rolls on even after last weekend's agreement. There are sharp tensions within Europe as well as growing doubts about the political and financial sustainability of the deal.

At the core of the crisis is a failure to properly understand the importance of national scale. Small countries are not scaled-down versions of large countries. Small countries face more policy constraints, are more exposed to shocks, and have a more limited margin for error. It matters that Greece is a small country, with a population of 11 million people.

This small-country perspective helps to explain the origins of the crisis, why it has been mismanaged and misinterpreted, and provides guidance on what might be done. The importance of national scale has been missed by three groups - the Greek government; the creditor institutions; and large-country pundits.


If you are a small country, certain things follow in terms of the policy approach. But for many years Greece has not acted as a small country, has not taken seriously the experiences of other small countries, and is now suffering the consequences. Greece has made several strategic policy errors.

The negotiations, tension and uncertainty will likely continue for some time. But irrespective of the outcome of this process, the immediate implication is that Greece needs a small-country economic growth strategy.

First, Greece has not focused on building a productive economy with firms that can compete in global markets. Greece is markedly different from other small advanced economies on key measures such as export share (30 per cent of GDP against shares of 50-90 per cent common among nearby small European countries); low knowledge intensity of exports; and low public and private investment in innovation (about 0.6 per cent of GDP, compared to a small-country average of about 2.5 per cent of GDP). Greece's historical strong growth relied on the domestic sector, supported by loose fiscal policy.

Greece has neither a lean, productive domestic sector nor an innovative, competitive external sector. Indeed, even with a massive internal devaluation in Greece over the past few years, and now a much lower euro (because of quantitative easing by the European Central Bank), Greek exports have been reduced. This is in stark contrast with other southern European countries, such as Spain and Portugal, whose exports grew after similar events.

Second, Greece has run large, sustained fiscal deficits, reaching 14 per cent of GDP in 2008, leading to a very high public debt stock (at about 130 per cent of GDP before the euro zone crisis). The lack of fiscal sustainability became obvious when growth rates slowed during the global financial crisis. This record contrasts sharply with small advanced economies, which act as fiscal conservatives - fiscal balance, low public debt - because they know fiscal space can erode quickly in small countries and that they are subject to stringent capital market discipline. This is why many small advanced economies made strong efforts to restore fiscal balance after the crisis.

Greece's final strategic policy error was to leave itself exposed to large countries, ignoring (perhaps ironically) the well-known lessons of Thucydides from the Peloponnesian War: "The strong do what they can, the weak suffer what they must."

These uncomfortable political realities explain why small countries try to minimise their external financial and geopolitical exposures. Small countries should not overestimate their importance; requiring large countries to expend financial and political capital on your behalf is a high-risk strategy (exacerbated in this case by the political grandstanding of the Syriza government). Other small European countries, like Ireland, positioned themselves more realistically through the crisis.


Successive Greek governments are the primary authors of the country's misfortune. But the creditor institutions also share some of the blame. This is not so much because they imposed excessive austerity, worsening the Greek recession, but that not enough focus was placed on developing a growth strategy.

Substantial debt relief is clearly required - the International Monetary Fund estimates that Greek government debt will peak at 200 per cent of GDP in the next couple of years, even on optimistic assumptions - and this needs some agreement on stabilising the structural fiscal outlook. But the negotiations were dominated by detailed arguments on fiscal-balance targets, pension cuts, increasing value-added tax, and the like. These are important matters, no doubt, but by no means sufficient: without stronger growth, there can be little hope for achieving the fiscal targets.

And the negotiations were much less creative on the growth side. The usual laundry list of orthodox measures was on the table: labour market flexibility, privatisation, institutional capability-building - right down to greater competition among bakeries. Most of these actions are necessary for Greece, but they are unlikely to place the economy on a sharply different trajectory. Many specific demands were made of Greece, but these measures do not amount to a small-country economic strategy with a sharp focus on where and how the economy is going to compete in global markets.

The problem is that large-country experts are not well placed to advise a small country on how to grow. Greece was seen as a regular country in crisis, not as a small country in crisis. The absence of a clear understanding of the elements of a small-country economic strategy limited the outcomes achieved because the formal process was not focused tightly on what really matters.


Lastly, there has been a prominent stream of large-country economic commentary that has treated the Greek crisis as primarily due to imposing austerity on a weak economy. In this reading, the main element of a solution to the Greek crisis is substantial debt relief.

Greece's debt load is (now) clearly unsustainable. But the large-country framing of the crisis as a consequence of a German-led austerity agenda mischaracterises the fundamental issues.

Several high-profile American economists (such as Paul Krugman, Joseph Stiglitz (see article below), and Jeffrey Sachs) are playing out a US policy debate in a different small-country context. Many of these commentators also criticised small European countries for pursuing tight fiscal policy after the crisis, an approach that worked relatively well.

More prominent small-country voices may have led to a more balanced framing, with a focus on Greek growth and competitiveness. It is instructive that the small-country approach to Greece has been consistently different from many larger countries. Small-country governments have been the toughest in the negotiations on the Greek debt, perhaps because the small European states deeply understand what being a successful small country requires.


The negotiations, tension and uncertainty will likely continue for some time. But irrespective of the outcome of this process, the immediate implication is that Greece needs a small-country economic growth strategy. To this end, Greece should engage seriously with small countries. Successful small countries like Singapore and New Zealand, as well as small European countries such as Ireland and Denmark, could help Greece identify areas of strength, attract investment, build strong public-sector institutions and so on.

There are also direct implications for Singapore and other small advanced economies. First, the Greek experience vindicates the policy approaches that many small countries have in place: conservatism on fiscal balance, a focus on competitive strength, strong public-sector institutions and maintaining important external relationships. Small countries should continue in this direction. And it is a reminder of the acute risk exposures that small countries face, and the limited margin for error.

Second, this experience emphasises that small countries need to have a louder voice on global policy debates.

More small-country voices may have led to a reframing of the Greek debate, and a more constructive process. These issues are too important to be left to large-country voices and institutions.

Small countries, including Singapore, need to find creative ways of contributing their perspectives more forcefully to the global policy debate.

• The writer is director of Landfall Strategy Group, a Singapore-based economic research and advisory firm with a focus on small advanced economies.

[I think this is an insightful piece that properly frames the Greek crisis. Too bad, it would not be taken up by those who need to.

Anyway,  the commentary alluded to hihg-profile American Economists mischaracterising the crisis as a consequence of externally imposed austerity programme. Here is one such characterisation by Stiglitz.]

Greece, the sacrificial lamb

Joseph E. Stiglitz

28 July 2015

A Nobel prize winner and former World Bank chief economist castigates the European troika for its harsh treatment of Greece that seems to protect the rich and lower Greeks' standards of living

ATHENS • As the Greek crisis proceeds to its next stage, Germany, Greece and the triumvirate of the International Monetary Fund (IMF), the European Central Bank and the European Commission (now better known as the troika) have all faced serious criticism.

While there is plenty of blame to share, we shouldn't lose sight of what is really going on.

I've been watching this Greek tragedy closely for five years, engaged with those on all sides. Having spent the last week in Athens talking to ordinary citizens, young and old, as well as current and past officials, I've come to the view that this is about far more than just Greece and the euro.

Some of the basic laws demanded by the troika deal with taxes and expenditures and the balance between the two, and some deal with the rules and regulations affecting specific markets.

What is striking about the new programme (called "the third memorandum") is that on both scores, it makes no sense either for Greece or for its creditors.

As I read the details, I had a sense of deja vu. As chief economist of the World Bank in the late 1990s, I saw first-hand in East Asia the devastating effects of the programmes imposed on the countries that had turned to the IMF for help.

This resulted not just from austerity but also from so-called structural reforms, where too often the IMF was duped into imposing demands that favoured one special interest relative to others. There were hundreds of conditions, some little, some big, many irrelevant, some good, some outright wrong, and most missing the big changes that were really required.


Back in 1998 in Indonesia, I saw how the IMF ruined that country's banking system.

I recall the picture of Mr Michel Camdessus, managing director of the IMF at the time, standing over President Suharto as Indonesia surrendered its economic sovereignty. At a meeting in Kuala Lumpur in December 1997, I warned that there would be bloodshed in the streets within six months; the riots broke out five months later in Jakarta and elsewhere in Indonesia.

Both before and after the crisis in East Asia, and those in Africa and in Latin America (most recently, in Argentina), these programmes failed, turning downturns into recessions, recessions into depressions. I had thought that the lesson from these failures had been well learnt, so it came as a surprise that Europe, beginning a half-decade ago, would impose this same stiff and ineffective programme on one of its own.

Whether or not the programme is well implemented, it will lead to unsustainable levels of debt, just as a similar approach did in Argentina: The macro policies demanded by the troika will lead to a deeper Greek depression.

That's why the IMF's current managing director, Ms Christine Lagarde, said that there needs to be what is euphemistically called "debt restructuring" - that is, in one way or another, a write-off of a significant portion of the debt.

The troika programme is thus incoherent: The Germans say there is to be no debt write-off and that the IMF must be part of the programme. But the IMF cannot participate in a programme in which debt levels are unsustainable, and Greece's debts are unsustainable.

Austerity is largely to blame for Greece's current depression - a decline of gross domestic product of 25 per cent since 2008, an unemployment rate of 25 per cent and a youth unemployment rate twice that.


But this new programme ratchets the pressure up still further: a target of 3.5 per cent primary budget surplus by 2018 (up from around 1 per cent this year).

Now, if the targets are not met, as they almost surely won't be because of the design of the programme itself, additional doses of austerity become automatic.

It's a built-in destabiliser.

The high unemployment rate will drive down wages, but the troika does not seem satisfied by the pace of the lowering of Greeks' standard of living.

The third memorandum also demands the "modernisation" of collective bargaining, which means weakening unions by replacing industry-level bargaining.

None of this makes sense even from the perspective of the creditors. It's like a 19th-century debtors' prison. Just as imprisoned debtors could not make the income to repay, the deepening depression in Greece will make it less and less able to repay.

Structural reforms are needed, just as they were in Indonesia, but too many that are being demanded have little to do with attacking the real problems Greece faces.

The rationale behind many of the key structural reforms has not been explained well, either to the Greek public or to economists trying to understand them.

In the absence of such an explanation, there is a widespread belief here in Greece that special interests, in and out of the country, are using the troika to get what they could not have obtained by more democratic processes.


Consider the case of milk. Greeks enjoy their fresh milk, produced locally and delivered quickly. But Dutch and other European milk producers would like to increase sales by having their milk, transported over long distances and far less fresh, appear to be just as fresh as the local product. Last year, the troika forced Greece to drop the label "fresh" on its truly fresh milk and extend allowable shelf life.

Now it is demanding the removal of the five-day shelf-life rule for pasteurised milk altogether. Under these conditions, large-scale producers believe they can trounce Greece's small-scale producers.

In theory, Greek consumers would benefit from the lower prices, even if they suffered from lower quality. In practice, the new retail market is far from competitive, and early indications are that the lower prices were largely not passed on to consumers.

My own research has long focused on the importance of information and how firms often try to take advantage of the lack of information. This is just another instance.

One underlying problem in Greece, in both its economy and its politics, is the role of a group of wealthy people who control key sectors, including banks and the media, collectively referred to as the Greek oligarchs.

They are the ones who resisted the changes that Mr George Papandreou, the former prime minister, tried to introduce to increase transparency and to force greater compliance with a more progressive tax structure.

The important reforms that would curb the Greek oligarchs are largely left off the agenda - not a surprise since the troika has at times in the past seemed to have been on their side.

As it became clear early on in the crisis that the Greek banks would have to be recapitalised, it made sense to demand voting shares for the Greek government. This was necessary to ensure that politically influenced lending, including to the oligarchic media, be stopped.

When such connected lending resumed - even to media companies that on strictly commercial terms should not have got loans - the troika turned a blind eye. It has also been quiescent as proposals were put forward to roll back the important initiatives of the Papandreou government on transparency and e-government, which dramatically lowered drug prices and put a damper on nepotism.


Normally, the IMF warns of the dangers of high taxation.

Yet, in Greece, the troika has insisted on high effective tax rates, even at very low income levels.

All recent Greek governments have recognised the importance of increasing tax revenues, but mistaken tax policy can help destroy an economy. In an economy where the financial system is not functioning well, where small and medium-sized enterprises can't get access to credit, the troika is demanding that Greek firms, including mom-and- pop stores, pay all of their taxes ahead of time, at the beginning of the year, before they have earned it, before they even know what their income is going to be.

The requirement is intended to reduce tax evasion but, in the circumstances in which Greece finds itself, it destroys small business and increases resentment of both the government and the troika.

This requirement seems at odds, too, with another of the demands with which Greece has been confronted: that it eliminate its cross-border withholding tax, which is the withholding tax on money sent from Greece to foreign investors.

Such withholding taxes are a feature of good tax systems in countries like Canada and are a critical part of tax collection. Evidently, it is less important to ensure that foreigners pay their taxes than that Greeks do.

There are many other strange features of the bailout packages, in part because each member of the troika has its favourite medicine. As doctors warn, there can be dangerous interactions.

The battle, however, is not just about Greece. It's not even just about the money, although special interests in the rest of Europe and some within Greece itself have taken advantage of the troika to push their own interests, at the expense of ordinary Greek citizens and the country's overall economy.

This is something I saw repeatedly first-hand when I was at the World Bank, most noticeably in Indonesia. When a country is down, there is all manner of mischief that can be done.

But these policy debates are really about ideology and power.

We all know that.

And we understand that this is not just an academic debate between the left and the right.

Some on the right focus on the political battle: The harsh conditions imposed on the left-wing Syriza government should be a warning to any in Europe about what might happen to them should they push back.

Some focus on the economic battle: the opportunity to impose on Greece an economic framework that could not have been adopted any other way.

I believe strongly that the policies being imposed will not work, that they will result in depression without end, unacceptable levels of unemployment and ever-growing inequality.

But I also believe strongly in democratic processes - that the way to achieve whatever framework one thinks is good for the economy is through persuasion, not compulsion.

The force of ideas is so much against what is being inflicted on and demanded of Greece. Austerity is contractionary; inclusive capitalism - the antithesis of what the troika is creating - is the only way to create shared and sustainable prosperity.

For now, the Greek government has capitulated.

Perhaps, as the lost half-decade becomes the lost decade, as the politics gets uglier, as the evidence mounts that these policies have failed, the troika will come to its senses. Greece needs debt restructuring, better structural reforms and more reasonable primary budget surplus targets.

More likely than not, though, the troika will do what it has done for the last five years: Blame the victim.


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