One rather obvious conclusion which should be drawn from the experiences of Greece in the past four years or so is that fiscal austerity does not work—in the sense of bringing economic recovery. The IMF forecasts of what would happen under the austerity programme were already indicating that unemployment would increase in the initial phase but recovery would come. The forecasts were that from 2011 there would be positive growth, though output would be some 3½% below its 2008 level. (All the statistics in this piece are derived from OECD Economic Outlook 96 November 2014, Statistical Annex.) Unemployment was forecast to peak at just under 15%. The actual results were much grimmer; unemployment up to 25%, some glimmer of growth only in 2014 (and then nominal GDP declined) with GDP in 2014 some 25% below the 2008 level. These are spectacular failures of forecasting—some of which, at least, could be ascribed to the general IMF failures over the value of the multiplier and hence of the effects of austerity on GDP (see on this score, Blanchard and Leigh, 2013).
The debt to GDP ratio rose from 111% in 2011 (having declined from 135% in 2009) to over 180% in 2014—which looks as though the Greek government ran up further debt. But, of course, the reality was that the ratio rose because GDP shrank by 25%. A high and rising debt ratio appears to go with low (and here negative) economic growth. Is this a confirmation of the Reinhart and Rogoff (2011) thesis? Not really, it is more a refutation since the causation runs from negative growth to rising debt.
The “fiscal compact” is based on two principles—a balanced structural budget and “structural reforms.” Greece has massively reduced its budget deficit (with the consequences that has had for unemployment) to 1% of GDP for 2014. Its primary budget position (that is excluding interest payments on debt) is in surplus to the extent of over 3% of GDP. Further, its cyclically adjusted budget surplus is near 4% and its underlying primary budget surplus over 7%. Against the criteria of the “fiscal compact” this is a massive surplus for which there is no justification.
The second principle has been the imposition of “structural reforms.” The Memorandum of Understanding (MOU) between the Troika and the Greek government sets out clearly what those “structural reforms” entail. As it was put in the letter from then Greek Prime Minister, George Papandreou, agreeing to the MOU, “despite the fact that we support Collective Bargaining and Agreements between social partners on principle (a longstanding European value and position recently included in the proposed new Treaty changes), our Party [PASOK] has decided and supports the deep structural reforms in the labor, product and service markets. The agreed adjustment of labor market parameters has been taken in order to give a strong upfront impetus to unit labor-cost reductions, and promote employment and economic activity.” It is the “structural reforms” imposed by that Memorandum, which have become central to the resolution of the crisis. Yet there is precious little evidence that these “structural reforms” will improve the Greek economy. Privatisation at most reduces the calculated budget deficit for the year it is undertaken—but at the expense of foregoing future revenues from the to be privatised assets. It also shows a fetish with the gross debt position whereas what would be relevant anywhere else would be the net asset/liability position. Cutting minimum wages does little to increase employers’ hiring of labour, and overall depresses demand leading to higher unemployment. What is required is “structural reforms,” which would actually benefit the Greek people, and which are tailored to the requirements of the Greek economy, and not imposed as conforming to some neo-liberal agenda.
We have noted before the democratic issues which the “fiscal compact” raises (more formally the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union). When a country has signed up to the Treaty it is committed to a fiscal austerity agenda, however appropriate or inappropriate such a policy is to their circumstances. Further, it is a commitment to a mysterious structural budget position, which is ill-defined, and which is to be guessed at by the European Commission. It is well-known that estimates of “potential output” on which the structural budget position is based vary widely and subject to revisions. It then becomes pointless for a political party to campaign on the basis of raising public expenditure or reducing taxation as if elected and seek to maintain their mandate it is ruled illegal by the EC. This is rather the position in which the Greek government now finds itself—it has a mandate to confront austerity but prevented from doing so by the unelected Troika.
We may thereby conclude that the insistence on austerity by Greece’s euro area partners after the disastrous experience of Greece’s recent years cannot be justified. It can only lead to more unemployment and economic activity decline, which can only lead to social unrest and further unpleasant, if not disastrous, consequences not just for Greece but also for the European Economic and Monetary Union (EMU).
Blanchard, O. And Leigh, D. (2013), Growth Forecast Errors and Fiscal Multipliers, IMF Working Paper WP/13/1, Washington D.C.: International Monetary Fund.
Reinhart, C.M. and Rogoff, K. (2011), This Time Is Different: Eight Centuries of Financial Folly, Princeton, New Jersey, USA: Princeton University Press.