Introduction
The Eurozone is often discussed as a single entity. It is only a single entity in that all members use the same currency. In fact, the Eurozone countries have very different economies. This article highlights their differences using Greece as an example and explains why it is heading for a breakup.
Greece
Since 2010, I have been tracking the Greek crisis. It is a story of three entities unwilling to see the big picture and make the compromises necessary to move things forward in a productive way.
a. The Greek Government
Since 2011, Greece has had to agree to a numerous austerity measures resulting in the unemployment rate reaching 28%. Alexis Tsipras and his Syriza Party came into power in 2015 by promising to stop giving into the demands of the IMF and the Eurozone. The following recent quotes from Mr. Yannis Stournaras, the governor of the Central Bank of Greece, provide a sense of the current antagonisms between Greece and the IMF.
Commenting on the findings of the IMF’s most recent review, Stournaras said:
“However, at its present form, it [the IMF review] misses the opportunity to be fair to history since it criticizes everybody else except the IMF. As far as this point is concerned, being Finance Minister between July 2012 and June 2014, I can confirm that during this period:
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The IMF pressed for more and more parametric fiscal policy (austerity) measures ignoring even its own research regarding the size of fiscal multipliers and tax buoyancy, thus consistently underestimating progress in the reduction of the primary general government deficit;
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The IMF is partly responsible for delays in closing the 2013 review since it was unjustifiably (given the final outcome) asking for additional parametric fiscal policy measures even when it was more than clear that 2013 fiscal developments were pointing to a primary surplus large over-performance;
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The IMF insisted on additional recapitalization of banks disregarding the views of the authorities, the Bank of Greece and the European Central Bank, and it turned out that it grossly overestimated capital needs and underestimated the impact to the economy of excess bank capital;
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The IMF consistently played down the progress on structural reforms, ignoring, among others, OECD’s assessments.”
Prime Minister Tsipras is fighting for his political life. His strategy: at the last minute, agree to some reforms and then do far less than he promised.
b. The IMF
The Greek Central Bank Chief is right. Back in 2011, the IMF pressed for extreme austerity measures that resulted in the collapse of the Greek economy. However, at least the IMF saw what was happening and gave up on fiscal policy austerity measures. In their place, the Fund has insisted on a wide array of reform measures. In all the years I have been covering the IMF, I have never seen such a long list of policy changes being demanded of any country. The general categories include: fiscal reforms, pension reforms, health sector reforms, social security reforms, government performance reforms, and economic system reforms. In order to achieve these objectives, the Greek government agreed to foreign technical assistance in more than 20 different fields. OK. So maybe if Greece did everything on the IMF list, they could stay in the Eurozone and compete with the Germans. But don’t hold your breath.
What will it take to make the Greek economy competitive with Germany? From the latest IMF Article IV Consultation:
“Greece requires a notable increase in productivity to become competitive within the Euro-zone. Without a substantial acceleration in the pace of structural reforms, Greece will be unable to narrow the gap in its real per capita income relative to the Euro area, raising concerns about the ability of the economy to prosper and remain competitive inside the Euro-zone. Greece will thus need to make rapid progress to close remaining gaps with best practice both in labor and product market reforms.”
And of course, the Greek government, in trying to survive politically, is resisting. It ignored its international lenders and gave pensioners a one-off Christmas bonus. The handout earmarked $656 million for a one-off payment to low-tier pensioners.
And while the IMF has conceded that pressing too hard to increase the government surplus will be too deflationary, most of its reforms will also be deflationary. For example, its call for pension “reform” involves the government reducing pension payments and its call for tax reform would increase tax revenues.
c. The Eurozone
Germany dominates Eurozone (EU) thinking on what Greece should do. And Germany has been consistent all along: more austerity and no more debt relief. The EU wants a Greek government surplus of 3.5% of GDP; the IMF says no, too deflationary, the target should be a deficit of only 1.5% of GDP. I quote from the IMF:
“Aiming for a higher target (3.5%) would necessitate further net fiscal consolidation, which is not advisable at this time, as it would be detrimental to the nascent recovery. Should the authorities choose to maintain a medium-term primary surplus of 3½ percent of GDP, then they will need to implement additional credible and high quality reforms. These reforms should be implemented only once the output gap closes, to mitigate the impact on the recovery. Still, such a policy will undoubtedly have an adverse impact on growth, as it will constrain demand.”
And there is another important area where the EU and the IMF differ: debt relief. In 2011, Greece and its creditors agreed to a 75% debt reduction. In addition, the European Central Bank has been buying Greek debt to keep rates from skyrocketing. The EU is opposed to further debt relief. The Fund makes a strong case that more is needed:
“[The Greek government] debt is projected to reach 170 percent of GDP by 2020, and 164 percent by 2022, but will rise thereafter, reaching around 275 percent of GDP by 2060, as the cost of debt, which rises over time as market financing replaces highly subsidized official sector financing, more than offsets the debt-reducing effects of growth and the primary balance surplus. Gross financing needs cross the 15 percent-of-GDP threshold already by 2024 and the 20 percent threshold by 2031, reaching around 33 percent by 2040 and around 62 percent of GDP by 2060.”
The IMF has sat on the sidelines of the latest bailout program and says it cannot participate in a program which could keep Greece in a never-ending cycle of indebtedness that could push national borrowing to 275 percent of economic output by 2060. Because of these differences, the Fund had not been part of the third and latest bailout agreement last July for up to $91billion. However, disbursements from this agreement have been delayed because of Tsipras’ Xmas pension gift. A real mess.
Conclusion
I see no way in which this can end well. Back in 2011, I recommended that Greece and the other “weak sisters” in the EU should leave and go back to their own currencies. Why? Greece will never be as productive as Germany and other Eurozone countries. The only lasting solution is for Greece to leave the Eurozone and return to its own currency. That way, currency rates will adjust for competitive differences.
It is worth keeping in mind that currency rate adjustments kept the US competitive with Japan. The dollar weakened from (¥360/$ in 1971 to ¥120/$ in 2015). And that change made Japanese goods three times more expensive to Americans.
An Addendum – The Weak Sisters
My latest list of weak sisters includes: France, Italy, Portugal, Spain, and Greece. Table 1, below, lists the danger signs for all of these countries.
Unemployment is particularly notable. Largely because of these countries, the unemployment rate for the EU overall is just under 10%. The deficits of France and Spain are troubling as are the high debts of Greece, Italy and Portugal.
Table 1. – Selected Data, Eurozone Countries, 2017
The Brexit negotiations starting soon will add more uncertainty in Europe. I see nothing but trouble ahead for the EU.