Representatives of the troika – from the European Commission, European Central Bank and International Monetary Fund – are back in Athens for another review of progress in fiscal adjustment and structural reforms.
Their strong posture demonstrated on similar occasions in the past has been paradoxical. One might not expect such confidence given the substantial evidence of the dire economic and social consequences of such economic policies.
International creditors have, however, insisted that the country slash fiscal deficit and public debt and undertake structural reforms with the expectation of regaining external competitiveness and thus restoring confidence in bond markets. Is the creditors’ policy working now? The latest macroeconomic data suggest that the policy is not working any better now than before.
Poor real GDP performance was the first sign of economic policy failure. The last year of economic expansion was 2007, when Greece reported a real GDP of €211 billion at the growth rate of 3.5%. Each of the subsequent years saw a deepening recession, as indicated in Figure 1. The recession was remarkably deep in 2010 (-4.9%) and 2011 (-7.1%) – the years when the international creditors and the Greek government sealed two bail-out deals amounting to a total of €219 billion. The plummeting income was not surprising in view of the exceptionally harsh fiscal targets and structural reforms the Greek government was obliged to undertake. It was only in 2012 that the recession started to bottom out, as shown by the growth rate of -6.4%. This year, Greece can expect a growth rate of -4%, but this information will only be officially confirmed once the visit to Athens concludes.
The unemployment rate and youth unemployment rate (15-24 years old) has lagged behind the trend in real GDP. The first crisis year to record an unemployment rise was 2009 when it amounted to 9.5% (Figure 2). What followed was the exponential rise in unemployment to reach almost a quarter of the working-age population at the end of 2012. The most recent data from July this year indicated a staggering rate of 27.6%. The situation is even gloomier if one looks at the soaring youth unemployment, which stood at 61.5% as of the end of June.
Bringing government finances back in order has proven to be another area of policy failure. While it is true that the government deficit was slashed from 15.6% in 2009 to 10% in 2012 (Figure 3), it is still above the pre-crisis level. The persistence of the government deficit over time has translated into government gross debt accumulation, with the public debt-to-GDP ratio standing at 156.9% (Figure 4) at the end of 2012. Instead of reducing the debt level, the reform measures have perversely increased it. The thing that remains to be seen, however, is whether the well-known theoretical prediction that lower deficit must lead over time to lower debt, even if the debt-to-GDP ratio deteriorates in the short-run, will be supported empirically. The current account dynamics, despite notable improvements, do not make the overall impression significantly better. The reform process has been designed to improve external competitiveness through engineered internal devaluation, i.e. sustained decline in prices and wages. This process, together with the exploding unemployment rate that slashed incomes and imports, has improved the country’s current account position (Figure 5) and increased the likelihood of repaying foreign debt with rising exports. Yet, the naiveté of such expectations has recently been demonstrated by the renowned LSE economist Paul De Grauwe, who calculated that Greece would need to run a 3% current account deficit for the next 30 years just to halve its foreign debt (of which a share of 61% is in hands of the Greek government).
The troika’s policy is not working. The negative trends in real GDP, unemployment and government finances belie its underlying logic and credibility, as well as the political legitimacy of the choices the Greek government was forced to make. Currently, the external re-balancing appears to offer rare evidence that stands in support of the creditors’ policy choice. But the prospect of repaying any serious amount of foreign debt any time soon is dim. If the troika continues insisting on a policy patently detached from the rapidly deteriorating social and political context, political support for the Greek government and European institutions will continue to decline. And in that case, more adjustment pain for the economy and the people will inevitably follow.