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How Austerity destroyed Greece

The IMF just threw a nuclear bomb on Greek debt drama when it announced that even in the case of the best possible scenario the offer of the Institutions would lead to an unsustainable debt path, and any deal would have to contain a substantial write off of Greek debt. With this they have effectively admitted that from a purely economic point of view Syriza was right all along. Naturally this gave a massive push to the NO campaign.

In light of all this it is worth taking another look at how the Greek debt path became unsustainable as a consequence of austerity. In 2008, the year before the crisis, Greece had a debt level of no more than108% of GDP, which is high, but not unmanageable. Japan’s current debt level is two and a half times as much, and Great Britain had managed do almost eliminate its 200% debt level after World War Two while even increasing social expenditure during the postwar welfare state decades. Thus Greece’s debt level at the outbreak of the crisis was by no means fatal. Then came austerity.

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The elements of austerity in Greece were the following:

1.) a 30% decrease in wages,

2.) a 50% decrease in pensions,

3.) a significant increase in tax revenues from small and medium sized enterprises (contrary to widespread opinion, tax evasion by the self employed was estimated to be around 4.5% of GDP in 2009),

4.) the firing of hundreds of thousands of civil servants,

5.) massive cuts in social spending, education and research and development, the engines of growth,

6.) the introduction of new taxes, which increased the tax burden on the top five income tenths by 9% and the tax burden of the lowest five income tenths by 337.7%,

7.) at the same time the oversized military expenditure of the country (3.5%) was left intact, and was spent to purchase military equipment from French and German firms,

8.) at no time during the two Greek-Torika memoranda did the word “offshore” figure, even though it is an open secret in Greece that there was a massive leakage of the tax base towards Cyprus, Switzerland and the British crown dependencies.

All this together led to a greater tightening of belts than anywhere else. The consequences were also greater. As it is well known, the IMF was unable to forecast the effects of the programmes in advance. It kept publishing super optimistic scenarios that later had to be revised:

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Furthermore, the privatisation revenue predictions of the IMF also failed to materialise in a dramatic way:

 

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The outcome of the austerity programmes resulted in perhaps the most obvious policy failure in the history of economic policymaking:

1.) GDP fell by about a quarter,

2.) unemployment increased from 8% to 27%,

3.) youth unemployment reached a staggering 58% by 2013,

4.) three out of five Greeks live below the poverty line, or are threatened by it,

5.) while the debt stock increased from 108% to a 180%, and thus spiralled completely out of control.

 

Greece became an extreme case study of how austerity can destroy an economy. As Nobel prize winning economist Paul Krugman explains, the philosophy of austerity was based on the assumption the trust of investors is regained by the actions of the government. What happens in reality is that firings and salary cuts cause internal demand to collapse, leading to further firings.

 

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All this perhaps explains why it was in Greece that the first anti-austerity party came to power, even though austerity had similar negative effects in other countries as well. As the now famous chart of Professor Krugman demonstrates, more severe austerity was correlated with a higher drop in GDP during the crisis years:

 

 

 

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Economies under austerity saw massive rises in unemployment and debt, which indicated that those who wish to explain the Greek crisis with shallow culturalist explanations (“Greeks are lazy and corrupt”) are mistaken.

Syriza came to power in January of 2015 with a double mandate: 1.) to keep Greece in the eurozone, and 2.) to end austerity. They started negotiating in the hope that they can maintain these two very rational goals simultaneously. This was a reasonable assumption given that even the IMF had concluded  in a landmark study of austerity programmes that austerity is harmful.

Syriza’s famous Thessaliniki Programme was completely coherent with the ideals professed by the European Union: Social Europe, Sustainable Europe, as well as the Lisbon/Europe2020 strategy of competitiveness based on investment into human capital. In addition, this programme was to be carried out by a government that was accepted by everyone to be pristine clean, cleaner than any other government Greece has ever had or is ever likely to get. The new government was decided to hold accountable the oligarchs who had captured the Greek state and political elite.

Thus it was quite understandeable that Syriza expected the finance ministers in the Eurogroup to give in to economic rationale. However, this turned out to be a mistaken assumption. During the five months of negotiations we did not hear Juncker, Schauble or Dijselbloem emphasize the need for Greece to invest in growth: to raise its extremely low expenditure on education, its almost non existent research and development expenditure, or to exploit its gigantic sustainable energy potential. What did the EU-IMF pair insist on instead? On cutting pensions further, with almost half of pensioners already living under the poverty line, and on introducing new taxes…

There is a widespread speculation, based on Varoufakis’ past in game theory, which believes that the Greek government was engaged in some sort of a gamble. It did nothing of the sort. It was defending its rational standpoint in a very consequent manner. The often mentioned Chicken Game came about because it soon turned out that the other side was also unwilling to compromise. It makes no sense to refer to the fact that at the end of the day creditors dictate the terms and the indebted must comply. In the case of Greece the creditors financed a catastrophic austerity policy for long years from taxpayers money, why they saved their own banks who had financed the irresponsible Greek elites earlier, and where therefore heavily exposed to Greek debt. 90% of what was nominal christened “the Greek bailout” was in fact spent on interest payments and other issues, but not on any reforms in Greece:

 

 

 

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It was equally irrational for indebted Greece to accept any proposal from the creditors. Austerity has brought very obvious tragedy to Greece, and made a manageable debt stock unmanageable. What is the likelihood that further austerity is going to suddenly do miracles in the sixth or seventh year?! As we have mentioned, it is the official position of the IMF itself that the offer of the creditors would lead to an unsustainable debt path without a debt write off. And as we have seen, the IMF has proved to be overly optimistic in past years…

In this situation it was not rational for Syriza to accept the proposals of the Eurogroup, and it was not rational for the Eurogroup to even propose them. It became clear that making these proposals in light of the obvious failure of austerity meant that their approach to the talks is not based on economic rationale, but on a political one. The wanted to stop Syriza from creating a European precedent in terms of debt relief or post-austerity governance. They held on until Syriza capitulated to austerity, as did all mainstream Social Democratic parties before. By embracing austerity, PASOK has managed to basically eliminate itself from the Greek political scene, giving rise to the term “pasokification”. Was Syriza to hold out, they were sure to lead Greece into default, which is what happened eventually. Those Greeks who are not aware of the fact that it was austerity that essentially lead to default would believe that this was Syriza’s fault, after only a few months of governance, in a situation when they were effectively blocked from independent governance by the February agreement, which stipulated that they would make no independent moves without consulting with the Eurogroup and the IMF. The perfect trap.

What the Eurogroup ministers did not expect was that Syriza would receive unexpected intellectual support not only from the studies and statement of the IMF, but also from a large segment of the international press, as well as the cream of the global economics elite. This included the Nobel prize winners Joseph Stiglitz, Paul Krugman, Amartya Sen, Thomas Piketty, as well as eurozone experts who can hardly be blamed by pro left bias, such as Charles Wyplos or Barry Eichengreen. Even the renowned German sociologist Jürgen Habermas lent his support.

 

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The author has written a book on The Political Economy of the Greek Crisis, which you can find here.

 

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