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When in a hole, stop digging! Why growth policy in Greece needs a rethink

RTorbett

We all know that Greece has been at the centre of debate about the Euro-zone crisis. TV images of protestors in the streets, political turmoil and increasing poverty have not – in my view –come close to conveying the hardship that many in that country have come to know since the start of the crisis. Many who are lucky enough to be still in employment, particularly in the public sector, have seen their salaries cut drastically. A friend of mine recently told me how her salary was cut to a third of what it was previously. “That’s awful”, I said, “It must be so hard to live on a third less income”. “No”, she said, “You misheard. It was cut TO a third not BY a third”…And she is one of the lucky ones! For the 27% unemployed – a figure matched only by Spain – life and prospects have been looking pretty desperate.

So, it is with interest that I read the OECD’s latest Economic Outlook on Greece, hoping to see some positive signs of recovery. Sadly, those signs are pretty flimsy, although the OECD makes a valiant attempt to sound upbeat.

Greece, they say, “has made impressive headway in cutting its fiscal and external imbalances and implementing structural reforms to raise labour market flexibility and improve labour competitiveness”. Like I said, the OECD is understandably trying to sound positive, but let’s break this down. Yes, the extent to which they have cut fiscal imbalances could be seen as impressive. They have, by and large, done what the international community has asked of them in terms of their government budget deficit. But this is not without cost (see, here and here for some examples in healthcare) and, of course, such a dramatic fiscal contraction was the wrong thing to do anyway, given the larger than expected fiscal multipliers (as pointed out by the IMF). The simple fact is that if Government cuts back at a time where everything else in the economy is cutting back, by definition, aggregate demand falls through the floor and you have a problem. (Incidentally, some excellent work by Aaron Reeves at Oxford University has gone one step further than the IMF and has calculated separate fiscal multipliers for different types of government expenditure (See page 22 in this presentation that was given at the recent Sustainable Health for Inclusive Growth conference in Vilnius.  His conclusion is that cutbacks in health spending have an even more negative effect than for overall government expenditure).  

So, the ‘impressive headway’ that’s been made in fiscal contraction may have been impressive headway at doing the wrong thing. Not exactly something to shout about!

Let’s now look at ‘external imbalances and labour competitiveness’. In plain English this means, respectively, whether or not Greece is importing more than it exports (or vice versa) and whether or not ‘labour’ in Greece is cheaper or more expensive than in competing economies. This is where I start to have problems with how some commentators are spinning the latest numbers in Greece. The improvement in the current account balance, as shown in Chart 1, is often presented in a positive light and described as an improvement in competitiveness.

Yes the trade balance has been ‘improving’. But is this really a sign of strength? An improving trade balance, in itself, is not necessarily a sign of a strengthening economy and neither is a worsening of the trade balance necessarily a sign of weakness. Context matters. If we look at what’s been happening to imports and exports in Greece over the last few years (see Chart 2) you can immediately see the real story since the start of the economic crisis has been the collapse of imports.

 

It makes intuitive sense that, with declining national income and extreme levels of unemployment, people are simply less able to spend money on imports than they once were. The ‘improvement’ in the trade balance, then, is sadly a sign of weakness in the economy more than it is a sign of improved competitiveness and successful structural reform.

This is not to say that progress hasn’t been made in structural reforms. On the contrary, real effort has been made in some areas. Real and relative wages have come down, which ought to – in the long run – lead to the ‘good sort’ of improvement in the trade balance. Even in healthcare, where I think some appalling decisions have been made, a lot of good work has been done to rebalance the medicines market, finally making off-patent and generic medicines cheaper (prices were among the highest in Europe back in 2009, a situation that could hardly be sustained by a crisis country). The new electronic prescribing systems that have been established to support a more rational use of medicines are also a positive move in the right direction.

So, some good has been done. But reform in other areas has been less obvious. A country the size of Greece, for instance, by international standards should have around 2000 pharmacies. I am told that, in fact, it has more like between 10, 000 and 12,000. This is an enormous driver of cost. Now, I’m certainly not suggesting that 10,000 pharmacies should have been put out on the streets. But I am highlighting the fact that when we talk about ‘structural reform’, the issues that need it most are usually politically and practically the hardest to address – and so we shouldn’t kid ourselves. Reforming the Greek pharmacy market would not be impossible but such change takes a lot of time and a lot of money – hard to do in a crisis, when budgets are being slashed.

So, at least for healthcare, while some worthwhile structural reform has been started, the real cash has come from a series of blunt instruments – price cuts, claw-backs, taxes, etc. more often than not targeted towards pharmaceuticals. These may generate the short-term funds required to meet international obligations but they do not guarantee a more stable platform for the efficient management of the system in future.

A good understanding of what is really happening in terms of major microeconomic policy (like healthcare) is critical to inform a proper understanding at the macro level. So, when it comes to that macro discussion, we need to be careful about how to interpret the data.  Anything that purports to demonstrate competitiveness needs to be handled with care. When things do improve in Greece, we’ll probably see a ‘worsening’ of the trade balance – and that will be a good thing!

More generally, there needs to be a rethink on Greek growth policy. Not only has austerity failed to make progress in reducing public debt, Greece actually has worse public debt than ever (2012 was 157% of GDP; 2013 estimate is 176%).  And when it comes to growth – there just isn’t any. GDP growth is still estimated to be -4% in 2013. So we’re in a hole and we should stop digging. What would help the Greek economy more than desperately trying to spot positive stories (that aren’t there) in what can only be described as dismal data, would be a renewed focus on demand. Greek businesses cannot grow without demand. And that demand is unlikely to come from a sudden bout of market confidence.

I realise that Greek Government spending is unlikely to grow any time soon, but demand has to come from somewhere and at very least the straightjacket imposed by Eurozone rules should be loosened. If nothing else a loosening of fiscal policy should allow enough money to facilitate the most difficult structural reforms that have the potential to provide more long term benefit to the Greek economy.  There’s no quick fix. But it is time for a rethink of the direction of policy. And that does need to happen quickly.

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RTorbett

EFPIA Chief Economist

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