Sunday 19 December 2010

Finding the Loch Ness Monster: The Continuing Search for Higher Educational Reform in Greece

Lost in the furor of the general strikes and public reactions against the IMF-led financial rescue package has been the fate of the government’s attempt at higher educational reform. Educational reform is something like the Loch Ness monster of Greece: people have been searching for it for decades, but they have never actually seen it. Every government revisits the issue: Studies are commissioned, consultations are held, laws are passed--yet the problems continue, while Greece continues to lose ground in international comparisons of higher education.

The latest round of tertiary-level policy initiatives by Minister Anna Diamantopoulou build on past attempts by Minister Marietta Giannakou, and include some noteworthy initiatives such as ending (really, this time) the problem of eternal students, devolving decision-making authority to universities and possibly closing or merging university and higher vocational education and training (VET) institutions and/or departments. These are worthy initiatives, but I feel that any solutions they may bring will only temporary, since the core issue of competition, student focus and the public monopoly on higher education is not resolved.

The Greek higher education system is based on the public monopoly on higher education in a variety of ways:

·     The Greek government (via the Constitution) did not, until May 2010, recognise graduates from private post-secondary educational institutions in Greece. There are no fully-functioning private universities in Greece accredited by the government at the tertiary level. The 10 “private” universities which do exist usually specialise in certain limited areas (usually in the liberal arts), and are usually based on provision of foreign degrees. They face continual problems with state validation of teaching staff, curricula and diplomas. Ironically, the Greek government does recognise the diplomas of foreign private universities, while it also permits secondary and primary private education within Greece.

·       The Greek government is responsible for nearly 100% of funding to state universities, which are not allowed to officially charge for tuition or materials. It does not provide any financial support to the private post-secondary, non-tertiary institutions it has recognised.

·      The non-temporary staff in the state system have the status of permanent civil servants. For all intents and purposes, they cannot be fired for any reason except possible criminal behaviour. A large number of temporary staff have been hired to cover shortfalls due to poor performance of the permanent staff. These temporary staff face payment delays, job insecurity and the constant threat of contract termination every time the government changes.

There have been any number of studies from both sides of the political spectrum which testify to the inefficiency and waste of university operations and learning outcomes, which I do not want to repeat here. Interested readers can consult various CEDEFOP and Eurydice studies on higher education, international rankings, the various Lisbon Agenda and Bologna studies carried out by the European Commission, and various reports implemented by the ND and PASOK governments over the past 10 years.

What I would like to do instead is to focus on the fundamental unfairness of the public monopoly on education, and the detrimental effects this has on society. While proponents of free public education claim that a public monopoly is necessary to assure for social justice, the actual record of such a system in Greece leaves much to be desired. Its defenders cannot account for the regular destruction of university property, the low or variable quality of lectures and teaching,  the high class sizes, the abysmal management (many universities apparently do not even know their own enrolment), the sub-standard facilities, the problem of eternal students, etc.

In such a climate, it is also irresponsible to speak of more funding being the solution. There is absolutely no guarantee that reaching the magic number of 5% GDP invested in education will make any difference whatsoever, beyond propagating and exacerbating inefficient and illogical practises.

I would therefore like to suggest the following proposals for the higher education system, which I believe are the only method of addressing the issue of quality in higher education in Greece. These are as follows:

1.     The state monopoly on higher education must end. Each university or vocational training institution which so desires should become a self-managing, legally-independent organisation responsible for its curriculum, staff hiring and firing and enrolment. Those that do not desire this should be closed. Exceptions can be made for a few institutions considered vital for national reasons, such as defence / military-related, fire and police academies.

2.      The state’s role in providing financial resources should switch from funding institutions to funding student enrolment. This funding should be prepared using a lump-sum calculation based on courses of study (e.g. a chemistry major may require higher funding than a literature major). The funding should be paid to the institution based on the number of students enrolled (subject to a maximum cap on student funding and places). The funding will only be available for a studies up to an including a masters’ level, in line with the minimum (not maximum) number of years foreseen per specialisation, e.g. 3-4 years for a bachelor’s and 1-2 years per master’s degree. A separate provision should be made for doctoral and postgraduate work. A limited number of scholarships should be available for international study.

3.      Public universities will be able to levy tuition on students. This should be capped at a logical rate (e.g. EUR 2,000 per year), but grow in line with economic conditions and market competition. A set number of scholarships should be offered based on full or partial scholarships for means-tested families. Scholarships should include a mix of loans, work-study, and grants. Tuitions charged to non-residents of Greece can be set to market rates.

4.     This funding mechanism should apply to enrolment at all accredited “private” (i.e. non-state) and “public” institutions in the country. The difference in status should become one of for-profit and non-profit education, where the former is characterised by a company where profits can be distributed as dividends, and the latter by an institution where 100% of profits made are re-invested into the institution. For-profit education should fall under the standard tax code. Non-profit educational institutions should not be taxed. State funding and scholarships should only be available for enrolment in non-profit educational institutions.

5.   All value-added tax (VAT) on higher education services which comprise study (or provision of study) in full enrolment at a non-profit institution should be set at 0%.

6.   The financial foundation of the new educational institutions should be strengthened by the legal transfer of land, buildings and other assets already in their possession, as well as by the potential transfer of additional state assets (primarily real estate), to form an endowment for future operations.

7.    All educational institutions—and the government—should immediately end the practice of owning and operating student dormitories at no cost to the students. If the cost of housing is an important part of student costs, then either:

  • This cost should be covered by scholarship grants or loans or work-study, or
  • A stipend should be added enabling the student to rent suitable premises.

In any case, the true financial costs and benefits of student housing (or stipends for housing) should be clearly recorded and understood by all parties involved. Housing benefits should only be provided for the minimum study term: eternal students or students who have finished their study should vacate the premises and make room for actively-enrolled students.  

8.   The government should immediately drop its constant war against the private sector in higher education, and recognise that:

  • As taxpayers and legal entities, private companies have equal rights to state companies in the provision of educational services in Greece and the European Union;
  • It is morally indefensible to retain a government de facto monopoly in the educational sector given the Greek experience and record in this sector, and given that private taxpayers (either in Greece or the EU) are required to pay for this.

9.   All educational institutions are acknowledged to be self-managing institutions. Decisions on staff performance assessment, staff retention and development, compensation, hiring and firing and other issues is left to the discretion of each institution, but must be based on a professional and transparent code of conduct and operating procedure. The staff working in these organisations should be removed from the list of government employees. The staff “managing” the tertiary sector in the Ministry of Education and its agencies should be refocused and reduced accordingly.

10.  All educational institutions are allowed to raise money for capital expenditure endowments through fundraising. All institutions are allowed to carry out revenue-earning work for non-state employers, providing that this revenue is properly accounted for, and that this does not detract from the core educational mission of the institution.

11.  EU funding absorption should be maximised, with the objective of sending every student outside Greece on an Erasmus or similar scholarship for at least 3-6 months of his/hear career. Further absorption should be used for staff training and exchange, including voluntary rotation within Greece as well as internationally.

12.  A separate accreditation body for higher education institutions should be established, comprising, representatives of educational institutions, employers and other social partners. This should be legally independent and insulated from the corrosive effects of political interference.

13.  Every institution receiving public money will be expected to be manage itself transparently and in line with standard, international professional competency. It will be subject to a full audit each year by at least two organisations:

  • A private, internationally-recognised audit firm
  • The state audit commission
We strongly recommend that the EU Auditor audits the use of all EU funding in Greece as well on an annual basis. All audits will be published online. Cases of fraud or mismanagement of public funds will be prosecuted quickly to the full extent of the law, and will resulting criminal and civil charges against the individuals committing the crimes. Conviction may also result in a reduction of public expenditure to the institution.

14.  In addition to auditing the use of public funds, the role of the auditors should be to advise on issues such as valuation of land and assets as well as leverage ratios. It is strongly recommended that a medium-term legal cap on borrowing be implemented for each institution to assure it self-sustainability. This cap should be in place for at least 10 years to avoid the syndrome of high debt taken by public and semi-governmental organisations in Greece.

15. The pan-Hellenic university entrance exam should end. This has an important impact on secondary education, which is currently gravely distorted by two phenomena:

  • Teaching for the pan-Hellenic exams rather than for the student
  • The excessive institutionalisation of cram schools (frontisteria).
There are two potential solutions for university admissions:

  1. A pan-Hellenic standardised exam which includes two tiers, basic competencies (mandatory), and specialised knowledge (optional), be implemented. This would be used in conjunction with other admissions criteria.
  1. Each university implements its own transparent admissions process.
The fear is that in the latter case, political and financial connections may assure the entrance of well-connected individuals. Unfortunately, given that the pan-Hellenic exam preparation process has also become a process driven by money, it does not seem that the current system is doing any better. Despite this, the distortions on secondary schooling remain.

16.  Each institution is allowed to choose how many campuses or departments to have, whether to invest abroad or in Greece, whether to open multiple campuses, whether to offer many degrees or whether to specialise (e.g. business schools, medical schools). Each institution is able to define whether it will provide vocational or academic degree tracks, providing of course it meets the national curriculum standards in each area.

17.  All ecclesiastical education and training should be immediately devolved. If government funding is to be available to higher or vocational education in religious institutions, then it should be on the same funding basis as other institutions, but should be equally available to the religious institutions representing all religions, not solely the Greek Orthodox religion. There should be a total separation of Church and State in education.

18.  University asylum must end. Every institution can either pay for its own policing, or rely on the standard forces of law and order in certain or all cases. Theft and other criminal acts should be fully prosecuted by the law: students and staff who commit such acts should be expelled.

These proposals are radical in nature, and are not likely to be acceptable to the majority of university administrators, staff and possibly students. Unfortunately, I do not see any long-term alternative. Unless we want to accept continual “reforms” of the system every four years or so, and a continual decline in educational quality, we must sever the connection between the politically-dominated educational policy-making and management process, and the management of higher educational institutions.

This will also be of utmost benefit to the institutions themselves. We know that in order for them to succeed, they must internationalise as rapidly as possible, developing alliances with European and other universities, investing in new facilities, rewarding their staff properly, and developing spin-offs and endowments. If a devolution of the kind I propose occurs, we should be ready to transfer up to EUR 500 million of state land and assets to each institution, assuring it of the means to operate independently. (The Greek government has recorded assets of over EUR 300 billion, most of which is mismanaged. Total government income from these assets amount of less than EUR 50 mln per year).

We also know that given the tremendous debt burden hanging over Greece (itself a product of gross public sector mismanagement and political corruption), there is practically no chance for a real investment in higher education to occur in any other way. To thing otherwise is to dream.

It may be necessary to split such a reform into phases over 10 years: calling for a first wave of volunteers and allowing them to operate for 5 years to see the results. But unless the system changes, the chronic issues of mismanagement and declining standards will continue, while the long-term damage to the society grows. 

(c) Philip Ammerman, 2010

Friday 17 December 2010

The Parody of Political Protest in Greece

The elusive logic of the political situation in Greece is perhaps best illustrated by a single event: Every November 17th, a march occurs on the US Embassy in Athens to protest the US support for the military dictatorship that ruled Greece from 1967-1974. The march is held on the anniversary in which the dictatorship’s military forces entered the Polytechnic University and killed 24 civilians in the process. It is usually attended by at least 10,000 participants, and inevitably degenerates into violence, with masked youths trying to break a police cordon and stone or burn the Embassy.

The fact that this march continues every year illustrates that while Greek protesters have been remarkably effective at channeling their anger against foreign enemies or conspiracies, they seem much less ready to take on the vested political interests that have brought the country to what is widely and euphemistically referred to as a dictatorship of the troika, or a loss of sovereignty.

Today, Greece is confronted by at least EUR 340 billion in debt, which is rising at a rate of at least EUR 15 billion in interest costs alone each year, and will increase in 2011 as higher bond spreads take effect. Unemployment has reached 12.4%, a historic high. Pensions and wages have been cut, and the vast state apparatus is slowly being reformed, with tremendous human costs.

At the same time, we are broadly aware that a small minority of political families and companies have been responsible for the vast corruption in public contracts and wider public spending in this country. Their names are fairly well-known, and if specific evidence is needed, an objective investigation into cases such as Siemens, Vatopedi, Skaramanga, OTE procurement, military procurement, pharmaceutical procurement and hundreds of others would quickly reveal them.

For instance, we know that a former Minister of Defence has been implicated in purchasing a luxury house in central Athens from a Cypriot offshore company. This property was valued at a fraction of its market price. This individual goes unpunished. The case is even more remarkable since by most estimates this person’s fortune gained while in office is likely to be two orders of magnitude higher than that published sales price.

Today, we also know that according to Eurostat, Greece has actively falsified or mismanaged its economic statistics and engaged in various financial transactions which proved detrimental to the Greek economy for at least three administrations. None of the high-ranking officials have faced criminal or civil charges, Parliamentary censure, loss of privilege or any other measure.

Today, we know from Germany investigations in that bribes paid to Greek political parties in the Siemens and Skaramanga cases amounted to hundreds of millions of Euros, and we can assume that the conduits for this bribery—the Hellenic Telecommunications Organisation and the armed forces—should rapidly implement a forensic audit of prior contracts to determine additional sources of corruption. This is not being done.

There are hundreds if not thousands of cases like this. So my question is simple. If every year we can march on the US Embassy, why don’t we march every week or every day on a different politician’s house and protest outside it? After all, we know where most of them live. You can see them drinking coffee in Kolonaki or Politeia quite regularly. If the justice system will not work, and if the political parties themselves do not act, then clearly, the citizens must.

Yes, I am sure this will open me to charges of naivety, historical ignorance, inciting vigilantism or worse. But I look at this another way. Certain political elites have managed to brainwash entire generations of Greeks that the Americans are the Great Satan (among myriad other conspiracies) while conveniently distracting attention from their own misdeeds.

Today, we are falling over each other to condemn the violence that occurred on Wednesday. Fair enough. Yet I have to ask: Which politician has every had their accounts audited properly–including their Swiss or Cypriot accounts, or those of their family members or the contractors commissioned during their tenure? Which politician has ever been fined for misuse of funds? Which politician of the generations of incompetents which rule this country has ever faced jail time or property seizure?

In Austria, the former Prime Minister Ivo Sanader of Croatia is in jail awaiting extradition due to an unexplained EUR 1.2 million in secret bank accounts. In Germany, the political giant Helmut Kohl resigned in 2000 due to suspicious party contributions of DM 2 million. Our politicians are far more venal, and have far fewer achievements to their name, yet so far none have resigned or faced prosecution, apart from Tasos Mandelis.

In ancient Athens, public figures could be fined as well as ostracised, or expelled from the city. We have no such system today. Shouldn’t the politicians that have ruined the country at least be deprived of their pensions, or face censure or civil charges?  

Prime Minister Papandreou has repeatedly promised to crack down on corruption regardless of the political cost. So far, nothing substantial has been achieved.

My feeling is this: unless a serious, concerted effort is made, and fast, the events of Wednesday will seem like child’s play compared to what may actually happen. A “Bastille Day” scenario, where a mob storms the Parliament and takes justice into its own hands is no longer an unrealistic scenario, no matter how outlandish this may sound. In the final analysis, it may be no more than what is actually deserved. 

Saturday 11 December 2010

The Uselessness of Scrappage Schemes and other Tax Policies

The Greek government has, despite its earlier opposition, announced a scrappage scheme which offers a tax exemption of up to EUR 2,800 on purchase of a new vehicle, providing the vehicle has an engine capacity of under 2,000 cc. By doing so, it hopes to generate short-term tax revenue, since a “luxury tax” of 10% on purchases of vehicles costing EUR 15,000 – 20,000 applies, as does VAT. It also hopes to generate future tax income, since vehicle circulation taxes apply every year.

The current policy is, like many others, deeply inequitable and absurd. According to the current tax system, a middle-income family of five which buys a station wagon or mini-van which usually costs between EUR 20,000 – 25,000 pays VAT and a 10% “luxury” tax for a vehicle which is hardly a luxury item.

At the same time, companies have essentially no limits on what they can purchase and declare as a company car. Thus, a company which buys a new BMW 7-series (starting around EUR 65,000) can, after paying VAT and the luxury tax, fully deduct the depreciation cost as a corporate expense. Given that VAT is often returned—at least in theory—this is something of a double insult to families and private consumers.

I therefore propose that if the government wants to gain tax revenue and equalise the presently unfair situation, it adopt a simple and transparent tax code:

a.       VAT applies to all vehicles, public or private, regardless of the vehicle cost, at a low rate of 8% for new vehicles and 5% for used vehicles.

b.      Companies and individuals (private citizens) can purchase a vehicle of up to EUR 15,000 without a further tax surcharge. Companies can book this as a maximum depreciation per vehicle, with special categories for commercial vehicles which are used for specific enterprise functions (e.g. commercial deliveries).

c.       Families with children can purchase a vehicle of up to EUR 25,000 without a further tax surcharge.

d.      If needed for the purposes of tax revenue, any vehicle purchased above these limits be assessed with a tax surcharge at the same rate, whether the purchaser is a private citizen or company. This should be based on vehicle value rather than emissions rates or engine size.

e.       Unless they fulfill a specific function, companies cannot claim depreciation for vehicles above EUR 15,000 per unit. Thus, a lawyer who purchases a new Mercedes C-Class can claim a maximum EUR 15,000 depreciation, whereas a logistics firm which purchases a EUR 125,000 Volvo Freightliner would claim 100% depreciation.

This system would have the following benefits:

·         It provides the freedom of choice to both individuals and companies to purchase a vehicle according to personal disposable income rather than to temporary incentives which distort the market and favour new imports (worsening the current account balance).

·         It provides an incentive for purchasing older vehicles (which have already been imported), leaving the current account balance neutral and making better use of an under-utilised resource. Fears that this will favour vehicles with higher emissions rates are counterbalanced by the fact that fuel efficiency of older vehicles is lower, and every consumer understands the need to minimise fuel costs with unleaded gasoline costing  over EUR 1.50 per litre.

·         It is likely to focus the market on smaller-value vehicles, which by their nature have lower carbon emissions and better fuel consumption.

·         It would end an egregious tax loophole, whereby well-off companies and self-employed professionals buy a prestigious, expensive car, and then deduct 100% of the depreciation as a company expense, further weakening public revenue.

·         It would balance the treatment of individuals (private citizens) and self-employed professionals and companies in the tax code.

In my eyes, there is absolutely no justification for a BMW or a Jeep Cherokee to be treated as a 100% tax-deductible vehicle, when it is so clearly a corporate perk. If PASOK is really interested in social equity, it should pass such as law immediately, rather than passing another inefficient scrappage scheme.

Monday 29 November 2010

The Good News from Brussels: Extending Greece's EUR 110 bln Loan Term

Over the weekend, the Eurozone and IMF agreed on a EUR 85 bln bail-out for Ireland (the total sum includes IMF and Irish own contributions).

The excellent news for Greece is that its own loan repayment term has been extended from 5-6 years under the current agreement, to at least 10 years in total, i.e. to 2024. This is to harmonise its conditions with those of Ireland’s.

This is excellent news, because one of the main risks since the drafting of the EUR 110 bln bail-out has been the apparent impossibility of repaying the bailout and refinancing private sector loans in 2013 and 2014, which total EUR 70 bln in 2013 and EUR 76 bln in 2014.

This news should, however, also be viewed with caution:

·         The greatest threat now would be a diminishing appetite for further austerity and reform efforts: we should be reminded that so far, only the simplest of reforms have been enacted.

·         The total interest on the debt will continue to rise, with the bail-out itself at 5.2% on the normal loan term, and the debt to the private sector coming in at astronomical yields (under current conditions). This is not sustainable. It remains to be seen whether Greece’s purported primary surplus in 2013 and thereafter will be able to deal with this added debt load.

·         The continuing contagion in the financial market, and the unchanged severity of public deficits and debt in the OECD (together with longer-term economic decline and apparent political paralysis), means that conditions continue to deteriorate over the long term. What will the financial markets be like in 2013-2014? Hard to tell.

The government has gained some breathing room, and for this we should thank the feckless EU banking stress tests in the summer of 2010, and the apparent dissimulation of the Irish government on the true severity of its banking crisis. Or at least the Eurozone's apparent reaction to the latter. For once, PASOK has nothing to do with it. Eireann go braugh!

Sunday 28 November 2010

Watching the Decline

Since November 1st, I’ve been shuttling back and forth to Cyprus for a consulting project. From this vantage point, I’ve been able to monitor the remarkable decline of Greek political and economic fortunes from a more remote and objective viewpoint. The events of this past month have been staggering:

·         On November 14th, the second round of local and regional elections took place. It would seem that the lessons of the financial crisis have not been learned, since these elections proceeded in much the same way as those before, driven by personalities or party affiliations, without any practical plans or budgets on offer. Five of the six parties running differentiated themselves as being “anti-Memorandum”, as though their “resistance” against an act of Parliament was relevant, and as though our European creditors would be amused to learn that the legal conditionality of their bail-out loan to Greece was now being challenged, at least in the court of public opinion.

·         The elections themselves were carried out again the backdrop of a magnificent blackmail by the Prime Minister: “Vote PASOK, or I will call national elections.” Again, our European creditors were hardly amused—Papandreou backed down on the evening of the first round, claiming, somewhat weakly, that the results in the first round provided enough support. In any event, it would not seem that the voters themselves were convinced, since over 50% of them stayed home or cast a white ballot.

·         The elections themselves were prefaced by PASOK engaging in pre-election maneuvers of the worse kind. ERT announced the hiring of 640 staff (perhaps ERT’s 5 orchestras needed more trombone players); the Prefecture of Pireaus hired 67 workers; a range of other organisations announced or implemented last-minute hires.

·         On November 15th, Eurostat published its revised and final (they claim) estimate of Greece’s 2009 deficit. This included the addition of EUR 18 billion is semi-governmental organisation debt to the central government’s books, driving the deficit to 15.4% GDP, and total debt to 126.8% GDP. As predicted, the government deficits from 2006-2009 were increased as well. As the government’s 2011 draft budget succinctly states:

From EUR 168 billion in 2003, the total debt grew to EUR 298 bln in 2009, an increase of EUR 130 bln.

This debt level is obscene, and the fact that most of it occurred during the Karamanlis government’s 6 years in power is regrettable.

·         On November 18th, the government announced its 2011 draft budget. Given the deteriorating financial situation, the budget calls for a massive fiscal adjustment. With the 2010 deficit estimated at 9.4% GDP, the 2011 target has been set at 7.4% GDP, and 6.5% in 2012

·         On November 21st, Dora Bakoyianni launched her new, centre-right political party, “Democratic Alliance”. Its platform calls for a number of interesting policies, including a 20% flat tax, but makes no reference to how these will contribute to solving the debt crisis. Given Bakoyianni’s own record as Mayor of Athens, it is difficult to see how credible her calls are for transparency in the public sector, but this is not a problem unique to this politician or this political party.

·         Her political launch led to the expected paroxysms in Antony Samaras’ New Democracy, including the expulsion of one MP, and it would now appear that, following the left, the right will splinter as well. For all the good the right has been doing recently, I can’t say this outcome is the wrong one.

·         These events have led the government to announce a panic-ridden search for additional sources of expenditure cuts and revenue increases. Unfortunately, it is difficult to see how this will happen given the implementation record to date, and when Ministers such as Louka Katseli or Dimitris Reppas continue to pander to the unionised public sector.

But these facts, dismal though they are, regrettably confirm the longer-term trend:

a.       Greece’s public debt at end-2009 starts at EUR 298 bln, but the deficit target set out in the 2010 estimate and 2011 budget is based on each government component meeting its targets. So far, this has not been happening. Social security funds, hospital debts, and the debt of other entities such as the Hellenic Railways Organisation or the Agriculture Insurance Funds continue to rise. The government itself manifests a cash flow debt of at least EUR 7 bln, which until now has been met by payment delays and delays in VAT reimbursements.

b.      The major problem affecting Greece is not necessarily the public debt, but four far more serious, systemic “debts”:

·         The lack of political will among Greece’s political elite, and even within the governing party, to implement painful yet necessary reforms.

·         The lack of a competent, value-driven civil service capable of right-sizing itself and developing a meritocratic approach.

·         The lack of a comprehensive approach towards reducing corruption and prosecuting past instances of corruption. The fact that major cases such as Siemens, Skaramanga, MAN, Vatopedi, hospital procurement, military procurement, and many other cases remain unresolved or even unprosecuted is an insult not just to Greek taxpayers, but to our European creditors, who are increasingly wondering whether they should pay for the orgy of crime which has occurred for years, and apparently continues.

·         The fact that the Greek professional and commercial classes continue to avoid paying their fair tax assessments, while making increasing use of standard tax avoidance (e.g. by not reporting income), or “legal” tax avoidance, using offshore structures.

c.       The micro- and macro-economic environment against which Greece is making its reforms appears to be almost ignored. We are working in an environment characterised by three major trends:

·         The long-term trend of declining international competitiveness, both within Greece, but also within the EU. In this environment, Asian producers are increasingly winning market and value share, and climbing the innovation ladder. Greek and wider European producers, in contrast, rely excessively on protected markets or subsidy schemes, most of which nurture sunset industries such as agriculture or cotton textiles, while penalising (through regressive tax systems) future industries.

·         The fact that we are not fighting against the deflation of one bubble, but two. The first bubble is the high sovereign debt issues which characterised most countries in the past 10 years, and which are regrettably set to continue into the future. The second bubble is the fact that nearly every sector in Greece (and Europe) is characterised by massive overcapacity, at a very time when public and private sector consumption must fall to balance excessive debt. Much of this overcapacity is value-destroying (based on sunset or protected industries) rather than value-creating, or is based on the import of Asian products (textiles & garments, electronics).

·         The fact that the primacy of the state as a means of development is still followed avidly in Europe, and particularly in Greece. This is despite the fact that state spending in Greece has crowded out and distorted (through corruption, regulation and subsidies), private sector investment, and created much of the overcapacity mentioned. Until the dead hand of the state relinquishes its rigor mortis grip, we cannot expect serious economic development, i.e. development based on commercial viability rather than government subsidies, protectionism or crony capitalism.

I believe that the changes sought by the PASOK government are necessary. But I also believe they are doomed to fail. Neither the Greek political system nor Greek society appears aware that they are operating in a deeper, wider, global economy characterised by a fundamental paradigm shift in competitiveness, demography and debt. The Greek budget forecasts, while an improvement over previous years, suffer a massive credibility deficit and implementation risks, not to mention further hidden system debt. And all the time, the interest on EUR 340+ billion public debt keeps rising, while the threat of default looms as it is highly unlikely the markets will be prepared to resume lending to Greece by 2013 at the levels needed to refinance its debt.

We should therefore see the situation as it really is, rather than as we would like it to be, and prepare for the inevitable. In this case, we should prepare for the worse. 

Sunday 14 November 2010

The Return of the Bond Vigilantes … and Financial Common Sense?

This past week saw the return of the bond vigilantes in force, as Irish yields were pushed up to nearly 9% on Thursday, driving up yields in Spain and Portugal as well. In Greece, Prime Minister George Papandreou’s threats to hold an early election resulted in Greek yields rising to over 11%. His retreat from this position last Sunday, after extensive and well-merited criticism from Eurozone partners, was made under the cover of what could only be described as anemic results in the first round of regional elections.

This coming week will see a likely exacerbation of the public sector funding crisis, at least on the Eurozone periphery. On Monday 15 November, Eurostat announces the revised Greek debt levels for 2009 and presumably for earlier years. Ireland is being pressured to take action by announcing plans to access the European financial stability mechanism before the Eurofin meeting on Tuesday, 16 November.

In Greece, the crisis illuminates the worsening stage of the country’s public finances. New measures on public expenditure and revenue will have to be announced given the shortfall in revenues in 2010 and the fact that many financial and policy measures have so far not been implemented.

Concealed by the election furor is the fact that the European Commission has called upon Greece to pay back illegal state aid or improper disbursements in Common Agricultural Policy subsidies, agricultural insurance, investments in rail terminals and a range of other projects, which may reach a level of EUR 650-800 mln in 2010 alone.

In 2010, the Troika has decided to add OSE’s EUR 10 bln debt to the central government’s books (presumably over several trailing years) as well as the debt of other semi-governmental organisations. I forecast these additions driving Greek public debt to a level of 150-152% of GDP by end-2010.

This level may even be overshot, as media sources announced yesterday that, according to initial reports by the Hellenic Statistics Authority, 2009 GDP was probably lower than expected, at EUR 233 bln rather than EUR 240 bln.

Adding the 2011 expected deficit level brings the 2011 Greek public debt to at least 160% of GDP in 2011, and 168-170% of GDP in 2012.

The greatest threat, therefore, will be in 2012-2013, as I have already stated in a number of posts here. In 2013, Greece will have to pay back the first installment of the EUR 110 bln bail-out package which, together with rollovers or repayments (impossible to imagine given the current budget levels) of remaining private sector debt, will reach EUR 70-80 bln.

It is impossible to assume this level of funding will materialise. There will be three likely scenarios which emerge:

a.       The loan term of the current bail-out package will be extended to 6-8 years, with a second bail-out package of at least EUR 80-100 bln to cover bonds maturing in the next 2-4 years. In this case, we can anticipate an austerity programme in place to 2020.

b.      A rescheduling of the bail-out package will take place, together with an orderly restructuring of Greek debt to private sector organisations. In this case, the haircut will have to be on the order of 45-50% for this to have any real impact. A condition for this will be a budget surplus in Greece, enabling it to at least service part of the EUR 110 bln bail-out package.

c.       A total collapse of funding for Greece, leading to a disaster scenario where no further bail-out packages are possible, and where no further private sector loans are forthcoming.

We should not discount the third option. Our tendency at present is to focus on investor sentiment turn-around in individual markets on a time scale of months. Yet the public finance situation in most OECD countries is deteriorating rapidly, and by 2013 will have reached crisis levels absent the successful implementation of major austerity packages.

In this category, I particularly place Italy (likely public debt 128% GDP in 2013) and the United States (likely public debt 118% GDP in 2013).

Official Italian debt-to-GDP was already over 115% in 2009, with a 2010 deficit forecast at 5%. Given the likely impending collapse of the Berlusconi government and the fact that there is no clear political majority or political will for public sector reform in that country, it is difficult to understand why Italian bond yields are so far below Spanish ones.

In the United States, the total public debt limit was lifted to $ 14.3 trillion earlier this year. While President Obama’s Fiscal Responsibility Commission recently recommended $ 3.8 trillion in debt reduction, the divided Congress makes it highly unlikely that any rational decisions will be taken. Together with the QE2 package of $ 600 bln announced by the Federal Reserve and underlying economic weakness in unemployment, housing prices and foreclosures, we should expect that the risks of future lending to the US government will rise. Perhaps these will be offset by a currency decline or yet another “safe haven” flight to “quality”, but I would not place too much hope in this.  

We may, however, find ourselves in a “new normal”, where public debt levels of over 100% GDP are the norm, and where bond yields rise by 1-2 percentage points, without an adverse economic impact. This scenario would be similar to boiling a frog by slowing increasing the temperature in the pot, rather than pitching it directly into the boiling water. Either way, the frog gets boiled.

To summarise: there is nothing on the intermediate-term horizon which suggests to me that Greece will be able to repay its debts in 2013 as predicated by the EUR 110 bln bail-out. The quality of the regional election campaigns ending today, and of the general political debate over the last 6 months, has been abysmally low, with political parties refusing to accept reality and engaging in immoral electoral promises which have no hope of being realised.

Regrettably, exactly the same political climate exists in the United States or Italy. There is a total lack of political will to focus on the root causes of economic problems, and implement solutions. I have a higher regard for the economic reform being undertaken in the United Kingdom or Ireland, despite the major risks of the size of the fiscal adjustment being planned.

Together with the Franco-German proposal for making financial institutions bear a share of responsibility for future public finance defaults, and all the ingredients appear to be in place for major problems ahead.  

(c) Philip Ammerman, 2010