Sunday 28 March 2010

Rocket Science in Kharkhiv

The first time I visited Kharkhiv, an industrial city in north-eastern Ukraine, was on 8 March 2000. I was implementing a sales audit of JSC Obolon Brewery, Ukraine’s largest drinks group, and I spent the day visiting customers and the Obolon sales office and distribution centre. It was bitterly cold, snow covered the ground, and the season was definitely not suited for beer.

Coincidentally, it was International Women’s Day, the first of the new millennium. At the hotel we were staying, a grim block in the outskirts of Kharkhiv, the hotel restaurant was packed with young couples dancing and celebrating. For a tired consultant thinking of home, it was just about the last thing to deal with.

What I remember most about this trip occurred in the hotel room. One of the windows was either broken, or hadn’t been insulated properly, and it was cold. Too tired to go back down 12 floors to a reception that was otherwise occupied, I decided to tough it out. Waking up the next morning, after taking a shower and getting dressed, I went to put on my shoes, which I had left at the foot of the bed. As I reached down to take the first one, a little grey blur jumped out and disappeared somewhere under the bed. It was a mouse! A little grey Kharkhiv mouse had apparently taken shelter in my loafers for the night, and was most rudely awakened by their inconsiderate owner who needed to start work in the morning. I still remember that cold day in March 2000: another story from the road.

Since then, I’ve been to Kharkhiv twice more, once for customer interviews in 2004; once for a due diligence study for the Kharkhiv Tile Plant, Ukraine’s largest ceramic tile factory, in 2007. It’s a city I’ve never really had time to explore, so I was really looking forward to my trip this week. My consulting company, Navigator, started a due diligence and business plan for the CIS leader in ball and roller bearings.

The first thing I decided was that, unlike the last trips, I would stay in a good, city centre hotel. After consulting TripAdvisor, I chose the Chichikov Hotel, located on Gogol Street off the central boulevard. The Chichikov is named after the protagonist of Gogol’s ‘Dead Souls’, a story of wealth and self-discovery in 19th Century Russia. Apparently a staple of Soviet education (I had never read the book, but all my Ukrainian colleagues had), this book was the inspiration for the hotel, which was excellent in every respect. Modern, understated and casual, with first-class furnishing and cuisine, and attentive, considerate service by every single staff member encountered, the Chichikov will be our hotel of choice in Kharkhiv in the years to come.

The second thing I decided is that even if the schedule would be hectic, I would take some time to walk through the city’s historical centre. And I was glad I did. Despite its vast industrial heritage, Kharkhiv is a university town, with over 5 major universities and polytechnics in various disciplines of science and engineering. You see groups of people talking in cafes or on the street, discussing in a quiet manner which is totally foreign to Kiev or other major cities. Kharkhiv has one of the highest per capita populations of PhD graduates, well above the Ukrainian and Russian average.

The cafes are glorious: small but elegant, with excellent coffee and food, at a very competitive price—less than half Kiev or Athens prices. It’s rare to find a good cafe in Kiev, where pretention is often confused with quality. In Kharkhiv, you see little jewels strung out along the main street or tucked into quiet alleys.

WiFi is free, and available everywhere. People walk the sidewalks, speaking into mobile phones or sit in cafes, reading their textbooks, or tapping away on laptops. There are also some fantastic jazz bars—I wasn’t able to visit any this trip, but in 2007 I stumbled upon a jazz trio which was simply sublime. Next time!

The city shows the typical development of Ukraine after 2000. Buildings have been renovated; designer stores have opened; the city centre has been improved to the extent the Municipality’s limited budget allows.

There are some problems: the roads are among the worse I’ve seen, particularly in the outskirts of the city. Living standards are still low: prices are low because the average per capita income is lower than Kiev. But there is a lot going on—new factories opening, buildings being renovated, new projects launched.

Another major discovery on this trip wasn’t the city itself, but the company I was working in. This company is part of a larger industrial conglomerate, which recently decided to centralise its research and development function, and invest in this area. They reasoned that only by increasing the ‘intellectual value’ of their products to over 50% of total value could they compete with lower-priced Asian imports.

This is the first Ukrainian company I’ve seen, after working here in over 20 leading CIS manufacturers, which has a serious industrial R&D function. With over 200 of Ukraine’s best and brightest engineers and scientists employed on a full-time or project basis (including former designers of the Soviet Union’s ICBMs), the conglomerate has established clear research priorities, budgets, projects and return-on-investment monitoring.

And their efforts have paid off. One of the first new products out the gate was a new rail bearing specifically designed for the harsh conditions of railroad transport in the former Soviet Union. Working with their major customers, the R&D group developed a duplex bearing unit which increases the rated lifecycle from 350,000 km to 800,000 km, and provides improved properties against friction heating and wear. This product included joint research with Western equipment providers, including some of Europe’s top names in the field. This product has been patented, and now being tested in major customers.

I was really impressed. The last time I had the privilege of working in a company with a strong R&D function was at ABB in Sweden 10 years ago. To see this level of engineering in Ukraine, in the face of challenging financial conditions and a competitive environment marked by declining profits, was inspiring. This is exactly what European manufactures need to be doing more of: investing in basic and applied research, with a clear link between customer needs, corporate strategy and R&D priorities.

So, it was a great trip. Apart from the necessity of transiting through Kiev, Kharkhiv is a great place to do business, and a great place to relax after work (in the remote case this might be possible). And I finally got to meet a genuine, bona fide rocket scientist.

Friday 19 March 2010

George Papandreou’s Third Act of Political Theatre

Prime Minister George Papandreou, emboldened by the success of his campaign to portray Greece’s debt problems as a result of financial speculation, has launched the third act in his ongoing political theatre. This is his threat to turn to the IMF if the European Union or the Europgroup do not soon decide on a financial support mechanism at the March 25-26 meeting of EU leaders.

His first act came in November-December 2009, when upon taking office, he raised the estimate of public debt from about 6.7% before the October elections to 12.7%. This was done by adding certain costs relating to public healthcare expenditure. The mistake he made was not adding these debts, but:

a. The fact that he added some debts, but not all debts (there are at least another EUR 40-50 mln off the books), and

b. The fact that the primary motivation for this was not necessarily to resolve the debt issue, but to discredit the previous government, and

c. Miscalculating market reaction, as well as that of the European Union.

To put it bluntly, his essentially political tactic back-fired massively. The European Commission and the Eurogroup were more incensed that the National Statistics Service had been partially doctoring its statistics collection and reporting methods (though this was hardly new), and rapidly put Greece under intense financial supervision. Greek lending prices rose; Greece’s credit rating fell.

As a parenthesis, I will add that this is not necessarily a bad thing. Greece should pay more for its sovereign debt, since it has a far higher credit risk given its macroeconomic and fiscal situation, and clearly it is only the threat of external financial events which has finally prompted the government to act.

His second act of political theatre was to denounce the rise in interest rates as “financial speculation”. In doing so, he made it appear as if Greece’s low credit rating and high borrowing costs were somehow the result of “profiteers”, rather than Greece’s own debt mismanagement. Greece’s latest sovereign debt issues have been at rates of 6-7%, about 300 basis points above the German Bund. This is more than fair, given the fact that the government appears to have no idea what its actual public debt level actually is, or how it will repay it.

This act too appears to have succeeded. Papandreou received favourable hearings from Nicholas Sarkozy, Angela Merkel, Barack Obama, and others. He has not, of course, solved his primary goal (to access low-cost credit), or even his secondary goal (to somehow restrict financial derivatives, which are largely irrelevant to the situation). But it’s made for good press.

Now, he’s launched his third act. This involves threatening European political leaders that unless they come up with a financial support mechanism by March 25-26, he will turn to the IMF. This is perhaps a triple irony:

a. Why should the European leaders agree to a financial mechanism, when at every press conference Papandreou states that “we are not looking for financial help or a bail out?”

b. Why is a financial mechanism needed, when all that remains of the major debt refinancing tranche in April – May is EUR 10 bln, and Greece’s most recent issues have been 3-4 times over-subscribed (albeit at a higher interest rate)? There will be no problem at all to raise EUR 10 bln between now and mid-May.

c. Does he really understand what going to the IMF entails? So far, the government has not taken a single structural reform measure. It has undertaken cosmetic measures of partial salary reductions or bonus reductions. It has tinkered with the tax system. It has not fired a single useless public sector employee (of whom there are tens of thousands); it has not closed a single redundant public sector organisation. It has not jailed anyone for tax evasion; has not confiscated any property; has not razed a single illegal villa built on forest land; has not closed a single illegal nightclub or restaurant.

I am personally in favour of an IMF exit. I see this as the only change that a serious external organisation will force serious change upon Greece. Left to its own devices, neither this government, nor one lead by Papandreou’s former college room-mate, Antonis Samaras, will take meaningful structural reforms.

An IMF exit would enable a Greek government to blame yet another nefarious external bank, while hopefully taking serious measures to clear up its own mess.

I can only hope that the IMF will be involved for at least 5-10 years in Greece, and impose the harshest conditions possible. Unfortunately, it’s the only way forward, absent a debt default and expulsion from the Eurozone. It may also be the only way Papandreou can force through reforms in the face of determined opposition from his own party, and the usual craven tactics of the other political parties.

I seriously doubt George Papandreou has fully understood what he is about, but in the case of the IMF, let’s hope he continues on his current track. I will raise the first toast to him if he succeeds in alienating our European partners to the extent that the IMF is the only option left.

Thinking about Government II – The Role of OSE

To illustrate my earlier post on government, I have a few examples of government operations from Greece. Greece has over 1,800 government organisations or entities in which the government exercises a direct or indirect controlling share. I will focus on the Hellenic Railways Organisation (OSE), as an example of the most egregious such entity.

OSE is a state-owned organisation which includes three major holdings:

a. EDISE – management of rail infrastructure

b. Erga OSE – project development

c. Gaia OSE – buildings and commercial centres

A fourth subsidiary, TrainOSE, was transferred out of the OSE holding structure and spun-off as a 100% government-owned, independent entity, for provision of transport services (drivers, conductors, scheduling, etc.)

The company employs 1,800 full-time staff (including TrainOSE employees, who have since been transferred), and is responsible for running both suburban and inter-city rail services. OSE does not include the Attika or Thessaloniki metros, which are separate organisations. It does include the Athens Suburban Rail (Proastiakos).

Some basic financial dimensions:

· In its 2008 Annual Report, OSE claims total debts of EUR 8.04 bln. Of this debt, EUR 964 mln was borrowed in 2008.

· Total turnover in 2008 was EUR 195.6 mln, as opposed to EUR 116.2 mln in 2007.

· Annual losses in 2008 were EUR 794,6 mln, compared to EUR 950.3 mln in 2007. This reduction in losses is not a result of better operating results, but due to the “sale” (or transfer) of TrainOSE to the government.

· Total payroll costs were EUR 274.2 mln in 2008, nearly EUR 90 mln higher than sales.

· The company estimates its fixed asset value at EUR 12.6 bln. Of this asset value, however, the majority concerns rail lines, equipment and technical infrastructure.

· OSE is owed over EUR 500 mln in VAT returns from the government.

· The company is committed to investing a further EUR 9.3 bln in the period 2008-2017, for track upgrades and expansion.

In 2008, the company changed its Board of Directors and President four times.

According to its 2008 Annual Report, OSE objective is to have satistfied citizens, either as passengers or as commercial clients; to achieve a better image in international markets, and to contribute as a productive factor to the commercial, industrial, processing, and tourist development of Greece.

OSE’s further objectives are:

· The direct and indirect creation of new jobs

· The attraction of new investors in the fields of logistics, transport, port expansion, movement of goods, etc.

· The freeing up of transport capacity on the national road network through the reduction of trucks on the road

· To contribute to the environment, given that rail transport comprises the most economic and the most ecological form of transport for passengers and goods.

In reading the Annual Report, I can’t help but be struck by a powerful sense of unreality. OSE has over EUR 8 bln in debt, which grows by about EUR 400-900 mln per year in new borrowing. In 2008, its sales accounted for EUR 195 mln; its losses were EUR 795 mln. Financial expenses alone (debt service) amounted to EUR 428 mln). Payroll costs are far higher than annual sales. The company is bleeding money: no amount of restructuring is going to be sufficient to change the situation.

Not a single objective mentioned in the OSE report has to do with reaching economic self-sufficiency. Perhaps the Board and President of OSE have already determined that this is impossible, in which case the only option left is to decide some nebulous goals which have little bearing on reality.

A further danger is the fact that, according to the findings reporting by a Commission set up by the Ministry of Finance, although OSE’s EUR 8 bln debt is guaranteed by the government, it has not been added to the government balance sheet.

Asset sales and/or privatisation will probably not be enough to recoup the EUR 8 bln loss. Although there is a high asset value, little can be sold off separate from the technical assets and rail lines.

My questions for the Greek government are the following:

1. Do we need a national railways organisation?

In the 19th and early 20th centuries, the expansion of the rail network was considered to be a strategic asset for economic and military purposes. However, this experience accrued mainly from countries such as Germany, Russia, France and England, where the geographic, urban and industrial conditions were far different from Greece today. What is the strategic value of a national railways organisation today? Given the amount of money this is costing, are there no better means of realising this strategic value?

2. The privatisation option

Privatisation in the rail industry has been catastrophic, as the examples of the UK indicate, but there may be other examples where the damage has been less in financial terms. The government claims it is studying seriously the option of privatisation, and in particular the attraction of a strategic investor for OSE. If the government is considering privatisation, what provisions and guarantees will it make to ensure that after 4-5 years, it will not have to step in to bail out the investor? Can it split up OSE so that some lines, e.g. the Suburban rail line, will be sold separately (and have a higher chance of economic survival?)

3. Throwing good money after bad

How can the government justify, on economic terms, investing a further EUR 9 bln in OSE, when OSE already owes EUR 8 bln+? What will the financial impact of this investment be on OSE’s accounts? Why is it not mentioned in the 2008 Annual Report? Does the government still have the money, given its enormous debt, to make this investment?

4. The better transport argument

If a strategic argument for keeping OSE alive is to have more environmentally-friendly transport, or less-congested roads, what are the economic costs of the alternatives? How many trucks and passengers does OSE transport per year, and what is the net environmental benefit of transporting this number by rail as opposed by private or public transport? How many pubic busses could we buy for EUR 964 mln per year? How many trees could we plant? How many solar power installations or wind farms could we build?

5. The places of employment argument

If OSE has 1,800 employees, then one measure of the total cost of their employment in capital terms is EUR 535,556 per year. (Debt issued in 2008 / # employees). This is, by any objective measure, far too high, and given OSE’s debt needs, will rise every year. It would be much cheaper to pay them to stay home.

My assessment is the following:

a. Greece has copied a model of industrial development from the early 1900s, ignoring the economic and geographic realities of the country.

b. Successive administrations have packed the organisation with political appointees, and launched grand investment programmes, for political and personal benefit in the form of bribes, kickbacks or other benefits.

c. The “strategic” value of OSE is not even zero: it is a huge liability in public finance, which will have to be paid by the Greek taxpayer, who has had absolutely no part in the decision-making concerning this “organisation”.

d. There are similarly no alternative sources of value given the costs involved: not in terms of environment, nor of employment, nor of transport.

e. The fact that the government has not declared the liabilities of OSE on its total debt is yet another example of financial manipulation.

f. Even assuming that a privatisation results in EUR 1 bln of income (which it won’t with the financial indicators already seen), at least EUR 7 bln in debt will have to be transferred to the government.

It would be far better to close this organisation immediately and sell off its assets, which will have a higher value as real estate than as railway plant or equipment. The Proastiakos can be sold separately or even converted to a dedicated bus line run by someone else. Other rail links can be sold or converted to road transport, real estate or other use.

The Greek government (of any political affiliation) cannot run a railroad: it can’t even build sidewalks or roads properly. To pretend otherwise is a gross distortion of reality.

Wednesday 17 March 2010

Thinking about Government

A recent Facebook post on Cypriot agricultural subsidies prompted an interesting exchange of views between various friends on the role of government. I was impressed to receive responses which did not respond to the specific example given, but to the theoretical virtues of government. Since this issue set off so much debate, I’d like to add a first stab at a more coherent personal view of how I feel about the role of government, in theory and in practice.

Strengths / Necessities

The role of government should be to provide an objective service, usually of last resort, that is fair and which cannot be fulfilled with the same conditions by a private sector or NGO provider. Some domains, such as defence, law enforcement, the law itself, regulation of business sectors, protection of the environment and natural heritage, and international relations at the national and super-national level are clearly those of government.

These roles are also justifiable on the basis of efficiency and effectiveness. It is often better, for instance, to have a national police force, given the common nature of the law (and of human nature), rather than a series of regional or private police forces, providing of course this national force is honest, flexible and adaptable.

Risks / Weaknesses

The main risk is that governments are neither intelligent, nor responsive or flexible, and do not adapt quickly to changing conditions. One a precedent is set (e.g. a subsidy granted), it become very difficult to unwind that precedent due to changing business conditions. The European Union’s Common Agricultural Policy (CAP) or the subsidies offered to various businesses, are cases in points, especially when these create a dependency culture.

The second major risk is that government over-extends its role. Fortunately or unfortunately, the government cannot do everything, yet the standard impetus of internal decision-making (which our ministers often call “policy-making”) is precisely for government to do too much, particularly since this reflects on the personal prestige of political leaders and parties. The result is “mission creep”: situation where government organizations miraculously find more and more things to do, dominate a given sector, and strangle or suffocate all other alternatives.

Government and Political Parties

One of the main points of the recent discussion was the theoretical role of governments. In general, it’s easier to agree on the theory, than on the practice. Yet we live in a real world, where countless millions of consumers, business managers, government employees and others make millions of decisions. We also live in a world where, for Europeans at least, we claim to be a democracy, but the structure both of political decision-making, and political parties themselves, is fundamentally undemocratic and rigid. Political parties are characterized by a strange permanence of “elected” leaders, while democracies are characterized by a strange inability of their citizens to influence important political decisions, after an election has taken place.

The Athenian ideal of democracy (which was hardly a broad or stable democratic franchise) was quite different from the current national interpretation. Today in Europe, we have national or regional elections, in which we mostly elect long-serving career politicians. But we have no influence over specific decisions. In the Athenian democracy, the electors voted not only for an administration, but for specific decisions as well. (This comment is not meant to praise Athenian democracy—it merely compares two systems).

Look at any European political party, and what will you see? Long-serving, career politicians who rarely face any personal responsibility for decisions made in office. This is arguably one of the major shortcomings of our current political system, since it creates a culture of impunity in which there are few real consequences for the political elite.

Government and Individual Politicians

Which leads us to another dilemma: are we sure that individual politicians are governing in the interest of the law, and of the country, or for their own narrower benefit? In the case of the United States, we see many examples of special interest lobbying which clearly contradict the greater interest, or the greater public good. In Greece, we see open examples of personal enrichment and corruption, which are unpunished by the law.

When speaking of the role of government, we should differentiate between theory and practice, where the practice is rarely as immaculate as the theory.

Government and Moral Hazard

If we are really in favour of equal opportunities and social equity, then we must answer the fundamental question on whether public money is really well spent. It’s far too easy to justify public spending as a benefit for “the poor” or “the disadvantaged”, particularly if this spending is the result of a government monopoly which restricts or removes any alternatives.

Given that the financial resources for government activities are ultimately derived largely from tax contributions of corporate and individual taxpayer citizens, it is not a moral imperative that services of the public good should be delivered solely by the public sector.

There are many sectors in Europe, for instance education and healthcare, where the government monopoly of provision through public sector providers has lessened the impact and efficiency of the resources invested, rather than improved them. This cannot continue, unless we use a different moral standard to judge a government organisation than a private one.

A Generalisation of Opposing Viewpoints

I like to think as government as the plumbing. Plumbing silently and humbly serves the vital functions of a house and the family that lives in it. When the plumbing breaks, it’s a crisis, and I can in a plumber to repair it, usually at low cost.

Our politicians, unfortunately, have a very different view of themselves. They tend to see themselves as protean heroes in the struggle of good versus evil. (Read any election campaign speech, and you will see what I mean) They rarely question the limits of their remit: once elected, they are free to roam at will, becoming increasingly arrogant and ubiquitous in the media. To justify their existence, it often seems that they must create a role for themselves, even if no role is really needed.

Obviously, I exaggerate: the functions of government are far more complex than that of a plumbing system. How can we connect the two viewpoints: those of the individual taxpayer, who wants a decent service at a fair tax and no poncing about, with the elected decision-makers who actually run government to further their political and individual careers?

Judging the Cost of Government

How can we tell government has over-extended itself? Usually when it has surpassed the financial limits in a political struggle to deliver higher public services or benefits. And this is what we see today. We have a society in which we, the taxpayers/citizens, have grown to expect the theory of public goods in healthcare, education, etc. but appear less willing to pay the price for them. Certainly, judging in terms of quality delivered, it would also appear that even now, we are paying too much for what is offered (at least from our viewpoint of public services in Greece and Cyprus).

The solution, from my viewpoint, is not to mindlessly extend the role of government as it is currently practiced, but to restrict and/or replace it, or at least the administrative elements of it. There is no reason, for instance, why more administrative functions interacting with citizens could not be placed online. There is no reason why at a certain point, a government should quite simply say “no” in terms of deciding a public investment.

We cannot continue the public spending track most countries are on. It will be necessary to adapt cuts in public spending, which have to be undertaken on a far better, economically rational basis than is currently the case. Implicit in this reduction of government expenditure is a restructuring of the public sector workforce and fixed positions. Do we really need, for instance, a Commissioner for Fisheries? Do we really need a Minister for Culture?

No Taxation without Representation

If we are going to view companies as legal organisms which will be taxed and regulated, then I suggest it is only fair that these entities are also given a voice in political decision-making. I do not recommend giving companies a vote, although this might make for an interesting simulation on a political theory class. But clearly, the role and energy of the corporate sector remains largely unused as a means of delivering a public good, since most companies are seen as passive respondents to the law, or to public policy. Yet the move towards “Corporate Social Responsibility” indicates that among many companies, there is a genuine interest in supporting key areas of public good: environment, charity work, education.

At the same time, other key issues have to be resolved:

· Why do most governments derive fewer taxes from companies than from individuals?

· Why do companies use lobbyists and “public affairs” consultants to pass favourable legislation?

· How can the system of “social partnership” work in practice?

The same principle applies to individuals: If we expect individual compliance with the law, or with a policy, it is only fair to allow individuals to influence the decision. Until now, such consultations are usually toothless exercises: in the future, a visionary democracy may separate, or re-define, the role of (a) elected politicians, (b) the permanent civil service, and (c) active citizens in decision-making and policy.

Certainly, my perception is coloured by my experience in Greece, Cyprus, France, Germany, the United States, and other countries where I have lived and worked. Many of these are hardly ideal as examples in various respects. Yet I hardly feel that, given the growing crisis in key areas such as public finance, education, pension systems, demography and economic competitiveness, we are moving in the right direction.

In fact, I believe the opposite is happening. We have constructed an elaborate experiment in social democracy in Europe after the end of World War II in 1945, which is not sustainable for the next 65 years. Because few politicians or citizens are willing to analyse the status quo on an objective basis, there is little incentive to consider alternatives.

As a result, we are being led into a situation where we will be forced to make changes, responding to symptoms rather than root causes of problems. And as such, we are making, and will continue to make, the wrong decisions.

I do not recommend the privatisation of society; nor do I have any fixed answer to many of the issues I have raised. So, if you do respond to this post, please do me the courtesy of an objective response, rather than ascribing to me a hidden agenda.

Sunday 14 March 2010

A Consultant’s Guide to Tax Auditing. Part 1: How to Identify under-reported Income

We all know that in Greece, the under-reporting of income by individual workers such as lawyers, plastic surgeons and other worthy members of society is a chronic problem. Government efforts to date have yielded some interesting press accounts, for instance, of doctors in Kolonaki who declare less than EUR 30,000 per year. Unfortunately, I haven’t read of any practical steps since then.

I have a simpler way of implementing a tax audit. This is based on the fact that most unreported income is no longer stored under mattresses, but in bank accounts. The disparity between total bank deposits and income reported indicates that bank accounts are essentially operating as a repository for income which is not reported.

At present, national law prohibits the “opening” of a bank account, i.e. the sharing of information between the bank and the tax authorities, on financial holdings by individuals, without a court order. This is a major problem in the fight against tax evasion, and one of PASOK’s priorities should be to reverse this decision to make it easier to audit private accounts.

If this can be assured, then the audit method becomes easy. Audits can be run using the deposit account information of each bank branch, as follows:

Step 1: Request from each bank branch a list of the 1,000 largest personal accounts, in terms of cash flow (deposits and withdrawals), including the name, address, ID number and tax identification number (AFM) of the account holder.

Step 2: Cross-check the volume of incoming cash to total income declared in the annual tax declarations of these same individuals.

Step 3: If a disparity is detected, freeze their bank accounts until the account holders come in to their local tax office to justify the disparity.

Step 4: Tax the difference between income reported and income incurred at the prevailing tax rate, with the tax to be paid in 12-24 months installments, and the bank account freeze lifted only once this agreement has been signed, and the first payment has been made.

This relatively simple method removes the needs to visits to specific professions, and removes the risk that the members of the Hellenic Tax Authority “adjust” the results of the audit in exchange for bribes.

This is a data-based check, so it can be done quickly, and cannot be changed through the forgery of historical data.

This is also important, because it sends a clear signal to banks that they cannot continue to facilitate large-scale money-laundering and under-reporting of income. The role of even state banks in this area is endemic, and must be stopped.

Greek Debt Forecast March 2010

The Greek government austerity package approved on March 5th, 2010 is forecast to add EUR 2.4 bln in government revenue and cut EUR 2.4 bln in government expenditure from 2010.

I have used these numbers to update the original Stability and Growth Programme forecast (published in January 2010), and adjusted for the 2009 GDP revision of -2.6% announced by the National Statistics Services, as well as the Bank of Greece’s 2010 GDP forecast of -2.0% announced this week.
Under this forecast:
· The deficit falls to -0.31% of GDP in 2013, of EUR 0.76 bln
· Total debt rises to EUR 327.01 bln in 2013
· Government income and expenditure equalise, at roughly 52% of GDP, in 2013

The implementation risks in this forecast include the following:

a. Total debt was over EUR 300 bln at end 2009

b. In its May 2009 press release, the Ministry of Finance claims that the expenditure cuts are permanent. This is highly unlikely, unless we consider that these are one-off cuts, which will be followed by annual cost-of-living or inflationary increases in subsequent years.

c. The next planned national elections will have to be held in 2012 or 2013 at the latest. Will government fiscal discipline continue in an election year?

d. It is impossible to predict government income as a function of GDP in a recession of the magnitude currently under forecast. Government income from taxes will likely be lower than planned.

e. The government debt forecast does not provide for a number of liabilities which are known, but for various reasons have not been consolidated or provided for in the central government debt. These include:

  • Higher interest rates for sovereign debt;
  • The EUR 7 bln debt of the Hellenic Railways Organisation (OSE);
  • The state aid repayment and other debt provisions from Olympic Airways and its former employees;
  • The continuing high and essentially unknown liabilities originating from state social security funds and hospitals;
  • The opaque state of actual liabilities stemming from public-private partnership deals as well as interest rate swaps.
f. The likelihood of a further drastic economic collapse, due to payment delays and liquidity problems among small and micro-enterprises; creative accounting by large companies; and bank recapitalisation issues, is growing.

g. The fact that in general, the Greek corporate sector model must be rationalised through the closure of the high number of small and micro-enterprises, and larger firms.

There are also a number of potential upside benefits which may not be reflected in the forecast:

a. The government could, in theory, accelerate the funding absorption of European Union funds. In practise, however, the past record of absorption has been low, and requires government co-funding at a time when general public investment expenditure is being cut. Fund absorption has in general not delivered longer-term economic benefits proportional to the investments made, for a variety of reasons.

b. Greece could privatise a number of strategic assets, and green-light a number of investments. The privatisation potential is probably limited to EUR 2 bln per year, and will meet with major public sector protests.

c. The scale of the crisis could prompt a fundamental restructuring of the Greek public sector, which is what Prime Minister Papandreou has promised. Obviously, the main risk is whether this can actually be implemented.

I do not believe the relatively optimistic scenario reflected by this updated SGP will be possible. Indeed, I believe that total “official” public debt will top EUR 330 bln in 2010 and EUR 350 bln in 2011 unless additional measures are taken, primarily to combat tax evasion, streamline the competitive environment and attract external investment.

Saturday 6 March 2010

ND votes against the Greek austerity plan

Prime Minister George Papandreou has finally realised the gravity of Greece’s macroeconomic situation, at least as regards the public debt. The latest round of tax cuts and revenue raises is a good further addition, and possibly the only serious, quantifiable measures announced to date. My own doubts about the government’s Stability and Growth Agreement targets have been fully verified by Greece’s European partners, and have to some extent now been addressed in the short term, but I must warn that few of these measures are permanent, and that there are still too many open questions regarding the public debt and the general issue of macroeconomic competitiveness.

This present post is dedicated to New Democracy, the main opposition party under Antonis Samaras. By voting against the austerity package voted yesterday in Parliament, ND is doing a disservice to the Greek economy, and to Greek society.

We have before us an austerity plan which was developed with the agreement of the International Monetary Fund, the European Central Bank, and the European Commission. No, it is not perfect. However, it is the first serious attempt by the government to solve the situation, and reassure Greece’s international partners and the markets.

Instead of voting against it, ND should have voted for it. We are not living in a utopian society. Yes, there are other possibilities for debt reduction, but frankly, there is little time to address them, and the present plan is better than no plan at all, particularly since it has the blessing of Greece’s main institutional partners.

Beyond this, there is an equal lack of clarity or detail in ND’s "plan" (really just a list of policy announcements), which does not provide for a means-tested debt reduction, and in many ways is equally regressive for lower-income segments of the population.

In a time of national crisis, the opposition should function as a loyal opposition. This, ND has not done, all protestations of innocence to the contrary. It will gain few political benefits from its vote, since most citizens correctly blame it for most of the situation the country is currently in. By adopting to score political points in a time of crisis, all ND proves is that Greece is ungovernable: it will face the same tactics when it is the party in power (much as it has faced them in the past).

I believe that most citizens can now see the political machinations of PASOK and ND for the sham that they are. Successive governments led by these two parties have bankrupted the country and destroyed the moral fabric of society by fostering a culture of nepotism, corruption and hapless inefficiency. Let’s hope that in the future, one of these parties becomes a party governing in the real interests of the country, or that an alternative party can be founded which does.