Yesterday the Greek government sent its new proposals for austerity to Brussels. Several people have asked me what I think of the package. I’ll respond with a little bit of perspective.
The First Bail-out
In May 2010, Greece accepted a first bail-out promising € 107 billion, primarily in loan refinancing. There were four major mistakes with this bailout:
It fully compensated private sector holders of Greek government bonds (mainly French and German banks) at a time when these bonds were discounted by 20-30%. There was no debt haircut on private bondholders at the outset, which is standard in most cases. This was basically a financial rescue package for the European banking system.
The weighted average interest rate was about 4.5%, meaning that over the five years of the programme, the cost of interest would equal the cost of austerity and privatisation. The cost of interest wasn’t properly calculated. In 2011, for instance, total interest paid was € 16.34 billion, versus € 6.6 billon as calculated in the bail-out. This is an elementary error that any first year finance student would have presumably corrected: Calculate 4.5% of € 300 billion.
The programme envisioned that by 2014, Greece would have a deficit of 2.55% and a public debt of € 359 billion, yet return to the markets for financing. This is difficult to believe, given at the outset of the crisis Greek public debt was at least € 290 billion and Greece was already cut off from the markets.
There was no overall list of priorities for structure reform.
The first Bail-out was followed by a second Bail-out, in which the keynote feature was a Private Sector Involvement (PSI). PSI saw private bondholders with a nominal value of € 100 billion have their bonds written down by about 75%. But this too was wrongly calculated:
A € 20 billion “sweetener” was added to induce bondholders to participate;
The Greek banking system had to be recapitalised with € 50 billion via the Hellenic Financial Stability Fund;
The Greek social security system, which held at least € 20 billion of Greek government bonds, was not recapitalised, leading to massive financial losses.
So the actual net benefit of PSI was, at best, € 30 billion (out of a nominal € 100 billion), and if one counts the losses to the social security system, it is actually lower. These social security system losses had to be reimbursed by the Greek government in subsequent years.
One positive aspect of the second bail-out was that the effective interest rate paid by Greece fell thanks to refinancing by the European Financial Stability Fund and a low interest rate policy by the European Central Bank.
The Last Instalment of the Second Bailout
This brings us to the present package, which in fact is simply revised conditionality for the last instalment of the second bail out. My comments are the following:
The first two bail-out packages have been monumentally botched. These have been exclusively errors made by the Troika of lenders, who have set the terms for each of these.
Successive Greek governments have not helped matters, in that they have been more intent on safeguarding public sector sinecures and related oligarchs rather than implementing true structural reform or a pro-growth agenda that respects European law (or even common sense). Although a significant fiscal adjustment has been achieved and public sector employment has fallen by 30% (mainly through early retirement and non-renewal of temporary contracts), structural reforms have been few and of limited impact.
Greece has been financially self-sufficient since August 2014, and in this time has successfully repaid or rolled over its debt load. The argument over new conditionality for the last instalment is therefore entirely misplaced, particularly since 100% of this instalment is going to repay the IMF and ECB. None of it goes to sustain the Greek public sector. I believe this is sufficient good faith in the process—particularly given the Troika’s monumental mistakes in the past—to warrant an immediate release of the final tranche, directly to creditors if need be. All this fuss is about creditors paying € 7.2 billion to repay creditors, and is simply not serious.
SYRIZA has done itself no favours given its chaotic negotiating style, its statist demagoguery and its blatant disregard of economic and financial reality. However, in some aspects it is correct: a debt restructuring is needed, and its proposals in this direction bear some serious consideration, which was unfortunately never afforded to it by the Troika.
Misperceptions among national and international press and deliberate politicking are creating problems where no problems should exist. Greece’s debt is manageable, providing the short-term distortions of the previous two bail-outs can be managed, and proving Greece finally implements a pro-growth agenda. The large majority of bail-out funds disbursed to date have been to refinance existing debt. The distortions in the bail-out packages have been exclusively the fault of Greece’s official creditors.
Which brings me to the specific measures proposed by SYRIZA. I can affirm the following:
In their sum, the incremental changes in taxes are minor. For instance, corporate taxes are set to rise from 26% to 29% (a 3% difference). The real problem in Greece is that existing taxes are not being collected. Total tax arrears from the beginning of the year are now € 5.5 billion; total uncollected taxes (stock) are € 77 billion.
Increasing value added tax bands in a financial depression can only be described as stupidity on a colossal scale. Greece has seen a real GDP decline of 25% since the crisis began and unemployment is currently 26%. Hitting consumers and households with higher VAT is simply an exercise in stupidity. The high VAT rate is 23% and already captures too many products and nearly all services. If you want GDP growth, and if you accept that consumption is a core component of GDP, then you don't increase consumption taxes on an impoverished population with an already-high VAT rate.
Apart from a nebulous related commitment to privatisation, there is not a single pro-growth structural reform in the entire proposal. There is not a single structural reform in terms of the real operations of the Greek public sector. It’s all about raising taxes during an economic depression.
Finally, even if these measures are implemented, they will not be enough to handle Greece’s refinancing needs in the next 18 months.
Sadly, I see no indication from the Troika that they understand the deleterious impact these measures will have. What I see are ivory tower theorists and career politicians who apparently have little understanding of economic reality or facts on the ground, and who have apparently never worked in any serious capacity in the private sector. As such, they simply don't understand the reality behind the numbers on their Excel charts.
For SYRIZA, I can see how these “reforms” will be interpreted as being positive. They comply with a statist mentality that the private sector should pay for everything. They increase poverty and unemployment, thus favouring the political party that controls the public purse strings. And when they fail, as they inevitably will, they will embolden SYRIZA to say yet again to the Troika: “We tried it your way, and your way failed.”
Although I believe a negotiated solution will be reached, this will therefore merely extend the problem and introduce yet further distortions, which will then require yet more “reforms” to mend.