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Surviving EMU
Prospects for the Greek Economy
George Alogoskoufis
June 2, 2003
On January 1st 1981 Greece became the tenth member of the European
Economic Community. The architect of Greece’s accession, the then Prime Minister
Konstantinos Karamanlis, had pressed for early entry for three reasons. First, in order
to stabilise Greece’s democratic structures. Second, in order to enhance security vis-àvis Turkey. Third, in order to force Greece’s economy and institutions to adjust. He
declared at the time that he was throwing the Greeks into the sea to see whether they
could swim.
The adjustment of the economy has proven anything but plain sailing. Soon
after Greece’s accession to the Community, in October 1981, a new socialist
government headed by Andreas Papandreou was voted in. It lasted for eight years. At
the time of Greece’s entry, GDP per head stood at 71.8% of the EU-15 average. Ten
years later, it had fallen to 59.4%. The unemployment rate in 1980 stood at 2.7% of
the labour force. Ten years later it had more than doubled to 6.4%. Public debt stood
at 25% of GDP. Ten years later, it had more than tripled to 79.6% of GDP. Annual
inflation stood at 22.5%. Ten years later, it still stood at 19.8%. In 1990, Jacques
Delors, the then president of the European Commission, reprimanded Greece for
mismanaging its economy and questioned its future in Europe.
In 1990, after a year of political instability, a new centre-right government,
headed by Konstantinos Mitsotakis, was sworn in. Putting the economy back on track
was its top priority. The Mitsotakis government put Greece on the path to eventual
participation in Economic and Monetary Union as it signed the European Union
treaty, it initiated a convergence program for the Greek economy and embarked on a
program of structural reforms. The reforms proved unpopular, and Papandreou won
new elections in 1993. Fortunately, the convergence process was continued under
Papandreou and his successor Kostas Simitis. In the year 2000, after a delay of two
years, Greece became a full member of EMU and adopted the euro as its currency.
The path to the euro was not plain sailing either. However, the economy
showed distinct signs of improvement in the 1990s. In the year 2000, Greece’s GDP
per head stood at 65.5% of the EU-15 average. It was still lower in relative terms
compared to 1980, but much higher than in 1990. However, the unemployment rate
had almost doubled to 11% of the labour force. Public debt had risen further, and it
stood at 106.2% of GDP. Inflation however had been slashed to 3.2% per annum,
while interest rates tumbled as the devaluation risk disappeared.
Two years after the adoption of the euro, the importance of Greece's
participation in Economic and Monetary Union cannot be underestimated. EMU has
delivered most of its promises. Inflation has converged to levels which are very close
to the EU average. So have nominal and real interest rates. Even the growth rate of
GDP has picked up in recent years, and is now one of the highest in the EU. However,
unemployment persists, exports are sluggish, and the current account deficit in 2002
stood at 4,7% of GDP.
In its latest survey of Greece, Τhe Economist commented that “Squeezing into
the euro has done wonders for the economy. All of a sudden, the naughtiest pupil in
the class is getting top marks.”
At the same time, in Greece itself, public opinion has become much more
pessimistic. The stock market boom, that took place in the run up to euro entry in
1999-2000, luring more than one million Greeks to invest in the Athens Stock
Exchange, has given way to a painful crash. From a high of 5535 points at the end of
1999, the Stock Market Index stood at 1748 points at the end of 2002. The 70% fall in
stock prices, has wiped out the equivalent of a year’s GDP from total market
capitalisation and caused a painful redistribution of income. In addition, for
households, the introduction of the euro was accompanied by unexpected price rises.
The cost of small ticket items to the consumer rose significantly after prices were
converted to euros. Inflation in Greece has remained higher that the EU average in the
two years since the euro was introduced. It remained above 3.5%, while the average
for the euro-zone is about 2%. Firms have become more pessimistic as well, despite
the relatively high growth rate. Many Greeks attribute the relatively high growth rate
to temporary factors. The construction boom that is linked to the forthcoming
Olympic Games of 2004, and the housing boom that was initiated after the fall in
interest rates and the liberalisation of credit markets are often cited as two such
factors. What will happen to the economy after the Olympics is an often asked
question.
Is this pessimism justified? How can one explain the persistence of both
inflation and unemployment, at a time of relatively high growth rates? Was the Greek
economy prepared in the run-up to EMU participation to withstand the competitive
pressures of the single currency area? What policies ought to be followed, in order to
ensure that an economy such as Greece’s can benefit from EMU participation?
These are the questions that I shall try to answer in the remainder of this talk.
I shall start by examining the policy record of the 1990s.
The attempts to control fiscal deficits, inflation and the structural imbalances
that grew in the 1970s and the 1980s started with the election of the New Democracy
government in 1990.
The macroeconomic situation in 1990 was critical. Government deficits were
getting out control, "hidden" debts had accumulated throughout the public sector
during the 1980s, the social security system was on the brink of collapse, foreign
exchange reserves had been depleted and inflation was accelerating.
The nominal convergence efforts that started in 1990 were reinforced through
the two convergence programmes that were approved by the European Union. The
first program was submitted by the Mitsotakis government, and approved in March
1993. The second, was submitted after the socialists returned to power and was
approved in September 1994. These programs, which were similar in the priorities
that they set, although not in the time frame for the completion of these priorities,
have been the guide of Greek macroeconomic policy throughout the 1990s. The
priorities were the following:
1.
2.
3.
4.
5.
To gradually reduce the General Government Borrowing Requirement below
the 3% of GDP required by the Maastricht treaty.
To initially stabilise and subsequently reduce the General Government Debt to
GDP ratio.
To reduce inflation within 1.5 percentage points of the average of the three EU
economies with the lowest inflation rate.
To reduce the fluctuations of the drachma exchange rate vis-à-vis European
Union currencies.
To reduce long-term interest rates within 1.5 percentage points of the average
of the three EU economies with the lowest long-term interest rates.
The international recession of 1993 and the early elections, which led to a
change in government, resulted in the first convergence program missing its first year
targets. In any case, that program applied for less than 8 months. The revised
convergence program submitted by the new government, stipulated a much more
gradual adjustment effort. The revised program stated explicitly that the aim was for
Greece to participate in EMU from the 1st of January 1999, but it failed to take into
account that this required satisfaction of the five nominal convergence criteria by mid1998. Thus, the fiscal targets were not officially realised when the first wave of
countries entered EMU. In addition, because Greece was forced to devalue in
February 1998, in order to ensure the drachma’s participation in the Exchange Rate
Mechanism, it did not satisfy the exchange rate and inflation criterion either. By
February 2000, the criteria were deemed to be satisfied, and Greece was accepted in
EMU from the 1st of January 2001.
1 Fiscal Adjustment
The fiscal adjustment effort took more than ten years. It involved an
impressive improvement in the primary deficit of the General Government, which
took place mainly in the early 1990s and an equally impressive fall in interest
payments, as a result of the fall in inflation and nominal interest rates in the latter part
of the 1990s.
Three points can be made about the fiscal adjustment effort.
1. The improvement in the primary balance of the General Government was
achieved mainly through increases in taxation, rather than the containment of
government consumption. Current government revenue rose from 29.6% of GDP
in 1989, to 36.9% in 1994, to 43.2% of GDP in 2000. Government consumption
initially fell, from 15% of GDP in 1989 to 13,8% in 1994. However, it
subsequently rose to 15,7% of GDP in the year 2000.
2. “Creative accounting” was used extensively in the latter part of the 1990s, in order
for Greece to satisfy the deficit and debt criterion. In 2002, Greece had to revise
its public debt and deficit figures upwards, as Eurostat tightened the rules to limit
the scope for creative accounting. The revision of General Government debt was
of the order of six percentage points of GDP. The revised debt for 2002 stands at
105% of GDP, showing almost no change from 1998. The deficit had to be
revised upwards by almost three percentage points as well.
3. As a result, Greece still struggles to satisfy the fiscal requirements of the stability
and growth pact, especially the debt criterion. It has to be noted that the fiscal
difficulties remain despite the dramatic fall in interest rates. Interest payments of
the General Government peaked at 13.9% of GDP in 1994, and have been
declining ever since, mainly due to the fall in inflation and nominal interest rates.
In 2000, they stood at 6.3% of GDP.
To conclude, the fiscal problem of Greece has not been solved in the run up to EMU.
Of course, Greece is not alone in this. Portugal encountered similar problems, and
even Germany and France have problems with their budget deficits. However, the
public debt of Greece, at 105% of GDP in 2002, is among the highest in the European
Union. Only Belgium and Italy are in a similar situation. The average public debt to
GDP ratio in the EU-15 was only 62.7% in 2002, while the average for the twelve
members of the Eurozone it stood at 69.2% of GDP.
2 Monetary Policy and Inflation
The second element of the nominal convergence efforts of the 1990s was the
reduction in inflation. After the Papandreou government abandoned the short-lived
stabilisation program of 1986-87, inflationary pressures returned. The Mitsotakis
government, that came to power in April 1990 initiated a new anti-inflationary
strategy, based on exchange rate targets. The rate of depreciation of the drachma was
gradually reduced, and exchange rate policy stopped accommodating inflation
differentials. This was the policy that over the years brought about the reduction in
inflation. Inflation peaked at around 20% in November 1990. It continued falling
throughout the 1990s, until Greece entered EMU.
The non-accommodating exchange rate policy was facilitated by the fact that
fiscal deficits were on a downward trend. It was also made possible by the gradual
elimination of financing of government deficits by the Bank of Greece. Financing of
the government by the Bank of Greece was eliminated between 1990 and 1993.
There were a few instances in which the downward path of inflation was
interrupted. The first was the 1992-93 period, when measured inflation temporarily
rose as a result of indirect tax increases, aimed at boosting government revenue. This
was planned for and was temporary. The second was the second half of 1994, due to a
relaxation of monetary policy in the previous six months. That relaxation had brought
about a drachma crisis, that caused a sustained rise in short-term interest rates
throughout the summer of 1994. The monetary relaxation was accompanied by a very
lax wage round. In the end, both monetary and exchange rate policy were tightened,
and inflation resumed its downward path. Inflation rose temporarily in two other
instances. In the 1996 pre-election period, due to high wage increases in the public
sector that also affected the private sector, and in 1998, after the drachma devaluation
of March 1998.
The devaluation of March 1998 came about after a sustained crisis of
confidence, which forced the Bank of Greece to maintain short-term interest rates
high for about six months. The devaluation relieved the pressure and also allowed the
drachma to enter the exchange rate mechanism of the European Monetary System.
The stock market rally that followed and the perception that Greece would eventually
take part in EMU caused a virtuous circle sparked by expectations of falling interest
rates, falling government deficits, a stronger drachma and falling inflation.
Inflation has been reduced significantly, but it has not fully converged to the
average for the Eurozone. In the last two years, it remains at above 3.5% while the
average for the Eurozone is 2%. Greece is not alone in this either. Ireland and
Portugal have inflation rates which are close or even higher than Greek inflation.
However, both countries have very low unemployment rates, unlike Greece, which
has the second highest unemployment rate in the European Union. Inflation displays
an extremely small response to persistently high unemployment, it gradually erodes
Greece’s competitiveness and is again becoming a concern.
The question of unemployment persistence and
competitiveness bring us to the issue of structural reforms.
the
problems
of
3 Real Convergence and Structural Reform
If nominal convergence was a slow process, structural reform and real
convergence has been even slower. As already mentioned, at the end of the 1980s
Greece’s GDP per capita had fallen to 59% of the EU-15 average. A slow process of
real convergence started after the change in policy in 1990. By 1993, GDP per head
had risen to 64% of the EU average. In 2002 it stood at 66.6%. At this rate, it will take
Greece more than forty years to approach the average. The other “Cohesion
Countries” did a lot better. Ireland moved from 75% of the EU-15 average in 1990 to
122% in the same period. Portugal and Spain, covered more ground than Greece in
the same period, and now stand at 69.2% and 84.5% respectively.
In addition, the other “Cohesion” countries have been much more successful
in tackling unemployment. Greek unemployment rose from 6.4% of the labour force
in 1990 to 11% in 2000. In 2002 it stood at 10%, versus 7.6% for the EU-15 average.
In the same period, unemployment in Portugal has remained quite low. It fell from a
peak of 7.3% in 1996 to 5.1% in 2002. In Ireland, unemployment fell from a peak of
15.6% in 1993 to 4.4% in 2002. Even in Spain, unemployment has fallen
impressively. From a peak of 19.8% in 1994, it has fallen to 11.4% in 2002.
For growth rates to accelerate and in order to tackle unemployment, Greece
needs an ambitious program of structural reforms. It needs to make room for private
investment in sectors that have hitherto been the exclusive domain of the state. It
needs to liberalise markets. It also needs a better utilisation of European Union funds
that are being transferred to Greece, in order for the country to improve its economic
and social infrastructure. Unfortunately, although both convergence programs gave
emphasis to structural reform, the record in the 1990s has left a lot to be desired.
It is worth looking at the priorities of the revised convergence programme,
regarding structural reform.
The revised 1994 convergence programme of Greece highlighted five
priorities for structural reform in order to help economic growth and real
convergence.
The first priority was to exploit the transfers of funds from the European
Union. During the 1990s, these amounted to 4% of GDP on average, and were meant
to help Greece upgrade its economic and social infrastructure. However, these
transfers do not appear to have had a major impact on Greece's growth rate up to now.
Poor management resulted in cost overruns, delays poor quality. Training and
education programs proved extremely badly managed and ineffective. Major projects
like the new Athens Airport, the Athens Metro, bridges and roadworks have been
characterised by major delays and cost overruns. Therefore, the EU structural funds
did not fully play the role that was envisaged.
The second stated priority of the program was a new system of regional
investment grants, aimed at fostering investment by large firms, in new products and
the utilisation of state of the art technologies. Unfortunately, this also failed. Although
the available funds have been spent, the results were more or less disappointing, and
the government revised the system of investment incentives once more in 1998,
shifting its priorities from grants to tax credits. It is worth noting that Greece spends
only 0.67% of GDP on research and development, versus 1.93% of GDP for the EU15.
The third priority was the rise in the productivity and competitiveness of
public enterprises. The means envisaged was the introduction of private sector
management, floating in the stock exchange and restructuring programs for loss
making enterprises. The national telecommunications organisation (OTE), Hellenic
Petroleum, the Public Power Corporation and others were floated in the stock
exchange. However, the government continues to exercise tight control over the
management of all these enterprises and it has failed to open important markets to
competition. Thus, important sectors such as electricity, telecommunications,
banking, oil refining and air transport are dominated by public enterprises.
Liberalisation has proceed slowly, if at all, the pricing policy of public enterprises is
decided by the government, inflexible labour arrangements continue to exist. Loss
making enterprises have not been restructured, obscure accounting practices remain,
and, despite huge capital injections, their investment programmes are insufficient and
badly planned. It is worth quoting the recent OECD survey of Greece on this:
"Despite substantial investment expenditure, which has averaged annually about 3.5% of
GDP since the early 1980s, most public enterprises have not succeeded in updating to modern
technologies or maintaining properly their infrastructure and/or equipment. Partly due to these
modernisation delays, Greece has received a derogation from most EC directives related to
the liberalisation of key sectors such as telecommunications, electricity, natural gas and air
transportation. Since the beginning of the 1990s, a more significant effort has been made to
narrow the existing large investment and technology gaps. … Despite some progress, critical
investment lags remain." (OECD 1999, p. 107).
In that same report, the OECD attempts to quantify the likely growth effects
from liberalisation of the state enterprise sector and privatisation. It estimates the
effects at around 9-11% of GDP. Thus, if reforms are introduced in a period of three
to four years, it would not be impossible to imagine that growth rates can be doubled
solely on account of reform of the public enterprise sector. A lot remains to be done in
this area, and this is critical now that Greece is has adopted the euro and the scope for
using other policy instruments has narrowed.
A fourth element of the program has been emphasis on education and training.
However, this has remained more or less on paper. Utilisation of EU funds has been
insufficient and few useful reforms have been introduced. University education
remains a public monopoly. Public expenditure on education remains at only 3.5% of
GDP, versus 4.9% for the EU-15. Universities are poorly funded and badly managed.
Despite initiatives in some institutions and some firms, universities are not sensitive
to the needs of the economy, and most training programs are designed with the sole
aim of absorbing EU funds. However, training programs have a poor record. Only
1.2% of the population of working age participates in training programs, versus 8.4%
for the EU-15. Thus, training and life-long learning, which is an important element of
a coherent long-term growth strategy for Greece remains unexploited.
Similar remarks can be made about the fifth priority of the program, namely
the initiatives to help small and medium sized enterprises (SMEs). 97% of Greek
enterprises are small, employing less than 10 employees each. However, small
enterprises account for about half of Greece’s employment, versus one third for the
EU-15. Attempts to help SMEs modernise and adapt have been badly planned. There
is no coherent strategy to help SMEs, which face numerous obstacles in their attempts
to obtain finance, in their tax treatment and in public procurement. As a result, a
potentially dynamic growth source has not been tapped.
A new growth strategy is required for Greece. EMU provides a significant
backdrop of stability. It has delivered on its promise to reduce inflation as well as
nominal and real interest rates. It allows Greece to participate on better terms in
international markets. However, EMU participation cannot ensure real convergence.
A national strategy is required for that. A strategy that will give emphasis to
microeconomic reforms, restructuring of the civil service and the state, modernization
of Greece’s institutions. The successful introduction of these reforms must become
the most important priority for Greece in the next few years.
There are seven important priorities for the years ahead.
•
•
•
First, the consolidation of public finances. This will probably be the most
immediate priority, given that the recorded reduction in the public deficit is to a
large extent due to the heavy use of creative accounting and public debt is still
extremely high. Despite the reduction in interest rates that the introduction of the
euro has brought about, there is still a need to control primary expenditure and the
deficits of loss making public enterprises.
Second, the simplification of the tax system. There is a pressing need for a tax
reform that would simplify the tax system, deal with corruption and relieve the tax
burden on enterprises and the self employed.
Third, the reform of public administration. The Greek state has ceased to function
even in its traditional domains of security, justice and social protection. 21% of
Greek households live below the poverty line, even after social transfers, versus
15% for the EU-15. Social transfers result in only 1% of households escaping
poverty, versus 9% for the EU-15. It has to be noted that spending on social
•
•
•
•
transfers in not much below the EU average. In addition, the state puts too many
obstacles in the operation of private enterprises, small and large, slowing down the
growth process. Incentives have to be introduced in public administration,
monitoring of performance ought to be adopted, and the infrastructure of the state
ought to be improved dramatically. In addition, privatisation and outsourcing
ought to be introduced as soon as possible. The economy cannot be made more
competitive, unless the state is made leaner and more efficient in its core tasks.
Fourth, a serious reform is required in education. Education is one of the major
engines of growth and probably the most efficient mechanism of intergenerational
redistribution. It is still hindered by lack of funding and the inefficiencies of the
state. The reform must proceed as a matter of national urgency, and must be
decided on grounds of consensus so that it can be durable. The direction should be
to create a more balanced system, with a large state presence in primary and
secondary education, but more private involvement and an overall increase in
funding.
Fifth, the health and social security systems ought to be reformed as well. The
Greek state does not have the administrative skills or the tax resources to be the
sole provider of such services. The mixed system that exists ought to be developed
further, with a view of attracting new investment in health, introducing more
incentives for doctors and health workers and promoting higher reliance on
private insurance.
Sixth, markets ought to be liberalised and the state enterprise sector ought to
forego dramatic reforms. Privatisation, liberalisation and competition are the key
directions. This reform is likely to have the more immediate growth dividends.
Sectors like banking, telecommunications, electricity and transport can become
important engines of growth in the first years of the new century. Labour market
reform ought to proceed quickly as well, regulatory authorities ought to be
introduced in the privatised sectors and the stock exchange ought to be overhauled
in order to regain its credibility.
Finally, a new regional policy is required. A policy aiming at creating scale
economies in selected regions outside of Athens and Salonica has to be designed.
The present policy of spreading regional aid thin, redistributes income but does
not generate growth. A rebalancing is thus needed.
Although the difficulties in introducing so many reforms at the same time have to be
acknowledged, Greece has little time to spare. EMU provides a backdrop of stability,
but it has also reduced the number of available policy instruments to foster
competitiveness and growth. The new growth strategy must give emphasis to
microeconomic reforms. The necessary social dialogue ought to take place on
concrete government proposals and have a short duration. At the end of the day,
simultaneous reforms in several areas are likely to bring about the best results,
through the reinforcement of the growth effects of several inter-related changes.
Greece can and will survive EMU. However, surviving EMU is a policy of
diminished expectations. The challenge is to use the available opportunities and
achieve real convergence in the next decade. I am confident that Greece can adopt the
right policies to meet this challenge head on.
Figure 1
Greece’s GDP per Head
75,0
65,0
60,0
55,0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Figure 2
Greece’s Public Debt
120,0
100,0
80,0
% of GDP
% of EU average
70,0
60,0
40,0
20,0
0,0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Figure 3
Greece’s Rate of Inflation
25,0
% per annum
20,0
15,0
10,0
5,0
0,0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Greece
EU-15
Figure 4
Greece’s Unemployment
14,0
12,0
% labour force
10,0
8,0
6,0
4,0
2,0
0,0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Greece
EU-15