The IMF seems ready to throw in the towel – not least because of the recent revelation that Greece could post a small primary budget deficit (which excludes interest payments) this year, rather than the planned sizeable surplus. But, with Greece’s economy tanking again, its government is convinced that the current repayment program is not working – and that, in the absence of significant adjustments, it never will.
Fundamental to Greece’s case for new bailout terms is the narrative – reinforced by its current economic travails – that it has been a victim of excessive austerity. But this neglects a crucial fact: austerity worked in Europe’s other crisis-hit countries. Indeed, Portugal, Ireland, Spain, and even Cyprus are showing clear signs of recovery, with unemployment finally falling (albeit slowly and from high levels) and access to capital markets restored.
Why is Greece different?
The short answer is exports. In all of the other crisis-hit countries (and, indeed, in most of the dozens of countries that have received IMF loans in recent decades), rising exports offset, at least partly, the hit that demand took when their governments slashed spending and raised taxes to balance their books.
Of course, in a large economy where external financing is not a problem, as in the United States or the eurozone, attempting to reduce a budget deficit could conceivably lead to such a large decline in demand (and thus tax revenues) that austerity becomes self-defeating. But this argument does not apply to Greece.
In fact, Greece was running very large current-account deficits – exceeding 10% of GDP – when external financing dried up suddenly in 2008-2009, forcing an adjustment in domestic spending. If the Greek government had not made such an adjustment, domestic demand and employment would certainly have remained higher – but so would imports and large external deficits. So, while austerity did cause a deep recession, it enabled Greece to avoid large external deficits, thereby reducing the size of the bailout the country needed.
Export performance is thus the key to escaping the austerity trap. The problem for Greece is that what little export growth it has experienced lately is largely illusory, as it has come mostly from petroleum products. Since Greece does not produce oil, this can mean only that Greek refiners, which now have considerable excess capacity, are simply exporting imported crude oil in a slightly different form. With refinery margins typically less than 5%, the economy is gaining little added value from these exports. Other exports that have increased, such as metals, raise a similar problem.
Moreover, Greece’s largest services export, maritime shipping, has few real links with the rest of the economy, given that companies in the sector pay no taxes and employ few Greeks (the crews hail from low-wage countries). Undermining the sector’s economic contribution further is the fact that global commodity prices, on which shipping rates depend, have lately been declining. Meanwhile, manufactured goods, which do add domestic value and employment, form only a small share of Greece’s overall exports.
In fact, Greece’s total foreign trade, if properly measured, amounts to only 12% of its GDP, much less than what one would expect from such a small economy. More jarring is the fact that Greece’s total trade deficit (including both goods and services), was even higher in 2008, amounting to 13% of GDP, implying that, in order to avoid a subsequent decline in imports and thus in domestic demand, exports would have had to more than double.
In Portugal, by contrast, the trade deficit amounted to only about one-third of exports in 2008, meaning that exports had to increase by one-third to close the external deficit, without reducing imports. Since then, Portugal has increased exports cumulatively by more than one-quarter, so that, despite a slight increase in imports since 2007, it runs a trade surplus.
To be sure, Greece’s trade deficit has declined, but only because imports collapsed. Meanwhile, exports stagnated, even as wages declined by more than 20%. That, not austerity, is Greece’s real problem. If Greece had experienced the same growth in exports as Portugal (a country of similar size and per capita income), it would not have experienced such a deep recession, and tax revenues would have been higher, making it much easier for the government to achieve a primary budget surplus.
This suggests that a combination of fiscal consolidation, lower wages, and export-oriented reforms could have enabled Greece to move toward a sustainable recovery. This approach has been tried before, and it has failed only once, when Argentina had to default on its foreign debt in 2002 and break a decade-long 1:1 peg to the US dollar.
Unfortunately, Greece resembles Argentina in two key respects. Both countries have only a small export sector, which makes external adjustment much more difficult; and both have an export structure that is skewed toward commodities, the supply of which is unlikely to change much, even as structural reforms are pursued or wages decline.
Of course, this does not mean that Greece is doomed to follow in Argentina’s footsteps toward default. But it does highlight the challenge that the country faces today – namely, to rebuild its export sector from the ground up.
It is time for Greece’s government to recognize this imperative and expand the scope of negotiations with its creditors to include not just the budget, but also strategies for stimulating exports. But, first, Greece must finally recognize that austerity is not the enemy.
Copyright: Project Syndicate, 2015.