Even as we were hearing the news of tapering off of the Great Recession, as the current economic crisis is now popularly known, Europe started witnessing an increased share of the crisis. While it is true that we see Greece as the country reeling under the sovereign debt crisis at the moment, there are ominous signs that there are other countries like Spain and Portugal where public debt is growing at a fast pace. Whether these countries would follow a similar trajectory as Greece’s is a difficult question to answer at the moment. Much of it would depend on the fate of the Greek economy itself. In this note we argue the following. First, if the IMF conditionalities of fiscal ‘consolidation’ are adhered to, it would further prolong the crisis and make the recovery extremely painful, especially for the working class and the poor sections of the population. Second, if it wants a long term solution, the only option that might be left for Greece would be come out of the European Monetary Union (EMU). Though the paradox is that, in the short run, this itself would fuel the crisis even more both for Greece and Euro. So, Greece finds itself in a catch-22 situation with very limited options.
Magnitude of and Reasons for the Debt Crisis
There are different facets of the debt crisis in Greece. Greece has 13% of fiscal deficit and 113% of public debt as percentage of GDPi. There are a few reasons for this.
First, the share of wages in GDP has been declining in Greece since the real wages of workers have grown at a much lower rate than the growth of productivity. In other words, the total benefit of growth in labour productivity has not gone to the workers in the form of increase in real wages, rather some of it has gone in increasing profit margins. This means the share of wages in GDP has been decliningii. This process has led to a declining domestic market since workers spend a higher proportion of their income on consumption than the capitalists or the rentiers. A declining domestic market ipso facto means lower tax incomes. For a given level of government expenditure, this means a higher fiscal deficit and, therefore, growing public debt over time.
Second, despite improved labour productivity leading to lower prices, aimed at increasing export competitiveness, Greece, among other European countries like Spain, Portugal and Ireland, lost out to Germany. In an era of export-led growth, it is the relative nominal labour costs that matter. A comparison between Greece and Germany would make the matters easier to understand. Heiner Flassbeck shows that while unit labour costs in Germany rose only by 5 percent between 2000 and 2010, it increased by 30 percent in Greece. Therefore, Germany was at a relative advantage over Greece in its effort to maintain export competitiveness. It comes as no surprise that while Germany runs a trade surplus, Greece is saddled with a trade deficit. A leakage of Greece’s GDP in the form of imports from Germany means a decline in tax revenue of Greece since the expenditure of Greeks is going into the pockets of German exporters. Paradoxically, this process increases the tax revenue of the German government. Thus, Greece is at a double loss because of the export policy of Germany. For this reason alone one could argue that Germany’s trade policy is also a factor in this crisis.
Third, there are two portions of government debt — principal and interest payments. In an open economy with hot international money flows, a government facing a crisis, has to keep increasing the interest rates to make its bonds saleable. An attempt to lure the international finance in this manner reinforces the very problems that it seeks to address. This seems particularly to be the case for Greece since their interest payments are growing at a very high rate.
Last but the most important, this would not have been such a big problem had Greece not been a part of the EMU. By becoming a part of it, they have limited their policy responses. Let us see why. If they had an independent currency, they would have had an independent central bank. This bank could have bought government bonds to finance the deficit expenditure. This is how most central banks function when the government runs a fiscal deficit. Moreover, such an arrangement would have stabilised the interest payment portion of government debt. Since interest rates in the economy are pegged to the interest rate announced by the central bank, the bank could help the government by keeping its own interest rate low.
But as soon as a country becomes a part of a unified currency under a common Central Bank, its independent monetary policy practically disappears, particularly for the relatively poorer and less powerful countries. An analogy in an Indian context could make it simpler to understand. Bihar can potentially run a budget deficit today and still not face a crisis similar to Greece’s because it has the backing of the RBI which would always be ready to buy bonds floated by the Bihar government. Therefore, Bihar despite being in a similar position as Greece, in the sense that they both have a monetary union with other states/nations, enjoys the luxury of not going bankrupt since it has the support of a Central government. That is not to say that Bihar has the luxury, especially in today’s world of fiscal ‘prudence’, to run high budget deficits but at least it will never face the problem of bankruptcy in so far as there is an RBI and a Central Government. Greece’s problem is that although there is a central currency, there is no central government. This is Greece’s predicament today. It could have solved the problem if it were out of the EMU.
IMF’s Solution and the Bailout Package
IMF has identified Greece as facing a dual challenge of controlling fiscal deficit and restoring international competitiveness. IMF has proposed to address both these issues by putting stringent conditions on Greece through the bailout package, which self-confessedly might be a ‘multi-year effort’. In specific, the IMF has proposed, among other things:
- Controlling Fiscal Deficit: ”Fiscal consolidation—on top of adjustment already under way—will total 11 percent of GDP over three years, with the adjustment designed to get the general government deficit under the 3 percent level by 2014 (compared with 13.6 percent in 2009).” [emphasis added]
a) Government Spending: ”Since wages and social benefits constitute 75 percent of total (non-interest) public spending, public wage and pension bills—which have grown dramatically in recent years—have to be reduced… Spending measures will yield savings of 5 ¼ percent of GDP through 2013. Pensions and wages will be reduced and frozen for three years, with payment of Christmas, Easter, and summer bonuses workers abolished, but with protection for the lowest-paid.” [emphasis added]
b) Revenue Measures: ”Revenues measures will yield 4 percent of GDP through 2013 by raising value-added tax, and taxes on luxury items, and tobacco and alcohol, among other items.” [emphasis added]
2. Enhancing Competitiveness: “This means pro-growth policies and reforms to modernize the economy and open up opportunities for all. It also means that costs must be controlled and inflation reduced so that Greece can regain price competitiveness. … Government [should] modernize public administration, strengthen labor markets and income policies, improve the business environment, and divest state enterprises.” [emphasis added]
To comprehend fully the repercussions of these proposals on the Greek economy, we need to analyse them more closely. First, bringing down fiscal deficit from 13.6 precent in 2009 to under 3 percent by 2014 means a drastic cut in government expenditure over this period. It is obvious that such a cut would be painfully deflationary for the economy in general and the working class and the poor in particular. This would particularly be so given the route through which it is sought to be done. Given that public wage and pensions constitute 75 percent of total (non-interest) public spending, the biggest burden of fiscal consolidation would fall on them. This would mean an absolute decline in the domestic demand. A decline in wages does not only mean that the incomes of the employed would go down but also the number of people employed itself would go down drastically. This is so because a decline in wages means that the workers would be able to demand less, and thus, some of those engaged in producing these commodities would go out of job. Therefore, a unit decrease in fiscal expenditure means a more than one unit decline in the total GDPiii and increased unemployment. The working class ends up getting doubly squeezed in this process. A lot of them go out of jobs and those who remain get a reduced income.
Second, if the goverment seeks to increase the revenue through increasing indirect taxes (VAT), it would increase the prices of essential commodities. Any increase in prices of essential commodities would hurt the poor the most. Unlike direct taxes, indirect taxes are by definition inequalising. This policy would mean the government would levy same tax on the poor as well as the rich. This would obviously affect the poor more because their tax payment as a proportion of their income in this case is much higher than the rich. It is interesting to see that, apart from a mention here and there about strengthening its direct tax collection, there is not a single concrete proposal on how much revenue would be mobilised through increase in direct taxes on the rich and the wealthy.
Third, the claim that these measures will yield savings of 5 ¼ percent of GDP, which would help revive the economy, is completely flawed. What this argument misses is that decreasing fiscal deficit ipso facto, as explained above, also decreases the GDP. Therefore, overall savings (government and personal savings), instead of increasing, would actually decrease for the economy.
Fourth, controlling costs to regain international competitivenessiv requires either keeping nominal wages under control or increasing labour productivity or both. Given countries like Germany are far ahead of Greece on the technology curve, catching up with them through productivity rise is extremely limited v. Thus, the burden of maintaining cost competitiveness requires wage cuts. But this might not increase Greece’s export competitiveness since German goods could still be preferred to the Greek goods purely because of their quality. Moreover, Greece would be competing with other nations as well for the external markets and there is no guarantee that they would not follow suit. At any rate, if the wage cuts increase their competitiveness one does not know whether it would be sufficient to allow Greece overcome its debt crisis. This would particularly be the case because decreasing wages also means a declining domestic market. Therefore, it is very likely that the marginal increase in exports would be overweighed by the decline in domestic consumption. The fallacy of such an argument is that wage bills not only enter as cost of production, they also enter as a source of demand into an economy. Moreover, this strategy demands thorough reforms in the labour market, divestment of state enterprises, which amounts to imposing the discredited neoliberal agenda on Greece using crisis as an excuse.
Based on the argument made above, one could conclude that this bailout package is going to be one of long hardship for the poor and working people of Greece. As shown above, not only do they lose their wages and employment, they get squeezed though increased cost of living. Therefore, such an adjustment is inequalising and deflationary by its very nature and would not solve the Greek problem in the long run.
Is There a Way Forward?
Let us see if there is any other way out of this crisis without accepting the IMF’s deflationary and extremely painful path to recovery. To understand the possible ways out, we need to first establish that the IMF and the European Union is barking up the wrong tree. Contrary to common perception, fiscal deficit is not the villain here. In fact in an economy saddled with idle capacity and unemployment, expansionary fiscal policy is always a sure route to increasing employment.
The real reasons for the crisis, and accordingly the possible solutions, are the following. First, as noted above, by becoming a part of the EMU, Greece gave away its independent monetary policy which could have helped them get out the present fiscal problem. This could have been solved even within the EMU if there was a central government accommodating the fiscal needs of its constituent nation states. In fact Greece, along with the other nations facing a crisis of similar nature, should demand reforms in the EMU system where the central bank would be under obligation to buy the bonds floated by different nation states. To come out of this problem in the long run, either the EMU system has to be reformed or Greece would have to abandon the EMU.
Second, the fright of government bankruptcy was fuelled by the international finance pulling their funds out of the Greek economy. Therefore, there is need for strict capital controls to tame the hot money flows in and out of the economy so that they cannot hold the economy to ransom.
Third, even to decrease the fiscal deficit, the answer lies in what IMF does not want Greece to do i.e. increase direct tax rates. The Greek government could decide to increase the direct tax rates while maintaining its expenditure on job-creating activities. This would have a dual effect. It would increase the growth rate and at the same time decrease the debt burden of the government by increasing tax revenues for the same level of expenditure.
Fourth, instead of joining the rat race for export competitievness which leads to declining wage share, they should concentrate on domestic sources of growth. One of the primary sources is wage growth which increases domestic consumption.
Solution to the Greek crisis holds the key to the problems arising in other EMU nations. Spain, facing a problem of growing public debt, has already announced a fiscal austerity package announcing cuts in civil service pay by 5% and government pay by 15%. Germany has launched its severest austerity measures since 1945. In Britain, which is not even a part of the EMU, controlling government expenditure was a common election promise of all the three political parties. Such a concerted fiscal contraction across Europe does not bode well for the world economy in general and Europe in particular. These nations need to break away from the IMF logic of small government as a one-size-fit-all remedy to any crisis that emerges in the world. Only by breaking away from this logic can they ensure that the common people would not have to face the brunt of the adjustment process to a crisis in which they had no role to play in the first place. If these nations stick to the IMF path, it is already clear that they would have to face the wrath of their working people. Whether this wrath would be channelized by the right-reactionary forces or by the progressive elements is a moot question.
i It is important to note here that the concept of public debt as a percentage of GDP is quite misleading. While public debt is the sum of all the accumulated debt over the past many years or what is called a stock in Economics, GDP is a one year variable i.e a flow. If at all, the correct figure would be a weighted average of the share of fiscal deficit as a proportion of GDP over the period in question.
ii Put simply, prices (p) are generally determined as a markup (μ) over labour costs:
p=μ w/b, where w= money wage and b=labour productivity (Output (O) per unit of labour(L))
Wage share (ω)= wL/pO
Change of wage share over time:
This implies that if the rate of increase of real wages is less than that of productivity, share of wages (profits) decline (increase). In other word, gain in productivity is partially passed on to the increase in profit markup.
iiiThis is the Keynesian multiplier working in reverse.
iv Even Paul Krugman has argued in favour of this point. This argument is reminiscent of the British Treasury during the Great Depression which asked for decrease in wage costs to increase profitability of business and make it competitive.
vMoreover, maintaining comptetiveness through increasing productivity has its own problems. If growth in exports requires higher increase in labour productivity, there could arise a situation where rate of unemployment could rise (in case rate of growth productivity is greater than GDP growth rate). At any rate, the catching-up phase would most likely require such an adjustment.
Flassbeck, Heiner: “Cry Wolf but Do Not Ignore Tomorrow’s Tigers”, March 12, 2010. Last accessed on May 16, 2010 from http://www.networkideas.org/news/mar2010/news12_Tigers.htm
Guardian News Report: “Germans Face Bitter Round of Budget Cuts as the Price of Eurozone Bailout”, May 12, 2010 . Last accessed on May 16, 2010 from http://www.guardian.co.uk/business/2010/may/12/germany-budget-cuts-eurozone
Guardian News Report: “Spanish PM Makes Debt Crisis U-Turn with Emergency Cuts”, May 12, 2010. Last accessed on May 16, 2010 from http://www.guardian.co.uk/business/2010/may/12/spanish-pm-debt-crisis-emergency-cuts
IMF Staff-Level Agreement: “Europe and IMF Agree €110 Billion Financing Plan With Greece”, May 02, 2010. Last accessed on May 16, 2010 from http://www.imf.org/external/pubs/ft/survey/so/2010/car050210a.htm