Sat, Aug 15, 2015 - Page 9 News List

Greece needs to nurture innovation and entrepreneurial spirit

By Edmund Phelps

Some economists overlook the modern idea that a country’s prosperity depends on innovation and entrepreneurship. They take the mechanistic view that prosperity is a matter of employment, and that employment is determined by “demand” — government spending, household consumption and investment demand.

Looking at Greece, these economists argue that a shift in fiscal policy to “austerity” — a smaller public sector — has brought an acute deficiency of demand and thus a depression. This claim misreads history and exaggerates the power of government spending.

Much of the decline in employment in Greece occurred prior to the sharp cuts in spending from 2012 to 2014 — owing, no doubt, to sinking confidence in the government. Greek government spending per quarter climbed to a plateau of about 13.5 billion euros (US$15.1 billion) from 2009 to 2012, before falling to roughly 9.6 billion euros last year. Yet, the number of job holders reached its peak of 4.5 million in 2006-2009, and had fallen to 3.6 million by 2012. By the time Greece began to cut its budget, the rate of unemployment — 9.6 percent of the labor force in 2009 — had already risen almost to its recent level of 25.5 percent.

These findings weigh heavily against the hypothesis that “austerity” has brought Greece to its present plight. They indicate that Greece’s turn away from the high spending of 2008-2013 is not to blame for today’s mass unemployment.

Another finding casts doubt on whether austerity actually was imposed on Greece. Government spending has certainly fallen — but only to where it used to be: 9.6 billion euros in the first quarter of this year is, in fact, higher than it was as recently as 2003.

So the premise of austerity appears to be wrong. Greece has not departed from past fiscal norms; it has returned to them. Rather than describing current government spending as “austere,” it would be more correct to view it as an end to years of fiscal profligacy, culminating in 2013, when the government’s budget deficit reached 12.3 percent of GDP and public debt climbed to 175 percent of GDP.

The “demand school” might respond that, regardless of whether there is fiscal austerity now, increased government spending (financed, of course, by debt) would impart a permanent boost to employment. However, Greece’s recent experience suggests otherwise. The huge rise in government spending from 2006 to the 2009-2013 period did produce employment gains, but they were not sustained.

The real sticking point is that the government would have to issue bonds to finance its extra spending. Assuming a limit to foreign investors’ willingness to buy these bonds, Greeks would have to buy them. In an economy unequipped for growth, household wealth relative to wages would soar and the labor supply would shrink, causing employment to contract.

So spending more is not the remedy for Greece’s plight, just as spending less was not the cause. What is the remedy, then? No amount of debt restructuring, even debt forgiveness, will suffice to achieve prosperity (in the form of low unemployment and high job satisfaction). Such measures would only help Greece to revive government spending. Then the economy’s stultifying corporatism — clientelism and cronyism in the public sector and vested interests and entrenched elites in the private sector — would gain a new lease on life. The European left might advocate that, but it would hardly be in Europe’s best interest.

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