As Greece activates its 45 billion-euro (US$60.2 million) rescue package with the IMF and EU, it is becoming clear that a new, far more comprehensive approach is needed. Two problems need to be addressed: The credibility of Greece’s fiscal stabilization program and how to cover the country’s medium-term financing gap.
The magnitude of the fiscal adjustment effort being demanded of Greece is now well known. The deficit has to be reduced by at least 10 percentage points of GDP (from around 13 percent to less than 3 percent). The key problem, which has not been addressed so far, is that a fiscal adjustment on this scale requires the government to take two steps that can be implemented only with wide social approval: A cut in wages and a cut in social expenditure. Both steps are now as unpopular there as they are unavoidable.
The country’s competitiveness problems are well known. Unit labor costs have increased by 10 percent to 20 percent more than in Germany. Assuming that Greece wishes to stay within the eurozone, an “internal devaluation,” ie, a significant cut in nominal wages, is inevitable. The government can (and has) cut wages in the public sector, but this is not sufficient. A large cut in private-sector wages also is urgently needed to stimulate exports (which currently amount to less than 20 percent of GDP, even if one counts both goods and services) to create at least one source of growth.
Greece thus needs a “National Competitiveness Pact” in which government, opposition, employers and workers agree on a set of measures that cut unit labor costs by at least 10 percent. Three levers could be used to reach this goal: Adjustment in nominal wages, extension of working time and a reduction in social security contributions (compensated for by an increase in value-added tax). The mix of measures should be left to Greece to decide, but a cut in unit labor costs of this size is an essential first step for a successful adjustment and should be a pre-condition for IMF/EU support. Deep cuts in social expenditure are also unavoidable in order to achieve sustainable public finances. The growing fiscal deficits in Greece over the last decade were essentially the result of a massive increase in the size of state social benefits, from 20 percent to close to 30 percent of GDP, without any significant increase in tax revenues.
Contrary to popular perception, the public-sector wage bill is only of marginal importance. The government has already forced through most of the necessary adjustments in this area. Indeed, cuts in public sector wages can yield at most 1 percent to 2 percent of GDP in fiscal consolidation. Given that social expenditure amounts to close to 60 percent of total public spending, a successful fiscal adjustment will ultimately require that it be cut significantly. The alternative, an increase in tax revenues by almost 50 percent in the span of a few years, simply is not feasible.
Profound reform of the welfare state and building a modern tax administration system requires time. However, financial markets are in no mood to give Greece time, which brings us to the second major problem facing the country.
In order to gain the breathing space necessary for the reform process to be effective, Athens could just announce a simple rescheduling: The due date of all existing public debt is extended by five years at an unchanged interest rate. In that case, the Greek government would face no redemptions for the next five years and would have to refinance about 30 billion euros per year from 2015 onwards, which should be manageable by then. Official financing needs would then be much more limited and the IMF/EU package of around 45 billion euros should be sufficient to cover most of the progressively lower deficits over this grace period.
Without such a rescheduling, it is unlikely Athens will be able to roll over the 30 billion or so euros maturing annually for the next few years. Over time, the eurozone countries would inevitably have to refinance most of Greece’s public debt. This is a recipe for continuing political problems, as the Greeks would always consider the interest rate too high, while Germany would consider it too low (at least relative to market rates). Moreover, once the eurozone had started refinancing Greece without any contribution from private creditors, it would be politically impossible to stop. The type of rescheduling proposed here would signal the Greek government’s readiness to service its debt in full and thus might be accepted without too much disruption in financial markets. Of course, markets would view any rescheduling without a credible adjustment program merely as a prelude to a real default later on, thus leading to an even higher risk premium.
However, even the best adjustment program cannot be financed without some contribution by private creditors, ie, some form of rescheduling. The only way out for Greece is thus to combine both elements: Rescheduling its debt plus national agreements on wages and social expenditure. The current approach — focusing only on the financing needs and fiscal adjustment for this year and leaving all the hard choices for later — will not work.
Daniel Gros is director of the Centre for European Policy Studies.
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