Evaluation of further draconian austerity in Greece

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The problems of Greece stem from internal and external factors. Can austerity in the country lead to recovery and can it address deep seated structural flaws? Image Source: Daily Mail

The Greek government is determined to implement an even stricter austerity package in order to secure the next tranche of loans from the “troika” (EU-IMF-ECB) and to show that the country is poised to overcome its problems. The new austerity package will outline major layoffs in the public sector, spending cuts and further tax increases. It will be in other words the same drug that has been given to Greece for almost 18 months now and has only produced adverse effects regarding the objective of avoiding the prospect of default; plus it has increased opposition in surplus countries against any form of bailout, or any idea of a common strategy to deal with the systemic crisis.

There is a common argument against austerity policies, which advocates that austerity measures are self-defeating if imposed on an already depressed economy. Austerity further deepens recession and thus does not succeed in reducing debt to GDP ratio since debt (the numerator) increase or remains constant while GDP (the denominator) falls. Elementary mathematics are enough to understand that in such a case the overall debt ratio increases. I myself support this idea, which in general theoretical principles, holds true.

In the case of Greece this theory is less than enough though to explain why austerity is producing adverse effects. There are more profound economic fundamentals that prevent growth and worsen/escalate the undeniable contractionary effects of austerity, as illustrated above. These can be categorized into internal and external.

The internal factors are all those malignancies that make the Greek economy very uncompetitive. Apart from the ineffective tax collection mechanisms, Greece is also notorious for its cumbersome bureaucracy that constitutes a serious block to investment and to overall economic activity. Moreover the Greek public sector is both too big with relation to the labor force, but also very unproductive. Add to these the chronic inability of Greek governments to channel European funds into structural investments that would make the country better-off (Greece a country with rich agriculture today imports most of its agricultural goods – great paradox or a great tragedy).

Additionally, it is a common secret how certain politicians took advantage of various micro-interests that exist in the Greek society to exploit most of Community funds for personal purposes. In fact all politicians that were involved or are suspects of involvement to this systematic corruption remain unpunished – for instance not a single politician has been taken to court over the “Greek statistics” scandal – outrageous indeed -, and the people of Greece are now called to carry the burdens in their stead. Of course there are many other issues of lesser importance that every single European citizen has learned well so far. However out of all these issues there is one that clearly stands out within the current context and that is the consistent trade deficit Greece has with core European countries (mainly Germany). The reason why the latter is the worst internal problem shall be made clear once the external factors are put down further on.

The external factors are the architectural flaws of the euro. Greece does not exist in a vacuum, but is part of a very specific currency union, with given rules and mechanisms. It is false to treat the situation in Greece as a purely internal issue, when the Euro lacks a genuine fiscal union to back it. In other words when it lacks all those central mechanisms of debt harmonization that would never allow for divergence. A fiscal union, would include, among others, a surplus recycling mechanism that would recycle/reinvest the accumulated surpluses of the center in the periphery so as to cover for the structural trade deficits I mentioned above.

Had such a mechanism existed, the trade deficit would have been part of ordinary economic life and not a problem in itself. Yet in the absence of a fiscal union, in the lack of any surplus recycling mechanism, in the existence of a one-size-fits-all hawkish ECB main interest rate policy, in the insistence on fiscal discipline alone, this trade deficit is in fact enough to make an economy unsustainable over the long-term, since the trade deficit translates into a gradual but steady divergence (lack of competitiveness) that can only be covered through means of borrowing – since surplus recycling doe snot exist to fill in the gap. Understandably this is the setting of a vicious cycle, since once the borrowing starts there can be no end to it – and we see its effects today and how the entire euro edifice is suffering from its own structural flaws (and its constituent economies from their own mistakes).

Within this context, the austerity policies that are implemented in Greece do absolutely nothing to address the fundamental factors that led to the vicious cycle. Yes the public sector will be reduced, maybe together with bureaucracy, yes more oversight will not allow for corruption (at least not wide-scale). However austerity will do absolutely nothing to restore a trade balance and it will in fact make it even worse, since the Greek economy now contracts to such extend that many of its last standing healthy parts are falling apart (let alone the fact that no rational entrepreneur would invest in such a hardly depressed economy and when taxes are increasing every few weeks – it is a very risky venture that no serious investor dares). Moreover austerity alone without any parallel strategy to revise or at least temporarily cover the structural flaws of the euro, is a half-measure that will not produce the desired results.

As such I repeat what I have long been advocating that more austerity is not the solution to Greece’s insolvency and that Greece cannot be seen individually but must rather be seen within the context of a system wide strategy that will take into account all three dimensions of the systemic crisis of the Euro. European leaders are now faced with three clear-cuts options regarding the prospect of a Greek default (for details see Greek default: Optimal and suboptimal choices – Full analysis). Will they make the right choice and deal with the structural problems?

Greece can be -and must be- blamed for all its internal malignancies. But that alone would constitute a serious misreading of the real dimension of the crisis.