A tragic common fate looms for Greece, Portugal and Spain

Even from a Greek perspective, the austerity measures the Spanish government adopted last week were alarming. The cuts to pensions and unemployment benefits, the rises in VAT and the rest triggered the shocking realization that yet another country is about to walk the same treacherous road of abrupt fiscal adjustment that Greece has been stumbling along for the last 2.5 years. But it was the sight of riot police clashing with protesting miners and their supporters in Madrid that really drove the chilling reality home. Whereas Greece has been suffering a painful but largely lonely death, Spain seems poised to commit a spectacular mass suicide. The reasons that led the two countries to this point are not exactly the same but it is now clear that the miserable realities they face are absolutely identical.

While Greece’s rotten public finances have pushed its banking system and the country itself to the edge of collapse, it is Spain’s overexposed and undercapitalized financial sector that is threatening to raise public debt to dangerous levels and destabilize the country. Ultimately, taxpayers in both countries are suffering. Spain’s decision to adopt a new round of austerity measures, though, makes it more urgent than ever to answer the question of whether this suffering is part of an effective strategy to exit the crisis.

“These measures will only marginally improve the fiscal situation in Spain in the short term,” wrote the Economist Intelligence Unit (EIU) of the latest decisions by the Spanish government. “The main reasons behind the current level of the budget deficit are the fall in revenue owing to the economic contraction and the rise in spending on social benefits, also a consequence of the poor state of the economy. The measures announced try to tackle these issues, but will in the end harm the economy more than help the public finances.”

For Greece, these are familiar consequences of applying asphyxiating levels of austerity during an economic depression. The latest economic data released by the Greek government last week confirm the pattern that the EIU suggests: the deficit is shrinking but as the life is squeezed out of the economy tax rises are no longer delivering higher returns and in many cases revenues are falling.

The figures for the first half of the year show that although Greece is ahead of its deficit targets due to deferring of payments and reduced public investment spending, it is falling short of its goal for tax revenues by 1 billion. The effect of the austerity on revenues has been visible for some time.

In 2011, after two years of draconian austerity and repeated taxation measures, which included increases in all VAT brackets, the reduction of non-taxable income levels (from 12,000 euros to 5,000) and the controversial emergency property tax levied through electricity bills, Greece’s revenues were marginally lower than in 2009: 88.1 billion euros vs 88.6 billion, according to the Hellenic Statistical Authority (ELSTAT). Taking into consideration that 2009 was the year of the absolute fiscal derailing that forced the country to seek assistance from its eurozone partners, the self-defeating nature of this policy mix is evident.

The argument is often put forward in Greece and abroad that one of the reasons the fiscal adjustment program has failed is because the focus on raising revenues has not been matched by an effort to cut spending. While Greece has yet to tackle some public sector privileges, the assertion that it has not addressed expenditure at all is false. Between 2009 and 2011, Greece cut its primary expenditure by 20 billion euros, a reduction of approximately 18 percent, from €112.7 billion to €92.7 billion. The public sector wage bill was reduced from 31 billion euros to 26.1 billion, or 16 percent.

Greece’s primary deficit in 2011 stood at 2.2 percent of GDP compared to 10.4 percent when the fiscal consolidation effort started. This reduction has come at great political and social cost: Greece has had three government, two tense elections and countless protests, while social services such as education and healthcare have been stretched to breaking point.  European officials who are quick to criticize Greece or who believe that fiscal austerity is the only possible answer to the perceived profligacy of the South, should consider what kind of effect fiscal adjustments of this magnitude would have on their own societies.

For Greece, the cost of following this course will be that by the end of this year its economy will have contracted by about 20 percent from pre-crisis levels and 15 percent of the labor force will have been forced into unemployment, as the jobless rate closes in on 25 percent.

These figures suggest the country is reaching the limit of what it can do fiscally to address its situation. A fifth year of recession and third of austerity means that although there is still plenty to do in terms of structural reforms, the government has virtually run out of spending and taxation options.

Despite this obvious dead-end, Greece is being asked by the troika to find further savings of 11.5 billion euros over the next two years. While some of this spending rationalisation can be achieved through the necessary intervention to reduce public sector waste, the government will eventually be forced to turn to more tax hikes and cuts to wages and pensions in a likely vain attempt to meet its latest targets.

Given the latest economic data, there must be serious doubts about the wisdom of imposing further austerity measures of this magnitude while the economy continues to deteriorate. The pattern of the last couple of years suggests that this will simply lead to Greece running even faster to stand still. The danger that the country will collapse from fiscal exhaustion and social unravelling is looming. It should be of utmost concern that rather than serve as an example for other countries in similar difficulties to avoid, the formula applied in Greece has begun to take root in Portugal and Spain.

From the start of the crisis, Greece has been singled out as a “unique” case. In some ways it was. Perhaps of all the eurozone countries, it was the one more than others that was prone to a perfect storm caused by public sector overspending, uncontrolled borrowing and lack of structural reforms. But this does not mean that these, and other, weaknesses were not evident in other members of the single currency. The crisis has been a great leveller in this sense, showing little discrimination for the depth or breadth of problems that existed in each country. Singling Greece out as being completely different to any other euro member meant the problems the country has suffered under its fiscal adjustment program could easily be dismissed as also being “unique”. But what has happened to the Portuguese economy over the last couple of years suggests that the Greek experience, for all its differences, is far from an isolated one.

Just half way into the year and there are already concerns over Portugal’s ability to meet the program’s fiscal targets.  The worrying signs for Portugal first came at the end of last year when the country had to revert to a one-off transfer of banks’ pension funds to the state in order to meet the 5.9 percent deficit target. The latest budget execution shows revenues stuck at 23.9 billion euros due to lower indirect taxation and lower social insurance contributions for an economy that is expected to shrink by 3 percent this year, according to troika estimates.

This week, the IMF published a broadly positive review on the implementation of the Portuguese program. However, paying closer attention, the review highlights the downside risks, the deeper-than-projected unemployment and the challenges in the budget execution, including the accumulation of arrears (3% of GDP at the end of March) driven by local authorities and hospitals.

Portugal’s difficulty in meeting the program targets in exchange for its 78-billion-euro bailout is not because of the country’s unwillingness to bring its public finances back in order.  It is because it is facing the same uphill battle of having to adjust fiscally in a shrinking economy while unemployment rises. Portugal is also beginning to go around in circles, like a dog chasing its tail. And, as Greece discovered, the ability to implement a fiscal adjustment program depends on people’s willingness to tolerate it. These programs demand drastic changes in a short period of time and the longer they go without producing results that ease the burden on citizens, the more difficult it is for governments to call on society’s support. While Portugal has not experienced the same social upheaval as Greece, nor does it have the same culture of protest, there are signs of austerity-weariness in the Iberian country, where the fiscal program began a year after Greece. At least 100,000 people protested the measures in Lisbon in February, the country’s largest union CGTP went on strike in March and medical staff walked off the job for 48 hours last week in opposition to health cuts. This suggests Portuguese society is less tolerant of continues austerity than is sometimes suggested.

The mistakes of Greece and Portugal now look set to be repeated in Spain where taxpayers are being ushered onto the treadmill of austerity. The cost of a failed financial sector is to be absorbed by a faltering economy which has the highest unemployment rate in the eurozone. It seems it is easier for policy makers to explain and defend this economic anomaly rather than address the decisions made by banks in Spain and other parts of Europe leading up to this crisis.

If the experiences of Greece and Portugal are anything to go by, Spain’s turn to austerity also points to trouble ahead. The Spanish government last week announced fiscal measures of approximately 6.5 percent of the country’s GDP over the next two years in order to meet the conditionality of the bank recapitalisation from EFSF/ESM. According to a publication from the IMF this could translate, in the best case scenario, into a 0.6 percent reduction in income and a rise of 0.5 percent in unemployment for every percentage point of consolidation effort.  The IMF adds that in the absence of aggressive rate cuts from the central bank and when the consolidation effort is happening simultaneously by other partner countries the impact can double.  It would be unreasonable to expect the Spanish economy to absorb an added 6 percent of economic contraction and unemployment without suffering long-term structural damage.

“The rise in the VAT rate and the cut in unemployment benefit will hurt households directly,” EIU says in its report. “Spain is therefore more likely than ever to see renewed social unrest, potentially leading to some disruption to the economy and political stability.”

With Greece, Portugal and Spain heading towards economic dead-ends, there is an urgent need to identify how this downward spiral can be broken before Southern Europe turns into a zombie zone always reliant on the reluctant generosity of its Northern partners. We have reached the point where rather than ask what spending can be cut or what taxes can be raised, we must demand to know where growth will come from.

In Greece, the failure to answer this question has led to the debt crisis become a liquidity and credit crisis, which means that even healthy businesses are starved of the funding they need to keep going. There has been a trend over the last few months for policy makers in the EU to talk about growth. Words, though, are not going to be enough to keep businesses from going bust or to create new jobs.

There are a number of ways the troika, which has spent the last few days inspecting Greek finances ahead of talks on a new round of cuts, could help foster some growth in Greece. It has been satisfied to release loans to Athens to meet bond maturities and coupon payments to the European Central Bank but has not taken any steps to hasten the settling the 6.8 billion euros of arrears the Greek government owes in tax returns and to suppliers. The head of the EU Task Force for Greece, Horst Reichnebach, recently identified that payment of these arrears as being vital to keeping Greek businesses alive. If there is a genuine interest in Greece being in a position to grow, not just cut, its way out of the crisis, its lenders need to show a greater interest in steps that could encourage this.

There also appears to be reluctance from the European Investment Bank to guarantee loans to Greek SMEs even though an agreement was reached on this several months ago. If Brussels wants to genuinely restore Greece’s competitiveness and growth, then this has to be addressed. The EU could also show further commitment towards projects able to play a role in getting Greece out of its economic rut by reducing the level of co-financing for structural funds. Last year, Brussels reduced to 5 percent Greece’s participation in these schemes but the deterioration of economic conditions mean even this is an extra cost the country can hardly meet. Scrapping the Greek contribution altogether would make sense at the moment.

Equally, the troika has tolerated delays in the bank recapitalization process – vital for providing the fuel that could help restart the Greek economy – when it is unwilling to put up with procrastination in other areas. And, if fiscal sustainability is the overarching objective, it is incomprehensible that there has not been a greater discussion about conducting this recapitalization through.

These are all basic steps that can be taken within the current framework to stimulate growth and to show the eurozone is committed to helping countries like Greece work their way out of the crisis based on something more than spending cuts and tax hikes. These steps can be taken before the eurozone decides on more complicated issues, such as a banking union, Eurobonds and restructuring of official sector debt, which could also help southern European countries get out of the current dead-end.

There is little doubt that Greece allowed itself to become the weakest link in the euro chain ahead of this crisis. It failed to evolve in a changing economic environment and to adapt to the demands of being in a single currency with much more robust economies. However, it’s now clear that other countries in southern Europe are suffering the effect of similar weaknesses, even if they were not as pronounced as Greece’s. The response has been to follow similar austerity policies in all these countries. While the need to get public finances under control is a natural reaction to the crisis, the speed and depth with which these cuts are being made is open to question. The results in Greece indicate that the impact of the measures is counter-productive.

Fiscal discipline is an understandable part of moving the eurozone towards closer union and debt mutualisation but the manner in which it is being implemented in Greece, Portugal and Spain is putting the economic viability of these countries and the single currency in doubt. Implementing austerity but not taking measures to encourage growth threatens to lock these countries into a death spiral. The eurozone needs to strike a balance between the structural reforms, the fiscal housekeeping and the growth initiatives that are needed in southern Europe. As Martin Wolf wrote in the Financial Times last week: “Far too much policy making and advice neither recognises the post-crisis challenges nor crafts effective answers. The heart of the matter is accelerating de-leveraging, while promoting recovery.”

If this issue is not addressed quickly, Greece will slide past the point of no return. Portugal and Spain could quickly follow. A crisis that has created so much disagreement and division within Europe will leave the people of these countries alone to face the terrible fallout caused by the lack of courage and imagination shown by policy makers who refused to see the signs of impending danger. Our vision of a prosperous, united future would be replaced by the mutual wretchedness of a tragic economic present.

Nick Malkoutzis & Yiannis Mouzakis*

*Yiannis Mouzakis is an economics content specialist for a global content supplier. He blogs at Prodigal Greek.

20 responses to “A tragic common fate looms for Greece, Portugal and Spain

  1. Exactly, which highlights the uselessness of the Teutonic morony of austerity.

    And it also highlights Germany’s self-interest in pursuing it until she is forced to abandon it either through a quick self-introspection or a violent and brutal uprising which will erase Germany from the face of the earth once and for all.

    Her choice: either quit while ahead or face assured annihilation.

    • Why the interventions of Dean so often lack manners? Or reasoning? It is always the same complains and lack of introspection which bring no value to a debate about the Greek situation.

      • I suggest it’s best to post your thoughts and not get caught up in issues that sidetrack the debate.

      • Estevao buddy, I like your thinking.

        So, when Dean gives Germany a taste of her own medicine, Dean is rude. But when Germany does the same to Greece in spades, somehow Germany is the apotheosis of sophistication and good manners.

        Anthing else with your Greek coffee or that would be all?

  2. What are you guys talking about? That if Germany doesn’t pay up and continue to fund the budget deficit in Greece and the property bubble in Spain, an uprising will annihilate Germany from the face of the Earth?

    Get real.

  3. This article, particularly the economic happenings it describes, really emphasizes the question which is raised by more and more economist, whether adjustment via deflation is a workable premise, particularly when the necessary adjustment is a large as in Greece. I understand that there are not too many precedents in the world where this has worked.

    I lived in Chile in the early 1980s when that country was in a similar situation. While it had not converted its currency to the USD, it had pursued a “fixed USD exchange rate until eternity” and everyone from Pinochet down the line swore repeatedly that eternity meant eternity. A tsunami for foreign funding entered Chile; domestic asset prices and everything else rose and became overvalued; the foreign funding was spent on consumption (huge current account deficits). Like in Greece, the point came where something hit the fan.

    Chile swore to pursue a deflationary adjustment policy and with an authoritarian government behind the economic policy makers, one would have thought that they would carry it though. Unemployment skyrocketed. Even voluntary salary cut were made in the private sector.

    Well, no one would blame Pinochet for being a sissy but even he got cold feet once he felt the reaction to his threat of cutting public sector salaries. Within weeks Chile replaced “eternity” with “now” and devalued. From that standpoint, one could say that the Greek leadership has been tougher so far than Pinochet was then.

    I have been a staunch defender of Greece’s holding on to the Euro and, as of now, I still am. But, if deflation doesn’t work at all and if deflationary measures bring only pain but no future perpective, there will have to be a point where one has to be prepared to revisit the issue of the pro’s and con’s of staying in the Eurozone. It can’t go on forever that income are reduced while prices remain the same (or even go up).

    • Thanks Klaus. An interesting comparison. I think in Greece’s case, the difference is that it’s part of a currency union and as such its viability in the euro doesn’t depend just on its own decisions.
      The moment is approaching when the eurozone must also decide how/if it wants to move forward. At the moment, the argument that Greece has not done enough in terms of structural reforms and fiscal adjustment provides an excuse to jettison Greece at some stage. But were this to change to some degree over the next few months without any positive impact on the economy, there would be pressure on Greece’s partners to adopt a completely new approach.
      Clearly, if this doesn’t come then the ball would be in Greece’s court, as you describe.

    • Whether you politely call it “jettison” or others call it “kicking-out”, any such move which is triggered by the EZ would be bound to have enormous long-term political damages for everybody involved, possibly forever.

      I have from the start insisted that it must be the borrowing country, i. e. Greece in this case, which is perceived as driving the process. The moment the borrowing country leaves the impression (above all to its own people) that it is acting at the whim of others, the game is lost. That is how I learned it 30 years ago from the Great Latin American Debt Restructurer Bill Rhodes (as far as I know, Bill Rhodes had pointed that out to Mr. Papandreou in a personal meeting a couple of years ago).

      So, should it indeed come to the point where Euro-alternatives are discussed for Greece, that, too, would have to be initiated by Greece with Greece in the driver’s seat. All I am saying is that the point is likely to come where it might be in the interest of Greece to initate something.

      The most important question for Greek leadership would have to be: what do we need to get out of the EU so that our people praise us for what we have negotiated to make the transition as tolerable as possible? And then go for that!

      I grant the new government that it has used rather impressive words so far but words are easy and action will speak. Thus, I would not call it quits just yet but I would guess that at the latest by year-end, one ought to have a good idea about the likelihood that words can become reality. If yes, fantastic for Greece! If no, one has to start thinking in terms of alternatives, I believe.

      • My concern is that those who fail to develop a Plan A will be called on to devise a much more difficult Plan B. This fills me with fear. Let’s hope it doesn’t come to that.

  4. nonviolentconflict

    Reblogged this on NonviolentConflict.

  5. Robert Guy Danon

    Cutting pensions & salaries in the public sector and taxing the overtaxed Greek household has certainly reached its limits, however very little has been achieved in deregulating markets, in breaking long established monopolies and cutomer centric practices and privatising public sector companies. In fact there is very little mention on your bolg on the latter. For example creating a simplified tax system that is able to control tax evasion and avoidance is a step in the right direction. This is easily achieved if there is the will to comply by for example prohibiting exchange with cash and creating a computer based monitoring system for each tax person. Equally, the process of privatisations in the current straight jacket environment is a highly expansionary policy objective. It is imperative that Greece opens up and creates a climate conducive to foreign investments so that international investment capital is directed to the projects that will yield long term growth and maximise returns to both government coffers but more importantly to Greek society at large.

    • Robert, we are in agreement on the issue of structural reforms. Some steps have been taken – by the standards of previous years, quite a lot, actually – but many significant changes are yet to be implemented.

  6. Dear Nick Malkoutzis & Yiannis Mouzakis,

    While you are writing this substantiated analysis, Caroline de Gruyter writes in the NRC, a major Dutch newspaper, a “serious” one as we call it in Greek, that patience runs thin on the Greeks.

    To continue with: “Well-informed sources tell this newspaper that 7 to 8 MS would like to put Greece out of the EZ”.

    Greek government would have given the time until mid September to “live up to its promises”.

    “The program is completely off the rails” according to an unspecified “European officer” who is further quoted saying “Cuts, privatizations, it is hopeless. How can we continue to send loans?”

    Upon which Caroline de Gruyter adds, “The relief over the fact that Greece, would make the best of it within the euro zone, has evaporated.”

    And then this amazing passage: “Stournaras has to find 11,7 billion Euros. Many think that he got the message. He talks about “duties” and not about postponements. But THE SOCIALIST PASOK THREATENS AGAIN TO STEP OUT OF THE COALITION?” (!?, is that so?)

    The article ends with the following prophesy: “The fate of Greece shall be decided upon during a summit of government leaders.” (I think that’s a brilliant idea! ). “This autumn already, unless miracles happen”.

    So, whom are you writing all this reasonable stuff for, my friends? If the well-respected” Dutch NRC chooses to write like this then I am very, very pessimistic about the usefulness of reason at this point of time (and this is an understatement).

    I can provide you with an electronic copy of the Dutch article dated 18/07/2012 and I will be happy to provide you with the full translation, if you like.

    Kind regards,
    Demi Theodori

    • Demi, thanks for taking the time to write to us and inform us about the article. It seems that the mood against Greece has turned over the last few months. This needs to be addressed immediately because we cannot allow Greece to be seen as a country not interested in progressing or ‘saving itself’ as some might describe it.
      With regards to PASOK leaving the coalition government, there has certainly been no such suggestion. In a country not familiar with consensus politics, there is always going to be friction when parties have to work together. But let’s not forget that given Greece’s political history, it is a substantial step that three parties from different backgrounds are sitting around the same table. It may be too little too late. We’ll see.

  7. All I know is this. Greece has nothing to do with the profound failings of Germany.

    If you don’t understand(or pretend not to understand, or pretend to not want to understand) what I am talking about, this is a glorious analysis of what the real problems are and how to fix them. And if you don’t understand it, then read it again, and again….and gain until you do. It’s all in there. 100%.


  8. The biggest culprit in all this was the ECB which set the interest rate too low for overheating peripheral nations, and indeed some core economies too. The ECB is also to blame for the lack of regulation and the easy availability of cheap credit. Be that as it is may we now find ourselves in a situation with many countries, including Greece, Portugal, Spain and Ireland, saddled with unsustainable debts and/or deficits. Something that tends to get overlooked in these austerity conversations is that it is not Germany, nor the Troika blocking access to new funding, but the bond markets. The bottom line is that sovereign states are responsible for funding their own economies. I have no doubt that Greek, Irish and Portugese citizens would not have it any other way. Should these funds dry up then the sovereigns themselves need to take actions to address the funding shortfall. The Greek government made the decision to avail of EC/ECB/IMF loans, but let’s not forget they had other options, as did Ireland and Portugal. So please let’s try and re-frame this austerity debate.
    Austerity is not imposed by external institutions or governments.


    Wed, Jul 4, 2012 at 4:13 PM, Allen, Peter S. wrote:

    Just got back from Greece where I heard the following joke:

    Angela Merkel decides to visit Greece
    (I heard one version where it is France, but no matter).

    At passport control, the following takes place:

    Agent: Name?
    Merkel: Angela Merkel
    Agent: Nationality?
    Merkel: German
    Agent: Occupation?
    Merkel: No, just visiting

    This only works in English, of course

  10. Perhaps you should rename your blog into Chronicle of a Death Foretold, Nick. Whether it’ll be that of Greece alone, or of Southern Europe, or of the Eurozone as we know it, who knows. Certainly not the delusional lot who dream up – or sign – bailout agreements.

  11. Pingback: Vuelta a España, pensando en Fotiní y en el futuro de Grecia | elfindefiesta

  12. Pingback: Regreso a España, pensando en la pequeña Fotiní y en el futuro de Grecia | elfindefiesta

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