July 2, 2015 | By

It’s all Greek to Me

Protesters wave a Greek flag during an anti-austerity rally in Athens, Greece. REUTERS/Alkis Konstantinidis

As the Greek suffering mounts and they careen towards Sunday’s referendum, it has been hard to focus on anything else. Earlier in the week, in the Chicago Tribune, I wrote about the perils that await if Greece departs the eurozone. Then, in Foreign Policy, I wrote about why the Greek Prime Minister, Alexis Tsipras, might be pursuing such an odd and destructive course of action. (On that latter topic, see a similar line of reasoning from The Wall Street Journal’s Simon Nixon in today’s paper).

Here, then, are quick thoughts on two additional questions surrounding the Greek crisis:
  1. Why was Greece not able to implement reforms the way countries like Spain did?
  2. What does this economic crisis tell us about the strengths and shortcomings of economic analysis?
  On reform, Rahm Emanuel, now Chicago’s mayor, famously argued that one should not let a crisis go to waste. Greece’s crisis has now been around for years. Shortly after the global financial crisis it became apparent that Greece had accumulated a large and unsustainable amount of debt and that the Greek economy had serious structural problems.

We can divide reform possibilities into two types. There are reforms that would attack Greece’s fiscal deficit by plugging the budget hole, and then there are structural reforms that would make Greece’s economy function better and grow. The two are not mutually exclusive, of course – a growing well-functioning economy generates more tax revenue. But the structural reforms tend to pay off only over time and can be disruptive in the short run.

Fiscal measures first. Greece did dramatically reduce its deficit and undertake substantial austerity measures. It was dismay over the pain of this that helped elect Tsipras and his Syriza party in January. What options did he then have upon taking office? To cut into the deficit he could:
  1. Cut spending. 
  2. Adopt broad-based tax increases.
  3. Adopt narrow tax increases targeting the rich. 
  The first two options would clearly have enraged Tsipras’ base and would have been political suicide for him. He probably would have had a revolt in his party or his governing coalition. So what about the third? The problem tends to be that the wealthy are influential, they are not numerous enough to bring in the requisite revenue, and they are mobile. The New York Times had an excellent, if depressing, story about doctors and others emigrating from Greece at a rapid rate. This is a particular problem when the talent pool has unhindered access to higher-paying markets, as Greeks do as citizens of the European Union. At the highest end, shipping magnates can just sail away (it’s an inherently mobile business). You don’t raise much revenue taxing something that is very elastically supplied.

What about more structural reform? That can be a very good thing to do, but market rigidities often have entrenched interests behind them. Things can get worse before they get better, and only committed reformers are generally able to see things through. Tsipras does not seem to fall in that category; his is a party of the left and he is more of a protest candidate than a market devotee. Greece’s failure to reform is discussed in an astute piece by Harvard’s Ken Rogoff.

Question 2: So what does this all say about economics, that Europe could end up in such a mess?  It’s a big topic, but here’s a first cut. To the credit of economists, problems with the eurozone were foreseen. Martin Feldstein wrote in advance about the problems the eurozone would face. My counterpart at a Chicago Council event this spring, Angel Ubide, anticipated some of the banking problems that would face the eurozone when he was at the International Monetary Fund. These all go in the plus column for economics.

In the minus column, the field often has difficulty with the interplay between economics and politics.  The Greek situation has been particularly difficult to analyze because solutions that might have seemed viable from a purely financial standpoint (e.g., just forgive the Greek debt; or just cut payrolls) were not politically viable in the democracies of Europe. While there are some economists who pay attention to institutional constraints, many tend to be dismissive, causing them to err in their forecasts.

A related failing is that economics offers poor guidance on the timing of a crisis. There were more than a few economists who saw “Grexit” as inevitable (including myself). But when? It looked like Greece was heading there in 2012, but the eurozone powers, the IMF, and the ECB agreed on a bailout. In retrospect, that didn’t seem to help much. It bought time, but at a high cost (Greece has suffered a lot these last three years, with more to come). Yet, the failure to get the timing right meant there was additional complacency now. “Sure, Greece is in crisis. They’ll work it out somehow. They always do,” the thinking went. And such complacency was richly rewarded in the past – Greek bonds were one of the best investments around in 2013.

Sunday’s referendum in Greece will mark another instance in which economics will grapple with politics. It will be interesting to see which way they go.





| By Alexander Hitch



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