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Wednesday, August 22, 2018

"The Rescue Is Over" - Reviewing 7 Years Of Blogging








Around that time, I read an analysis of Greece's economic situation by a reputable international institution. Regrettably, I did not keep it and I don't remember the name of the institution. The gist of the analysis was that Greece would probably remain unharmed by the financial crisis because its banks were not involved in international speculation. If anything, Greece had a good chance of coming out of it as a winner.

Upon returning to Munich later in the spring of 2009, I happened to attend a presentation by the well-known economist Michael Huether. He was talking about the financial crisis in Eastern Europe and how the banks had to put together a rescue package. And then he said: "Mind you, before the crisis is over, we will also have to put together a rescue package for Southern Europe." I thought the man was dreaming. A rescue package for Greece? Didn't he know that Greece was a booming place and that analysts predicted a glorious future for the economy?

Around that time, I happened to read "The Battle of Bretton Woods" by Benn Steil. It was the battle between the British John Maynard Keynes and the American Harry White. Keynes had one predominant objective: to assure that the new monetary order would control imbalances in the current accounts. He proposed a new reference currency ("Bancor") in which surpluses/deficits would be settled. Over a certain level, a surplus country would have to pay into the Bancor and the deficit countries would receive them. A perfect recycling mechanism. Keynes' counterpart White also had a predominant objective and it was diametrically opposed to that of Keynes: to establish the predominance of the USD in the new monetary order. The dollar would be fixed against gold and the other currencies would be kept in a trading range versus the USD. Responsible conduct of the US would assure that world-wide imbalances would he held in check. White prevailed.


I came away from reading that book with the conviction that the most important factor in international financial stability was a country's current account, that it was a country's balance of payments that had to be checked, and that conviction shaped almost everything which I would write about Greece's financial crisis later.



The most important factor for the success of the Chicago Boys was that they had a plan and consistently and unwaveringly pursued it. It was nothing but applied common sense: increase exports, reduce imports, apply efficiency criteria to the huge public sector, create market conditions for the private sector and create an economic framework which would attract foreign capital. The Chicago Boys committed one major mistake which eventually caused their downfall and the external payments crisis of the early 1980s: they fixed the exchange rate to the USD 'forever'. With Chilean interest rates much higher than USD interest rates and with no perceived foreign exchange risk, foreign capital flowed into Chile like there was no tomorrow. When the bubble exploded, the Chileans eliminated the fixed exchange rate and the economy stabilized relatively quickly. Chile's luck was that they had only fixed the exchange rate instead of joining a currency union with the USD. The rest of the model of the Chicago Boys remained in place, resulting in Chile's becoming one of the most successful economies in Latin America to this day.

Later in the 1980s, I was transferred to Argentina where my bank was one of the largest foreign creditors of the country. In 1983, Argentina hit the then largest external financing crisis ever with American banks being by far the largest creditors. It was the American Citibank which headed up the crisis management. Its principal negotiator, Bill Rhodes, literally personally developed the model for handling Argentina's external financing crisis, a model which became the standard for handling the dozens of external financing crises throughout the world since then. Its components, again, were quite simple: negotiations had to be carried out directly between Argentina and its private creditors; official institutions (the Fed, the US government) only quarterbacked behind the scenes; private creditors had to maintain their Argentine exposures, i. e. loans and trade credit ("risk takers must remain risk carriers"); and the IMF assumed responsibility for providing fresh money and negotiating economic measures ("memorandum") with the Argentine government. The banks agreed subject to the involvement of the IMF, the IMF committed subject to the agreement of the banks. The mutual dependency between private creditors and the IMF was born. No bank was bailed out. Instead, their benefit was that they could keep their existing exposures on performing status instead of having to write them down.


By early 2010, I was baffled with the events unfolding in the Eurozone. Instead of consulting experts, Angela Merkel consulted with the CEO of one of Greece's largest creditors, Joseph Ackermann of Deutsche Bank! Ackermann, as his job required, defended the interests of his institution and argued with Merkel that not only the Euro and the Eurozone but the entire world-wide financial system would fall into chaos if Greece were not bailed out. At the peak of those dramatic developments, Merkel coined a phrase which may go down into history as the most expensive phrase ever: "If Greece falls, the Euro falls and if the Euro falls, the EU will fall!" That misinterpretation was the source of every other problem which followed subsequently.





As I studied the first memorandum, I couldn't help to think that it was a bookkeeper's approach to solving financial problems: increase tax revenues and cut costs. What I was looking for was a long-term economic development plan à la Chile which would aim to drastically restructure the Greek economy so that it could stand on its own without funding/subsidies from abroad. A plan which would have a 10-20 years time frame. In the first month of this blog I proposed such a plan. To summarize the content: "If Greece cannot make it with the Euro but if a Grexit is the worst of all evils, Greece should hold on to the Euro but temporarily simulate a situation as though it had returned to the Drachma: import controls and substitution with the focus on 'infant industry protection and development'; export promotion; attraction of foreign investment AND, finally, a shock treatment for the public sector. Instead of attempting to change the entire economy at once, Special Economic Zones should be established where the new economic framework could be gradually spread through the country." I later referred to it as the "4 obsessions" which would have to be fostered throughout the Greek economy and population: an obsession with import substitution, with exports, with attracting foreign investment and with making the public sector efficient. To this date, I have not seen such a plan.

Soon after I started this blog, I became aware of Yanis Varoufakis and his blog and other publications. His 'Modest Proposal' had caught my attention because it was a most ingenius proposal to solve the Eurozone's problems. It was certainly better than everything I had heard from EU elites on the subject. The only problem I had with it was that it was a solution for the Eurozone's problems and not a solution for Greece's problems. My dialogue with Varoufakis began at that time. It continued throughout the years and became extremely intensive in the weeks prior to the election of January 2015. Only a few weeks after his appointment as Finance Minister and after observing his conduct on the international scene, I discontinued the contact.

My early critique of Varoufakis was as follows: "Why do you use all your intellectual brilliance, your competency, your eloquence and your charisma to solve other people's problems (i. e. the Eurozone's problems) and don't focus at all on solutions for the problems which Greece could provide on its own?" Varoufakis' standard reply was that, during the American depression in the 1930s, there was nothing which the state of Ohio could have done on its own because it was a systemic crisis. My standard answer was: as long as Greece ranked as the least attractive country for doing business in the entire EU (World Bank) and as the most corrupt country (Transparency International), there is no one other than Greeks who can solve these two problems.


Two things happened in the fall of 2011 which enormously encouraged my optimistic thinking: the EU Task Force for Greece (TFGR) was established and the Athens office of McKinsey published its economic plan titled "Greece 10 Years Ahead". McKinsey proposed how 500.000 new jobs could be created over a period of 10 years and 50 BEUR added to Greece's GDP and the TFGR proposed "to be at the disposal of the Greek authorities as they seek to build a modern and prosperous Greece: a Greece characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos."



When Papandreou surprised the EU by announcing a referendum, I thought that this was an ingenius plot. Obviously, not to really hold a referendum but only to use it as a negotiating instrument versus the EU. I expected the Nice conference to become a showdown: when the French President lost his nerve, exploded and pounded the table, I expected Papandreou to remain quite relaxed and say to the President: "Look, there is no reason to get so excited; there is an easy way out. All I ask is that you do this and that for Greece and I will call off the referendum. Otherwise, the will of the Greek population will count and I am afraid you may not like the result." Given that discussions had already been in the 3-digit billion Euro sphere, a demand for, say, 10-20 BEUR in the form of additional investments in Greece's private sector would have been like the icing on the cake, a satisfactory 'this and that'.




In his book "The 13th Labor of Hercules", Yiannis Palaiologos gives an account of the reckless mismanagement referred to above. In essence, PASOK managed to change Greece's political and economic climate in only a few years: a bloated welfare state with stifling interventions and overregulation; welfare populism, cronyism, statism, nepotism, protectionism and paternalism. And worst of all, the opposition, Nea Demokratia, when in power, did its best to copy PASOK instead of correcting their policies. There no longer were checks and balances. Aristides Hatzis described this as follows: "Today's result is the outcome of a disastrous competition between the parties to offer patronage, welfare populism and predatory statism to their constituencies." The responsibility can be assigned equally to both parties: if it was PASOK who initially embarked Greece on this disastrous path, the last chapter in the story "how to ruin a country" was provided by ND when, during their term from 2004-09, they drove the public sector out of control.



The economic crisis turned into a financial crisis during 2008. The sub-prime crisis had made lenders very risk-aware and cautious and many of Greece's lenders, previously unanimously enthusiastic, had begun looking more carefully at Greece's numbers. New lending to the Greek banking sector dried out and some existing loans were called back. This is evidenced by the rise in Greece's Target2 liabilities which began during 2008 (before then, Greece's Target2 was rather balanced). In 2009, the outflow of capital accelerated and once the new PASOK government revealed the true dimensions of Greece's deficits, 'sudden stop' was only a natural consequence. I once read an analysis which pointed out that there have been about 70 'sudden stops' world-wide since 1945. As a result, there was nothing new or unusual about Greece's 'sudden stop'. What was new about Greece's 'sudden stop' was the inadequate, if not irresponsible, EU's handling of it. Any 'sudden stop' triggers a major domestic crisis, particularly when an economy has become totally dependent on foreign capital. Thus, the question is not whether the suffering of the Greek population could have been avoided. Instead, the questions are: Could the suffering have been less? Could it have been for a shorter period of time? And, above all, did the suffering serve any constructive long-term purpose?

Anyone who argues that the post-2010 rescue programs intended 'to save Greece' is disavowing reality. As long as the mantra was "If Greece falls, the Euro falls and if the Euro falls, the EU will fall!", the obvious conclusion is that the purpose of the post-2010 rescue was to save the Euro and the EU. The only thing that Greece was saved from was a default on its external liabilities, something which doomsayers dramatically referred to as 'the bankruptcy of Greece'. The Chief Economist of Citibank reacted to this as follows: "What the Europeans did not know was that sovereign defaults have been the most ordinary thing in the world of finance in recent decades." When the threat of a default appears on the horizon (or when it has already occurred), countries - like private or corporate borrowers - need to sit down with their creditors to discuss a restructuring of the debt. Never before in the history of finance have private lenders been let so easily off the hook as in the case of Greece!

Only self-centered dreamers can have the nerve to call a rescue program which still leaves the country in shambles after 8 years a success. "Never let a serious crisis go to waste", the saying goes. The Greek crisis went to waste. No Greek parent can tell his children that "yes, we really had to suffer for a long time but we did it for you because you now live in a better country!" What went wrong?

It is much easier to identify responsibility for the failure on the Greek side instead of elsewhere. Yes, 'ALL Greeks had eaten the lunch', as a Greek politician once said, and, therefore, all Greeks should now pay for it. Yes, the Greek side never left the impression that it assumed ownership of the problem but always left the impression that reforms were undertaken only unwillingly, only under severe pressure from the Troika and then only haphazardly. Yes, the Greek side always focused on the victim's role and sought to put blame elsewhere. Etc., etc.


Looking back, I would argue that the resource allocation over the last 8 years was at best 10% for assisting Greece "to build a modern and prosperous Greece: a Greece characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos" and at least 90% for debt issues. What if it had been the other way around? A debt problem, however large, can be solved by a group of people in a conference room as long as they agree. To 'build a modern and prosperous Greece: a Greece characterized by economic opportunity and social equity, and served by an efficient administration with a strong public service ethos' is a project for a generation and it requires the best brains not only of Greece but of the EU in general.







With that kind of an offer of 'help for Greece', the EU would have acquired a legitimate claim to put 'demands' to Greece in exchange. Those 'demands' would have consisted of the standard measures of a memorandum, albeit it in a more intelligent way than it was done. But most importantly, the 'demands' would have had to address the 'hot potatoes' of the Greek public and private sector, all those structural weaknesses that everyone knows of but no one dares to touch. Above all, the 'demands' would have had to assure that the 20 BEUR for growth measures would not go to waste.


Well, it's like the above mentioned conversation with Joseph Ackermann: "We offer you help but it's up to you to accept it. If you don't accept it, you have to live with the consequences!"




PS: reviewing what I have written above at great length, the thought comes to mind that I have said everything there is to say and that, perhaps, this is a good time to close this blog. I will ponder this.

Friday, August 17, 2018

Long-Run GDP Growth Prospects Are Poor

Last month, the IMF pubslished its 2018 Article IV Report on Greece and it was widely commented in the media. I have now read the full 80+ pages and can only recommend others to read the full report. It can be found under this link (under the caption Electronic Access, click on Free Full Text).

I focus here on Annex VI about Greece’s Long-Term Growth Potential and I reproduce it below. A summery statement would be: "Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades. Labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output). Long-run GDP growth prospects are thus poor, absent a major change in policies. Structural reforms to raise TFP growth and employment are therefore the only option to achieve higher long-term output growth."

Below is the Annex VI about Greece's Long-Term Growth Potential.

1. Greece is set to experience dramatic population aging over the next several decades. In its 2018 Aging Report, the EC projects Greece’s working age population to fall by about 35 percent between 2020 and 2060 due to a shrinking and rapidly aging population. This is among the largest such declines in the Euro Area, and three times the average fall for the Euro Area. Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades.

2. Greece’s productivity growth has historically been poor. Greece’s underperformance relative to peers is often associated with relatively low openness of the economy and a high share of labor allocated to non-tradable sectors. Total factor productivity (TFP) growth over the last 47 years averaged just ¼ percent annually, by far the lowest in the Euro Area. Assuming this historical average TFP growth rate going forward, labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output).

3. A pickup in investment could provide a short-run boost to growth, but productivity and demographics will dominate in the longer run. Investment is bound to recover from its highly depressed level once Greece emerges from the crisis, but the growth effect of this will wane once the capital stock returns to its long-run level. Staff’s medium-term projections already assume a temporary boost to GDP growth from higher investment (with real GDP growth rates averaging close to 2 percent during the investment recovery). Once the transition to the new, higher capital ratio is completed, however, the impact of increased investment will fade and growth dynamics will be determined by the evolution of output per worker and of the number of workers.

4. Long-run GDP growth prospects are thus poor, absent a major change in policies. As a starting point, combining the historical growth in output per worker of 0.4 percent with expected growth in the number of workers of -1.1 percent would imply long-term annual growth of -0.7 percent. This simple result is broadly similar to other recent findings in the literature, which estimate Greece’s baseline growth rate (before the effect of reforms) at -0.4 percent during 2024–2043.

5. Structural reforms to raise TFP growth and employment are therefore the only option to achieve higher long-term output growth. Estimating the gains from structural reforms is technically difficult, and results are necessarily imprecise. The empirical evidence suggests that the GDP growth gains from reforms are somewhat modest and transitory: while studies have documented an impact on output levels of 3 to 13 percent over the initial decade, the impact of reforms on growth tends to fizzle out afterwards.

 • The 2016 WEO estimates the GDP level gain from past episodes of product market deregulation in 26 advanced economies over 1970–2013 at about 3 percent on average, with gains accruing over a period of eight years, suggesting a GDP growth gain of about 0.4 percentage points per year during the eight-year period.
• Adhikari et al. (2016) looks at case studies of major past reformers in both labor and product markets—Australia, Denmark, Ireland, Netherlands, and New Zealand in the 1990s, Germany in the 2000s—and finds that the GDP effect of reforms ranged between 0 and 34 percent over a period of 5 years. Excluding Ireland, which is a clear outlier, the average impact was 0.6 percentage points per year over the five-year period, and in two out of six cases, there were no significant gains. Permanently raising growth would require a period of reform implementation that exceeds in both ambition and duration what Greece has achieved so far. While Greece has initiated numerous structural reforms in the context of its adjustment programs—from labor markets to energy, judicial reforms, closed professions, and others—implementation has sometimes lagged. The country’s key accomplishment has been a cornerstone labor market reform adopted in 2011, but this is set to be partially reversed after the current program. Other legislated reforms have faltered at the implementation stage. For example, numerous attempts at privatizing state monopolies in the energy sector are yet to reduce significantly the state’s share in this sector; judicial reforms have been slow moving, with continued high court backlogs; reforms to liberalize close professions have fall short from expectations in terms of both pace and scope; and; the investment licensing reform, which started in 2011, is still not fully completed. Given demographics, the impact of structural reforms will need to be substantial to achieve an overall long-term GDP growth rate of 1 percent over the next half century. Lifting long-term growth from its baseline of –0.7 percent to 1 percent requires reforms to add 1.7 percentage points to growth per year for the next decades. The OECD (2016) estimates that full implementation of a broad menu of structural reforms could raise Greece’s output by about 7.8 percent over a 10-year horizon, which translates into an increase in annual growth of some 0.8 percentage points for about a decade. Bourles et al. (2013) estimate this gain to be slightly higher, at about 0.9 percentage points per year, while Daude (2016) finds that reforms focused on product markets and improving the business environment in Greece could boost growth by about 1.3 percentage points per year for a decade.

9. In conclusion, achieving staff’s assumption of 1 percent growth in the face of adverse demographics and historically weak productivity growth will require that the Greek authorities and people commit to an extended period of profound structural reform. Implicitly, the 1 percent growth projection presumes that Greece would manage to increase labor force participation to levels that exceed the Euro Area average (to offset the significant projected decline in Greece’s working age population) and that would generate TFP growth rates permanently far above Greece’s historical average. This underscores the importance of rapid and decisive action on the part of the authorities to tackle the many bottlenecks that constrain growth and limit the country’s ability to prosper in the Euro Area.