Poor Greece... (Literally)

At last, the outline for the new austerity measures has been agreed with Troika and presented yesterday... Good news for Troika, horrible news for the Greek people. 

Greece's next economic model. So unfortunately true... Source: Wikimedia Commons

With the announcement of the austerity package came the announcement for a 48-hour general strike next week, when the measures are expected to be voted on the Parliament. The total monetary value of the austerity package is expected to be about €13.5 billion, the majority of which (€9.2 billion to be exact) is expected to be implemented in 2013. The package consists of a two-year increase in retirement age (from a current 65), pension cuts and even greater taxation. Greece is now waiting for the additional installment of €31 billion from the IMF and EU, without which the country will run out of money on November 16th.

As for the latest forecasts for Greece's indicators: unemployment will rise to 22.8%, government debt to 189.1% of GDP, deficit will grow from 4.2% to 5.2%, primary surplus of a mere 0.4% and an economic contraction of 4.5%! One cannot help but wonder what the outcome would have been, had the measures been lighter and Greece received the €31 billion installment. I guess things would have been better wouldn't they?

Now, pessimism will prevail in all issues of the economy, uncertainty will rule everyday life and with this, economic activity will take a larger tumble. One cannot understand the rapidity of movements concerning budget cuts. If the country was not already in a recession, then effects would not have been that great and rapid, harsh reforms could have been pushed through faster and will less implications. Yet, this is not the case.

Greece's lenders want their money back. That makes sense, but why do they need it now? When banks invest in government bonds, they either stick to their investment until maturity or try to sell it through the secondary market. It seems like Greece's lenders do not want either of these! Using the same rationale, banks should be allowed to force a man who has a contract for a 20-year housing loan, to repay them in 5 years! Now that seems to be a bit odd doesn't it? They say that markets know better. Well they do, and when a person goes to a bank and says "I cannot pay the remainder of my housing loan with the monthly installment this high" the bank does not force that person to take severe cuts in his life to repay it. Instead it refinances the loan for a longer period of time, with less monthly installments, making them both happier: the person can pay less per month and live better than before, and the bank receives more cumulative interest. 

Truth or Lies? Your choice. Source: Wikimedia Commons

The same idiotic reasoning holds with Schäuble's proposal for an all-powerful Commissioner to have veto rights over countries' national budgets. Really? Then why not have an all-powerful Commissioner to dictate policy in all matters of the EU? Or why not have that Commissioner draft the budgets himself? (for a great discussion on Schäuble's proposal read Protesilaos's article here)

Let's focus again on Greece: rapid solutions, especially in times of recession, cause extreme trouble. The US, after the collapse of Lehman Brothers in 2008 injected 3 Quantitative Easing packages in the economy. And the economy has only now started to grow. In comparison, Greece has only made budget cuts and reforms. I do not know whether the Troika has a "long-run plan" but the "short-term" consequences are horrid. And any recession which is expected to last for 6 years is not "short-term" any more. Remember Keynes: "In the long-run we are all dead"

A €13.5 billion package could have been easily broken up to fit a 3- or 4-year horizon. That way, the consequences from it would have been much softer. What difference does it make to Troika if a pensioner in Greece earns €600 or €700 a month? None. It only cares whether the country can repay its debt and that its lenders do not lose any money. Thus, why not have a longer horizon? If GDP rises, then it would make sense that income from taxes will rise too. Then, the debt-to-GDP ratio would have been lower and the country would be able to continue paying its interest and even imposing more reforms, tax increases or budget cuts GRADUALLY!

I guess the above plan was too difficult for the IMF, EU and EC "experts" to understand. If they can understand this then I would ask the Troika to let us know whether or not they are interested in destroying just specific economies (e.g. Spain, Cyprus, Greece) or the EU in general. Worst of all, the Germans, usually (supposedly?) people with patience and common sense, agree with them.

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Austerity Measures and Reforms in Cyprus

The first thing I read today were the austerity and reforms guideline plans prepared by Troika for the island of Cyprus, which has requested a bail-out in the summer. According to them, the country's fiscal deficit has to be reduced to about 4% of GDP in 2012, 2.5% in 2013 and in the realm of 1% in the next two years. 

Austerity measures for 2012 include:

1. Freezing of the Cost-of-living-adjustment (COLA), extension of the special contribution

2. Freezing of wages and filling of vacancies in the public sector for another 2 years (until 2015). Extend this regulation for all state officials and Members of the Parliament who will now see their allowances taxed (the law for the state officials has already been passed as I have seen)

3. Introduce an immediate early retirement penalty of 6% of the Government Employee Pension Scheme (GEPS)

4. Introduce a permanent contribution towards pension entitlements for all government employees

5. Abolish the 13th salary of the broader public sector employees and state officials, reduce 13th pension by 50% in the 1000-1500 bracket and 75% in the above 1500 bracket.

6. Increases in the excise duties for tobacco, alcoholic drinks, and motor fuel

7. Increase tax on dividends by 1% and to deposits by 0.015%

If one takes a good look in the above measures, the fact is that rough and rapid changes (like the ones in Greece) are proposed. The only measures which would be considered rough would be the abolishment of the 13th salary of all state officials and pensioners. However, we are talking about the 13th salary, an additional one which should not have been calculated in e.g. bank loan repayment installments. Granted, a 13th salary in Cyprus is part of the gross yearly salary and people are taxed on that, however, this is much better than actually reducing the rest 12 wages. As far as dividend tax is concerned, from what I understand, Cyprus has a fixed tax of 20% - which is rather odd since people who are earning 1 million euros a year and 50 euros a years end up paying the same rate. I would like to see the Troikans propose a new dividend tax scheme based on the tax bracket one belongs instead of a fixed rate (that is, for individual dividend-receivers). 

The 2013 cuts will include:

1. Abolishment of obsolete allowances as well as general government wages and salaries with a target reduction of 15% in the government bill (hopefully, they will be wise enough to focus on abolish allowances instead of reducing wages and salaries by 15%)

2. Reduction in social transfers by 10%

3. Reduction in the Easter, Christmas and Dietary allowance as well as abolishing heating allowance

4. Consolidate housing-related schemes

5. Reduce the number of government employees by 250 per year (1250 in total)

6. Reform shift-work system to reduce overtime remunerations by 20% in 2013, an additional 10% in 2014 and keeping the amount paid stable for 2015

Even in 2013, although Cyprus will still be in recession, austerity measures will not be so harsh as they have been anticipated. To compare in 2011 the Cypriot government had taken measures of 500 million euros compared to the 360 million of permanent measures the Troikans ask for 2012. Things will obviously get worse before they get better, however, the measures are much more conservative than those originally expected by the press and public. In addition, these measures were very much needed by the country, but just like any other nation in the world, politicians and policymakers did not want to make any reforms until the final hour. In any case, what I have been saying for over 2 months now, has finally been understood by the Troikans. Harsh and rapid changes are not a good solution for an economy. We have Greece to thank for that lesson (the country has paid a rough price for it though). Cyprus will have a much smoother bail-out period, provided of course that nothing extreme occurs!

Resistance to change: 3 reasons Unions and the Public are unreasonable

One of the usual pieces of news in the EU (especially in the South) is that spokesmen from various trade unions declare that they will not accept/negotiate/give in to the reforms that the Troikans or the nations' governments (or both) are proposing. It is my opinion that in order for the spokesmen/leaders of several organizations to appear powerful, they indulge in a game of what in economics is called an "incredible threats" (an incredible threat is a situation where somebody would threaten to do something that would harm himself as well as the other. Rational people would never choose to propose nor do any of those threats. An example is: a person enters your car and threatens that if you do not give him money he would blow your car with him inside it.) These are the reasons why I consider the aforementioned threats are incredible (or irrational):

1. Neither the Unions nor the Member-States requesting bail-outs are in a proper position to negotiate, since they are not considered credible any more. The lack of credibility derives from the fact that during the crisis their actions had been close to none. The only countries which are currently trying to restore market confidence are Italy and Greece. Only after their creditors are convinced that much has been done by their respective leaders will Italy and Greece (especially the latter) be able to negotiate. That is exactly what the Greek Prime Minister is trying to accomplish at the moment with harsh austerity measures which will allow him to expand the austerity horizon by 1-2 years. One may easily realize that if a national leader is not able to negotiate, the Union leaders or spokesmen have even less ability to do so. (In a similar note, the Cypriot GDP contraction is expected to be 1.5% in 2012 rather than 0.5% as it was originally estimated, another incredible estimate from Cyprus)

2. Not imposing any reforms or other austerity measures is even more irrational than imposing a lot rapidly (e.g. Greece). Blame for the current situation in Greece can only be assigned to the Greek politicians who had been overspending over the last 10-20 years. The political system in Greece was correctly defined as Kleptocracy rather than democracy. Both Italy and Greece are considered more corrupt than all of the other EU nations, where Cyprus, Portugal and Spain are just above average. In order for the crisis-ridden states to move forward and hope for a better future many necessary reforms should take place, notably concerning the public sector size and pay-scale. Reforms should also promote more transparency, so that nations may regain their lost credibility and their people will start believing in them again. (A major issue both in Italy and Greece)

3. Union leaders and others believe that when salaries, wages or benefits decrease, their lives will be more difficult. Although this may be partially true in the short run, (up to 6 months) in the long run, prices will adjust to the lack of liquidity (i.e. money) in the economy and they will subsequently fall. Let's use Greece as an example here: the proposed austerity measures state that the cuts will be 2% for pensions of up to 1,000 euro, 3% for pensions from 1,000 to 1,300 euro, 5% for pensions from 1,300 to 1,600 euro, 10% for pensions from 1,600 to 2,000 euro and 15% for pensions of 2,000 euro and more.  This would mean that all prices in the Greek economy would drop (though not from one moment to another, although much faster than any other other nation), which may even raise the standard of living for the Greeks.

People cannot distinguish between nominal and real income. Neither can economists in their real life. Obviously people would like to see their salaries and benefits rise in perpetuity regardless of prices. However, this is not rational thinking as with a 3% inflation and a 2% rise in wages people would be worst off. This was exactly what had happened over the last few years after the introduction of the Euro in the Southern EU nations. (for more details see here)

Although it may appear to be unthinkable to many, especially those who are -erroneously- relying on the state to cover their expenses, accepting the reforms and  austerity measures will be the only way forward.

Do we need a Crisis?

When people face difficulties, it is always easier to blame someone else for their mishaps. When a nation views its own problems, and as nations are governed by people, it is more than easy to criticize and assign fault to others. The same has happened now, as many Northern Europeans believe that the responsibility for the crisis lies only on the shoulders of Southern Europeans who, "do not work enough".

This, however, couldn't be farther from truth. Although South Europe is portrayed in the media as a place where everyone is constantly partying and nobody is working this seldomly depicts real life in the South. Germany on the other hand has the reputation of being a hard-working country. Still, German working hours are amongst the lowest in the world. So is France's. Look at the following chart comparing work hours in the OECD countries:

So what happens here? Are the poor Greeks and Italians working hard the whole time but the bad Germans take the GDP from their hands? In all fairness, no. It seems that although South Europeans are working many hours, what they lack is productivity. A quick glance in Wikipedia may help: Italy, Greece and Cyprus have below average productivity. Specifically, in the case of Cyprus and Portugal, their productivity is much lower than the EU average.

The only difference, is mentality. While Germans and French work less, their time put to better use and thus their productivity is greater. On the other hand, whilst Greeks, Italians, Cypriots and Portuguese work many hours, they do not do much in that time. The big question here is why? Is it just that they sit around and do nothing all day? I hardly think so (although many civil servants in the South are accused of doing so). The problem here lies in the heavily bureaucratic systems, with many anachronistic rules, laws and perceptions. The legal systems in Cyprus, Greece, and Italy were graded by Moody's as some of the worst in the EU, whilst Portugal's was merely average. Spain's on the other hand was very good.

This is why the South is in need of a crisis. A change in mentality and institutions is essential. Greece has only begun to realize these changes and the effect is disastrous. People are never ready to rapidly move from one mentality to another as this would mean a change of the world they live in. In the words of Olli Rehn: "And even in Greece, more has been achieved than is often realized."

This is one reason I state that change should be slower than it is now. Humans do not enjoy change. The labor force has been shown to be more resistant to change than anything else, surprisingly more than capital! (By capital one means things like machinery, plant and equipment). This reminds me the frog anecdote: If a frog is put in hot water then the frog jumps right out. If the frog is put in cold water and the water is heated slowly until it reaches the same temperature as the hot water from before, then the frog stays in and gets boiled.

The case is the same with measures: Move too rapidly and people will revolt. Take change slowly, allow people to adjust to it and you will have much better results. If you don't trust me just take a look at Greece nowadays!