End “Extend and Pretend” With Greece

by Lucrezia Reichlin, Elias Papaioannou, and Richard Portes The authors are professors at London Business School, where they recently organized a high-level workshop on Greece. 15.06.2015
LONDON – Greece needs an agreement now with its creditors (the so-called troika comprising the International Monetary Fund, the European Commission, and the European Central Bank). Yet all parties are pursuing a disastrous “extend-and-pretend” strategy with a narrow focus on fiscal issues and pensions. In fact, rumors are now emerging that the Greek administration and the troika are considering yet another extension of an agreement that was supposed to end last year.

At the core of the Greek crisis are structural problems: a dysfunctional public administration, oligopolistic product markets, ludicrous regulatory burdens, bureaucratic red tape, and an absurdly slow judicial system. Without a clear strategy to address them, any agreement will lack credibility.

But if this is true – and many seem to believe it is – the current strategy is bound to fail for two reasons. First, any comprehensive package of structural reforms can be implemented only if austerity is relaxed. Second, an extension would prolong the sense of uncertainty that has so far jeopardized Greece’s recovery.

A credible commitment by Greece to sound macroeconomic policies requires adjusting the troika’s targets to reflect realities. Current negotiations seem to envisage a modest primary budget surplus of 0.8-1% of GDP for 2015. But the best feasible target would be a tiny symbolic surplus for the primary balance (which excludes interest payments on debt) this year, and a gradual increase thereafter to a realistic 1.5-2% of GDP.

The fact is that, given the liquidity crunch, oligopolistic product markets, and a small export sector, any further austerity will simply drive Greece deeper into recession. By contrast, minimizing the primary-surplus target would encourage the government to pursue structural reforms and help restore Europe’s image for ordinary Greeks, thereby countering the populist, conspiracy-theory arguments that are sabotaging negotiations.

Realism is needed on pensions, too. Early-retirement schemes – one-third of public-sector employees currently retire before the age of 55 – should be targeted immediately. The government should gradually increase the retirement age for new workers, crack down on evasion of social-security contributions, and accept the no-deficit principle for supplementary pension funds.

But economic and social common sense demand that the troika allow a transition phase, because pension cuts will be recessionary. The same holds true for further reforms of the labor market, which has been liberalized significantly in recent years, amid rapidly declining real wages.

What is needed now is a new reform-oriented agreement – one that recognizes the need for measures to be implemented in the right sequence, delaying those that will have a recessionary effect. The agreement’s focus should be the business environment, allowing the forces of creative destruction to lay down the foundation for a sustainable recovery.

The Greek economy needs a reallocation of capital and labor to export-oriented firms and skill-intensive sectors. Government officials should not demonize private enterprise and entrepreneurial activity, nor penalize them with excessive, capricious taxation. Instead, they should focus on the urgent remedies that are needed if sustainable growth is to return.

First, product-market reform cannot be delayed. Lawmakers must, for example, remove the obstacles that deter foreign and domestic investment; open closed professions; remove price caps; and reduce licensing requirements and other anachronistic barriers to firm entry and expansion.

Second, the state’s limited administrative capacity must be improved. At a minimum, civil-service jobs should be detached from political patronage. Mechanisms to improve transparency and accountability should be strengthened – for example, through computerization.

Third, Greece needs a sound and predictable legal system. At the moment, the framework for property rights, investor protection, and corporate governance is extremely weak, and recent legislative measures regarding the personal liability of shareholders in limited liability companies have made things worse.

Fourth, the Greek government should overhaul the judicial process. Courts’ inefficiency protects insiders and impedes entrepreneurship. It also contributes to inequality and fuels Greeks’ belief that the system is unfair – as indeed it is. Rather than taking an incremental approach, the government should launch a “big push.” To clear the system’s massive backlog of cases, the authorities should consider recruiting part-time magistrates and opening courts on weekends and during the summer. Medium-term reforms should include the establishment of specialized courts and the promotion of alternative dispute-resolution mechanisms.

The new government promised a new departure. But so far it has done little, even in high-priority areas (such as tackling fuel smuggling). In fact, many of its policies – most notably, the new education bill – have been regressive. Rather than safeguarding the independence of the Bank of Greece and the National Statistical Agency, the government and affiliated MPs call them into question. Rather than fostering transparency, the government has tried to jeopardize projects like Diavgeia (the website on which all government decisions are supposed to be published). While the government tells the troika that privatization of ports and municipal airports will continue, many cabinet members argue against it.

The current discussions show little will – on either side – to overcome the failures of the past five years. The troika maintains its myopic focus on fiscal austerity; Greece remains reluctant to reform. But now, with the economy in free fall, it should be obvious to both sides that “extend-and-pretend” is no solution at all.

The Greek government must take ownership of a comprehensive reform program, communicate it to the public, and implement it with the support of other pro-European political parties. National unity – at least among pro-European forces – is desperately needed. At the same time, the European Union and the IMF should help Greece to reform its public administration, strengthen the judiciary, break up cartels, and implement product-market reform. If the government embraces this agenda, the troika should reward it with debt relief, both by extending loan maturities and by lowering interest rates.

Copyright: Project Syndicate, 2015.

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