Greeks bearing economic burdens

By Kerin Hope in Athens and Ralph Atkins in Frankfurt

Sotiria rarely complains about her workload. At the office where the Greek public sector employee aged in her forties records value added tax payments, supervisors take a relaxed view of breaks for coffee and shopping, she says. If a family member falls sick, she stays home. “I don’t feel bad, because there are always plenty of other people around to cover for me,” she says. “Nobody here has too much to do.”

Stories of such insouciance in Greece’s bloated state sector are creating alarm across Europe. As the Continent emerges from the worst recession since the 1930s, the precarious and unsustainable state of Greek public finances is threatening a fresh crisis for the region’s 11-year-old monetary union.

Last week, the difference between the interest rates on Greek and German government bonds soared to a seven-month high as financial markets fretted about the possibility of default and the stability of Greece’s banks. If European Union leaders thought they had navigated the storms of the past two years, they could yet be proved wrong.

The EU helped shore up Latvia, Romania and Hungary. But unlike those countries, Greece is a member of the eurozone, Europe’s most successful experiment in financial integration. And for all its treaties, there are no clear rules on how to react. “The EU has elaborate crisis prevention measures; it doesn’t have a crisis management apparatus,” says Jean Pisani-Ferry from the Brussels-based Bruegel think-tank.

But the increasing frustration in Brussels, other capitals and at the European Central Bank in Frankfurt suggests at least a few policymakers might favour throwing the book at Greece. “This is a game of chicken and we don’t know who will lose their nerve first,” says Daniel Gros of the Centre for European Policy Studies, another Brussels research institute.



Is Greece really heading for nemesis? Around the world, governments abandoned fiscal restraint to combat crisis. But elsewhere, for instance in Ireland, governments are now acting to bring budgets back under control. Greece’s crisis has taken on a different dimension, largely because of the behaviour of the Athens government.

Most blatantly, Greece misled the world about the acuteness of its fiscal plight. Back in March, the situation looked bad – but manageable. The European Commission forecast that the Greek public sector deficit this year would be above the 3 per cent limit set under EU rules and “exceed 4 per cent in 2010”. At the time, officials were concerned the actual numbers would be higher. Nobody, however, was prepared for the shock unveiled by the Socialist government elected in October. Statistical revisions showed the public finances so much worse that the Commission changed its projections to a deficit of 12.7 per cent this year and 12.2 per cent in 2010.

Worries have been compounded by the new government’s apparent dithering. Brussels wants George Papaconstantinou, finance minister, to rewrite his 2010 budget, which relies heavily on curbing tax evasion rather than cutting spending. In a letter to the Financial Times published on Wednesday, he said Athens was “fully committed to . . . the necessary steps to restore our credibility and finances”. But his claims that a tax crackdown on wealthy Greeks will be decisive in cutting the deficit next year to 9.1 per cent ring hollow with many – especially as his new revenue collection team has yet to be appointed.

Last December, youth discontent fuelled by the economic situation led to rioting in Athens – and the Socialists are reluctant to reverse a campaign pledge to protect incomes and boost welfare payments.

Moreover, Greece’s economy looked sickly before the events of the past few weeks. Prior to the global slowdown, the country was growing at annual rates of 4 per cent or more, with consumption boosted by the low interest rates it enjoyed as a eurozone member. But Europe’s recession has exposed a massive loss of competitiveness. Unit labour costs have soared more than 40 per cent since Greece joined the eurozone in 2001, while in Germany they remained almost constant before edging up this year.

On almost every measure, Greeks have been living beyond their means. The current account deficit reached almost 15 per cent of gross domestic product last year, making the US deficit of 5 per cent look modest. External public debt now exceeds GDP.

With hindsight, it is clear that a lax fiscal policy was also pumping up an economy based largely on just two sectors – shipping and tourism. Now, “Greece’s mix of problems is unique in the eurozone – a large budget deficit, rising debt and an unsustainable pension system”, says George Pagoulatos, a professor at Athens Economics University.

Since joining the euro, Greece has regularly flouted the deficit and debt limits set in the zone’s “stability and growth pact” that is meant to correct for the lack of a single eurozone fiscal authority. Scant progress has been made in reforming the country’s public sector, which added 50,000 mostly low-skilled employees in 2004-09.

Public sector wages are again set to rise, by 5-7 per cent in 2010. “Wage cuts may not be needed, because the economy isn’t projected to shrink significantly next year, but there should be an immediate freeze on salaries and recruitment,” says Yiannis Stournaras, a former chief economic adviser at the finance ministry and now a professor at Athens University.

On pensions, expected big increases in expenditure relative to the size of its economy make Greece more vulnerable than other EU countries to an ageing population. “It’s the largest of the fiscal imbalances and the system will become unsustainable within a decade,” says Mr Stournaras.

Athens is launching a “dialogue” with trade unions on reducing the number of state pension funds from 13 to three and implementing a long-postponed plan to raise the retirement age for women to an equalised 65. The unions foiled previous pension reform efforts and are gearing up for strikes and street protests. “We’re going to war with the government,” says Aleka Papariga, leader of the still influential Greek Communist party.

What will happen next? European finance ministers on Wednesday issued a fresh reprimand to Greece, pressing ahead with a process that could lead to financial sanctions. One possibility would be for the Commission to withhold “cohesion funds” meant to help Greece catch up with richer countries.

Leaving the eurozone is not an option for Athens: the cost of servicing foreign debt would simply escalate. Beyond that, Greece’s fate will depend on the reaction in the markets and actions taken by Athens.

Nor is timing on its side. The eurozone has a “no bail-out” clause, which prevents collective liability for debts incurred by a member. In February – when the crisis was at its most intense – Peer Steinbrück, then Germany’s finance minister, admitted that in the worst case “we would have to take action”. That eased pressure on the weakest members, including Ireland. But Mr Steinbrück has since been replaced and his promise now carries little weight; in the eyes of conservative European policymakers, it increased the risk of “moral hazard” – rewarding bad behaviour.

“It is one thing if you are in the middle of a systemic crisis. Then you can’t allow anyone to fail and don’t worry about moral hazard,” says Mr Gros at Ceps in Brussels. “Now we are out of the woods and it may be a good time to reduce moral hazard.” In a research note last week, Deutsche Bank economists wrote that Greece’s continuing violation of the rules “may have changed the minds of EU authorities ... We believe that they may have to set an example for other countries in trouble”.

If the cost of servicing debt rose too high, Greece could have to turn to the International Monetary Fund. The rigorous conditionality attached to help given by the Fund could provide a framework to implement reform – and allow the government to deflect the responsibility for harsh but necessary measures.

But Mr Papaconstantinou says it is “out of the question” that Athens would turn to the IMF. “The new government is determined to put the economy back on a path of fiscal sustainability in the context of the EU rules.”

Greece’s small size – it accounts for less than 3 per cent of eurozone GDP – plays to its disadvantage. The Deutsche Bank note argues that the EU could ring-fence Greek debt, using a special fund to reduce the impact of a default beyond its borders.

Still, that is a scenario that EU policymakers would rather not contemplate. Even if containable, a Greek default would send worrying signals about the resilience of monetary union. Instead, the hope is that the markets force Athens to bring public finances under control. The stability pact is still regarded as “an anchor for policymakers”, says Erik Nielsen, economist at Goldman Sachs.

A comfort for EU authorities is that investors’ increased risk awareness means they are – at last – imposing discipline on governments. Prior to the economic crisis, Greece escaped punishment from financial markets. That is no longer the case. It may not be too long before even bored Greek public sector employees notice.

Copyright The Financial Times Limited 2009.