In Greece, UnLuCky for some: Another painful lesson from the euro crisis


First, the International Monetary Fund’s chief economist Olivier Blanchard, a highly respected figure, confessed in early 2013 that the fiscal multipliers used in the design of the Greek programme were off by a wide margin. As a result, the austerity being applied was inflicting three times the damage on the economy and employment than had been thought initially. When this was combined with the fact that the programme was designed not based on what funds Greece needed for a smooth transition period but on how much “generosity” was available from the eurozone, it led to the country losing a quarter of its economy on the troika’s watch.

A few months after Blanchard’s admission, the IMF issued its evaluation of Greece’s first programme. This opened a new can of worms. Without pulling any punches, the report threw all the dirty water – as Olli Rehn put it – on the European Commission, highlighting that it did not have a clue about how to handle the crisis. The IMF argued in the report that debt should have been restructured up front. Instead, Greece’s first programme worked as a holding operation that allowed defences to be built to stop the eurozone suffering from contagion. By protecting and giving a way out to fragile French and German banks, the burden was shifted from irresponsible lenders to eurozone nations and taxpayers.

Now, an IMF paper published this week delivers the final blow to what the troika defined as the foundation of Greece’s programme – the “correction of external imbalances and restoration of competitiveness.” It says:

“The large current account deficits in Greece, Ireland, Portugal, and Spain have shrunk drastically or turned into surpluses largely because imports and potential growth have slowed down drastically relative to pre-crisis trends.”

“Their NFLs (net foreign liabilities) remain very high (implying higher net income payments), and the progress with external rebalancing has come at the expense of internal balance, notably sharply higher unemployment rates.”

Design flaws

If you are a euro crisis season ticket holder you must have heard regularly that countries built imbalances during the first decade of the euro and they now have to go through the painful process of restoring balance, reducing current account deficits and regaining the competitiveness lost through wage inflation in excess of productivity gains.

The IMF paper provides a refresher for everyone concerned as it reminds those who created the euro that they were promoting it on the basis that balance of payments constraints would disappear at the national level and that capital flows would lead to a convergence of income levels within the euro area. Current account deficits, real effective exchange rate appreciations and higher inflation between periphery and core would be healthy by-products, they claimed.

The euro’s nemesis would lie right within this sales pitch: When the crisis stuck and there was a classic case of a sudden stop of capital flows, just as in any emerging markets crisis in the past, the oversights during the years of bliss came to the fore and there was a realization that weak counties were exposed because they had a currency they did not control. The euro’s problems suddenly became national rather than common.

Until that moment, the deterioration of Greece’s current account was considered part of the desired effect of euro convergence. When things started to unravel, though, critics started to line up to punish the Greeks. To make matters worse, when the architects of the single currency came to fix what had gone wrong they produced another mistaken diagnosis. As a result, 18 percent of Greece’s economy evaporated between 2011 and 2013, while 15 percentage points were added to the unemployment rate.

After deciding that current accounts do matter after all, one of the troika’s main objectives became to improve Greece’s competitiveness and close the current account gap, which stood at 15 percent of GDP at the start of the crisis. The term Unit Labour Cost became sacred. The sure way to achieve the desired effect is by depressing domestic demand via pressure on disposable income, reducing imports, improving the trade balance. Since there is no one to finance your excess imports you keep turning the screw until it is your exports that finance your imports and your trade is balanced.

Disposable incomes were depressed in a number of ways at the start of the Greek programme. Tax increases and higher unemployment gave rise to informal wage reductions and more flexible forms of employment until the troika decided as part of the second programme to speed up the process further by reducing the minimum wage by over 20 percent. This led to all the collective wage agreements in various sectors that were based on the minimum wage also being renegotiated downwards.


*Read the entire article at MacroPolis.


About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.

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