Greece: The Cyclical, the Structural and the IMF

In my last post, I outlined the IMF’s abysmal track record in charting Greece’s GDP growth path. The IMF’s initial Stand-By Arrangement (SBA) programme was expected to produce a single-digit dip in GDP followed by a rapid recovering. In reality, GDP has crashed by over 20% and we see no sign yet of any expansion.

In the Fund’s May 2013 “Greece: Ex Post Evaluation” publication, the IMF admitted some failings in its growth forecasting and its assessment of what would drive the recovery:

Competitiveness improved somewhat on the back of falling wages, but structural reforms stalled and productivity gains proved elusive.

Note that economic recoveries from recessions usually have two components: 1) the gradual removal of the gap between potential output and actual output as idle capital and labour is gradually put back to work, and 2) a pick up from long-term structural productivity gains as new technology becomes available. The former can be thought of as a short-term cyclical component of growth and the latter as a long-term structural component of growth.

The IMF’s biggest forecasting mistake was with respect to Greece’s true potential GDP. In short, as we headed into the Great Recession, Greece was probably in the situation of having actual GDP far in excess of potential GDP. Accordingly, the IMF expected the economy to rebound to an equilibrium that just did not exist. How could this be?

First, through the auspices of the euro, Greece had the wrong interest rate (the euro-wide interest rate) for its given level of risk. Thus, we had a plethora of GDP-enhancing mal-investment. Now this situation was not unique to Greece. The securitisation revolution and easy-money policies of the Greenspan Fed had led to the mispricing of risk globally (a Minsky moment in the academic literature). So Greece’s situation was one of “malinvestment-squared”: a global phenomenon laid on top of euro-orchestrated one.

You could even call the phenomenon “mal-investment cubed” since as well as the wrong exchange rate and wrong interest rate, Greece also had an influx of EU-financed  structural funds that according to the European Commission averaged 1.22% per annum between 2000 and 2009.

On my recent visit to Greece, I had the opportunity to visit the island of Samos, whose main town of Vathy hosts the main local government administrative centres for a district encompassing the islands of Samos, Ikaria and Fournoi Korseon — a region of around 40,000 people. Apart from the major’s office, I also visited the entity responsible for the oversight of European infrastructure fund projects. The head of the operation lamented over the loss of 10 employees over the last year (through retirement) who would not be replaced because of the austerity cuts, on top of the slashing of salaries by 30-40%. Nonetheless, his roster of employees still included 20 civil engineers, 20 agriculturalists, 3 chemists, 5 healthcare-related workers including a doctor, 4 economists and a raft of support staff to make a grand total of 120.

The projects his team supervised were substantial, including a road-building program, three new ports, a new museum and the renovation of a 6th century BC aqueduct, all of which required funds of over €5 million a piece. In my mind, the largesse appeared stunning for a population of only 40,000. Indeed, on my trip to Greece, I was continuously surprised by the quality of infrastructure—whether roads, airports or Athens subway (far better than what I was used to in the UK)—juxtaposed against a working population struggling to make ends meet.

If this weren’t bad enough, I would argue that much of this ‘bubble’ growth has actually helped destroy the potential for long-term productivity gains. Traditional Greek industries of agriculture, tourism and shipping services were being hollowed out and down-sized as workers switched into the hot areas of mal-investment. The bubble industries of real estate, construction and finance were sucking in capital and labour resources that rendered the old economy industries uncompetitive at best and obsolete at worst.

However, let us put to one side the fact that the IMF initially predicted a 2%-3% GDP decline and in fact has witnessed a 20% and counting decline. Are its policies putting in place the foundations for long-term growth?

Niall Ferguson in his new book “The Great Degeneration” follows in the footsteps of economists like Hernando de Soto in emphasising institutions as the key determinants of long-term growth, particularly the institutions that support democracy, capitalism, the rule of law and civil society. The Troika have concentrated much of their efforts on reforming these institutions.

As an example, property rights are considered to be a bed rock of both capitalism and the rule of law in the West. Yet in Greece, no land registry existed in the past, a problem the EU identified long ago and has been trying to address for decades. Nonetheless, The New York Times recently published an article on Greece’s land registry that suggested it will take many years before the problem could be resolved:

Greece’s creditors — the European Commission, the International Monetary Fund and the European Central Bank — have made it clear that they want the development of a land registry and a zoning map, called a cadastre, sped up. International experts have been visiting Greece in the past year, offering advice.

They concluded that the most recent setbacks stemmed from a very poor tendering process, which resulted in expensive and inefficient contracts. Julius Ernst, one of the experts from Austria who participated in a fact-finding mission, said the government had not been clear enough in defining what it wanted done and how. “There has been a lot of money spent, and no one knows where it went,” Mr. Ernst said.

The goal now is to finish by 2020, though Greek officials call this optimistic. In the end, they said, Greece will probably spend $1.5 billion straightening things out.

An example of the land registry issue was presented to me in my own trip to Greece, again on the island of Samos. An overseas investor had taken two years to get approval for the island’s largest ever inward investment, amounting to over €40 million euro, to build a tourist resort. Despite having the necessary seals from both local and central government, the project was challenged at the last minute by a neighbour on the grounds that it infringed on designated forest land. After becoming mired in Greece’s court system, the investor is now close to pulling out. The challenge may or may not be legitimate, but the investor can feel aggrieved that there is no infrastructure in Greece in place to identify legal property-right risks at an early stage, particularly as all the official government application procedures were followed.

From a bigger picture perspective, the IMF should certainly not be surprised that such long-term problems as Greece’s land registry still require a lot of time to resolve. They are not, by definition, easy wins in terms of productivity gains and they will not support Greek GDP growth any time soon.

The same could be said for tax reform, which has been a key requirement of the IMF and its Troika partners’ programme. Is tax reform working and helping to underpin future growth? I will come back to this question in a separate post.

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