Prof. Louka T. Katseli Chair, National Bank of Greece (Cyprus)

Lessons from the Greek Crisis Prof. Louka T. Katseli Chair, National Bank of Greece (Cyprus) Ioannina Meeting on Applied Economics & Finance (IMAEF) Thursday June 21st, 2018 Corfu 1

Five lessons • 1. In a small open economy, growing twin deficits • enhance vulnerability and generate debt unsustainability. • 2. Aggressive front-loaded restrictive policies can erode the sustainability of public finances. 3. The choice and sequencing of accompanying “structural reforms” is critical. • 4. Upholding policy coherence and an effective social protection • system is a prerequisite for sustainable public finances. • 5. European institutions and policies need revamping.

1. In a small open economy, growing twin deficits enhance vulnerability and generate debt unsustainability • Despite high growth rates in the 1980s and 1990s, Greece faced a serious competitiveness gap. Competitiveness gap of the Greek economy by year (%), 1995-2009 Source: European Economy, 192/2014

1. In a small open economy, growing twin deficits enhance vulnerability and generate debt unsustainability • Budget and current account deficits (twin deficits) were unsustainable and allowed Greece to become vulnerable to a speculative attack. • Policy makers delayed timely actions. • External debt rose rapidly after 1998, especially following Greece’s entry into the Eurozone (2002).

1. In a small open economy, growing twin deficits enhance vulnerability and generate debt unsustainability Greece: General Government Debt, External Debt and General Government Deficit, (%) GDP Source: European Commission

1. In a small open economy, growing twin deficits enhance vulnerability and generate debt unsustainability • A speculative attack against Greek sovereign bonds and the euro erupted between December 2009 and April 2010, with spreads on Greek bonds rising to unprecedented levels. • Speculators, who had proceeded since 2007 to cover themselves against a possible default through purchases of CDSs, unloaded Greek sovereign bonds.

1. In a small open economy, growing twin deficits enhance vulnerability and generate debt unsustainability Greek spreads 1998-2010 (yields on Greek over German 10-year bonds – basis points) Source: ECB and BoG, Working Paper 124/2011

2. Aggressive front-loaded restrictive policies can erode the sustainability of public finances Primary fiscal balance declined sharply Current account & primary fiscal balance (% GDP) Source: OECD, Hellenic Statistical Authority 8

2. Aggressive front-loaded restrictive policies can erode the sustainability of public finances … while liquidity was dramatically reduced… Source: Bank of Greece

2. Aggressive front-loaded restrictive policies can erode the sustainability of public finances The result was a sharp reduction of economic activity: Real GDP declined by close to 25% since 2007… Real GDP growth rate, percentage rate over the previous year Source: Eurostat

2. Aggressive front-loaded restrictive policies can erode the sustainability of public finances The recessionary impact of fiscal consolidation increased the Gross Public Debt to GDP ratio by c. 48ppts-of-GDP between end-2009 and end-2014… Source: European Economy, Country Profile, 2015

2. Aggressive front-loaded restrictive policies can erode the sustainability of public finances …while NPLs have risen dramatically Dec. 2007 Source: www.statista.com

3. The choice and sequencing of accompanying “structural reforms” is critical Structural reforms on average do not appear to have strong short-run growth effects… Source: Rodrick (2015), Babecký and Campos (2010)

3. The choice and sequencing of accompanying “structural reforms” is critical • The Greek economy needed and still needs the promotion of major structural reforms. • Given the relatively limited administrative capacity for effective planning, implementation and monitoring of multiple structural measures, prioritization and appropriate selection and sequencing of reforms is critical. • The choice and appropriate sequence of measures depends on the objective pursued.

3. The choice and sequencing of accompanying “structural reforms” is critical • The aim of the first two Financial Assistance Facility Agreements (FAFA) was to maximize the budget’s primary surplus over a short period of time to service the accumulated debt. This objective was pursued with: • Across the board sharp reductions in wages and pensions • Cuts in public spending • Increases in direct and indirect taxes • Imposition of new taxes (ENFIA) • Structural measures to reduce fiscal costs • An overly ambitious privatization program • Mainly under FAFA II, competitiveness was promoted through “internal devaluation” and deregulation of the labor market. • Insufficient understanding of the macroeconomic environment in which the reforms were introduced and of the structural characteristics of the economy in which they were implemented resulted in a problematic sequencing of reforms that deepened the recession, and widened distortions, including functional inequality.

3. The choice and sequencing of accompanying “structural reforms” is critical Greek labour-market reform agenda: - a telling example of the distortions that can ensue as a consequence of inappropriate policy design and sequencing.

3. The choice and sequencing of accompanying “structural reforms” is critical The Greek labour market reform agenda • 1. Rights at Work & Retirement • Minimum Wage • Working Hours & Compensation (Intermittent, Temporary, Part-time) • Retirement Benefits 3. Collective Bargaining • Structure of collective agreements • Degree of implementation of more favorable provisions • Automatic extension of sectoral agreements • Equal treatment provisions • 4. Employment Protection • Probationary Period • Employment Agencies • Dismissal Procedures • Notice & severance pay • Collective dismissals • Intermediation/ Arbitration Policies • Unemployment Benefits 2. Equality of Treatment • Anti-discrimination laws • Gender-specific policies • Youth Sources: L.T. Katseli & P. Boufounou, 2014, “The impact of Greek Labour Market Reforms on Competitiveness”, (unpublished) A. Lymperaki, C. Meghir & D. Nikolitsas, “Labour Market Regulation & Reforms in Greece” (unpublished)

3. The choice and sequencing of accompanying “structural reforms” is critical • Labour market reforms resulted in severe horizontal wage and pension cuts • Wages have been reduced by approximately 30% • The gross amount of non-farm sector pensions have been reduced by approximately 50% (Tinios, 2013) Source: IMF Country Report No. 14/151

3. The choice and sequencing of accompanying “structural reforms” is critical The decrease in actual earnings was the highest in Europe ... Cumulative change through actual earnings in EU countries (2010 – 2015) (Actual earnings per employee, private consumption deflator, total economy) Source:ΙΝΕ-GSΕΕ (2016) : «Greek Economy and Employment», Annual Report, G. Argeitis

3. The choice and sequencing of accompanying “structural reforms” is critical ... the percentage of flexible forms of work has dramatically increased...

3. The choice and sequencing of accompanying “structural reforms” is critical • The ensuing recession and adverse profitability expectations have offset the potentially beneficiary impact of “internal devaluation” on: • Employment • Private investment and • Competitiveness

3. The choice and sequencing of accompanying “structural reforms” is critical Unemployment rates rose to unprecedented levels Unemployment rate - annual average % Source: Eurostat

3. The choice and sequencing of accompanying “structural reforms” is critical Gross fixed capita formation as a percentage of GDP fell dramatically Source: World Bank national accounts data, and OECD National Accounts data files, 2015

3. The choice and sequencing of accompanying “structural reforms” is critical While price competitiveness as measured by ULC has improved… (ULC-based REER has depreciated by 16.5% since 2005) Source: IMF Country Report No. 14/151

3. The choice and sequencing of accompanying “structural reforms” is critical …competitiveness has deteriorated as measured by final good prices due to energy and tax cost increases (CPI-based REER has depreciated by only 5.6% since 2009) Source: IMF Country Report No. 14/151

3. The choice and sequencing of accompanying “structural reforms” is critical Neither the Greek governments nor the Troika placed product-market on their “high - policy agenda” at least till FAFA III by identifying them as “prior actions” for a positive evaluation of the program. As a result, a massive redistribution of income took place from wages to profits and from debtors to creditors.

4. Upholding policy coherence and an effective social protection system is a prerequisite for sustainable public finances Prolonged recession and the dramatic rise of unemployment reduced disposable incomes and led to firm closures: • More than 44% of Greeks were at risk of poverty in 2013 up from 20% in 2008 with poverty line defined at the 60 percent of median income (ILO, 2014) • Since 2009, average consumer expenditures of households (in 2013 prices) were reduced approximately by 32% (Kaplanoglou and Rapanos, 2015) • 250,000 SMEs have shut down • Gini coefficient rose from 33 to 34 percent • 400,000 families with children have no working parents

4. Upholding policy coherence and an effective social protection system is a prerequisite for sustainable public finances BUT It has also reduced households’ and firms’ capacity to pay taxes, social security contributions and debt obligations Source: The Small Enterprises’ Institute of the Hellenic Confederation of Professionals, Craftsmen and Merchants (IME GSEVEE), Survey, 2015

5. European institutions and policies need revamping Negative perceptions of EU citizens have increased significantly… Source: Standard Eurobarometer 82 Autumn 2014

5. European institutions and policies need revamping …especially in countries under a FAFA; perceptions improved when the countries exited the program. Percentage of citizens who responded that they do not feel like EU citizens (Greece, Ireland, Portugal, Cyprus, Spain and Italy) Source: Standard EurobarometerDifferent Years

5. European institutions and policies need revamping • Institutional Shortcomings • Macroeconomic imbalances and asymmetric power of Member States • in the Eurozone • Insufficient mutualization of risks • Limited powers of the European Parliament and inadequate interface with national parliaments. • Time-consuming intergovernmental procedures exacerbate systemic crises; role of the European Stability Mechanism (2012) under discussion. • Sole statutory competence of ECB to fight inflation • Conflicts in supervisory and regulatory competencies of ECB vs. Commission • Conflict of roles for the EU as a Troika partner versus guardian of the European Treaties • Decreased democratic accountability of Eurogroup and Troika in countries implementing a FAFA.

5. European institutions and policies need revamping • Preconditions • A convincing and credible narrative regarding the EU’s contribution towards the • provision of "regional public goods" : • Peace and Security • Investment and Employment • Decent Living Conditions • Migration Management • Climatic Change • Human Rights • An effective governance system that guarantees transparency and accountability through: • Publication of Eurogroup minutes • Election of Eurogroup President accountable to the European Parliament • Change of the ECB Statute • Abolition of Troika and establishment of specialized unit and services under the ESM • Independent monitoring and evaluation of economic and social policy effectiveness • Dissemination of outcomes • 3. Changing the mix of economic policy to promote not only fiscal adjustment and financial stability but also: • Sustainable economic, social and environmental transformation of the EU • Promotion of employment • Coordination of policies to mitigate macroeconomic imbalances between Member States • Publicandprivateinvestment • Promotion of social cohesion • Mitigation of inequalities

Looking ahead: Better prospects despite major challenges • GREECE 2020 • Strategic Objective: Promote sustainable economic and social transformation driven by new investment in tradable sectors • Challenges • Reduce cost of doing business • Enhance stability and simplicity of tax and regulatory system • Speed resolution of disputes in courts • Improve quality of governance and public administration • Strengths • Geo-political considerations • Strong comparative advantage in agro-food sector, tourism, real estate, shipping, cultural and business services ICT, pharmaceuticals • High-educated,, skilled and innovative labor force • Renewable energy sources AND Rebrand GREECE as a country of opportunities

Appendix A: The Chronicle of the Greek crisis Phase I 2008-2010: Eruption of the Crisis and the First MOU

Appendix B: The Chronicle of the Greek crisis Phase II 2011-2014: The Second MOU, PSI and Bank Recaps

Appendix C:The Chronicle of the Greek crisis Phase III 2015- today: The Third MOU and the Third Recap

Thank you 37

Prof. Louka T. Katseli Chair, National Bank of Greece (Cyprus)