The Greek Catastrophe and a Possible Way Out

Open Democracy, July 24, 2013. All Rights Reserved.

The lead author of a major econometric analysis of the Greek economic crisis discusses the disastrous outcomes of the policies enforced on Greece by its international lenders, and the IMF’s admission that it made serious errors in its assessment of the impact of austerity on the Greek economy and society. 

C. J. Polychroniou: The Levy Economics Institute has just released a Strategic Analysis report (pdf), with you as its lead author, on the Greek economic crisis and the effects of austerity on growth and employment. The analysis relies on the Institute’s specially designed macroeconomic model for the Greek economy, which is similar to the Institute’s model of the US economy. First, what does the model consist of and how accurate has it been so far in assessing and predicting trends in the US economy?

Dimitri B. Papadimitriou: The model’s theoretical foundations are rooted in Wynne Godley’s new Cambridge approach to economics, developed in the 1980s, enabling economists and the public alike to produce a serious study of how the whole economic system functions. The determination of national income, GDP growth, inflation and unemployment are all predominant concerns by which the public judges the success or failure of governments. The US model on which the model for Greece is based has had a rather spectacular success in predicting first the 2001-02 recession and subsequently very early on the American and the global financial crisis of 2007-08. An increasing number of economists and policymakers have come to realize the power of its predictive capacity, at least for the US.

C.J.P: Reading the report, the first thing that stands out is that Greece is in a depression today (in addition to suffering from malaria, hungry school children and a surge in suicides) which is worse than anything experienced during the Great Depression of the 1930s in the US. This is shocking when we consider that benefits for those in retirement and the unemployed for example, did not even exist in the US until 1935. From this analysis, what is the driving force behind the ongoing and deepening economic crisis in Greece?

D.B.P: It is true the Great Depression never looked so good as seen currently from Greece. Whereas during the Great Contraction, US government spending for consumption not infrastructure continued to grow, helping to arrest the economy’s decline, in Greece the same spending has fallen severely every year since 2008 with last year being the steepest drop in the country’s continuing downturn.

This continuous decline is in concert with the country’s international lenders’ requirement in exchange for the two bail-out plans. This is an application of the dangerous idea of austerity that has been proven catastrophic wherever it has been applied during recessions, with the predictable consequences we are currently witnessing. During downturns, private consumption and investment are on declining paths and it falls on the public purse to stimulate the declining aggregate demand. The economic and social conditions you mention are the consequences of a foolish policy based on a discredited economic theory of “expansive austerity” along with labour market reforms as the best, most appropriate medicine for growth in countries like Greece running large government deficits and debt as percentages of GDP.       

C.J.P: The IMF has admitted to miscalculations of the fiscal multipliers in the implementation of the austerity measures in Greece, yet the European authorities insist on fiscal restraint and implicitly accuse the IMF of playing politics. Who’s kidding whom here?  The IMF and the EU represent today what I call the “twin monsters of global neoliberalism.” So why should any economist be paying attention to what the IMF says? Action, after all, is what matters – and theirs towards Greece certainly haven’t changed. Correct? 

D.B.P: The IMF’s confession to big errors in the first rescue programme about three years ago has been viewed as irrelevant, and the Fund still insists that no matter what it did, then, Greece would have suffered a deep downturn. In effect, all three – IMF, EC and ECB (the troika) – still refuse to acknowledge the flawed handling of the Greek sovereign debt crisis, maintaining to the contrary that the overall policy was correct.

As my colleagues and I at the Levy Institute suggested when the first bailout programme was arranged, the amount was far smaller than required and the consequences of government spending cuts and tax increases were deeply underestimated.  But those charged with running the European Union and the IMF would not increase the bail-out funds to assist Greece, opting instead for muddling through until the big European banks (read German and French primarily) were willing to slough off their Greek bond holdings, thereby not risking contagion and the erosion of investor confidence in other troubled southern European economies, i.e., Spain and Italy. 

Conventional wisdom and free market ideology are alive and well, and very many economists consider themselves as high priests and defenders of this religion that informs IMF’s standard austerity remedies, despite the overwhelming evidence to the contrary.   

C.J.P: These “twin monsters of global neoliberalism” and the Greek government seem to have placed their recovery hopes for the domestic economy on an exports boost.  The Institute’s report analysis challenges this assumption. Why?

D.B.P: Exports have been on caught up in an unstable trend before and after the crisis and unable to offset the drop in domestic demand. The strategy imposed by the troika aimed at increasing exports through internal devaluation (a decrease in unit labour costs) has not brought about the anticipated effects, despite the reduction in relative unit labour costs achieved since in 2010.

Despite this decline in unit labour costs, consumer prices have not followed suit unlike in the single case of the European hegemon, Germany, that systematically maintains lower values in both. An analysis of the country’s exports by destination and technology content shows that the countries that import the bulk of Greek agricultural and medium-low technology goods and services are outside the euro area.

Greece has suffered a reduction in its exports to countries such as Germany, once a major foreign market. The recent large increase in the value of Greek exports is due to oil refinery operations positively affected by increases in the price of oil. In short, the current strategy of grounding Greece’s recovery on exports is not only wrong-headed but also will shift production toward sectors with lower value added, and larger volatility in oil-related trade.

C.J.P: Levy Institute projections are also highly pessimistic about unemployment and GDP growth rates in the middle term, questioning once again the rather optimistic predictions made recently by the European Commission and the IMF.  How much worse can unemployment get in Greece, which, as the Institute’s report states, already suffers“the highest level of any industrialized country in the free world during the last 30 years?”

D.B.P: IMF and EC projections of GDP growth and employment are bizarrely incompatible within the framework of the imposed austerity policy. As our model simulations show, to meet the troika’s targets of government deficit to GDP ratios from now to 2016, even more austerity would be necessary, further depressing GDP and employment.

On the other hand, to meet the troika’s growth and employment targets will require the reversal of austerity and a fiscal stimulus of close to a further 41 billion euros between now and 2016. Their projections have been consistently revised downwards four times between May 2010 and the latest occasion in June 2013. 

The fact is that since the peak in October 2008, over 1 million jobs have been lost, and there are no signs of meaningful easing of the flawed programme forthcoming. With joblessness now at 27%, a stark indicator of the troika’s and the government’s failure to accurately project the consequences of their own policies, it is astonishing that they continue to ask for more of the same. Our own simulations of unemployment show that more jobs would be lost should the current austerity policy be continued, with unemployment climbing the charts, and soaring close to 34% by the end of 2016.  

C.J.P: To the surprise of many observers abroad, the Greek population has remained rather stoical (or, some might say, politically apathetic) in the midst of a deepening crisis and the collapse of the nation. How do you explain this attitude when, for years, the impression given to the outside world was that contemporary Greek society thrived on a culture based on political radicalism?

D.B.P: One easy answer would be that Greeks have are suffering from austerity fatigue. The other and perhaps more important explanation is that we should never take underestimate the capacity for a social meltdown. The Greek population may appear politically apathetic at present but the continuing social chaos has created a ever-wider opening for an extremist party. Only a progressive party of the left can reverse today’s carnage on the ground.    

C.J.P: The way out of the crisis, according to the Institute’s Strategic Analysis report, is a recovery strategy along the lines of the Marshall Plan. Is it economics or politics and ideology that blocks discussions and initiatives from relying on the public sector for providing the necessary economic stimulus, via increases in public consumption and investment for a return to growth?

D.B.P: Our model’s simulations demonstrate that an EU-funded Marshall-type recovery programme would be a real “success story” for Greece. If it were directed at public consumption and investment and particularly at jobs this would put Greece on the road to recovery. The first Marshall plan wasn’t charity or a bailout. It was an effective investment strategy to create a vibrant European economic market and prevent political disintegration.

As Winston Churchill told us, we should learn from history. European leaders and our government need to learn fast. Instituting such a programme would necessitate our revising what are now discredited economic theories, together with the European institutions that continue to promote them.