Europe repackages austerity

So here we are on the eve of yet another of the perpetual Greek D-Days. It would be funny if it wasn’t so sad. If it hadn’t been going on for so long with the outcome so obvious. Readers who followed me over from my old blog would know I have been talking about the inevitably of the situation for nearly 2 years.  What is interesting is to go back to some old reports on the situation in order to realise just how much economic delusion there was about the situation,  for example May 29 2010 Reuters:

Greece will not restructure its debt and will not need more cuts to achieve fiscal targets set in the emergency funding programme it agreed with the European Union and the IMF, its finance minister told a Sunday paper.

The debt-laden country has been offered a 110 billion euro ($134 billion) bailout to avoid defaulting on its debt and in return promised to cut the deficit by 11 percentage points of GDP and bring it below the EU’s cap of 3 percent by 2013.


“Greece will not need additional measures, especially ‘painful’ measures. I see only one option ahead, delivering on our targets with consistency,” Finance Minister George Papaconstantinou told Sunday’s Eleftherotypia newspaper.

The Bank of Greece projects the economic downturn will deepen, with GDP seen contracting by 4 percent this year, as tax increases and cuts in wages and pensions take a toll.

“The recession will be deepest in 2010 and thereafter there will be a gradual recovery,” the minister told the paper. “I remain optimistic and believe we will recover fast.”

After reading that article back in 2010 I made a fairly simple macroeconomic observation of Greece’s situation which turned out to be fairly good approximation of the outcome that awaited the country:

If Greece cannot improve its current account balance ( which is nearly impossible given that it threw away control of its exchange rate when it joined the EU), then simple maths states that Greeces’ private entities need to reduce their current net saving position by 11% of GDP over the next three years. Realistically this means , far more unemployment and probably debt deflation.

The reason I made that statement at the time was because Europe was stuck inside a bizarre economic policy void in which there seemed to be a belief that simply cutting government expenditure would somehow turn an economy that was structured around credit driven consumption into an export driven economic powerhouse which would suddenly be able to service its debts. This was, as I pointed out numerous times over proceeding 20 months, a dangerous ideology based on a flawed understanding of macroeconomics. Even a glancing analysis of the Greece economy would have told you that the government sector was supplementing the private sector by running deficits due to the absence of a trade surplus, but even with that occurring the private sector was becoming increasingly indebted.

Under these circumstances what was required for Greece to become sustainable was 1) a write-off of a significant proportion of its debts; 2) a restructure of the economy in order to improve productivity. However ‘austerity’ based policy would provide neither of these things because the debts would continue to exist which meant the only possible way to improve productivity would have been through investment without some form of default. Under ‘austerity’ focussed policy there was never going to be a new surge in productivity focussed investment so the actual outcome of this policy was most likely to be a slow squeezing of Greek private sector towards default and associated falling government incomes.

Back in 2010 my assessment of Greece’s problems were all theory, but it has become quite apparent that this is exactly what ended up happening to the country. More evidence of that private sector squeeze appears daily:

Local banks are expecting a further decline in deposits by 10 percent or 17 billion euros within 2012, according to sources, as clients withdraw savings in order to cover their increased tax obligations.

The same sources estimate that some 70 to 80 percent of the outflow from the banking system, which in 2011 amounted to 35.4 billion euros, was channeled into the state coffers through the various tax burdens imposed last year. By contrast, no more than 1 percent of deposits headed abroad.

At the end of 2011 the deposits balance of corporations and households came down to 174.2 billion euros from 209.6 billion at end-2010, posting a 16.8 percent drop on an annual basis. Out of the 174.2 billion euros, 145.4 billion comprised household savings, which had slipped 28.1 billion euros compared to 2010, while corporate deposits amounted to 28.8 billion, down 7.2 billion euros from end-2010. Savings accounts posted a notable 19.9 percent decline on an annual basis.

Bank data point to a fresh outflow of some 2 billion euros in January, as the monthly rise of 1.3 billion in the December balance was deemed temporary and attributed to money gong into accounts due to the Christmas bonus. This quickly evaporated last month, as households paid off their December expenditure conducted through credit cards.

What I don’t understand is how it was possible that there was no one within the Greek and/or European establishment with the basic economic skills to take a look at the 3 sectors of the Greek economy and very quickly come to the same conclusion. Why was there no one within the European leadership willing and/or able to realise that the outcome that Greece faces today was completely inevitable and that being the case, how can we have faith in Europe’s on-going response for countries like Portugal or Ireland?

In a recent interview Angela Merkel stated:

We want a rational solution, meaning we need a second program, but that can only happen when, in the opinion of the troika, the long-term sustainability of Greece’s finances is secured […] we need the cooperation of private creditors.

One wonders why Europe needed an additional 18 months, to waste 130 billion euros and wait for the crisis to become far worse before coming to the same obvious conclusion.

Given this outcome , and what I suspect is some heavy influence from Mario Monti, we have seen a change in rhetoric from Europe about ‘austerity’ focussed policies over the last 6 weeks. The new focus is on ‘Jobs and Growth’, both of which sound horribly ironic given the last 2 years of periphery Europe’s economic history. As I mentioned on Monday, tomorrow we will see the first Alert Mechanism Report (AMR) under the new surveillance procedure on the prevention and correction of macro-economic imbalances in the Eurozone. I hope that this report is the measurable beginning of some positive policy changes across Europe, but at this stage I am concerned that the response mechanisms built into the framework are yet again far too one sided. Asking a periphery country to provide a plan about what it will do to solve its imbalance without asking its major intra-European finance and trading partners to do the same just sounds like austerity under a different banner to me:

The 5 European priorities of 2012 are listed as:

  • Pursuing growth-friendly fiscal consolidation
  • Restoring normal lending to the economy
  • Promoting growth and competitiveness
  • Tackling unemployment and the social consequences of the crisis
  • Modernising public administration

Supposedly Greece will get all of these things soon …. right after it has agreed to the latest round of nation-destroying ‘austerity’.

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  1. I see it as “playing for time”, and due to the complexity of the Greek debt, they needed time to try and sort out the mess. Everyone knows the outcome, unless Germany wanted a permanent transfer union, which they don’t. Now wait for the next state to follow the same path assuming Greece exits. I just hope that not all of Greece’s assets are looted by it’s friends before this ends.

  2. surely it must have been easier just to let default of debt and bankruptcy take place, reset the ‘system’ and start again???

    • It would, but it would have started a domino effect leading to a collapse of many banks in Europe and probably around the world.

      I think default is now more of an option than it was two years ago.

  3. Diogenes the CynicMEMBER

    It will be a messy default with lots of unforeseen butterfly wing ripples through the banking systems of the world.

    Anyone in Greece with cash still in the banks must be mad…

  4. DE thanks for the update. I do have a question though and a question I have asked before (not of you). When you say Greeks need to be more productive what do you mean? Does productive = competitive? If yes how could they ever compete with Germany let alone China etc. There “competitive” advantage is climate, beaches, history, culture and geographical location. Without a devalued currency how do they become more productive?

        • The way I see it is that SME’s usually form the basis of any healthy economy and may even grow into larger, multinational companies. Multinationals are not established overnight.
          SME’s require an environment where individuals are provided an incentive to become entrepeneurs and be competitive through innovation.

          Greece at the moment has quite the opposite. It’s just too easy to rely on services provided by government.

          • Anon and AH thanks for comments. I hope you are both right. It does however remind of some of my school economics around competitive advantage and an old joke.

            Why do the Irish have potatoes and the Arabs oil? The Irish had first choice.

            In todays globalised and mechanised world this does sound funny but would it have been a joke if it was asked before the industrial revolution?

            Australia had sheep initially and fortunately for us we know have iron ore and coal. What next?

            Clearly countries need to adapt to current environments. I think this problem is bigger than Greece. With complete trade imbalances globally the solution appears to be a bit of give and take from all parties not just give.

        • If I knew all the answers to Greece’s woes I would be far better paid than I am now. There are no easy answers, because their problems are as much cultural as they are economic. Tax evasion is endemic, everyone thinks they are entitled to a high standard of living in exchange for minimal work and that the state is a bottomless money pit. Until the Greeks wake up to the realities of no free lunches, nothing much can be done to fix their economic woes. This implies lots of pain until reality sinks in.

          The whole idea of lending money to states with neither the intention nor the capacity to repay the loan has always been disastrous. You would think that lenders would have learned from the numerous latin american debacles last century, but it seems never to sink in.

          • hear hear!

            As much as I understand and agree with DE’s viewpoint from a theoretical perspective, I’m with my countrymen and the guys across the border on their hard stance on Greece at the moment.

            Love to have them in the EU as a trustworthy partner, no probs putting some money after that if you know it’s going to amount to anything but so far all the Greeks have done is blatant lying. How can anyone expect other member states to invest in jobs and stimulus for the Greek economy when Greece has shown absolutely no commitment so far?

            Talking to a young Greek colleague (well, Australian from Greek descent) I have learned that at least some of the riots in Greece by young people are not so much anger directed at the EU but at the Greek government who they feel has taken away all opportunities from them for self-enrichment.

            I do hope Greece remains in the EU and will reform but right now I’m not so sure anymore that it will (odds still in favour of Greece turning around at the very, very last minute though). The EU and Euro will not collapse though…

          • There are problems of the kind you mention. There is no doubt about that. But high wages is not one of them. Average wages for, say, a teacher, in Greece are said to be about EU900/ month, or AUD 1260. This is about AUD10/day more than the Jobseeker Allowance is in this country.

            I think the real point is that the EU can depress living standards in Greece until they reach Sub-Saharan levels. In itself, this will not bring about a revival of the Greek economy and certainly will not enable Greece to service its debts.

            They need a policy that consists of much more than cutting wages and public spending.

          • Or possibly even more than EU65,0000…outrageous, but not typical….

            “Incredibly, the average salary on Greece’s railways is £60,000, which includes cleaners and track workers – treble the earnings of the average private sector employee here.


            The overground rail network is as big a racket as the EU-funded underground. While its annual income is only £80 million from ticket sales, the wage bill is more than £500m a year — prompting one Greek politician to famously remark that it would be cheaper to put all the commuters into private taxis.”

            Read more:

    • >productive what do you mean?

      Productive basically means producing more outputs using the same or less amounts of inputs. In terms of macroeconomics the idea is to become more productive so that your exports overtake you imports and therefore you begin to have a positive balance of trade. In normal cases, this is achieved through investment, research and developement .

      Competitiveness means something slightly different because it is a comparison of your productivity in comparison to others who offer these same or similar services. Obviously quality of service plays its part here.

      However something that is sometimes missed is not everyone can run a surplus, which is part of the reason I talk about the fact that Germany’s outperformance comes at the expense of the periphery. A rebalance of competitiveness under a common currency requires adjustments from all sides. What we have seen to this point is one-sided wage deflation focussed policy which makes no sense while the existing debt burden exists.

    • innocent bystander

      whoops lost the quote….
      “One wonders why Europe needed an additional 18 months, to waste 130 billion euros and wait for the crisis to become far worse before coming to the same obvious conclusion”

  5. When it comes to eurogeddon analysis DE you are one of the best on the net anywhere.

    You should adopt a superhero alter ego /persona such as “captain euro” or “euroman”. A massive dude in blue tights, wearing a kilt and a centurion’s breastplate with your might austerity club 🙂

  6. The Greeks have already experienced very deep cuts to wages, bu this has not made the Greek economy more “competitive”. All it has done is cause domestic demand to collapse and drive up business failures and unemployment.

    In this context (as DE has explained), becoming competitive means re-orienting the economy so that it generates an external income surplus, meaning the public sector can achieve fiscal balance without also driving the private sector into contraction.

    This is a long-term project and really cannot be done in the space of a few years, especially when Greece’s trading partners are trying to do the same thing.

    The austerity programs will have caused a great deal of destruction to Greece’s economic potential. The effects of 5-years’ of recession should be thought of as being similar in some ways to the effects of a war – in terms of loss of property, dislocation of workers, and personal financial hardship.

    What Greece really needs is respite from austerity, a 10-15 year moratorium on debt repayments and forgiveness of foregone interest, together with EU-sponsored, long-term reconstruction aid. In normal circumstances, deep devaluation would also be helpful.

    The current programs will only lead to default and chaos. What is happening is a terrible indictment of both Greek and EU leadership over many years. It is completely avoidable and yet seems completely irresistible at the same time.

  7. I have spoken with probably twenty different economists and financial analysts in Greece Cyprus Russia and Germany over the past two weeks and not a single one has said that Greece would do anything other than default.

    Greece does need a respite from austerity. Within the Eurozone there is no adjustment mechanism other than fiscal transfers or austerity. The politics outside Greece wont support fiscal transfers needed. The politics inside Greece wont support the austerity needed. That leaves default (moratoriums, forgiveness – call it what you will – it all adds up to default).

  8. I concur, Gunnamatta. These things should never happen. They reflect a weak Europe – a union in name only.

    At the end of the day, only the Greeks can resolve this situation, I suppose. They are a resourceful people and have great connections in other countries. Perhaps the diaspora can come to the aid of their cousins….

  9. Greece is not exercising its leverage in the situation. It would be different if Goldman Sachs were not running the country.

    The degree of interconnectedness in the derivatives market is the unknown. US (read Goldman Sachs) cannot allow a contractual default for fear of triggering CDS contracts – not yet anyhow.

    Buying time is allowing the employees of Goldman Sachs to sell down their shareholding while prices are still firm. The biggest buyer of GS shares is GS so the share price is being held artificially high while the employees unload. Once they are cashed up they can let Greece debt collapse and watch the CDS fallout.