The Greek economy continues to pay the price of heavy taxation adopted by consecutive governments and blessed by international lenders. No developed country going through a multi-year recession that is bordering on depression has experienced such an increase in taxes and other levies as a percentage of gross domestic product (GDP) in order to close the budget gap. This reflects both the inability and unwillingness of the political elite to rein in primary expenditures, and more specifically social spending, as well as the obsession of lenders with revenues.
The outcome is not good, as record unemployment and the huge loss of GDP clearly indicate. Rebalancing fiscal policy by cutting income and property taxes on one hand and primary spending on the other should be a priority.
Greece’s economy shrank below 194 billion euros in market prices last year to a level last seen in 2005. This represents a drop of about 17 per cent from the nominal GDP’s peak at 233.2 billion in 2008. Economic output is expected to shrink further to around 184 billion euros in 2013, representing a drop of 21 per cent since the peak of the nominal GDP at 233.2 billion euros in 2008.
The sharp drop in economic activity, which is behind the rise in the unemployment rate, which is close to a record 27 per cent, has been mainly the result of an ambitious fiscal consolidation effort and a sharp fall in investment spending as credit became scarce and expensive, and businesses grew concerned about the country’s prospects and a euro exit.
Of course, no reasonable person can question the need for fiscal discipline and primary budget surpluses for a country as heavily indebted as Greece.
Greece’s gross public debt (according to the Maastricht definition) has been steadily rising since it joined the eurozone in 2001, despite recording high GDP growth rates. Its debt stood at 152 billion euros in 2001 and went up to 212 billion euros in 2005, when the size of the economy was equal to last year’s, before skyrocketing to 355 billion euros in 2011 and falling to 304 billion euros in 2012 thanks to the largest-ever sovereign debt restructuring (PSI).
Undoubtedly, the dose of fiscal austerity has been excessive, causing greater economic output loss, and social pain and suffering in a largely closed, state-dependent economy like Greece’s, as many have argued over time.
However, it is not just excessive austerity but the wrong type of austerity that has undermined the fiscal consolidation effort and aggravated economic conditions.
A comparison of the country’s public finances last year with those in 2005 when the economy was of equal size is revealing. In 2005, the primary deficit of the general government stood at 1 per cent of GDP compared to about 1.5 per cent in 2012 without taking into account one-off items. But the contribution of expenditures and revenues to the primary budget outcome was quite different.
Back in 2005, primary spending accounted for 40 per cent of GDP and revenues, mainly taxes and social security contributions. Last year, following a series of cuts, primary expenditures stood at 50 per cent of GDP or close to an estimated 46 per cent without counting one-off items. In other words, government spending was 6 percentage points higher than it was in 2005 and reflects a bloated public sector in a shrinking economy.
Moreover, last year’s revenues stood at about 45 per cent of GDP, an astonishing figure if one takes into account the duration and depth of recession since 2008 and compares it with 2005 when revenues amounted to 40 per cent of GDP. The jump of revenues by 5 percentage points clearly shows the political elite’s preference for taxes over spending cuts and the lenders’ obsession – especially the International Monetary Fund’s – with taxes.
From the comparison, one should conclude that Greek fiscal consolidation has relied on raising revenues. This has clearly hit the engine of the economy, that is the private sector, and partly explains the protracted recession. New austerity measures were taken again and again to meet the annual budget deficit targets, hurting the economy as it was becoming evident that ambitious revenue targets could not be met, creating a vicious cycle.
It is ironic, but Greece would have had a large primary budget surplus by the end of last year if government primary spending stood at 40 per cent of GDP, the level of 2005. By choosing to boost revenues to 45 per cent of GDP in 2012 from 39 per cent in 2005 to close the budget gap, it both failed to produce even a small primary surplus and also aggravated economic conditions.
It is hard to believe that the political elite and the country’s lenders will change course and focus on cutting government spending rather than squeezing every euro they can from the private economy in order to close the budget gap.
However, a change in policy is necessary, and is more likely to happen if more people understand the consequences of misguided fiscal policies, according to which the urban working population is squeezed while others, like farmers, are essentially not taxed, and real spending cuts stay off the agenda because various vested interests and the sacred cows of the Greek political system have to be protected.
*Dimitris Kontogiannis holds a PhD and MBA in international finance and MPhil in macroeconomics, has taught graduate and undergraduate courses at US universities and worked at an established Wall Street firm.