Greece: Seeking a way forward

Elias Papaioannou, Richard Portes, Lucrezia Reichlin

19 June 2015



UPDATE: Greece needs an agreement now with the troika. The new deal will need to address both the immediate short-run (mostly financing) needs of the Greek state and (most importantly) tackle the deep deficiencies of the Greek economy.

In a Vox column posted on 4 June 2015, the authors summarised reforms that Greece would need to get back on track if an agreement with its creditors could be reached. A much more detailed version of their thinking is now available as “Greece: Seeking a Way Forward: White Paper – London, June 2015”. This distils the discussion of a group of senior stakeholders, distinguished academics and commentators who gathered 18-19 May 2015 at the London Business School to discuss the Greek Crisis.

Original column posted on 04 June 2015.

Press reports suggest that Greece and the IMF, ECB, and European Commission (formerly known as the ‘troika’) may finally reach a tentative agreement on the completion of the final review of the current (second) economic adjustment programme. This would release funds that Greece needs to meet its obligations due over the next month. It would also allow the Greek government to make payments to suppliers that have been delayed over the past months.

While preferable to a descent into chaos, an agreement on completion of the second programme will not restore confidence, nor will it resolve the deep economic, financial and political uncertainties that confront Greece today. Policy mistakes and uncertainty have pushed the economy back into a recessionary spiral, with some evident increase in unemployment, deposit withdrawals, and a liquidity squeeze. Thus the focus should swiftly shift to the design of an efficient, realistic and truly reforming new programme.

Relations between Greece and its Eurozone partners and international lenders are fragile, marked by suspicion, distrust and polemical rhetoric. At the same time, within Greece there is rising polarisation of views on the country’s role in Europe. It is not helpful to assign blame for this situation, although there is quite enough to go around. Policymakers must look forward and must convince the citizens of Greece and its partners that the country has a viable future in the monetary union. Absent a credible long-term programme, even if only in outline form, whatever agreement may be reached now will not be fulfilled.

In the spirit of helping to restore a dialogue and to rebuild trust, we convened a diverse group of senior stakeholders, academics and commentators at London Business School on 18-19 May to discuss the ongoing Greek crisis. Our objectives were to inform the discussions among the partners and to bring the different parties closer on the substance of a strategy for the years to come.1

A remarkable degree of consensus emerged. Greece should quickly reach a new agreement (contract/memorandum) with its partners, in two parts.

  • First, complete as soon as possible the final review of the current programme that was supposed to be completed by the end of 2014, but has been extended twice (initially by the previous Greek administration till the end of February, and subsequently by the current Greek administration till the end of June).
  • Second, agree on the goals and means of a subsequent (follow-up) programme that should not repeat the mistakes of the past.

A precondition for both tasks is the restoration of the trust that unfortunately has evaporated over the past years.

Completion of the current programme

An agreement on the completion of the second programme must reduce the prevailing, pervasive uncertainties and restore economic, political and social stability. It cannot be just ‘extend and pretend’. For the short run, there seem to be three key issues: fiscal, pensions, and labour markets.

On fiscal: Sadly the focus of the current negotiations (which started very late, mostly because of catastrophic delays by Greek government officials) is again on fiscal measures – primarily on tax increases and some expenditure cuts. The mistaken approach of the Greek government for ‘creative ambiguity’ and the similarly erroneous ‘pretend and extend’ strategy of the institutions have increased the tax bill, as the accompanied uncertainty has pushed the economy back into a recession. Tax revenues have plummeted in the past months.

Projections in late 2014 were that Greece could run a modest primary fiscal surplus of 2-3% of GDP for 2015 with little additional fiscal measures. But the renewed recession, uncertainty and depressed investment climate make it simply unrealistic to target significant surpluses. Further tax increases or expenditure cuts now would be self-defeating. They would only intensify the recession. The oligopolistic structure of product markets in Greece, the liquidity squeeze (banking troubles) and an inward-oriented economy imply strong Keynesian effects of a fiscal tightening (large multipliers), and thus a significant fiscal tightening nowadays will be counterproductive.

Of course Greece must continue sound macroeconomic policies, but the targets have to be adjusted to reflect realities.

  • First, the target for 2015 should be just running a balanced budget, perhaps with a tiny (symbolic) primary fiscal surplus.

Even running a balanced budget for the current fiscal year would require significant measures that could destabilise the fragile Greek economy. And unfortunately the tax bill will again hit workers and pensioners – as there has been no serious effort in tackling tax evasion over the past year.

  • Second, the Greek administration should commit to primary budget surpluses of 1.5% to 2.5% of GDP for 2016-2018, which could perhaps increase further in subsequent years if growth resumes.

The Greek government should recognise that returning to the era of fiscal deficits and populist policies is not going to help the economy rebound; and the institutions should recognise that further fiscal contraction would simply be bad economics.

On pensions: The parties should agree on (a) tackling the huge issue of early retirement schemes and the numerous exceptions to the general retirement age; (b) the no-deficit principle for supplementary pension funds, while at the same time the institutions should allow some transition phase for the associated cuts; (c) greater effort to reduce evasion of social security contributions. Given the size of ‘exemptions’, simply raising the general retirement age is absurd; such a policy could be considered for new hires once the disgraceful early retirement schemes are repaired. The Greek government should communicate to the Greek people that these interventions are just and necessary; the current system is both unjust for the young and clearly unsustainable.

On labour markets: Here we must stress that no further reform seems vital, given the significant liberalisation of past years. Labour market reforms are simply not a high priority; for the institutions to insist on more now would be misguided. Removing firing restrictions for large firms is an objective for the future; perhaps the Greek government can commit on this once growth rebounds. This is not the time for an ideological battle, but for pragmatism.

Towards a new programme

A viable way forward for the longer term requires that the Greek government – and the Greek political system more generally – claim ownership of a new programme that should aim to restore the competitiveness of the Greek economy. The new programme should be tailored to the idiosyncrasies of the country – and it should not be ‘copied and pasted’ from other experiences. The new programme should be designed by Greeks, with the government utilising the abundant human capital and expertise of Greek academics, business people, and former politicians. Clearly, international institutions could and should help, but it is vital that the new programme be designed by Greeks, so as to raise its effectiveness and its legitimacy. Although time is running out, it would be desirable to engage the public, social groups, NGOs and other stakeholders in this process.

It is essential to communicate both the immediate goals and the medium-run objectives of the new programme to the Greek people. Only effective communication can raise legitimacy and bring in much-needed social support for reforms in public administration, product markets and the justice system. Reforming these areas is essential for success in other areas and should therefore be considered the top priority.

The focus of the new programme/contract should be on improving the deep pathologies of the Greek economy, namely weak state capacity, inefficient public administration, malfunctioning and captured institutions, weak protection of investors, and inefficient and absurdly slow courts. The government must signal its commitment to deep structural reforms. These, rather than further wage cuts, are the only way to raise the competitiveness of the Greek economy. Strong signals are needed to reveal the government’s political will to tackle endemic corruption in public administration, tax evasion, and the complex oligarchic system that links the political parties to the media and the administration.

The objective is to improve drastically the business environment, so as to allow the forces of creative destruction to operate. The Greek economy needs a reshuffling and a paradigm shift, reallocating capital, labour, and human capital to export-oriented firms and skill-intensive sectors.

The priorities should be:

  • Massively reforming product markets that are oligopolistic, with numerous (administrative, regulatory, legal and other) barriers to entry.

Reforms must abolish unnecessary red-tape costs that deter foreign and internal investments. In spite of recent improvements and some reforms, Greece still scores very low in most cross-country measures proxying the ease of doing business. And unfortunately many past reforms have been reversed.

  • Improving and modernising the legal framework of property rights, investor protection and corporate governance.

Greece suffers from both low-quality legislation and weak de facto protection from courts. And recent legislative measures (by both the previous and current administration) regarding the personal liability of shareholders in limited liability companies have made things worse.

  • A major reorganisation and restructuring of the public administration is urgently needed to improve significantly the administrative capacity of the state. 

Public administration should become non-partisan and detached from political parties and the political cycle. In this regard – and as a minimum – the Greek government should respect the independence of the Bank of Greece, the Hellenic Statistical Authority, and the Hellenic Financial Stability Fund. At the same time, the administration should promote independence of tax collection mechanisms and various supervisory-regulatory agencies (e.g. the Hellenic Capital Market Commission). Unfortunately, some early decisions of the new Greek government in this regard are highly partisan, following the paradigm that (with some exceptions) has characterised Greek politics since the restoration of democracy in 1974.

  • Reforming tax collection.

A massive simplification of the tax code is desperately needed, as well as the computerisation of tax offices. Among other measures, the government should also recruit IT experts (and the institutions should not block such hires on budgetary grounds). And incentives should be offered for electronic payments and electronic clearance of VAT. It is also vital that the government respect and further safeguard the autonomy and independence of the chief tax officials, and not follow the practice of previous administrations that continuously interfered with tax officials.

  • Modernisation of the judicial system, which is absurdly slow, extremely formalistic, inefficient and unjust.

The Greek government should build on recent reforms, but rather than employing an incremental approach, it should proceed aggressively, as the system needs a ‘big push’. The massive case backlog – which is especially pronounced in administrative and tax courts – must be dealt with. The government and the institutions should consider recruiting part-time magistrates and opening courts on weekends and during the summer. Medium-term reforms include the establishment of specialised courts, promoting alternative dispute resolution mechanisms, and improving checks and balances, which, given the lack of computerisation and the chaotic situation in Greek courts, are absent. Unfortunately it seems that these issues are not part of the agenda, which is really worrisome as they are evidently linked to Greece’s inefficient economy and unjust society.

  • Dealing with the weak position of Greek banks.

In spite of the successful bank recapitalisations of 2013-2014, the interaction of the economic downturn, uncertainty, and deposit withdrawals has considerably increased non-performing loans. Restoring liquidity and private credit are necessary conditions for economic recovery. In this regard, the institutions and the Greek government should reach an agreement that moves non-performing loans to an asset management company (a ‘bad bank’) financed with the money that has been put in a special account of the ESM-EFSM (approximately €10 billion, though more is needed). However, the state’s involvement in the bad bank and also in other financial institutions should be minimal. In the past, Greek banks have been used by the political system for patronage, to protect insiders, and to buy media support. This cannot continue. Additional money for the bad bank could come from specialised institutional investors, such as private equity firms specialising in non-performing loans. And legal reform is urgently needed in bankruptcy-insolvency, so as to expedite the process and efficiency of firm restructuring.

De facto, the Greek labour market was quite flexible for most firms even before the Crisis, as labour legislation was not enforced and Greece has a very large share of self-employment and small family firms. Moreover, wages have fallen considerably. Further liberalisation of labour markets should not be a priority. Some interventions that are perhaps needed (on firing restrictions for large corporations) can be re-evaluated when growth resumes.

  • Rather than focusing on labour market flexibility, the institutions and the Greek government should design a coherent, complete, and just social protection programme.

Greece has to construct from scratch unemployment benefits and re-evaluate various social protection programmes. Moreover, with assistance from the institutions, the Greek government should extend the minimum guaranteed income scheme throughout the country. And the government should re-evaluate the criteria for the various social allowances, as the system is characterised by pervasive corruption.

  • The Greek government should take concrete measures to increase transparency in public administration.

This is necessary for raising accountability. The government should promote rather than jeopardise institutions such as @diavgeia (the obligation to publish online all the decisions of the government and public agencies)

A necessary condition for improving the efficiency of public administration and the justice system and tackling corruption and tax evasion is the installation of modern ICT systems. For example, the government should proceed quickly with the computerisation of courts (the E-Justice system) that has been slowed down considerably over the past year.

  • The government must pursue reforms that will drastically tackle the issue of 'insiders-outsiders' that is pervasive in most economic activities.

This will yield both efficiency gains and lower inequality.

Finally, on debt restructuring there are two facts that all stakeholders must acknowledge. First, after the Private Sector Involvement agreement (in 2012) with the sizeable extension of maturities and the reduction of interest, Greece’s debt service cost has fallen considerably for 2016-2022. Second, the nominal value of debt as a share of GDP continues to be large, something that raises concerns of debt sustainability, especially after 2022.

  • There was a consensus in our meeting that at this stage and given the political constraints, some debt relief could be offered by further extending the maturities and lowering interest rates.

Perhaps once the Greek government proceeds with structural reform and demonstrates its willingness and commitment to the programme, the EU could offer some reduction of the face value of the debt.

All these measures require trust and commitment. Greek government officials should abandon their polemics against the EU, the ECB, and the IMF. Likewise, EU politicians and officials should stop casting aspersions on the Greek people and their elected representatives. Both parties should learn from the mistakes of the past. All stakeholders have much to gain if the Greek economy and society recover from the devastating crisis.

Concluding remarks

Sadly, the leaks to the international press on the ongoing negotiations between Greece and the institutions indicate that once more, the discussions are centred on fiscal issues – and to some lesser extent on pensions and further labour market liberalisation. Yet while Greece should not revert to the era of deficits and establishing a sustainable social security system is needed, it is disappointing that there is not much discussion on the major structural deficiencies of the Greek economy. The new programme should focus on opening-up closed and oligopolistic product markets, removing barriers to entry and expansion, reducing red tape, and tackling tax evasion. The new programme should also focus on public administration reform and on building institutional capacity. It is time to tackle the deep issues rather than myopically focusing on fiscal measures.

Editor’s Note: The content of this column reflects the views that emerged as majority consensus at the conference, but may not reflect the views of all participants.


[1] Although the views expressed here have been informed by discussions at the meeting, they are entirely our own, and other participants have not seen this statement.



Topics:  Europe's nations and regions

Tags:  Greece, greek crisis, Eurozone crisis, trioka

Associate Professor of Economics, London Business School and CEPR Research Affiliate

Professor of Economics at London Business School, Founder and former President of CEPR

Chairman and co-founder, Now-Casting Economics; Professor of Economics, London Business School; CEPR Research Fellow; Fellow of the British Academy