The Logic and Fairness of Greece's Program

IMF Blog, March 19, 2012

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Greece needs a lower debt burden and improved economic competitiveness.
Debt had to be restructured because sustained high growth was not going to come soon enough.
The PSI (private sector involvement) deal—the largest ever negotiated write-down of public debt—has reduced the debt burden of every man, woman, and child in Greece by close to €10,000 on average.
Foreign and official creditors provided economic space that Greece must use through sustained political commitment to implement fiscal, financial, and structural reforms.

The fiscal effort so far: the primary deficit came down from 10 percent to less than 3 percent.
The reduction and rescheduling of debt will help cut interest payments but will not by itself fix the hole in public finances.
Greece is still running a primary deficit and will soon need to run a primary surplus.
Policy implications:
- Much spending will need to be cut.
- The program focuses on fairness in taxation to ensure richer people pay their fair share.

Rationale:
- No country can run a large current account deficit and borrow from the rest of the world forever.
- As fiscal austerity cuts domestic demand, returning to growth requires relying more on foreign demand.
Key facts:
- Greece still has a very large current account deficit, at close to 10 percent of GDP, despite depressed output.
- Greece’s exports amount to only about 14 percent of the goods it produces.
- An improvement in competitiveness—or a real depreciation—of about 20 percent seems to be what is required.

Two broad paths:
- Become much more productive (preferred but slow and difficult).
- Reduce wages and nonwage costs (quicker, especially under a common currency).
Constraints and facts:
- Productivity gaps exist across many sectors; necessary reforms involve changes in regulation and behavior and will take time.
- In countries with flexible exchange rates depreciation can adjust relative wages; in the Eurozone, adjustment must come via lower nominal wages and prices.
- Wages in Greece increased faster than productivity for years, compounding competitiveness problems.
- Unit labor costs increased by over 35 percent during 2000-10, compared to just under 20 percent in the euro area.
Program design and social considerations:
- The best route would have been negotiation between social partners to reduce wages and prices, avoiding a long painful adjustment; this did not happen.
- The program tries to accelerate adjustment while protecting the most vulnerable.
- The adjustment must occur; the faster it happens, the less pain there will be.

Large state-financed infrastructure projects are unlikely to boost growth or improve fiscal and current accounts in the short term; they would worsen the fiscal deficit and delay adjustment.
Leaving the Eurozone:
- Euro exit followed by a sharp depreciation could achieve the needed relative wage and price decline faster.
- However, Greece is part of the Eurozone; leaving would incur large costs from dislocations (collapse of the monetary and financial system, legal fights over contract conversion rates) that would be very, very large.

The program addresses the two fundamental issues: high debt and low competitiveness.
Success depends crucially on the government’s sustained and strong implementation of agreed reforms.
Programs will need readjustment in response to unexpected events; risks remain exceptionally high (as Christine Lagarde has said, "the risks remain exceptionally high.").
The program is fair in asking for shared sacrifices within Greece and between Greece and its creditors.

Olivier Blanchard, March 19, 2012 — The Logic and Fairness of Greece's Program

Η λογική και η αμεροληψία του Ελληνικοφ προγράμματοσ
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