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June 2013

The EuroFuture Project

Paper Series
A Silver Lining? Why Recent Reforms in Greece Warrant Cautious Optimism
by Jrgen Matthes

Summary: 2012 was a very difficult year for Greece. In spite of a new government and a renewed reform effort, the economy still appears to be shrinking. Recently, however, first signs of a silver lining are appearing on the horizon. The economic sentiment has improved and, upon closer analysis, the total reform record over the past years is considerable. Although the Greek economy still has several obstacles to overcome, the glass actually appears half full rather than half empty.

The Reform Record 2012 was a very difficult year for Greece. In spite of a new government and a renewed reform effort, the economy still appears to be shrinking. To many observers, the prospects for Greece seem to still be dark despite the delivery of a third aid package from the eurozone. Recently, however, first signs of a silver lining are appearing on the horizon. The economic sentiment has improved and, upon closer analysis, the total reform record over the past years is considerable.1 Furthermore, Greece has continuously met its relevant short-term reform goals and milestones. Thus, although the Greek economy still has several obstacles to overcome, the glass actually appears half full rather than half empty. Since the summer of 2012, the newly elected government in Athens has caught up on addressing several previously neglected reforms, reducing the reform backlog considerably. A large part of the progress can be attributed to a single effort, the so-called Omnibus Law 4093, which became law on November 12, 2012
1 The Troikas recent reviews from the European Commission make this clear, too. The following remarks about reforms of the fiscal administration and structural reforms in labor and product markets are broadly based on these reviews.

and combined a long list of individual reforms. Pressure from the Troika (the International Monetary Fund, the European Commission, and the European Central Bank) was undoubtedly important to achieve this goal. The Troikas decisive approach helped to put the Greek reform program back on track. In response to these reforms as well as the worsening government debt situation, further support for Greece was agreed upon late in 2012. These measures included a reduction of interest rates on European assistance loans, a partial deferral of interest payments on these loans, and considerably extended repayment schedules. Moreover, due to the ongoing deep recession, the European Commission provided Greece with additional time to meet its deficit targets by postponing the deadline from 2014 to 2016. Consolidation and Reforms in the State Budget Despite the fact that consolidation needs are still considerable in order to meet the deficit targets, the amount of progress to date is substantial and should not be trivialized. It is important to remark on four notable achievements. First, Greece will have reduced its primary government spending (without interest payments)

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by more than 29 percent between 2009 and 2013, according to recent data from the EU Commission.2 Second, the Greek government revenue ratio (revenues in percent of GDP) increased by more than 6 percentage points to nearly 45 percent of GDP between 2009 and 2012. Third, the fiscal deficit has decreased by a remarkable 9 percentage points relative to GDP, when one-off fiscal measures are excluded. Fourth, the structural (cyclically adjusted) deficit (excluding one-off measures) even shrank by nearly 14 percentage points. Such an adjustment is almost unprecedented. Hence, the structural primary balance (without interest payments) has reached positive figures in 2012 (around 4 percent of GDP), a significant achievement. With Greeces budget for 2013, passed in fall of 2012, this trend is expected to continue. The Troika set clear standards with regard to a reliable medium-term finance plan until 2016. Consequently, the proposed consolidation measures for 2013 and 2014 are clearly formulated and mostly already implemented. These austerity measures particularly address those expenditure items that increased significantly after 2000 until the beginning of the financial crisis, essentially, welfare spending and the government wage bill. Further, the government plans to reduce public sector employment over the medium term by 150,000 positions. It wants to replace only one in five voluntary or age-related exits from its workforce.3 Moreover, the medium-term strategy will be supported by clear expenditure limits, which are broken down to the level of individual ministries. Newly introduced online reporting obligations on expenditure developments are intended to make compliance with these limits easier to verify. Tax collection has improved, as the significantly higher government revenue ratio shows. However, the fight against tax evasion and corruption will remain a reform priority. Special units of skilled tax inspectors have been formed to collect taxes from wealthy individuals and from the self-employed. Key tax inspectors will rotate their posi2 The data for 2013 is based on Commission estimates. Between 2009 and 2012, primary government spending in Greece was reduced by 15 percent. When one-off measures are excluded (such as those related to financial aid to the financial sector in Greece), the reduction is significantly higher and amounts to more than 20 percent. 3 The most recent milestone to be reached included the identification of 15,000 employees for mandatory dismissals by 2015. These redundancies are intended to make room for new and better qualified employees, for example to improve the governments capacity to supervise the financial sector. After first persistently resisting mandatory dismissals, Greece has now provided a plan for stepwise dismissals of 15,000 public employees in total. The implementation of this measure should be closely surveyed by the Troika.

tions regularly in the future. According to media reports, withholding information about tax evasion will become a criminal offense for tax inspectors. Additionally, there will be investigations to ensure that the individual wealth levels of tax inspectors are in line with their official salaries. In light of the well-known and chronic problems with tax collection, these steps are highly welcome; however, it remains to be seen how effective they will turn out to be. Labor Market Reforms There has also been significant progress with regard to labor market reforms. Unfortunately, this has not yet led to an improvement in the current employment situation due to the deep recession. Once the economy recovers, however, this reform progress should become worthwhile, as major obstacles to employment have been removed.

There has been significant progress with regard to labor market reforms.
Before the reforms started, the system of collective wage negotiations was rather rigid. There were hardly any workplace-related wage agreements. National and industry-wide wage agreements were often extended to firms not participating in collective agreements and had a long-lasting effect even after expiration. This institutional arrangement meant that collective bargaining often failed to take into account the economic situation and evolution of productivity at the plant level. In addition, price competitiveness decreased via rising unit labor costs. Furthermore, sticky wages and working hours led to an excessive rise in unemployment during the recession, as firms had no alternatives to laying off their employees when sales contracted sharply. By now, much has changed. Several reform steps have allowed workplace-related wage agreements to gain ground. The automatic extension of industry-wide collective agreements to firms not participating in collective agreements has largely been abolished along with a clause that subordinated wage agreements at the plant level. Furthermore, employees are now allowed to directly negotiate their wages with their firms management

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without necessarily involving a labor union. Consequently, wage development will better take into account current economic conditions at the plant level and will, therefore, become more employment-friendly in the future. To this end, firms can now also determine working hours more freely. Thus, similar to short-time working arrangements in Germany, firms can reduce working hours in times of recession instead of having to lay off their employees. Moreover, wage bargaining rounds will be more frequent than in the past, so that firms can better react to changing economic situations. Several reform items contribute to this achievement, including the following provisions: The maximum duration for collective bargaining agreements has been reduced to a maximum duration of three years. Automatic extensions of collective bargaining agreements have been abolished. Instead, there will be automatic wage reductions after expiration. These reforms should also help to normalize the balance of power during negotiations between employers and labor unions. In addition, significant wage reductions were achieved in an increasing number of new collective bargaining agreements. This will help to reduce formerly sky-high wages, thereby making labor more profitable and competitive. A reduction of minimum wages further contributes to this aim. Relative to other countries, minimum wages in Greece were previously very high, at least when compared with the general living standard. These wages posed a significant barrier for young people to enter the labor market as well as for unemployed to enter or re-enter. Thus, the reduction of minimum wages by around 22 percent on average and 32 percent for young employees will increase employment opportunities for these disadvantaged groups. This step is also significant since fixed minimum wages threatened to prevent the required overall wage reductions. Finally, employment protection rules, which were extremely rigid and protected insiders at the cost of outsiders, were made more flexible. This was mainly achieved through a reduction of severance payments.

Product Market Regulation and Competition Sufficient competition in the product markets is not only necessary to ensure that employers have an incentive to limit wage increases in collective bargaining. Due to low competitive pressures, when firms are able to raise sales prices in reaction to higher labor costs, they become less likely to insist on limiting wage increases. Likewise, higher competitive pressure strengthens the link between lower labor costs and decreasing export prices, which in turn increases international competitiveness. In addition, reducing entry barriers to closed professions lowers prices, enhances productivity, and creates new employment opportunities (especially for young, well-educated Greeks). For these and other reasons, structural reforms in product markets, which create more competition, are crucial.

Structural reforms in product markets, which create more competition, are crucial.
Compared to fiscal consolidation, structural reforms were not given sufficient attention in the Troikas initial reform program. But over the course of the program, the emphasis has shifted in this direction. However, while the Greek parliament enacted many laws, including liberalizing closed professional services, the bureaucracy as well as professional organizations often failed to implement the legislation. In some instances, incompetence on the part of public servants was the problem, in others opposition to reforms was the cause of delay, especially by those who benefit from the existing regulations. This problem was addressed by the Troika in the fall of 2012, by focusing primarily on the effective implementation of reforms for 20 economically vital professional service groups, such as auditors, lawyers, and tourist guides.4 For example, the government broke up the monopoly of so-called customs brokers, firms that can directly clear customs. In addition, fees of notary publics were reduced by 30 percent. However, niches remain in which some professional service groups, with little competition and high fees, remain unchallenged.
4 However, the most recent review of the Greek adjustment program by the Commission indicates that progress is still protracted in this area.

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Efforts to reduce bureaucracy proceed sluggishly. While starting up new companies has been made somewhat easier, e.g. through the creation of a new form of enterprise, much remains to be done. According to the indicators of the World Banks Doing Business Ranking, Greece ranks 146th of more than 180 countries in this respect. Furthermore, trading activities in exports and imports remain relatively costly, and the judicial system is inefficient and slow. Overall, the business environment still discourages urgently needed private investments. It is difficult to understand why progress in simplifying overly complex business regulations is so slow, because these reforms (in contrast to higher spending on education and innovations) are essentially without cost for the government. There is a huge potential for the recovery of the Greek economy when a business-friendly regulatory environment is created. Unleashing market forces is essential in order to find the niches and opportunities that are needed to reinvent the Greek business model. However, Greek legislators and administrators even taking into account the considerable technical assistance provided by European partners seem unable to deliver sufficiently on this requirement so far. Therefore, the introduction of Model Regions with a separate highly business-friendly regulatory system should be promoted in order to attract foreign and domestic investors. These zones should not provide subsidies and generous tax advantages, since this approach can quickly fall foul with EU assistance rules. Instead, such Model Regions should provide, above all, a sound business environment with an efficient bureaucracy and reliable law enforcement as well as judicial system. For example, the

issuance of licenses for start-ups companies can be facilitated by creating a single contact point in the bureaucracy (a one-stop shop) that effectively deals with necessary approval steps. Such Model Regions would not only boost new investments, but also signal to the rest of the country that overregulation comes at a high price namely, stifling the economy. Communities outside these Model Regions would have the incentives to reduce harmful regulations in order to prevent companies from leaving. Alternatively, the new zones could be expanded over time in order to effect a fundamental change in the Greek regulatory system. Improvements in Competitiveness and Current Account Deficit Labor market reforms have reduced labor costs and have increased competitiveness considerably. On the basis of unit labor costs, the real effective exchange rate (REER) an important indicator for international price competitiveness decreased by a remarkable 20 percent between 2009 and the end of 2012, according to data from the European Commission. However, on the basis of export prices, the REER shows hardly any progress. This is mainly due to the fact that increases in consumption taxes temporarily led to increasing prices in the course of fiscal consolidation. Furthermore, firms do not yet feel sufficient competitive pressures to reduce their sales prices in response to labor cost reductions. Instead, they seem to be able to increase their profit margins due to the rigidity of product market regulation. Thus, more competitive pressures in response to current reforms should help to lower export prices in the near future. However, despite the lack of price reductions, Greeces goods exports increased by around 44 percent between 2009 and 2012, according to data provided by the Bank of Greece. This development is aided in part by a rebound effect after the crisis year 2009. However, total exports of goods and services only increased by 16 percent since 2009, because revenues from services exports hardly rose, due especially to a drop in tourism revenues in 2012. At the same time, total imports shrank by around 11 percent. The trade deficit decreased from 18.1 to 4.9 billion between 2009 and 2012, a remarkable 73 percent. Figure 1 shows that this progress is not only due to a decrease of

It is difficult to understand why progress in simplifying overly complex business regulations is so slow, because these reforms are essentially without cost for the government.
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imports (by around 6.4 billion), contrary to what is often suggested, but also to a slightly bigger increase of exports of goods and services (by around 6.8 billion).

Figure 1

Greece: Trade balance improvement carried by export increases and import declines - in billion euros 80

2009 2012 Change between 2009 and 2012 How sustainable is the associated considerable decrease of Greeces 60 current account deficit? Using the 40 REER on the basis of export prices to estimate the evolution of the trade 20 balance and current account balance, one could take a pessimistic view. But 0 this approach can be called into quesTrade balance Exports Imports -20 tion, since the improvement in exports does not correspond to the broadly -40 constant REER (based on export prices). Moreover, it seems as if a more Source: Bank of Greece, Cologne Institute for Economic Research dynamic development of tourism copied part of the reform agenda from the Nordic counservices can be expected this year, as tries) had a similarly encouraging experience. Concerning media outlets are reporting increased bookings of holiday the countries in the periphery of the euro area, the OECD trips to Greece in 2013. Finally, a recurrence of a strong calculated that the structural reforms taken by the former import boom with imports outpacing exports is not government of Mario Monti in Italy should boost the expected in the near future because domestic demand GDP over the medium term by a considerable 4 percent growth should remain relatively subdued for the time compared to a scenario without reforms. being, due to deleveraging needs. Thus, there is little indication that the considerable decrease of the current account Some maintain that the seemingly chronic inefficiency deficit is only a temporary and cyclical phenomenon. of over-regulated markets and a corrupt public administration would prevent Greece from returning to a solid Silver Linings Regarding Economic Growth growth path. However, this view can be questioned. In fact, Despite the aforementioned deficits, reform steps already as shown by Dani Rodrik,5 many developing countries with taken are quite impressive. This is demonstrated by the high degrees of corruption and government ineffectiveness OECDs reform responsiveness indicator (Figure 2). While benefited from extended growth periods after they had certain deficits remain, particularly regarding the fight embarked on significant economic reforms. against tax evasion and product market reforms, signifiThus far, the desired boom in Greece has been hampered cant and undeniable progress must be acknowledged in substantially by a deep pessimism of economic agents and the areas of fiscal consolidation, labor market reforms, and a severe credit crunch. However, there are new rays of hope the reduction of the current account deficits (which is also regarding both problems: driven by a stronger dynamic of exports). As a result, there is genuine hope that the structural reforms put in place The economic mood in Greece has improved considerwill foster growth, productivity, and employment in the ably (Figure 3). The OECD Composite Leading Indicator medium term. Several studies, as well as the experiences of has increased almost continuously in Greece since January many industrialized countries that reformed their econo2012 and has recently even exceeded the long term average. mies in the past, support this assumption. For example, Also, the OECDs Business Confidence Indicator has been most of the Nordic countries reformed their economies in the midst of deep crises in the 1980s and 1990s and bene5 See Dani Rodrik, One economics, many recipes: globalization, institutions, and ecofited from improved economic growth. Germany (which nomic growth, 2007, Princeton, NJ, Princeton University Press

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Figure 2
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0

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Range from 0 (no reforms) to 1 (significant progress on all reform recommendations)

Reform Responsiveness Rate

the European Investment Bank committed to loans of around 1 billion to small and mediumsized enterprises for 2013. Of that amount, according to the Greek Ministry of Finance, around 600 million are contracted and a fraction has already been paid out. If a strong upswing is truly about to get underway, this could give rise to new optimism in Greece. Since structural reforms have a higher pay-off in good economic situations, the significant reform progress should amplify the upswing. A rebound effect could emerge similar to those that have been observed in other countries after a deep crisis. In the initial phase of an upswing, relatively high growth rates could result, as a long holdup in investment and consumption is resolved.

Responsiveness rate: Ratio of reforms taken to reform recommendations of the OECD in several policy areas Source: OECD, Cologne Institute for Economic Research

on an upward trend since mid-2012. Thus, forecasts for a return to positive growth rates of the Greek economy in 2014 may finally and hopefully prove to be correct.

Furthermore, according to the Figure 3 Greek Ministry of Finance, net Greece: Better economic perspecives? lending to the industrial sector increased for the first time in OECD Leading Indicator OECD Business Confidence Indicator a while. On one hand, this is 103 due to a gradual stabilization 102 of the Greek banking system. 101 Between June and December 100 2012, around 15 billion in 99 98 deposits, initially withdrawn 97 due to concerns over Greece 96 potentially leaving the euro 95 zone, were returned. Addi94 tionally, the recapitalization of banks has made further progress due to additional assistance loans from other euro countries. Furthermore, Both indicators have been amplitude adjusted by the OECD, long term averages = 100
Source: OECD, Cologne Institute for Economic Research

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Self-reinforcing positive business cycle effects could take hold, for example through an increase in employment, which, in turn, would induce consumers to increase consumption. In case of a temporary rebound effect and a relatively stable upswing in the medium term, government revenues could increase considerably due to rising incomes. This positive cyclical revenue effect is likely to be reinforced by a certain, albeit limited, increase in the effectiveness of tax collection. In case of a solid revenue increase, the budget deficit should shrink faster than currently expected, as government spending has already been reduced (as depicted). Currently, considering the prolonged negative developments of the past years in Greece, such an optimistic scenario may not yet appear very realistic. However, predictions are often distorted by trends of the recent past, which tend to be extrapolated.

About the Author


Jrgen Matthes is head of the international economic order department at the Cologne Institute for Economic Research. He has published widely on issues ranging from the euro crisis, eurozone economic imbalances, sovereign defaults, and the German export model to impacts of globalization, trade policy, international competitiveness, global governance, and international financial markets.

About The EuroFuture Project


The German Marshall Fund of the United States understands the twin crisis in Europe and the United States to be a defining moment that will shape the transatlantic partnership and its interactions with the wider world for the long term. GMFs EuroFuture Project therefore aims to understand and explore the economic, governance and geostrategic dimensions of the EuroCrisis from a transatlantic perspective. The Project addresses the impact, implications, and ripple effects of the crisis in Europe, for the United States and the world. GMF does this through a combination of initiatives on both sides of the Atlantic, including large and small convening, regional seminars, study tours, paper series, polling, briefings, and media interviews. The Project also integrates its work on the EuroCrisis into several of GMFs existing programs. The Project is led by Thomas KleineBrockhoff, Senior Transatlantic Fellow and Senior Director for Strategy. The group of GMF experts involved in the project consists of several Transatlantic Fellows as well as program staff on both sides of the Atlantic.

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