End “Extend and Pretend” With Greece by Lucrezia Reichlin , Elias Pa... https://www.project-syndicate.org/print/greece-troika-fiscal-reform-by-...

ECONOMICS

LUCREZIA REICHLIN
Lucrezia Reichlin, a former director of research at the ECB, is Professor of
Economics at the London Business School.

ELIAS PAPAIOANNOU
Elias Papaioannou is Professor of Economics at the London Business School.

RICHARD PORTES
Richard Portes is Professor of Economics at London Business School and President
of the Centre for Economic Policy Research.

JUN 15, 2015

LONDON – Greece needs an agreement now with its creditors (the so-called troika
comprising the International Monetary Fund, the European Commission, and the
European Central Bank). Yet all parties are pursuing a disastrous “extend-
and-pretend” strategy with a narrow focus on ϐiscal issues and pensions. In fact,
rumors are now emerging that the Greek administration and the troika are considering
yet another extension of an agreement that was supposed to end last year.

At the core of the Greek crisis are structural problems: a dysfunctional public
administration, oligopolistic product markets, ludicrous regulatory burdens,
bureaucratic red tape, and an absurdly slow judicial system. Without a clear strategy to

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address them, any agreement will lack credibility.

But if this is true – and many seem to believe it is – the current strategy is bound to fail
for two reasons. First, any comprehensive package of structural reforms can be
implemented only if austerity is relaxed. Second, an extension would prolong the sense
of uncertainty that has so far jeopardized Greece’s recovery.

A credible commitment by Greece to sound macroeconomic policies requires adjusting

the troika’s targets to reϐlect realities. Current negotiations seem to envisage a modest
primary budget surplus of 0.8-1% of GDP for 2015. But the best feasible target would
be a tiny symbolic surplus for the primary balance (which excludes interest payments
on debt) this year, and a gradual increase thereafter to a realistic 1.5-2% of GDP.

The fact is that, given the liquidity crunch, oligopolistic product markets, and a small
export sector, any further austerity will simply drive Greece deeper into recession. By
contrast, minimizing the primary-surplus target would encourage the government to
pursue structural reforms and help restore Europe’s image for ordinary Greeks,
thereby countering the populist, conspiracy-theory arguments that are sabotaging
negotiations.

Realism is needed on pensions, too. Early-retirement schemes – one-third of public-

sector employees currently retire before the age of 55 – should be targeted
immediately. The government should gradually increase the retirement age for new
workers, crack down on evasion of social-security contributions, and accept the
no-deϐicit principle for supplementary pension funds.

But economic and social common sense demand that the troika allow a transition
phase, because pension cuts will be recessionary. The same holds true for further
reforms of the labor market, which has been liberalized signiϐicantly in recent years,
amid rapidly declining real wages.

What is needed now is a new reform-oriented agreement – one that recognizes the
need for measures to be implemented in the right sequence, delaying those that will
have a recessionary effect. The agreement’s focus should be the business environment,
allowing the forces of creative destruction to lay down the foundation for a sustainable
recovery.

The Greek economy needs a reallocation of capital and labor to export-oriented ϐirms
and skill-intensive sectors. Government ofϐicials should not demonize private
enterprise and entrepreneurial activity, nor penalize them with excessive, capricious

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taxation. Instead, they should focus on the urgent remedies that are needed if
sustainable growth is to return.

First, product-market reform cannot be delayed. Lawmakers must, for example,

remove the obstacles that deter foreign and domestic investment; open closed
professions; remove price caps; and reduce licensing requirements and other
anachronistic barriers to ϐirm entry and expansion.

Second, the state’s limited administrative capacity must be improved. At a minimum,

civil-service jobs should be detached from political patronage. Mechanisms to improve
transparency and accountability should be strengthened – for example, through
computerization.

Third, Greece needs a sound and predictable legal system. At the moment, the
framework for property rights, investor protection, and corporate governance is
extremely weak, and recent legislative measures regarding the personal liability of
shareholders in limited liability companies have made things worse.

Fourth, the Greek government should overhaul the judicial process. Courts’ inefϐiciency
protects insiders and impedes entrepreneurship. It also contributes to inequality and
fuels Greeks’ belief that the system is unfair – as indeed it is. Rather than taking an
incremental approach, the government should launch a “big push.” To clear the system’s
massive backlog of cases, the authorities should consider recruiting part-time
magistrates and opening courts on weekends and during the summer. Medium-term
reforms should include the establishment of specialized courts and the promotion of
alternative dispute-resolution mechanisms.

The new government promised a new departure. But so far it has done little, even in
high-priority areas (such as tackling fuel smuggling). In fact, many of its policies – most
notably, the new education bill – have been regressive. Rather than safeguarding the
independence of the Bank of Greece and the National Statistical Agency, the
government and afϐiliated MPs call them into question. Rather than fostering
transparency, the government has tried to jeopardize projects like Diavgeia (the
website on which all government decisions are supposed to be published). While the
government tells the troika that privatization of ports and municipal airports will
continue, many cabinet members argue against it.

The current discussions show little will – on either side – to overcome the failures of
the past ϐive years. The troika maintains its myopic focus on ϐiscal austerity; Greece
remains reluctant to reform. But now, with the economy in free fall, it should be obvious

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to both sides that “extend-and-pretend” is no solution at all.

The Greek government must take ownership of a comprehensive reform program,

communicate it to the public, and implement it with the support of other pro-European
political parties. National unity – at least among pro-European forces – is desperately
needed. At the same time, the European Union and the IMF should help Greece to
reform its public administration, strengthen the judiciary, break up cartels, and
implement product-market reform. If the government embraces this agenda, the troika
should reward it with debt relief, both by extending loan maturities and by lowering
interest rates.

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reichlin-et-al-2015-06

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