A catharsis long overdue

Rather than pray to speculation, Greece is a victim of its own structural weaknesses masked by Eurozone membership

During recent debates on their country’s debt cirsis, Greek politicians suggested that investors’ (or rahter speculators’) greed was the principal cause of the country’s plight. However, CDS-trading (even the notorious ’naked’ one) requires an imminent default against wich one can spekulate. And the default has been there, for roughly twenty years now. Ironically, it was the country’s Eurozone-membership that lubricated the Greek glide towards chronic intebtedness.

From the early 80’s (after two decades of rapid economic growth and the Greek EU-Accession Treaty signed) the Hellens’ economic policy started to fly in the face of the EU’s aspirations related to liberalization and the Single Market. The cause was Greece’s new middle-class craving higher welfare at the end of a 20 year-long high-growth period. Following the second oil-shock (prompting Europe to restructure its economies to make them more effecitve) Greece’s PASOK governments set out to redistribute the wealth of a slowing economy, and nationalized ailinompanies upon trade unions’ calls. To no surprise, in 1993 the Greek economy was sailing near to the brink with an inflation rate of 20.4 pct, public deficit nearing 16 pct and external debt hovering around 120 pct of the GDP.

Despite short-term doldrums in Greek politics (moments of wide-range consensus between political parties and unions) that led to the country’s accession to the Eurozone in 2001, structural problems remained unsolved. Between 1980 and 2007, Greek social spending rose form 11.5 pct to nearly 25 pct of the GDP. Apart form the mass of the spending, the structure of the social system has also been worriesome: pensions and healthcare now absorb nearly 80% of the social transfers, while family support schemes and unemployment benefits account for only 3-3.5 pct of total social spending.

Social expenditure by Function 2006

In contrast to conventional wisdom, families with less than four children are far less patronised in Greece than in other Southern European countries, as in terms of maternal and parental leave the Greek social system is not generous at all. As a result, Greece is one of the countries with a very low natality rate, a fact that amplifies the woes of spendthrift pension schemes and of burdens they will entail in the future. If recent estimations (see chart) prove true, pension schemes alone will eat up at least 20% of the country’s GDP) by 2020.

Percentage of the elderly (65+ years of Age) to total population

Moreover, ill-set pensions are transferred to benefifcaries through an incredibly fragmented structure. A plethora of pension providers (numbering 190 today) and categories make the Greek pension system a vespiary of colliding interests and political bargaining. Thus, beyond its complexity and its costs, it is its reform-resistence that makes the pension system even more remarkable (see last decades’ reform-attempts here and here).

Health care is the other costly reform-braker. It accounts for 23 pct of the social expenditures even with private clinics mushrooming (their turnover amounts to some 40 pct of the total health care expenses of citizens). In the early 2000s, the Simitis-government made the latest grand effort to change it, but the reform fizzled out, as rationalization (aiming to introuce a system of regional heatlh centres) was thwarted by doctors’ strikes.

High social security commitments are topped by the heavy load to finance a mini-cold war with Turkey. Greek military spending added up to €8.7 bn between 1997 and 2003, and had been increasing until 2009. Currently it accounts for 2.8 pct of the GDP, a figure well over the NATO average (1.7 pct). Only the United States spends more on guns and warships in realtive terms. Still, a crisis is a crisis: in its Canossa-march towards budgetary health, the Greek government has generously cut military spanding by around 6.6 pct a year on, outlining a military budget spending ’only’ €6.6 bn in 2010.

Greece is an example of a country that fails due to festering structural problems despite its steady economic growth and its Eurozone membership.

Greece’s annual growth rate (4.2 pct) between 2000 and 2007 helped to offset the bounces in indebtedness of the public and the private sectors. Robust economic growth was completed by the country’s Eurozone-membership securing access to cheaper credit until 2008 (see chart and deatiled analysis here).

However, as a Eurozone coutry can not resort to currency-devaluation to improve its competitiveness and its balance of payments, Greek exports were largely exeeded by imports (the gap tripled within seven years to near 3 pct). High growth and consumption went along with inflation 1.2-1.5 pct higher then Eurozone’s 2.2 pct average, leading to low (or even negative) real interest rates, making loans cheaper to households and private ventures. The respective indebtedness of these segments climbed to 46 and 49 pct of GDP by 2007. As a result, Greece, in the last eight years has borrowed up to 10 pct of its GDP from capital markets every year. When the crisis set in, loans went scarce and the EU was set to see what may happen to a currency area without close economic governance.

In a wider context, the Greek issue boils down to the old question of the Eurozone of how to coordinate 16 or more budgetary policies in a way that everyone prospers. Assimetrical shocks (currency areas’ biggest enemies) can only be averted if member states don’t (and can’t) hide their hazardous fiscal policies behind the common European varnish. In the latter case Greek politicians may also be relieved: ’speculators’ will temper their greed when lending to a boringly sound Greek economy.

The European Monetary Fund - born under bad signs

One of the concepts of proceeding to deeper European financial integration faces many obstacles. Its main flaw, however, is its timing.

CRISIS-HIT Europe is experiencing the first shock of its financial stability since it introduced the euro. The IMF’s appearance in Hungary, Latvia, Ukraine, Romania and probably in Greece, while disquieting for the EU as an ambitious political bloc, is not (and will not) be able nor authorized to solve the deep-seated structural and financial problems of ailing euro-zone economies.

Having this in mind, this February, two economists, Stephen Mayer (Deutsche Bank) and Daniel Gros (CEPS) published an article calling for the establishment of a European Monetary Fund (EMF). A rescue facility to provide EU member states with external funding when the markets don’t, or only at steep premiums. The authors argued that a higher level of monetary coordination was only possible if the EU challenged one of the contemporary axioms of global financial governance: that a country should never go under. They proposed a mechanism shielding member states from financial difficulties while enforcing stability criteria by punishment.

The idea of the EMF got a high profile when German finance minister Wolfgang Schauble announced in March he would initiate the creation of such an institution at the European level. France and Germany gave their backing to the concept but none of them enthusiastically. Since then, many others have considered the idea of the fund: some endorsed it (e.g. the current patient Greece), while others expressed pessimism (like the UK and Belgium). The European Commission and the European Parliament rushing to sign up to the idea, the ECB remained cautious saying they didn’t see the possible role of such a body, yet adding that the ECB would line up behind the mechanism if EU leaders deemed it necessary.

EU leaders seemed so when mandating European Council President Herman Van Rompuy to form a working group investigating the feasibility of such a facility in the end of March. But in the end, the very same problem (the Greek crisis) that opened Pandora’s box ended up derailing the debate about the initial concept. As a result, the idea has morphed into the image of a cash cow eating up the Germans’ and the City’s reserves.

However, the initial concept outlined a mechanism which largely dwells on the existing European monetary credo, aiming to reinforce and truly implement it. The EMF would have a twofold competence. The first ought to be the consolidation of member state’s financing by funds and surveillance.

The main contributors to the Fund’s reserves would not be the member states with healthy economic indicators, but the countries in breach of the benchmarks of the Stability and Growth Pact (SGP). Each of the renitent countries was to pay an annual 1 per cent of the amount of its current deficit above the 3 pct ceiling set in the SGP. Accumulated reserves would then be invested into A-rated (maybe German or French) bonds.

This would partly eliminate the moral hazard problem, namely that risky countries may further loosen fiscal policies with EMF aid in prospect.

The problem of moral hazard is rather a feature of the pre-EMF landscape, though. Indebted countries like Greece, Latvia or Hungary still hold a major asset their creditors don’t: statehood. Countries are never let go under, as long as the IMF exists, and the EMF doesn’t. An eventual bail-out is always likely to come on debtors’ rescue.

In contrast, in a system ruled by the EMF a country may go on default indeed. Beyond that point, the EMF could take over the management of state debt stock. This would manifest in a massive buy–up of the troubled country’s bonds by the EMF, at a significant discount. SGP rules would be strengthened by this discount (‘haircut’), a slash of toxic bonds’ value to the point where it doesn’t exceed 60% pct of the country’s GDP. This would allow investors to regain up to 20-25 pct of the total (face) value they would otherwise lose on the country’s bonds in case of its non-orderly default. The risk of contagion would be minimised, and the country in plight would be back from the brink. Upon such a bail-out, the renitent country would face rigorous fiscal diet geared at its financial recovery - just like during an IMF operation which may only entail short-term assistance or a one-off credit. In case of ultimate failure to comply with the EMF’s instructions, the country may be expelled from the Eurozone.

Apart from this last, appalling option, the concept offers long-term relief for all the three parties: to the saved country, to the surviving investors, and to the Eurozone as a whole.

The concept’s key appeal is, however, the automatic nature of the mechanism: no votes in the EU’s ECOFIN Council would be needed to enforce renitent members to pay, nor could such a vote break this obligation.

Yet what looks sleek on the drawboard may not always fly. That also holds for the EMF- project facing serious political obstacles right upon its birth.

If every country breaching the criteria of the SGP had to pay fines, the Fund’s assets would swell rather fast. To date 20 members states (including the UK, Germany, France and Italy) are subject to an excessive deficit procedure. Thus many of the member states would qualify for paying high amounts to the EMF every year. ConsensusEconomics, a macro economy watchdog estimates that Italy (a notorious Pact-breaker) should have paid more than €8 bn in 2009, would such a punishment mechanism operate. France, on the same account, would transfer roughly €4 bn to the European finance angel while Greece (trapped between a monstrous public payroll and a debt of around €300 bn) should pay a fine of round 0,55-0,60 pct of its GDP. Such a generous contribution on the score of budget deficit would spark anger in any country of post-crisis Europe. Instead of finding solace in Eurozone membership and gradual (albeit sluggish) economic revival, citizens of Pact-breaching countries would find dismay in punitive fines. Fury is predictable.

Nonetheless, fiscal freedom is a fundamental piece of state sovereignty, thus it is almost impossible to devolve to international, politically detached entitles. Even if there is a will to do this, the EU Treaty’s ’no bail-out’ clause (saying that none of the member states should be forced to bail out another one) remains to overcome. Speaking to Reuters recently, European Central Bank vice-president Vitor Constancio reminded: as long as member states patch up Greece’s financial holes with credits, the danger of violating the ’no bail-out’ clause can not emerge. To contrast, managing debt by buying up a country’s bonds would be a real bail-out, something the EU Treaty excludes.

But be necessary as it may, a treaty change seems unlikely to come any time soon, for Europeans have no appetite for another referendum-nightmare. Lawyers say, if not as an EU-wide institution, the EMF could still evolve as the first example of what the Treaty calls ’coopération renforcée’, an enhanced cooperation involving a smaller group of member states might be joined by others any time. The creation of such a community is possible without uneasy treaty reviews. But such an entity would not be worth creating without Germany and France (let alone the UK), countries giving the most to Europe’s economic weight.

However complicated this issue may be, countries enmeshed into a currency area like the Eurozone can’t tolerate any member’s fiscal meltdown. To date French and German banks hold nearly 70 pct of the Greek bonds the current price of which falls short of par value by some 20 pct on the markets. In case of a Greek default those assets become worthless or extremely illiquid, having serious consequences on the fragile economic recovery in Europe.The looming Greek insolvency affects weaker EU members as well. As predicted by analyst, 10-year Greek bonds’ yields (hitting historical heights of 8.4 pct this week) make other troubled countries’ interest rates climb. Portugal (another potentially weak Eurozone member) now borrows at an unprecedented 4.84 pct interest, as a result of market sentiment fearing contagion. Italy may follow, along with Ireland.

Under such an ominous outlook, creating a common European financial shield and assuring decent fiscal planning sound wiser then ever. It’s probably time for another big consensus in Europe, another rough ride.

Woes of "back there" are right here now

Polish President’s death fuels mixed sentiments in Brussels

In the European Parliament, Polish grief has been all around these days. As a matter of bizarre coincidence, a memorial exhibition presenting unearthed mass-graves in Katyn was supplemented with photos of the high ranking Polish victims of the Smolensk plane crash. Otherwise rejoicing receptions of the EP get more solemn as some Poles with memorial pins arrive. Two days ago EP President Jerzy Buzek led a ceremony where Polish and other MEP’s, offices’ staff and visitors paid tribute to the victims. It was a moving event, even if most of the names were unknown for non-Polish fellows.

Still, not all of Brussels’s fine-boned technocrats sympathise with such a display of condolences.

In the EP’s canteen I happened to eavesdrop a conversation of quite a big bunch of MEP’s. Some of them I know enough to state that at least three different groups were 'represented' at that overly informal lunchtime-chat. One of these MEP’s has hinted that as tragic as it was, the president’s death wouldn’t (and shouldn’t) overwrite his gaffes and his bad fame in Brussels. The table seemed swift to find common ground along this claim. Arguments such as 'he was a Euro-sceptic trying to stop the ratification of the Treaty of Lisbon', and 'he hated homosexuals' may have hit other ears around. On squelching some carefully put counter-arguments of a timid assistant, our representatives concluded that 'it’s fine back there in Poland. But here, we’re in Europe' – giving the latter word the tone of a fanfare.

Shortly: Jerzy Buzek should have kept his nation’s mourning out of the EP’s walls.

One thing some eurocrats tend to omit is that 'Europe' (i.e. the EU) remains an absurdly heterogeneous compound of nations and views. And although Mr Kaczynski was withholding his ink from the EU’s newest testament (the Lisbon Treaty) until its Irish approval, he did not balk the process as did its Czech counterpart, Vaclav Klaus. Still, he had his own view of Europe and of the role Poland deserved. He was not satisfied by the degree of influence (i.e. voting power) the new treaty guaranteed to his country which he considered to merit a bigger clout in Brussels. He was a stiff Atlanticist fearing (and irking) Russia, while hobbling reconciliation with it after the war in Georgia. Mr Kaczynski would raise many eyebrows at home and in Europe by his relentlessly rigid manner and his stubbornness to secure himself a seat on the Council meetings along with Polish PM Donald Tusk. He would take a line which was controversial (and sometimes scoffed at) in Poland as well as abroad. He was not a federalist. He was conservative and old-fashioned. But at the same time, he was the president of Poland, the far most important new member state of the EU.

Finally, he was not alone on that plane. Apart from his wife, the core leaders of the Polish national army and politics perished along with him. It is Poland’s citizens (or at least those 25 million beloved ’eurobscure’ Polish folks) to whom the EP paid tribute that day. Presidents come and go. Symbols last; especially 'here in Europe.'

Many EU officials should remake the order behind their facades and accept that the deeper the new treaties cut into states’ sovereignties (i.e.: the faster integration advances) the more frictions occur between them. Those who believe that all leaders should sign up automatically to an ever faster pace of pooling national powers do not understand democracy. Indeed, a 'united' Europe will also inherit the conflicts hitherto kept 'back there'. EU-staff is there to table proposals, not credos, and presidents’ reservation towards draft treaties may be seen as reflection instead of heresy.

However, the seamy side of the conventional European wisdom hardly gains publicity outside the EU institutions' canteens. If so, such claims get quenched by overwhelming official statements calling for compassion and unity.

Apart from some of its officials, Europe keeps valuing solidarity. These lunchtime discussions better remain ignored, stay deep in the jungle of European institutions groping for their place in a yet deeper jungle called The Treaty of Lisbon.