23 January 2012

George Provopoulos: Timely Greek lessons on the eurozone crisis

Bank of Greece governor Provopoulos comments that as Greece negotiates a new programme, it is important to ask why the previous one went off track, and what are the lessons learnt.

The first point concerns the implementation, which for many of the measures in our programme was slow and inefficient. Second, experience shows that programmes aiming for fiscal consolidation that are based on spending cuts lead to a smaller economic contraction than those based on tax increases.

The third lesson concerns the scale of fiscal adjustment. The magnitude of our fiscal consolidation was large, because of the size of the initial imbalances in the economy. Consolidation was not going to be easy because the fiscal adjustment per Greek household last year was almost twice that in Ireland and more than twice that in Portugal. However, difficulties in implementing structural reforms, privatisation and measures to improve the efficiency of tax collection have exacerbated the unavoidable pain. As a result of these difficulties, the fiscal adjustment has led to a greater economic contraction than initially projected because, for a programme to be effective, all the interconnected parts must be in place.

Finally, there is the issue of the fiscal multiplier. Not only has Greece undergone a larger consolidation than Ireland or Portugal, but, per percentage point of consolidation, the economy has contracted more. This stems from the fact that Greece is a relatively closed economy. Any decline in demand hits domestically produced goods more than imports. The decline in demand for domestic production, then, affects output more than if the economy were more open.

The potential of our economy to grow is vast. Greece has to move fast to implement bold structural reforms, far-reaching privatisation and effective measures to combat tax evasion. Fiscal adjustment should involve two-thirds expenditure cuts, so that the share of government spending in national output is reduced, allowing a competitive export sector to flourish. As growth resumes and tax collections rise, many of the recent tax rises can then be reversed.

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