Greece last act

NEW YORK – European Union leaders continue to play a game of brinkmanship with the Greek government. Greece has met its creditors’ demands far more than halfway. Yet Germany and Greece’s other creditors continue to demand that the country sign on to a program that has proven to be a failure, and that few economists ever thought could, would, or should be implemented.

The swing in Greece’s fiscal position from a large primary deficit to a surplus was almost unprecedented, but the demand that the country achieve a primary surplus of 4.5% of GDP was unconscionable. Unfortunately, at the time that the “troika” – the European Commission, the European Central Bank, and the International Monetary Fund – first included this irresponsible demand in the international financial program for Greece, the country’s authorities had no choice but to accede to it.

The folly of continuing to pursue this program is particularly acute now, given the 25% decline in GDP that Greece has endured since the beginning of the crisis. The troika badly misjudged the macroeconomic effects of the program that they imposed. According to their published forecasts, they believed that, by cutting wages and accepting other austerity measures, Greek exports would increase and the economy would quickly return to growth. They also believed that the first debt restructuring would lead to debt sustainability.

The troika’s forecasts have been wrong, and repeatedly so. And not by a little, but by an enormous amount. Greece’s voters were right to demand a change in course, and their government is right to refuse to sign on to a deeply flawed program.

Having said that, there is room for a deal: Greece has made clear its willingness to engage in continued reforms, and has welcomed Europe’s help in implementing some of them. A dose of reality on the part of Greece’s creditors – about what is achievable, and about the macroeconomic consequences of different fiscal and structural reforms – could provide the basis of an agreement that would be good not only for Greece, but for all of Europe.

Some in Europe, especially in Germany, seem nonchalant about a Greek exit from the eurozone. The market has, they claim, already “priced in” such a rupture. Some even suggest that it would be good for the monetary union.

I believe that such views significantly underestimate both the current and future risks involved. A similar degree of complacency was evident in the United States before the collapse of Lehman Brothers in September 2008. The fragility of America’s banks had been known for a long time – at least since the bankruptcy of Bear Stearns the previous March. Yet, given the lack of transparency (owing in part to weak regulation), both markets and policymakers did not fully appreciate the linkages among financial institutions.

Indeed, the world’s financial system is still feeling the aftershocks of the Lehman collapse. And banks remain non-transparent, and thus at risk. We still don’t know the full extent of linkages among financial institutions, including those arising from non-transparent derivatives and credit default swaps.

In Europe, we can already see some of the consequences of inadequate regulation and the flawed design of the eurozone itself. We know that the structure of the eurozone encourages divergence, not convergence: as capital and talented people leave crisis-hit economies, these countries become less able to repay their debts. As markets grasp that a vicious downward spiral is structurally embedded in the euro, the consequences for the next crisis become profound. And another crisis in inevitable: it is in the very nature of capitalism.

ECB President Mario Draghi’s confidence trick, in the form of his declaration in 2012 that the monetary authorities would do “whatever it takes” to preserve the euro, has worked so far. But the knowledge that the euro is not a binding commitment among its members will make it far less likely to work the next time. Bond yields could spike, and no amount of reassurance by the ECB and Europe’s leaders would suffice to bring them down from stratospheric levels, because the world now knows that they will not do “whatever it takes.” As the example of Greece has shown, they will do only what short-sighted electoral politics demands.

The most important consequence, I fear, is the weakening of European solidarity. The euro was supposed to strengthen it. Instead, it has had the opposite effect.

It is not in the interest of Europe – or the world – to have a country on Europe’s periphery alienated from its neighbors, especially now, when geopolitical instability is already so evident. The neighboring Middle East is in turmoil; the West is attempting to contain a newly aggressive Russia; and China, already the world’s largest source of savings, the largest trading country, and the largest overall economy (in terms of purchasing power parity), is confronting the West with new economic and strategic realities. This is no time for European disunion.

Europe’s leaders viewed themselves as visionaries when they created the euro. They thought they were looking beyond the short-term demands that usually preoccupy political leaders.

Unfortunately, their understanding of economics fell short of their ambition; and the politics of the moment did not permit the creation of the institutional framework that might have enabled the euro to work as intended. Although the single currency was supposed to bring unprecedented prosperity, it is difficult to detect a significant positive effect for the eurozone as a whole in the period before the crisis. In the period since, the adverse effects have been enormous.

The future of Europe and the euro now depends on whether the eurozone’s political leaders can combine a modicum of economic understanding with a visionary sense of, and concern for, European solidarity. We are likely to begin finding out the answer to that existential question in the next few weeks.

Joseph Stiglitz

Read more at http://www.project-syndicate.org/commentary/greece-creditor-demands-by-joseph-e--stiglitz-2015-06#akmcmFItSxr1MUM1.99

Middle Income Trap

SANTIAGO – Aside from an established tradition of bad macroeconomics, what do Greece and Argentina have in common? One answer is that they were the world’s longest-held captives of the so-called middle-income trap – and remain within its reach to this day. With countries in Asia, Eastern Europe, and Latin American fearing that, having reached the international middle class, they could be stuck there, Greece and Argentina shed light on how that might happen.

A recent paper by economists from Bard College and the Asian Development Bank categorizes the world economy according to four groups – with the top two categories occupied by upper-middle-income and high-income countries – and tracks countries’ movements in and out of these groups. Which countries were stuck for the longest period in the upper-middle-income category before moving to high income? You guessed it: Greece and Argentina.

Correcting for variations in the cost of living across countries, the paper concludes that $10,750 of purchasing power in the year 1990 is the threshold for per capita income beyond which a country is high income, while $7,250 makes it upper-middle income. (These thresholds may sound low, but the World Bank uses similar cutoffs.)

By these criteria, Argentina became an upper-middle-income country all the way back in 1970, and then spent 40 years stuck in that category before reaching high-income status in 2010. Greece joined the international upper middle class in 1972, and then took 28 years to reach the top income group, in 2000.

No other country that became upper middle income after 1950, and then made the transition, took nearly as long. In fact, the average length of that transition was 14 years, with economies such as South Korea, Taiwan, and Hong Kong taking as little as seven years.

Data in the paper stop at 2010, but the story may well be worse today. According to IMF figures, Greece’s never-ending crisis has cut per capita GDP (in terms of purchasing power parity) by 10% since 2010, and by 18% since 2007. Indeed, Greece may have dropped out of the high-income category in recent years.

Argentina’s per capita income has risen, albeit slowly, during this period, but the country was never far from a full-blown macroeconomic crisis that could reduce household incomes sharply. So it seems fair to conclude that both countries are still caught in the middle-income trap.

What kind of trap is it? In Greece and Argentina, it is both political and economic.

Start with the politics. In their book Why Nations Fail, Daron Acemoglu and James A. Robinson argue that societies with political arrangements that concentrate power in the hands of a few seldom excel at innovation and growth, because innovators have no guarantee they will keep the fruits of their labors. And, to the extent that outsiders cannot generate wealth, they have few resources with which to challenge the power of insiders; as a result, exclusionary political arrangements are mostly self-sustaining.

That is a useful account of why there is a poverty trap – which is the question the book seeks to answer – but it does not clarify why there is a middle-income trap. Greece and Argentina are, after all, democracies, however imperfect, and so are most of the countries in Latin America or East Asia that worry about being stuck at middle-income level. The Acemoglu-Robinson account of a single small elite pulling all the strings needs to be replaced by a different narrative, in which an array of politically powerful groups exercise veto power over decisions that affect their economic interests.

Think of powerful business groups vetoing moves to improve tax collection or strengthen competition policy. This helps explain why the Greek and Argentine governments are perennially in deficit (until borrowing options dry up and adjustment is inevitable), or why prices – and profits – are high in sectors (for example, transportation and telecoms) that provide would-be entrepreneurs with crucial (but often unaffordable) inputs.

Or think of public-sector unions vetoing changes in benefits for their members. That goes a long way toward explaining (add a bit of ideology to the mix) why the current Greek government has gone to the brink of default before agreeing to restrain public-sector pensions, as its European Union partners demand. It also helps explain why both Greece and Argentina have sizeable governments (public spending accounts for 46% and 39% of GDP, respectively) but puny public investment and outdated infrastructure.

This is not a case of too much democracy, as conservative commentators sometimes claim, but of too little. Underdeveloped democratic institutions allow for decisions that are individually rational but collectively shortsighted and harmful.

And bad politics makes for bad economics. To go from middle-income to high-income status, countries have to redeploy resources to high-productivity, knowledge- and skill-intensive sectors. That is a transition that Greece and Argentina, with their financial instability, poor infrastructure, and weak education systems, have never made.

Greece exports refined petroleum products, olive oil, raw cotton, and dried fruit. Argentina exports corn, soybeans, fruits, and wine – as well as cars and auto parts to the rest of the regional Mercosur trade bloc, where it enjoys ample tariff protection against third-country competition.

According to the Atlas of Economic Complexity, developed by Ricardo Hausmann and colleagues at Harvard University, the 2008 gap between Greece’s income and the knowledge content of its exports was the largest in a sample of 128 countries. By 2013, Greece ranked 48th in the Atlas’s index of complexity of exports – by far the lowest of any developed country in Europe – while Argentina ranked 67th.

Sluggish exports mean slow growth, which in turn places limits on social mobility and the expansion of an entrepreneurial middle class. That helps preserve the political power of entrenched veto-wielding players, closing the trap. Perhaps a weighty tome entitled Why Middle-Income Nations Fail will tell the story in full. Societies will then understand why high-income status eludes them – and what they might do differently.

Andres Velasco

Read more at http://www.project-syndicate.org/commentary/greece-argentina-middle-income-trap-by-andres-velasco-2015-05#YxEEGa8u1I80lWZD.99