Pelgidis mitsopoulos whos to blame for greece; austerity in charge of saving a broken economy (2016)

Contents About the Authors xv Part I The “Party Period” before the Crisis 2 The Costs and Benefits for Joining a Common Currency with Emphasis on Weaker Member States: between member s

Who’s to Blame for Greece? Austerity in Charge of Saving

a Broken Economy

Theodore Pelagidis

NR Senior Fellow, Brookings Institution, USA and Professor of Economics,

University of Piraeus, Greece

and

Michael Mitsopoulos

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Contents

About the Authors xv

Part I The “Party Period” before the Crisis

2 The Costs and Benefits for Joining a Common

Currency with Emphasis on Weaker Member States:

between member states 16

3 Greece before the Crisis: The Critical Years

membership and issues that relate to the common currency area and the chances of success of the

consolidation 34

3.2 Various other debates and key speeches in the Greek

Parliament during the term of the government that

brought the Maastricht Treaty for ratification

and infrastructure projects and the role of the state

4.1 IMF reports during the accession period (’90s) and

in product markets and professional services

4.2 The implementation of the conditionality program:

fiscal consolidation and the issue of spending cuts

4.3.1 Annual country specific recommendations

by the Council, and European Commission

Part II Greece’s Free Fall 2010– 2013

5.2 The run up to the memorandum 101

5.4 Implementing the memorandum as of

Appendix to Chapter 5: OECD structural indicators in

6 Assessing the Intentions of the Government(s) since the

6.2 The 2010 program: design, implementation,

6.3 The “internal devaluation” fallacy of 2010– 2012 123 6.4 The other side of the internal devaluation

fallacy – the approach to the labor market

deregulation during 2010– 2012 127

6.5 The lack of a strategy to enhance growth – in Greece

6.6 The private sector death-trap: undermining the

financial sector, jeopardizing macroeconomic stability,

Part III Looking Ahead

7 Greece: Why Did the Forceful Internal Devaluation

7.1 Introduction 155 7.2 Employment 156

9.1 The compromise of the euro area: common monetary,

9.2 Evaluating the current structure of powers and

9.3 How changes in the structure of the democratic

mandates can secure a “closer and more

List of Figures and Tables

Figures

including all Social Security Contributions and value

all Social Security Contributions and benefits: thousands

employee Social Security Contribution) per company size

6.9 Full- time employees, employed per company size class 1356.10 Public finances structure: key revenue and expenditure

7.2 Total employment to population ratio: euro area and Greece 157 7.3 Employment in government and pensioners/former

7.4 Compensation of employees for total economy

7.7 Compensation of employees (% of GDP, total economy

7.13 Nominal compensation per employee (thousands of

7.16 Profit before tax to sales: non- financial corporations –

limited companies and partnerships or equivalent

7.17 Profit before tax to total assets: non- financial

corporations – limited companies and partnerships or

7.18 Distribution of employees insured at IKA per bracket

of gross monthly wage Companies with up to 24 insured

7.19 Distribution of employees insured at IKA per bracket

of gross monthly wage Companies with 25– 249 insured

7.20 Distribution of employees insured at IKA per bracket of

gross monthly wage Companies with over 250 insured

7.21 Distribution of employees insured at IKA per bracket

of gross monthly wage Companies with up to 49 insured

7.22 Deviation of pay in sector and provisions of sectorial wage agreements in Greece for the year 2009 Difference of sector

7.23 Real unit labor cost Total economy, performance relative

to the rest of former EU- 15 1817.24 Stock to sales and road haulage regulation, 2008

7.25 Journeys and regulation of road freight haulage

7.26 Taxes on electricity for industrial use Consumption “C”

7.29 Exports of energy intensive and non- energy

7.30 Exports of energy intensive and non- energy

7.32 Exports except mineral fuels for Greece and Portugal

7.33 Exports of textiles, yarn, fabrics, apparel, clothing,

7.34 Interest rates, national difference with euro area average

8.2 Interest rates on Greek government debt and on corporate loans, non- financial corporations (NFC), 2009– 2014 198 8.3 Debt to GDP ratio Euro area countries, 2014 Loans

8.4 Non- performing loans as a % of all loans and

8.5 Accumulated provisions by Greek main

9.1 Mandates and powers of European bodies

9.3 Mandates and powers of European bodies

Tables

implemented, according to budgeted numbers, by

Fiscal Strategy (MTFS) for Greece, June 2011,

and item-by-item sum of measures immediately

leaders that may have contributed to the fear of markets

About the Authors

Theodore Pelagidis is a non-resident senior fellow at the Brookings

Institution, USA, and Professor of Economics at the University of Piraeus, Greece He has also been a NATO scholar at the Center for European Studies at Harvard University, USA; an NBG fellow at the London School

of Economics, UK; and a Fulbright professorial fellow at Columbia University, USA He has also served as an advisor to the International Monetary Fund in the Independent Evaluation Office, USA

Michael Mitsopoulos holds a PhD in Economics from Boston University,

USA He is an economist at the Hellenic Federation of Enterprises, Greece, and has taught at the University of Piraeus and the Economic University of Athens, Greece He has published in academic journals and

is the co-author with Pelagidis of Understanding the Crisis in Greece: From Boom to Bust (2011) and of Greece: From Exit to Recovery? (2014).

The strategic failures in the approach to deal with the problems of the Greek economy, namely the disproportionate internal devaluation of the private sector and the tax base with respect to the milder internal devaluation of the government expenditure, has certainly taken place

in the context of a country that was asked to undertake one of the most difficult adjustments made by any country and through a deal that appeared to be ignoring important warning signs (Mitsopoulos and Pelagidis, 2011, 2012; Pelagidis and Mitsopoulos, 2014) Essentially, the 2010 and onward sequential deals amounted to agreeing with the political leadership and the administration of an economy that has been turned by the former into a quasi-soviet economy at the fringes

of free markets that they will tear down the bureaucracy that has been established for over 30 years, while being offered the cash and support

to keep operating largely in a “business as usual” environment

It is within such a context that there were few apparent efforts to shift the balances in favor of the productive sector of the economy as a neces-sary precondition for success The lack of such an effort has been paired, after 2010, with a number of other unfortunate policy choices, both

by the Greek government and by the creditors – the IMF, ECB, and the European Commission These have further burdened the prospects of the private sector even as they kept the profligate state on life- support for

at least three years In particular, these are (a) the gradual entrenchment

of macroeconomic imbalances as a permanent situation, (b) the delayed PSI, and the large PSI of October 2011, as outlined in the respective Euro Area Summits statements, and (c) the uncertainty that stems from tying the European prospects of the whole of Greece with the insuffi-cient willingness of the government to implement the agreed program Overall, the above have managed to add to the private sector of the

1

Introduction

economy, in addition to the burden of persisting fiscal problems and competitiveness deficit, the impact of a full- blown liquidity crisis So, the question that springs in mind after all this policy failure is identi-

cal with the title of this book: Who’s to Blame for Greece, and, more

importantly, what lessons for the future can we learn from the failures

of the past?

In this context, the first part of the book sets the theoretical

con-text in which Greek policymakers, politicians, and the public opinion matured the decision to adhere to the single currency In this setting,

in Chapter 2, we briefly present the relevant debate in the literature

concerning the costs and benefits of joining a currency union This is necessary to examine the impact of the fundamental discussion that took place 20 years ago in the country, on the costs and benefits of get-ting rid of the drachma and join the euro area as well as to understand both the constraints and the opportunities that Greece’s economy has faced since 2010

In Chapter 3, we elaborate and analyze for the very first time in the

relevant literature, material that reviews what economic theories and narrative shaped the understanding of Greek policymakers and politi-cians about costs and benefits for Greece to join the single currency

We then match this narrative with the declared policy strategy, and its implementation, by the government that introduced the Maastricht Treaty for ratification, in order to investigate the extent to which its conviction that Greece could succeed to enter on equal terms as a con-structive member country was well-founded

In Chapter 4, we examine the IMF Director’s, and supporting staff,

reports on Greece from 1990 on, as well as the European Council recommendations to Greece and the preceding European Commission recommendations to the Council We present these in order to place them in context with the key issues raised in Chapter 3, as well as with the recent developments in Europe and the country

The central aim of the second part and originally of Chapter 5 is

to reconsider the troika period, focusing especially on the first three years of the program, where the adopted policy is supposed either to have failed or/and faced significant headwinds We initially focus on the Greek public finances and debt We analyze conditions that led

to the first Memorandum of Understanding (MoU) and we present an analysis on what it initially provided We follow the implementation of the MoU and the fiscal strategy involved in it We focus in particular

on the equilibrium between the opposition to reform and the nexus of state sponsored privileges in the country In the end, this analysis, and

the supporting facts, are contrasted with the criticalities emerging from the ex post analysis of surveillance reports done by international orga-nizations and the other material of Chapters 3– 4.

In Chapter 6 we assess the intentions of the government that ratified

the Maastricht Treaty in view of the current developments and place the developments in Greece within a broader context of European policies and approaches In particular, we assess the experience of Greece, and other European countries, that implemented at the same time structural and fiscal reforms, and compare them with the impact of the one- sided implementation of the conditionality program in Greece after 2010 We also attempt a preliminary assessment of where this one- sided imple-mentation has led the country, and what can be done from now on

In the third part of the book, Chapter 7 assesses the results on the

critical domain of exports In particular it explains the reasons that the

internal devaluation failed to kick- start an export led growth It focuses

on employment and wage earnings and reveals the real costs that made exports to grow albeit at an insufficient pace

Chapter 8 analyzes the financial conditions needed for Greece to

recover at a rate that would make not only the debt fraction to GDP sustainable but also increase significantly employment The section deals with the financial sector and more specifically with the conditions needed to finance the private sector

Chapter 9 addresses the issue of institutional reforms for the euro

area itself, elaborating on the notion and a project for a closer and more democratic union to heal economic asymmetries This is critical for the southern euro area member states and especially for the weakest economy among them, Greece, if it is to get its economy back on track and recover

Finally, in Chapter 10, we conclude.

In Afterwords, we focus on the rise of Syriza to power and the quences to the economy

conse-References

Mitsopoulos, M and T Pelagidis (2011), Understanding the Crisis in Greece,

London: Palgrave Macmillan.

Mitsopoulos, M and T Pelagidis (2012), Understanding the Crisis in Greece From Boom to Bust, London, Palgrave Macmillan, 2nd edition.

Pelagidis, T and M Mitsopoulos (2014), Greece From Exit to Recovery?,

Washington, DC: Brookings Institution Publ.

Part I

The “Party Period” before the Crisis

2.1 Potential sources of conflicts/costs:

de- synchronization of business cycles

Long before the crisis, the dominant theory of an Optimum Currency Area (OCA) was that there are necessary conditions or properties for success (Mundell, 1961; McKinnon, 1963; Kenen, 1969) The basic premise was that the fundamental requirement for a successful currency area

is wage/price flexibility and mobility of factors of production as well as harmonization of economic and political institutions This injects suffi-cient flexibility in the system to hedge against the so- called “asymmetric demand shocks/disturbances” Asymmetric shocks are demand shocks

or disturbances that hit two or more regions or countries with a common currency When shocks are asymmetric, business cycles between two countries – let us assume Greece and Germany – are de-synchronized De- synchronization of business cycles means that Greece experiences, for example, a negative growth rate along with relatively low inflation, while Germany experiences, at the same time, a high growth that goes with low unemployment Then, the two countries need different monetary stabilization policies Greece needs some accommodation through decreasing interest rates in order to stimulate economic activity, while Germany needs some contraction to fight an excessive inflation rate Then, the dilemma that the European Central Bank (ECB) faces has to

do with the diversified stabilization prescriptions the two aforementioned economies require

What it is important to recognize is that the incidence and magnitude

of demand shocks or disturbances ultimately depend on the output mix and degree of specialization across countries and regions These factors can in turn undermine the OCA The European Monetary Union (EMU)

2

The Costs and Benefits for Joining a Common Currency with Emphasis on Weaker Member States: The Pre-Crisis Debate

process itself tends to create some convergence (Rose and Stanley, 2005) but at the same time it also tends to, ironically, deepen the market inte-gration that increases the degree of sector specialization and reinforces differences in the structure of production and demand (Baldwin, 2006) The greater the differences in the structure of production, the greater will be the asymmetric incidence and magnitude of demand shocks

on individual countries and regions Institutional divergences in wage setting, for example, may lead in particular to divergent wages and employment tendencies and worsen adjustment problems, and differ-

national financial markets working differently across the euro area.Furthermore, the greater the difference in the structure of production, the greater the incidence and the magnitude of the demand shocks that individual countries and/or peripheries experience and, thus, the lower their speed of adjustment, if any, in the case of the labor mar-

countries at the center of the EMU (Germany, France, the Netherlands, etc.) experience very different supply shocks from those affecting other member states, such as Italy, Portugal, Spain, Ireland, and Greece

In the case of multiple countries and currencies, governments are able to use demand management policies to face idiosyncratic shocks, namely succeed in adjustment by applying accommodating monetary policies and using the exchange rate instrument to correct external disequilibrium (amid inflationary pressures) Currency can depreciate to lower relative prices and underpin demand or it can devalue The greater the asymmetric shock, the higher the option value of independent domestic monetary and exchange rate policy However, EMU, by defini-tion, involves the sacrifice of the monetary autonomy, and in the euro area authority for the implementation of a single and non- differentiated monetary policy now belongs to the ECB As economic integration proceeds and diversity of production structures deepens across the euro area, a negative aggregate demand shock is expected to have different, heterogeneous impact on member states and regions In this case, the cost of adjustment within the euro area depends on the size and inci-dence of asymmetric real shocks, as well as on the efficacy of the alterna-tive adjustment mechanisms, namely, labor market mobility/flexibility and fiscal policies (Obstfeld, 1997) Otherwise, the country hit by shock must deflate internally by lowering its wages through a policy of “inter-nal devaluation,” accepting unemployment and economic recession.Empirical evidence has shown that asymmetries in the EMU between core and peripheral countries were persisting well before the

crisis (Bayoumi and Eichengreen, 1992a,b; Bordo and Jonung, 1999; Krueger, 2000; Obstfeld, 2000; Dunn, 2001; Baldwin, 2006) and that they coincide with non- synchronized business cycles among member states An assessment which culminated in 2003 of the case for the UK joining the EMU by HM Treasury was in general agnostic Regarding

assessment failed to uncover strong evidence in support of such chronization Therefore, as the asymmetry of demand shocks raises regional unemployment by destroying industries and jobs, there is

syn-a need for monetsyn-ary syn-accommodsyn-ation (i.e., incresyn-ase of money supply and lower interest rates) to offset fluctuations and restore growth and employment For example, in the case where Greece suffers a perma-nent fall in GDP or in exports, output contracts and unemployment rises as currency depreciation is excluded from policy tools, and wages and prices are rarely flexible enough to react to economic slumps without causing a severe rise in unemployment The possible refusal

of ECB to implement an expansionary monetary policy in order to avoid recession in Greece had some people being afraid that such an attitude may cause continuing dissatisfaction among the Greeks and other EMU public

On the other hand, a decision by the ECB to implement monetary accommodation by lowering the rate of interest may cause continuing dissatisfaction among the anti- inflationary countries, such as Germany (Feldstein, 1997) Economic disagreement over monetary policy may then cause general environment distrust among member states and, as

a consequence, could very possibly bring about political disputes and instability The ECB, thus, may face pressures that cannot all be dealt with (e.g., see Frieden, 1998)

The critical role of a central bank is also confirmed by Cooper and Kempf (2004) In an economy with monetary policy alone, they con-firm the presence of the Mandellian trade- off (between unification and monetary autonomy) and find that, indeed, a monetary union will not

be welfare improving if the correlation of national shocks is too low However, the authors find that fiscal interventions by national govern-ments, combined with a central bank that has the ability to commit to monetary policy, overturn these results with welfare improving for any correlation of shocks Similarly, Beetsma and Giuliodori (2010) empha-size the complications that a monetary union poses for fiscal policy-making as governments policy objectives for a high and stable level

of economic activity may come at odds with ECB’s goal of stabilizing inflation at a level below 2% That, according to Dixit and Lambertini

(2001, 2003) may lead to extreme outcomes that make member states worse off.

Therefore, in the case of the net real economic effect being tive, instead of increasing intra- EMU harmony, fostering stability and promoting further integration, single currency may, according to some authors (like Dixit and Lambertini 2001, 2003), more likely lead to increased political conflicts within the EMU, with a number of adverse consequences, as is the euro area’s experience today

nega-2.2 Demand disturbances and trade

Optimistic voices emphasized that the establishment of the euro, besides other benefits, also would favor a further increase in the volume of trade among EMU member states and in trade dependence, thereby increasing welfare (Emerson et al., 1992; Rose, 2000; Rose and Stanley, 2005) Some authors’ results could support such optimistic predictions as having the volume of trade tripled by monetary union participation (Rose,

2000, Rose and Engel, 2000) The elimination of currency fluctuations within the EMU was expected to mark the end of a period of uncer-tainty, which is considered to diminish trade itself and trade- promoting benefits (McKinnon, 1994) In addition, since the EMU member states enjoy a large volume of trade among them, it was seen to be to their benefit to abolish national currencies, as the exchange rate policy tool becomes inefficient in tackling unexpected real asymmetric shocks

On the other hand, free trade combined with fixed exchange rates

to a large extent prevent governments from devising their domestic financial policy for the purpose of preserving domestic stability With

an exchange rate irrevocably fixed and the level of prices of domestically produced goods “sticky” to an unsupportable level, the loss of competi-tiveness can possibly lead to a fall in exports and, as a consequence, of trade volume This way, overall trade both within the EMU and, as a consequence, between the EMU and other trade partners may decrease

in the worst- case scenario For the weakest Mediterranean EMU tries, it was argued that there may be an increase of trade balance prob-lems in particular In fact, external deficits for Portugal and Greece at the time that they joined the euro area were as high (16% and 14% of GDP respectively), the same as they were in 1990; higher than they were right after the implementation of convergence policies (around 12– 13% in

posi-tion of the aforemenposi-tioned countries might be, at least partly, attributed

to a loss of competitiveness provoked in turn by the “hard currency”

convergence strategy followed during the 1990s on the road to EMU4and, of course during the following “euro area period”( 2000– 2010).The inefficiency of EMU mechanisms in facing the incidence and magnitude of demand disturbances under a single currency regime, might impair production systems and so diminish trade, particularly

in lagging regions, which otherwise may be able to survive Trade and,

as a consequence, welfare may then also diminish, as an individual member state could not leave its currency free to fall in line with a fall of a foreign currency, such as the dollar, to maintain exports If economic growth in such weak EMU countries (or regions) kept up with that external balance pressure, an overvalued euro would not be such a problem But if it did not, as the most possible scenario might suggest,

an “expensive” euro might cause a further loss of competitiveness, deepening the initial asymmetric shock

Moreover, a country, which trades to a large extent with countries outside the EMU, is likely to be affected by large fluctuations in the euro– dollar exchange rates Such countries are Greece (around 50% trade with non- EMU countries), Ireland, and Finland, while other coun-tries such as Austria, Benelux, and Portugal are unlikely to be affected

so much The observed sharp differences, which exist within the EMU area, are large enough for the one- size- fits- all monetary policy to be effective Thus, the larger the differences, the greater the strains in managing the dollar– euro exchange rate, and the greater the political disputes over the appropriate policy

2.3 Responses to labor market rigidities

The view of many analysts was that postponing the idea of a federal, truly unified euro area deprives the EMU from the absolutely necessary, according to OCA theory, option of a strong redistribution of income among European regions and/or member states through a high(er), as percentage of GDP, European budget Idiosyncratic shocks, low mobility

of factors of production, stickiness of wages and prices, and quite low economic performance in the so- called peripheral EMU southern coun-tries, seriously obstruct the accommodation of shocks by changing rela-tive prices and costs Cohen et al (1997) put the blame mainly on the high cost of firing workers, while Abowd et al (1997) emphasized the ill effects on jobs of a high minimum wage, which negatively affects the growth rates and, as a consequence, the creation of net new jobs Similarly, Blanchard and Wolfers (1999) and Blanchard (2000), pointed- out that labor market rigidities magnify the effects of shocks, although tight

macroeconomic policies still remain the number one culprit for the

As far as the European periphery in particular is concerned, the able data confirmed the aforementioned stories As Figure 2.1 below shows, the regulatory framework and employment protection legisla-tion was fairly strict by international comparison at least at the time of euro inauguration, in the EMU and in its periphery in particular, with the exception of Ireland As a consequence, the economies could hardly absorb asymmetric shocks as labor market rigidities get in the way of any adjustment effort Figure 2.1 also shows that labor flexibility was limited and differed from country to country in the EMU at the time

avail-of the euro inauguration Thus, given that labor flexibility is a requisite as a channel for adjustment in a monetary union, and since the exchange rate instrument can no longer serve as an adjustment mechanism, as Alesina et al (1997) correctly emphasize, aggravation of social tensions and increased political conflict both within and across countries might be a possibility

pre-Figure 2.1 McKinsey presentation of lack of adjustment mechanism in euro area Source: McKinsey & Company (Germany) (2012), The Future of the Euro: An Economic

EMU lacks the adjustment mechanisms necessary to compensate for the loss of exchange rate flexibility

but alternative mechanisms have not been activated

Flexibility of real wages and industry adaptability 1

Increase in unit labor costs, 2000–10 Percent

Germany Greece

2

35 Interstate immigration, 2008 Percent

EU

EMU US

Percent of GDP Fiscal transfers

Capital and labor mobility

As far as the antidote to labor migration (Figure 2.2), the shorthand for labor market flexibility, is concerned, labor flows of euro area

non- EM national migration to EMU has been sharply curtailed since the internal market was inaugurated

The existing social, cultural, and language barriers that significantly contribute to the low propensity of workers to migrate away from countries and regions where unemployment exceeds the local natural

migration is more than twice as high in the US as in many euro area

emigration The US absorbs asymmetric shocks by migration while the

is evident that, in the EMU case, labor does not migrate if one member state or region flounders With rigid labor markets, cyclical unemploy-ment turns into structural

A generous increase of the EMU budget could partly offset labor ket rigidities The EMU budget represents only 1% of the EMU combined GDP, a much lower share than what the Commission itself has proposed

In the US, the federal budget is four times higher than even those past EMU proposals Through transferring tax revenues to disadvantaged

Figure 2.2 Labor migration in key economic areas

Source: US Census Bureau, Current Population Survey, Eurostat LFS McKinsey & Company

(Germany) (2012) analysis of this data.

regions (i.e., federal states), the government subsidizes them through automatic fiscal stabilizers that function as an effective insurer against economic shocks ( Sala- i- Martin and Sachs, 1991; Bayoumi and Masson, 1995) The federal government absorbs between one- third and one- half

of each dollar of an asymmetric regional disturbance by reducing tax receipts and by transferring extra- money to the regions, which suffer a shock That is a government policy with high redistribution and stabi-lization effects

In the EMU, the corresponding effects are almost negligible, ing only one half a cent reduction per dollar in taxes in the event of

provid-an economic shock As wage flexibility is low, price adjustments very slow and migration limited, demand disturbances are expected to have

a severe adverse economic impact on any shock- stricken EMU regions unless a “generous” “Brussels budget” did the job of compensating

In addition, under Maastricht and Amsterdam fiscal restraints, the EMU member states could not have the possibility to use domestic sta-bilization mechanisms, namely the national fiscal stabilizer (Bayoumi and Eichengreen, 1994a,b) An EMU “generous” budget, which is still excluded from the whole project, could have alleviated unemploy-ment and regional inequalities, by redistributing fiscal resources to the floundered member states and/or regions This could be done either

as an automatic consequence of a progressive tax and social security system – the redistribution acts as a stabilizer with negative shocks, lead-ing to lower taxation and higher security payments in the region that is adversely affected (Arestis et al., 2001) – or even by establishing a central fiscal policymaking authority (Bordo and Jonung, 1999) Without such kinds of policy measures, economic prosperity and political stability across Europe might be called into question

2.4 Shortage of money stocks for the peripheral countries

We may assume that the member state A experiences a positive demand shock while another member state B experiences a negative one Such shocks may reflect shifts in the preferences of consumers from outside the euro area and therefore changes in the demand for and prices of the given countries’ products in international goods markets This is very much the original argument of Mundell (1961) Country B’s trade bal-ance will deteriorate and present a deficit while country A’s will present

a surplus Let it be assumed that country B is Greece and country A is Germany In this case, Greece’s currency stock will decline as it finances

its deficit in the trade balance As a result, money stock in country

A (Germany) increases and its interest rate declines while money stock

in Greece decreases and its interest rate increases The symmetric ment that takes place is unfavorable for Greece as it is forced to reduce money supply and accept a permanent recession The symmetric system could evolve to an asymmetric one, as Germany may absorb the extra inflows by selling government bonds in the money market to avoid an unexpected surge of inflation It is worth mentioning that Greece needs extra growth rates in order to reach the average EMU living standards Assuming that peripheral countries are more vulnerable to shocks due

adjust-to low(er) productivity levels, a predominance of traditional secadjust-tors, less skilled human capital, and so on, and taking into account that

EU money would dry up in the near future, the single currency may permanently bring economic insecurity for the weak and vulnerable member states such as Greece

Asymmetry is further enhanced by the variation of monetary mission mechanisms across the euro area Countries with a higher reli-ance on short- term bank credit (the Southern EMU group) would be affected more strongly and rapidly by interest- rate changes compared

trans-to economies (such as Germany, Belgium, Austria, and the Netherlands) that rely more heavily on longer- term finance (Ramaswamy and Sloek, 1997)

A large number of theoretical models postulated a causal relationship between shifts in real exchange rates (RER) and current account (CA) imbalances Arghyrou and Chortareas (2006) test this relationship within the EMU area and find it to be substantial in size and subject to non- linear effects Their analysis identifies two groups of EMU countries since the abolition of European national currencies in 1999: those pre-senting consistent RER depreciation leading to CA improvement; and those in which appreciation- deterioration are systematically observed These groups largely correspond to those previous research had identi-fied as respectively belonging and not belonging to a European Optimum Currency Area Such findings validate the theoretical arguments con-cerning the potential costs of participating in a monetary union; suggest that meeting the nominal convergence criteria has come, in some coun-tries, at the cost of growing CA imbalances; and pose important policy- response questions both for national authorities as well as the ECB This type of results lead at the time the authors to wonder if in order to avoid

further destabilizing polarization within the EMU, it might be optimal for newly acceded euro area countries to supplement the nominal EMU accession criteria with an additional one referring to the balance of the current account The main focus of the Maastricht criteria was on nominal variables An effort to meet such criteria was perceived to put strain on other aspects of economic performance and such strains might

be reflected in the current account imbalances, which may act as a carpet under which a number of other real imbalances have been swept According to Arghyrou and Chortareas (2006) more attention should

be paid to the current account position of the accession countries at the time they join the EMU At the same time, it was argued, a num-ber of reforms that enhance factor mobility within the euro area need

to proceed faster so that they can allow the economy to adjust more easily It should be noted that such imbalances are to some extent unavoidable given that a number of countries within the euro area are catching up with their more economically advanced partners From

an intertemporal point of view, the faster economic growth in those countries implies more wealth in future periods so savings decline while

at the same time new investment opportunities emerge This intensifies

account Such considerations lead Blanchard and Giavazzi (2002) to question the relevance of Feldstein- Horioka in the euro area

2.6 The effect of a monetary union on trade between member states

Examining the effect of monetary unions for 186 countries during 1970– 1990, Rose (2000) finds that two countries participating in a

conclusion of the “Rose effect” is that the EMU was at the time expected

to lead to proportional increases of trade within euro area, with positive effects regarding prosperity, efficiency, and growth rates These positive effects come not only as a result of absence of exchange rate uncertainty and/or “ beggar- thy- neighbor policies” or even from lower transaction costs They result from the establishment of a monetary union per se that in the long- term synchronizes business cycles and, consequently, renders demand shocks alike through enhancing intra- industry trade among member states

On the other hand Baldwin (2006) limits considerably the so- called

“Rose effect of a monetary union.” He argues that the size of it depends heavily on which are trade partners How open their economies are,

how integrated and how competitive their markets are, and what their economic size is Only big, efficient, and competitive economies can increase trade transactions within a currency union and thus, take advantage of a common currency area Baldwin’s calculations for the increase of trade transactions within euro area have shown hardly a 9% increase Other studies also confirm a rather mediocre common

Figure 2.3 depicts the share of the intra- EU export of the EU total export which seems to be on a steady rise since the early 80s of up

to 8% points according to the Bruegel study, after stagnating from

Figure 2.3 Intra- EU and intra- euro area shares of export on total export of the

two groups respectively

Source: Bruegel based on IMF data (Direction of Trade Statistics database) Note: The above

figure shows intra- EU and intra- euro area shares of export on total export of the two groups respectively Each of the two lines were constructed taking into account the changing com- position of the European Union and the euro area over time, meaning that a given country

is included in the series only by the time it joined the EU or the euro However, further culations show results do not change dramatically if considering a fixed group of countries

cal-in either series | Read more at Bruegel http://www.bruegel.org/nc/blog/detail/article/ 1420- chart- sharp- decline- in- intra- eu- trade- over- the- past- 4- years/?utm_source=Bruegel+ Chart+of+the+Week&utm_campaign= 8bca3a3d23- Bruegel+Chart_Week_35_2014&utm_

45

40

35

30 European Union (left hand axis) Euro Area (right hand axis)

the mid- 90s until the end of the 2000s The astonishing fact is that the intra- EU saw a sharp downward trajectory during the crisis years, imply-ing global trading partners have become and are becoming more impor-tant Interestingly, for member states, both for EU and the euro area, suggesting the common currency might not have had the expected effect on trade between euro area members.

2.7 Ten years of EMU ( 2000– 2009): convergence

or divergence prevailed?

There is no doubt that heavy and especially diverse institutional ties regarding mainly products, but also labor markets (the OCA’s first best antidote), increase the cost of a monetary union as they make adjustments more painful They create and, indeed, increase existing

recession-ary types of adjustments by accepting high rates of unemployment Existing institutional diversities such as more or less sclerotic regula-tions across euro area countries introduce permanent and significant costs for a monetary union as they normally lead to divergent wage developments, even when countries face same demand shock types.Diversion in member states’ institutional/regulation regimes regard-ing labor markets in particular is of critical importance As De Grauwe (2005) and Pelagidis (2009) point out, such significant divergences among member states, i.e., CA divergences (see Figure 2.4), may prove

to be critical in the case of an asymmetric shock in particular, as a “ one- size- fits all” monetary policy would certainly be, in that case, extremely costly for the less competitive member states Diversion in labor market institutions simply shows that the weapon of wage and price stabiliza-tion may not be an easy option for a number of countries and then, in the absence of fiscal federalism and/or political integration, the only source of stabilization would be a higher rate of unemployment in certain regions/countries of the euro area

This is exactly what is happening today in the less competitive southern euro area countries, primarily Greece The lopsided/ one- sided stabilization takes only the form of a sharp downward, spiral in nature, wage adjustment without prospects so far for increases of productiv-ity and growth rates or prospects of increasing export through surplus countries’ reflationary policies We will come back in this critical issue

in the following chapters

To conclude, since the euro area does not seem to have met the criteria

of an OCA almost 15 years after its inception, it is legitimate to argue

that some of the problems that have been observed in weaker mies might have been due to the incompleteness of the euro area Lack

econo-of significant labor flexibility and migration or even more, lack econo-of an adequate amount of fiscal transfers to those countries with a permanent deficit in the current account, have at least aggravated the current unfor-tunate situation that the euro area has found itself Greece, after all the

Figure 2.4 Divergence of current accounts within the EMU

Note: Net exports of goods and services plus net primary income from the rest of the world

plus net current transfers from the rest of the world

Source: European Commission/AMECO, McKinsey & Company (Germany) (2012) analysis

96

1995

Current accounts have diverged between Northern and Southern EMU

members, creating imbalances

Introduction of the euro, January 1999

Netherlands Germany

EMU-17

–47.3

–16.8

–28.0 9.1

–53.7 –43.3

evidence presented above, seems to concentrate all the problems that the theory predicts: negative asymmetrical shocks, capital flights, high unemployment, lack of antidotes regarding adequate labor flexibility, lack of significant integration with the currency partners, lack of adjust-ment tools.

In the following Chapter 3 we investigate whether all of the mentioned conditions to meet the OCA criteria, in other words, the reforms that should have been done before joining a common currency area, were on the agenda of the domestic politicians It is the first step

above-to understanding why Greece was not very well prepared above-to meet the difficulties of being a member of the euro area

to make macroeconomic shocks more asymmetric.

3 See Eurostat (2001).

4 In addition, Greece’s exports to the EU countries had decreased from 60.6%

in 1995 to 43.6% in 2000 Therefore, along with the relative decrease of exports, there exists some evidence of trade diversion with the EU member states It is also worth mentioning that Greece’s trade balance deficit has only deteriorated since then.

5 Peri and Obstfeld (1998), focusing on Italy and Germany show that regional price- level reactions do little to speed the adjustment to demand distur- bances On the impact of tight macroeconomic policies on the EU unem- ployment rate see Pelagidis (1998a, 1998b, 1999).

6 For relevant statistical data see Obstfeld and Peri (1998, p. 12) Alesina et al (1995) also argue that labor mobility in the EU has high utility costs That means that cultural and linguistic differences make the European currency union very costly and that the optimal size of member states is a function of cultural and linguistic homogeneity.

7 Differences in part- time employment among member states have also contributed to high unemployment in selective EMU countries Part- time employed as a % of total employment ranges from 39.4% in Netherlands to 6.1% in Greece (Eurostat, 2001) The percentage of persons usually working

on Saturday, Sunday, at night or doing shift- work vary also across member states (from 18.9% in Italy and 16.1% in Austria, to Denmark 7.2% and Portugal 7.9%) (Eurostat, 2001).

8 De Grauwe (2001) agrees that the, then, Community budget is too small to constitute the backbone of risk sharing at the EMU level although he him- self recognizes that risk sharing is essential for maintaining cohesion He, instead, proposes the building of institutions capable of implementing risk

sharing through the full integration of financial markets However, Rose and Engel (2000) find little statistical evidence that international risk sharing is enhanced by membership in a currency union.

9 Obstfeld (1997) argues that a fiscal system favoring regional cohesion acts with a rigid labor market to discourage mobility However, as argued in this paper, national fiscal policies across member states are too contraction- ary to cushion the country or regional downs In addition, then, Community Framework Programs are too little to have significant stabilization effects Therefore, despite the lack of fiscal automatic stabilizers, flexibility of wages and mobility of labor remain at very low levels As a consequence, it cannot

inter-be sustained that there exists a trade- off inter-between labor mobility/flexibility and fiscal stabilization policies.

10 For the positive effects of trade to euro, see also Rose et al (2005), Rose and Stanley (2005), Frankel and Rose (2002).

11 Baldwin (2004) and Baldwin and DiNino (2005).

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mar-ket and Greek politicians’ views in particular, on the issue regarding the costs and benefits of Greece’s economy joining the euro area We used material from various sources (e.g., archives of the Greek Parliament, interviews with prominent politicians of the time, published laws) to pre-sent and analyze their view on Greece’s economic possibilities to adjust

presents the results of this fieldwork We placed particular emphasis

on the 1990– 1993 period where a liberal government set an agenda

of structural reforms that remains pertinent even today and paved the way for the fiscal adjustment to the Maastricht convergence criteria, so that the economy could join the single currency Our summary draws from discussions within the Parliament, on important relevant topics, such as the debate preceding the ratification of the Treaty of Maastricht

by the Greek Parliament in July 1992 and other key discussions with regard the economic policy of the government Such are the discus-sions in the Parliament ahead of the votes for the annual budgets and the inaugural statements on policy from the time the government had started its term, and sought the vote of confidence of the Parliament in the summer of 1990

It is noted that most of the prominent politicians of the 1990– 1993 period continue to be present during the rest of the period until Greece’s accession to the euro area in 2001 For example, Mr Papantoniou (Socialist, PASOK party) of the opposition during 1990– 1993, became Finance Minister later, being considered – along with the then chairman of the Council of Economic Advisors of the Ministry of Finance Mr Stournaras (Finance Minister during June 2012– June 2014 and subsequently appointed gover-nor of the Bank of Greece) – the main architect of administering Greece’s

3

Greece before the Crisis:

The Critical Years in Domestic

Politics

accession to the euro area One can also identify other significant persons

of the current political arena, ranging from the previous Prime Minister

Mr Samaras (then Foreign Minister, Prime Minister during 2012– January 2015) to Mr Kouvelis (till 2015 leader of Dimokratiki Aristera and a sup-porter of the coalition government formed in summer 2012 until December 2014), or the former minister Mr Tsochatzopoulos (currently serving time for the laundering of money allegedly acquired from corruption and abuse

of office, the latter charges having no implications for penalties any more given the law regarding the responsibilities of ministers that applied dur-ing the period he held office – a fact that seems to reaffirm urban legends that expand well beyond this particular politician)

issues, such as employment, tax policy and evasion, the shape of tution, among others, in the new context of a prospective at that time- common currency zone The reformist government that introduced the Maastricht Treaty to the Greek Parliament for ratification in 1992, and which was brought down in late 1993, remains very controversial among the Greek public opinion and the prominent Greek opinion leaders As a result, this administration has rarely been studied (another effort to collect the available evidence that documents the economic thinking that shaped the understanding of the Greek policymakers and politicians who put Greece on the path to EMU accession was Featherstone et al., 2000, Featherstone and Papadimitriou, 2015, Pelagidis and Mitsopoulos, 2014)

insti-3.1 The discussion in the Greek Parliament ahead of the ratification of the Maastricht Treaty

The discussion in the Greek Parliament preceding the ratification of the Maastricht Treaty, which took place towards the end of July 1992, reveals a deep understanding, from the side of the Prime Minister and the ministers directly involved in the financial issues, of the challenges the country would face in order to participate on equal terms in the common currency area With regard to the opposition, one sees an understandably negative stance that is clearly motivated by political tactics But beyond that, one also can identify in the speeches of key members of the opposition an understanding of the key weaknesses in the design of the common currency area, and the threats that can fol-low as a result of those weaknesses, both for weaker member countries and for the union as a whole In the end, the leading ministers and the Prime Minister of the government seem to be preoccupied mainly with

how the country will manage to meet the economic policy benchmarks that were set by the Treaty to ensure a sufficient level of coordination

of economic and fiscal policies in the common currency area On the other hand, the preoccupation of the opposition’s speakers seems to be the weaknesses in the design of the common currency, and their impli-cations, in the case a member state failed to meet a sufficient level of economic policy coordination Regardless of the motives though, they did point out the dangers to the union stemming from the inability to address regional shocks with fiscal measures in a common currency area with the given fiscal constraints for each member state and without

a potent central fiscal authority Similarly, the implications of such a structure were set in the context of the North- South divide

The representatives of the government though, in the end, appeared confident that, with the right dedication and effort, the country would be able to secure its position as a constructive equal in the new, closer, European family, and thus reap the benefits of such a position that would in the end require that Greece addresses its significant shortcomings

Overall, all seemed to agree though that the strategic benefits weighed the costs, with the latter being emphasized by the opposition and largely discounted as irrelevant when compared to the benefits by the government

out-It is also noteworthy that some of the most vicious attacks on the ernment’s policies, which were policies of fiscal austerity that included cost cutting and privatizations, came from members of the then opposi-tion who were subsequently connected with large scale corruption and abuse of office

gov-Finally, it is interesting to note that in the speeches of the tion, on at least two occasions, the impact of fiscal consolidation that originates from cost cutting is stated to equal the impact of a fiscal con-solidation that is based on revenue increases, an issue that will become again pertinent during the 2010– 2012 period when the fiscal consoli-dation effort was predominantly driven by efforts to increase revenues, rather than to cut costs On the other hand, the government that intro-duced the Maastricht Treaty for ratification to the Greek Parliament, on numerous occasions, appears to hold the belief that, after a number of tax increasing measures, the rest of the consolidation effort had to come from reducing expenditure and from privatizing state activities The lat-ter would both raise revenue and execute a growth enhancing strategic retreat of the state from the economy

opposi-A list of specific references made by key speakers from both the ernment and the opposition ahead of the ratification of the Maastricht Treaty, sorted by subject, provides further insights.

gov-3.1.1 References to the strategic advantages of EMU membership and issues that relate to the common currency area and the chances

of success of the country in it

Almost all speakers examined for this study stressed the strategic advantages of EMU accession Mr K Mitsotakis (then Prime Minister,

ND party) and Mr Y Papantoniou (subsequently Minister of National Economy, then MP, PASOK party, under investigation from the tax authorities for the Swiss bank account of his second wife and for the fact that his living standard apparently exceeded the standard justi-fied by his declared income), argued that Greece would be part of a strong union, and that thus it would gain strength in many aspects

Mr St Manos (then Minister of National Economy, ND party) and

Mr Papantoniou listed specific advantages of joining a large market According to Mr Tsochatzopoulos (PASOK, Minister for Transport and Communications 1989– 1990, currently serving time), staying in Europe enables “renegotiation,” with an aim to enhance social cohesion and the unions Some speakers like Mr Mitsotakis, Papandreou (leader of

as Prime Minister from late 1993 till his death in 1996, before which

he famously purchased a mansion he could not afford with his past

2015) expanded more on the regional geopolitical and strategic tages and implications

advan-Membership costs were compared by Mr Manos to the vacations foregone by someone who has begun a period of concentrated study

Mr Papantoniou, after arguing that in the common currency area there will be no large enough fiscal authority to act effectively in the case of regional shocks, said that such a competence has to be created

in Brussels Otherwise, he predicted, the country will stagnate and unemployment will increase greatly and the income of workers will stay low Mr Papandreou argued that the duty of PASOK is to spell out

to the people the cost of membership at the end of an unequal path

He argued that econometric modeling of the convergence does not incorporate the social cost of achieving EMU accession benchmarks

He added that the EC, IMF, and OECD are alibis for the government to follow contradictory and myopic policies that put all the cost on the workers, unemployed, salaried employees, small and medium agents,