Serpent's Egg

The Eroticism of Fat Men

Greece’s new government and the Troika have to face the awful truth

“Greece is held prisoner in an ugly cage – the monetary system that is the euro”

Syriza Party Leader Alexis Tsipras Pre-Election Congress...Alexis Tsipras, leader of the Syriza party, holds a clove flower as he attends a pre-election party congress in Athens, Greece, on Saturday, Jan. 3, 2015. Greece's political parties embarked on a flash campaign for elections in less than three weeks that Prime Minister Antonis Samaras said will determine the fate of the countrys membership in the euro currency area. Photographer: Kostas Tsironis/Bloomberg *** Local Caption *** Alexis Tsipras

Syriza Party Leader Alexis Tsipras Pre-Election Congress…Alexis Tsipras, leader of the Syriza party, holds a clove flower as he attends a pre-election party congress in Athens, Greece, on Saturday, Jan. 3, 2015. Greece’s political parties embarked on a flash campaign for elections in less than three weeks that Prime Minister Antonis Samaras said will determine the fate of the countrys membership in the euro currency area. Photographer: Kostas Tsironis/Bloomberg *** Local Caption *** Alexis Tsipras

How will the Troika deal with Greece now? Photo: Kostas Tsironis/Bloomberg

With Greece having secured yet another bailout a few weeks ago, you could have been forgiven for thinking that its crisis was finally over. Recently, the markets certainly seem to have taken this view. Greece has been shunted to the sidelines, to be replaced by worries about China and US interest rates.

But not only is there bound to be an extended period of political wrangling after yesterday’s Greek election, the economic situation also still looks dire.

Admittedly, this is not the picture to emerge from the latest figures on industrial production. These showed a jump in July, perhaps suggesting that Greece has finally turned the corner.

Paradoxically, during the period covered by the data, anxiety about default, euro exit and the imposition of capital controls was at its height.

I doubt, though, that the industrial production figures give a reliable picture. The surveys of economic sentiment and the purchasing managers’ indices (PMI) remain bleak, consistent with sharp falls in GDP.

Interestingly, in Russia last December, when anxiety about the economy and the ruble was at its peak, there was a surge in retail sales and industrial production. People and companies sought to turn their cash into something that could be neither devalued nor effectively confiscated by the state. Something similar may well have occurred in Greece.

Alexis Tsipras before casting his vote at a polling station in Athens

The importance of Greece staging some sort of economic recovery cannot be overstated. Unless there is an upturn, the bailout deal could quickly unravel. In keeping with every other attempt at providing Greece with financial assistance, the Troika (the European Central Bank, European Commission and the International Monetary Fund) assumed that the Greek economy would contract by just over 2pc this year, and by 1.3pc next year, before growing by about 3pc in each of the next two years.

In practice, even if the economy does better than expected this year, thereafter I suspect it will do worse.

This is vitally important, because if the economy is recovering – as assumed in the bailout – then tax revenues should rise, thereby reducing the deficit. Even a standstill in the Greek economy would see the deficit numbers exceeding those laid down in the bailout plan.

This would pose a very awkward choice for the Troika: accept that the borrowing forecasts have to be revised up and be prepared to throw even more good money after bad; or force the Greek government into tougher austerity measures. The first would bring on apoplexy in Frankfurt; the second would cause a new political crisis in Greece – and lead to even weaker Greek GDP, thereby initiating a new downward spiral.

In fact, although the latest bailout plan was more moderate than previous versions, nevertheless there is still more austerity to come. This fiscal tightening will make it harder for aggregate demand to grow. Meanwhile, the anxieties about debt, default and devaluation that have dogged the economy for so long, continue. So what chance of a Greek recovery?

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Greece badly needs improved competitiveness to boost net exports and kick-start growth. The fact that its current account has improved tremendously from a deficit of 14pc of GDP in 2008 to a 1pc surplus now means little. It is normal for countries’ current account deficits to improve in recessions. As income and production fall, imports are bound to decline since people (and companies) have less money to spend. And, of course, the Greek economy hasn’t suffered an ordinary recession; since the beginning of 2008, output is down by a staggering 25pc.

The manifestation of Greece’s problem of uncompetitiveness has been shifted from the balance between exports and imports (the current account of the balance of payments) to the level of output and unemployment. The latter is currently running at 24pc of the workforce.

Clearly, the problem is still there. Theoretically, it would be possible for Greece to achieve improved competitiveness by “internal devaluation”, that is, continued falls in costs and prices. But not only is this process long and painful, it also increases the debt ratio. Hence the case for a lower exchange rate – which requires leaving the euro.

Of course, many commentators have argued that Greece could not take advantage of a lower exchange rate and that therefore an exit from the euro would do no good. One argument is that Greece has nothing to export, except tourism, and the tourist industry has no capacity to expand, at least not in the short term.

But this isn’t true. Admittedly, tourism accounts for about a quarter of export earnings. But there is significant scope to expand exports in other sectors – and to substitute domestic production for imports. For instance, food accounts for about 8pc of Greek exports, but agricultural output is down by about 25pc since 2005.

Greece exports a significant amount of olive oil but most of this is in bulk and unprocessed. Last year, over half of Greece’s olive oil production was exported to Italy where it was processed and bottled. At the right exchange rate, far more of this process could be located in Greece, increasing the value added there and boosting employment.

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As for the capacity to boost tourism, it is true that in recent years tourist arrivals in Greece have been rising. But Greece has been losing market share to other countries, including Turkey and Portugal. Moreover, because of extensive hotel building, occupancy rates are still well below full capacity. Last year, August occupancy rates were 73pc, compared with 94pc in 2003. Moreover, there is huge scope to increase occupancy rates outside the peak season. In other words, the Greek tourist industry can respond to increased competitiveness with increased output.

Greece is held prisoner in an ugly cage – the monetary system that is the euro. It is now widely recognised that it should never have been let into the single currency in the first place.

Nevertheless, neither the Greek government – of whatever stripe – nor the Troika wants to accept that, inside the euro, it is difficult to see how the country can recover. At some point, they will have to face the awful truth.

Roger Bootle is executive chairman of Capital Economics

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