Finance Archives - Financial Memos

Back in 2009, it felt like every day we would read about the Greek debt crisis, a country unable to find its way out of a financial hole it didn't understand how it fell into. Despite a 2010 European and International Monetary Fund (IMF) rescue package, the Greek government was unable to generate sufficient revenue to cover its considerable expenditure and was effectively insolvent in not being able to finance its short and long term borrowings. The Financial Rescue Package The rescue package, now referred to as the First Economic Adjustment Programme for Greece, was designed to bring Greek public sector debt “down to” 120% of gross domestic product (GDP), in effect assigned Greece to financial struggle for many years to come. To manage a debt burden of that size with the governance and political structure in place in Athens, it was thought Greece would eventually have to remove itself from the Eurozone and be forced to fix its broken governance framework. But alas, Greek politics continued along its regular path. In my opinion, Greece missed a golden opportunity to get its public finances in order. The first package in 2010 totalled €107.3 billion and was made up of a combination of financial aid and reform commitments (obligations) the Greek government agreed to undertake. In 2012 the First Economic Adjustment Programme for Greece was signed and started. This package was even grander, with €130 billion in aid and commitments included in the agreement. Governance or Money? And this is why the Greek problem is not around its level of debt. Although this is certainly a consequence, rather it is a matter of governance for Greece. Like many countries around the world with abundant natural resources and many advantages more successful countries do not possess, the heart of the Greek crisis is the manner it has chosen to govern itself – and the populous has chosen to be governed. For many years Greece’s public finances have been in a deficit position, i.e. each year, the government would spend more than it received and so would have to borrow the difference in order to pay its bills. Below we'll look at some of the numbers and see the level of deficit spending that was taking place. As a natural person, if a government is spending more than the revenue it is collecting, the difference is borrowings. And each year, the Greek people benefited from this unaffordable spending through generous public sector wages, pension plans, staffing levels and general inefficiencies that kept many people employed. But of course, this greatly distorted the Greek labour market in making a public sector job often much more attractive than a private sector one. An example often cited is the Greek public rail network, which on any given day would have more people working for it than paying customers travelling on it. Public v Private Sectors So naturally, the public sector became the largest part of the economy, i.e. there were more people earning a living from taxes than those generating taxes. That’s right; only private sector activity generates a net tax gain for a government (and so providing it with money to spend). For example, a private sector person is employed and earns a wage. That wage is paid by the income the firm makes from selling to its customers. The government then takes part of that wage (thereby increasing the net tax take) and uses it to provide a range of public services. The government provides these services largely through paying wages from the tax revenue it has received; these wages, of course, do have tax deducted, however, all that is happening is part of those wages are being paid back to the government and so just making the wage a little cheaper. That “tax” has not increased the net tax take for the government and so has not increased the government’s ability to spend (or repay the existing debt). If this cycle continues with more and more public sector workers being employed an equilibrium is reached, and then passed, where the sector generating real net taxation for a government does not generate enough to pay the wages of those consuming a net tax position. The Election Machine I am sure that Athens on a number of occasions knew its long-term, let alone its short-term, solvency problem was not sustainable. However, it also knew that its re-election would be but a pipe dream if they started to reverse this process, in any meaningful way, and put Greece back on a mature public financial footing. The only way that Athens, therefore, knew it had to continue this path was that each election had to give away more of what it did not have. People would ask the politician “What is my vote worth? What can I demand to get the most for me?” And when enough people do this, they all as individuals gain in the short-term, but all as a collective loss in the long-term. Unfortunately for Greece, the long-term has now arrived. Have the Number Improved? Setting aside the structural reform that Greece decided it didn't have the appetite for, how have some of the key economic indicators fared? Three measures are worth our attention to see how Greece has progressed over the last decade or so. We are largely interested in the general government sector, but their overall prosperity as a country is also of interest. We have taken our figures and charts from the Organisation for Economic Co-operation and Development (OECD). General Government Debt The first measure looking at government debt states it as a percentage of GDP. The reason why the percentage is a more reliable measure than the absolute debt figure is a larger economy can generally deal with a larger debt position. And vice-verser of course. Or if a country has a falling debt position, but the economy is shrinking at an even faster rate, this may indicate a worsening public finance position. So what makes up general government debt? The OECD uses the following definition: "... currency and deposits; debt securities, loans; insurance, pensions and standardised guarantee schemes, and other accounts payable." (source link) Using a standardised definition enables both cross-sectional and longitudinal comparisons of Greece's performance in relation to other comparable countries. In the chart below, taken between the years 2000 to 2019, Greece's debt grew from 112 per cent of GDP to 201 per cent. On an annualised basis, this is a 3 per cent increase per annum growth over the 20 years. In the year 2000, Greece was the fourth worse in this measure of the 35 countries the OCED provides data for. This list is made up of the member countries, being some of the largest economies in the world. Interesting enough, it does not include the data from countries like China and Russia. In 2019 Greece had moved up to the second place, achieving this position in 2004. As the chart below indicates since 2011 Greece has continued its increasing debt burden pulling away from other OCED members. We haven't included 2020 data due to the mess most public finance purses are in at this point. But it will be interesting to look back again in a few years to see how well Greece has weathered the current economic storms. I fear that given the trend it was on and the lack of meaningful reform that didn't happen, things will not be improving. General Government Deficit We next move onto general government deficits. Again, we are looking at this deficit in relation to GDP, rather than in isolation as an absolute number. The OECD defines this deficit as: "... the balance of income and expenditure of government, including capital income and capital expenditures." (source link) In the year 2000 Greece's public finances had a deficit position of approximately negative 4 per cent, bottoming out at negative 15 per cent in 2009. Unsurprisingly 2009 is around the peak of the government's financial problems with significant public unrest and fiscal pressures. Although its default on its IMF loan wasn't until 2015, you can see the buildup to this "foreseeable" event. However, what the chart below also shows is a glimmer of positive news for the country's state finances. In 2016 the government achieved a surplus of 0.26 per cent of GDP. And as the red line shows this line continued to make slow gains over the following three years. I suspect these figures paint a picture that is rosier than we should believe. What I mean by that, during a period of global economic growth and booming world trade most economies will do pretty well. Warren Buffet's famous quote does come to mind as I write this, which goes something like: Only when the tide goes out do you discover who's been skinny dipping. As economies have slowed, world trade has dramatically declined, domestic economic activity has tanked, we will see how robust government finances are. And for our friends in Greece, how their financial position has weathered another storm. Gross Domestic Product The final measure I would like to look at is GDP on a per capita basis. Like the two measures above, that compared debt and deficits to GDP respectively, GDP by itself can be a misleading measure. For example, if a country has a growing net population but stagnant output, the overall standard of living of the population is declining. At the same time, a country could have a declining absolute GDP but a faster declining net population. This would prima facie indicate an improving economic position (although perhaps not a great position to be). The OECD uses the standard definition of GDP, being it is: " ... the value added created through the production of goods and services in a country during a certain period. As such, it also measures the income earned from that production, or the total amount spent on final goods and services (less imports)." (source link) When we look at the chart below from the OECD we see Greece has actually done pretty well on a per capita basis. It has gone from a $19,525 GDP per capita in the year 2000, up to $30,869 in 2019. On an annualised basis, this is an increase of 2.3 per cent each year. However, this compares to the OECD average (the dark line on the chart) of 3.2 per cent per annum; a whole percentage point each year. An interesting calculation is to look at the last three years for Greece. On the chart, we can see things are improving at a faster rate when compared to previous years. From 2016 onwards Greece does pretty well with a 3.0 per annum growth, almost up to the OECD average. Again, it will be interesting to see how the country performs in the coming years as it recovers from all that has been going on over the last few years and what is to perhaps to come. An interesting twist to this GDP per capita data is what was happening to the Greek population absolute figures over the same period. In the chart below (from macrotrends) we see a worrying trend and a different perspective on the GDP figures. What we see is a declining Greek population. From the start of the decline in 2005 through to 2019, we see an average decline each year of around 0.5 per cent. Or another way of looking at it, Greece had a net loss in population of around 800,000. What would be really interesting data to have is the demographic and skill set of those people who left. At a very micro level, when I was involved at a policy level of decreasing a government's equivalent full-time numbers, it was the staff you wanted to keep that often left. They tended to be the younger employees, perhaps two or three years experience, university graduates, etc. And, for want of a better phrase, the "deadwood" who tended to be more expensive and less productive, staying exactly where they were. I wonder if Greece experiences something similar. They are young. skilled and ambitious people sought greener pastures elsewhere. Time will tell. The Outlook for Greece So when you look back at the problems on the streets of Athens and the “austere” measures that were imposed; do think that all that money that was spent came from somewhere and was consumed by somebody: early pensions, high wages, low working hours and a very big generous employer. All that happened was the people lending the money didn’t trust the governance model in place in Athens and took place their money elsewhere, perhaps where it was better treated, i.e. the person borrowing the money had a good chance of paying it back.