All posts by Periklis Gogas

Dr. Periklis Gogasis a frequent contributor to The Business Thinker magazine. He is an Assistant Professor of Economic Analysis and international Economics, Department of International Economics and Development, Democritus University of Thrace, Greece

Greek Crisis, Debt and Competitiveness: A Case Study of Irrational Expectations

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance. Recently, Dr. Gogas was a Visiting Scholar at the Ross School of Business, Uinversity of Michigan.

The economic crisis that troubles Greece since 2009 is the worst since WWII. A cascade of measures were taken by the Greek government and the troika supposedly trying to steer the Greek economy into primary surpluses and ultimately growth in order for Greek debt to become sustainable. The recipe chosen for this turnaround was apparently simplistic, one dimensional and is proving to be wrong severely damaging the Greek economy, its bond holders, the EU and casting serious doubts for the euro’s survival. The main ingredients of this failed recipe consist so far of huge direct and indirect tax increases, severe pay-cuts to public sector employees, a virtual halt in all government spending in education, health and government investment in infrastructure, research and technology. It is obvious to anyone, whether economist or not, that this policy is doomed for failure. Greece’s official statistics came to prove this belief. Two and a half years after the crisis unraveled, all the measures failed and this was no surprise to anyone but to the people that conceived them. Every single target projected by the troika’s “wise” and the Greek officials for government revenues when introducing a new tax or contractionary policy, was met with flat out failure. In economics we say that people have rational expectations when they do not make consistent errors in their forecasts about future events. They may be wrong many times but on average they must be correct. In this case, every single expectation is always over-optimistic and tax revenue falls short of the set targets. Anyone can see this, but the people who make the decisions. And even worst, instead of taking this as evidence that their policies are wrong and implausible they come back with new arrows from the same arsenal.

The examples of incompetence are numerous: one of the first measures taken was a major fuel tax increase that resulted in gas prices doubling from €0.85 to €1.70 per liter. At the same time, the annual road tax and car excise taxes increased in a similar manner. Apparently, naïve government officials assumed that government revenue will also double or at least increase significantly. Wrong! Government revenue from automobiles saw a sharp decrease from €1.7 billion per year to €0.7. Someone forgot to estimate the elasticity of demand on such huge price increases. To make the story even worst, after the huge decline in government revenue no one yet bothered to correct the mistake and increase revenues! This simple fuel and road tax hike of course had a multiple effect on the economy by burdening Greek production and worsening its competitiveness across-the-board.

Another example is tourism: supposedly tourism can be promoted as the heavy industry of Greece. At the same time, Greek government actions through indirect taxation actually divert tourism income from Greece to other countries. My master’s class students just organized a trip to Frankfurt. The whole trip including a direct flight to Frankfurt and a three-night stay in a down-town hotel costs €150 per student. A round trip from Thessaloniki to Athens by car would cost €150 for gas and €50 more for tolls. Apparently the Greek state is subsidizing the German tourism industry by making it prohibitively expensive for Greeks or others to travel within the country. Why would anyone implement such measures and even more so why stick to them when they are proven wrong?

Now, the bog issue is that the troika demands that private sector wages must decrease so that Greece will become more competitive. This is strange. Not even Greek employers themselves think this is necessary. A recent discussion with the president of a Greek chamber of exporters revealed something very important: total labor cost reflects not more than 8% of the final product price! Thus, even an extreme 50% decrease in private sector wages would not increase Greek competitiveness by more than 4%. Moreover, eliminating the 13th and 14th wage would further reduce government revenue through income taxes and social security contributions that are associated with these payments. The impact of these proposed cuts of course would be a vicious cycle that will further reduce total demand, production, employment and government revenue.  There is no economic reasoning for these contractionary and recession inducing policies. The evidence from their implementation is decisive beyond any doubt; they lead to a dead-end.

What is the solution then? Usually complex problems have simple solutions. The private sector is very efficient finding solutions to these problems when no governments or international institutions intervene and interfere. A firm that bears an unsustainable debt and is on the brink of bankruptcy would come into an agreement with its creditors to write-off part of the debt. This is a mutually beneficial solution. The firm will not go insolvent and the creditors will face the minimum possible capital losses. In the Greek crisis there is now the danger that both Greece will go bankrupt and bond holders will lose all of their investment. A real haircut of 50%-60% of nominal debt could render it sustainable. This haircut necessarily should include bonds held by both private investors and the European Central Bank (it is exempt now) and other creditors with only exception the bonds help by pension funds (they are not excluded now). The Greek banking sector could survive this hit by substituting Greek government bonds with an appropriate amount of government involvement in their capital structure financed by the troika. At the same time, a reduction of all taxes, direct and indirect, would help to stimulate the private economy, increase demand and jump-start production, employment and growth, ensuring that Greece could service the remaining debt and become credible again in international capital markets. And finally, Germany musts decide what it wants: a truly united Europe, or just some close trading partners for German products? If the former is the case, then they must immediately make the next necessary step for economic integration. This step will set the ground for the euro to survive and EU to become a true and stable union that can leave behind the fiscal problems that seriously challenge its structure and ultimate existence. This step is no other than the Eurobond: a united Europe that collectively borrows and distributes funds according to the need and economic cycle fluctuations. This, will speed up the convergence process within the national economies and significantly reduce from one hand the cost of borrowing to the economies in need and also one the other the risk assumed by international investors.

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About the Author:
Dr. Periklis Gogas is a faculty member at Democritus University of  Thrace and an adjunct lecturer at the Greek Open University teaching  Macroeconomics, Banking and Finance. He is also a Financial Consultant for Gerson Lehrman Group, Austin, Texas. He received his Ph.D.degree from the University of Calgary with supervisor Dr. Apostolos Serletis and worked for several years as the Financial Director of a multinational enterprise. His research interests include Macroeconomics, Financial Economics, International Economics and Complexity and  Non-linear Dynamics.

 

 

ECB: The Quest for Purity May Lead to Obscurity

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance. Recently, Dr. Gogas was a Visiting Scholar at the Ross School of Business, Uinversity of Michigan.

The European Central Bank, under the influence of Germany was designed with a single mandate: price stability. The function of the Fed in the U.S. is quite different as it is designed to play a significant role in preventing and fighting both recessions and inflation to avoid economic crises. It seems that the U.S. has a long memory regarding crises. The Great Depression and several other less significant in terms of impact crises since then are gone but not forgotten. This is evident in the dual mandate of the Fed that apart from the pursuit of price stability it can also intervene whenever seems necessary with an expansionary monetary policy to provide the liquidity to stir the economy away from danger.

In the European Union things are different. The design of the euro, the monetary union and the EU seems to ignore the history of crises and even recessions. The European Monetary Union’s “Stability and Growth Pact” is a great example. According to this, no member country can run a deficit and debt more than 3% and 60% of its GDP. On top of the fact that this requirement was proven to be hard to enforce, it also makes no distinction between normal economic activity and periods of recessions and even crises. This leaves European governments with no tools for implementing economic policy to avoid or dampen economic downturns as fiscal policy is limited according to the above requirements and monetary policy is in the hands of the European Central Bank where there is no mandate to fight recessions and crises.

Continue reading ECB: The Quest for Purity May Lead to Obscurity

A MODERN GREEK TRAGEDY:The Barber and the Referendum

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance. Recently, Dr. Gogas was a Visiting Scholar at the Ross School of Business, Uinversity of Michigan.

Sophocles, Aeschylus and Euripides after twenty five hundred years finally met their match. Papandreou, Venizelos and other Greek government officials are stunning the world not a bit less successfully than their ancient rivals. Some people used to say that modern Greeks did not live up to the legacy left by their ancestors but the current Greek government is proving them wrong. But let’s take a closer look to the storyline.

The deep fiscal crisis in Greece seemed to be finding a viable solution mid-last week when the long overdue haircut plan was finally put in place in the EU summit. As with the common
haircut at your barber, you cannot avoid the inevitable, you have to get a haircut and the longer it takes you to realize it and do it, the longer the hair is going to be. Hair, like debts do not get shorter by just waiting. The October 27th plan for the haircut on the Greek sovereign debt was desperately needed not only by Greece but for the euro and the financial markets as well. It was clear to everyone that despite the aid by the EU and the IMF, Greek debt was not sustainable and it was heading towards an uncontrolled default. In private business financing the picture is clearer and these situations are dealt with swiftly and usually successfully: the borrower and the lender come to an agreement so that the former is able to service part of its obligations and the later ensures minimized loses. The decision reached at the dawn of October 27th is a step towards the right direction for two reasons: Greece and the international community will avoid an uncontrolled default and

Continue reading A MODERN GREEK TRAGEDY:The Barber and the Referendum

Greece and the U.S.: The Importance of Monetary Policy Independence

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance

As a result of huge government deficits in 2009 Greece was faced with successive downgrading by all three major credit rating agencies that rendered its government securities to “junk bonds” status. This severely impacted Greece’s creditworthiness and it was forced to use a joint European Commission, European Central Bank and IMF rescue deal as Greek government bonds were plummeting and yields skyrocketed. This rescue package came with very strong “strings attached” as the package required a series of important austerity measures to curb government spending. These austerity measures led since then to a severe recession that Greece has yet to overcome.

Last week, Standard & Poor’s announced the downgrade of the U.S. economy for the first time in history from AAA to AA+ after the enactment of the Budget Control Act of 2011. Of course the severity of the fiscal problems of Greece and the U.S. are far from similar. Greece’s public debt amounts to 140% of its GDP while this number is only 70% for the U.S. But this is not the only difference between the two countries. What is most important is who is responsible for the conduct of economic policy: fiscal and monetary policy. Greece within this crisis is not in the position to conduct any of the two. Fiscal policy is virtually nonexistent as it is controlled by the bailout package and monetary policy is conducted by the European Central Bank since the country is a member of the Eurozone.

Continue reading Greece and the U.S.: The Importance of Monetary Policy Independence

THE EURO: A GOLDEN TRAP FOR GREECE

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance

The adoption of the euro as the common currency for the participating EU countries was hailed by politicians, academics and business people as a very important step-forward towards the ideal of European economic integration through the implementation of Robert A. Mundell’s Optimum Currency Area theory. The new currency was a greater success than many economists expected. Outside the EU it has become the second -after the dollar- reserve currency for many central banks and close to thirty nations worldwide chose to peg their currencies to the euro. The new currency helped to eliminate exchange rate risk and minimize transaction costs within the Eurozone, boosting intra-EU trade and efficient capital allocation.

Continue reading THE EURO: A GOLDEN TRAP FOR GREECE

The Proposed E.U. “Competitiveness Pact”

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance

The recent public debt crises in Greece and Ireland have put forward the issue of sustainable public debt in many of the developed industrialized countries. This crisis, like the mortgage crisis of 2008 and many other crises, stems from the extensive low cost flow of credit in recent years. Debt growth seemed harmless and innocent enough in an era of optimism, rising assets’ valuations and seemingly robust economic development. Unfortunately, for different inherent reasons, these debt bubbles started to burst for Greece and Ireland and the future looks gleam for many other heavily indebted countries in Europe, North America and Asia. The European Union, acting rather sluggishly, has, finally, put in place the European Financial Stability Facility (EFSF), a mechanism for dealing with bailouts of heavily indebted EU countries that are a threat to the economic stability of the Union and the Euro. As it is common for economic policy in the European Union, member states and the corresponding institutions that are responsible for designing it, act in panic or on undisclosed agendas. The last example is the proposed by France and Germany “competitiveness pact” that includes, among many others, increasing retirement age limits even for the countries that face no pension fund problems, setting minimum corporate tax rates across-the-board within member countries and applying constitutional provisions in all member states for implementing balanced budgets. These arrangements in the “competitiveness pact” may be problematic for two reasons: Continue reading The Proposed E.U. “Competitiveness Pact”

THE FAILURE OF THE PRIVATE SECTOR IN GREECE

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is a faculty member at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance

For many years now in Greece, even before the recent fiscal crisis, the public sector and the government employees were targeted by Greek national media and the public as the source of many problems that clouded the country’s future. At the center of the debate there is always the myth of the “high” salaries paid in the public sector, the constitutional provision for the permanence of public servants and their alleged low productivity.  At the same time, many young people in Greece have as a career objective to work for the public sector. Continue reading THE FAILURE OF THE PRIVATE SECTOR IN GREECE

The Making of The Greek Fiscal Crisis

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is a faculty member at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance

The public debate over Greek debt is in the headlines for months now ever since the first issues with regard to Greece’s fiscal problems were raised. Political and ideological confrontations on the subject are inevitable. Accusations over culpability are an everyday occurrence between members of the two major political parties PASOK and ND that ruled Greece by turns since democracy was restored in 1974. Academic economists in Greece follow these developments closely and they are often at the epicenter of heated discussions in the media with journalists and tax payers indirectly or directly accusing them for the current situation. People are wondering why all the economists that now stress the shortcomings of Greece’s fiscal policy remained silent or at least they did not criticize that strong the same policies in the past. The truth of course is that no politician ever asked them and no one ever listened to their warnings. Politicians were busy accusing each other for creating the debt. Thankfully, numbers can tell the truth impartially without subjective political judgments and deception: a simple graph like the one in Figure 1 depicts the truth. Continue reading The Making of The Greek Fiscal Crisis