A Problematic Proposal from Greece

Does Greece’s latest bailout proposal, now accepted by the Greek parliament, and currently being scrutinized at length by eurozone finance ministers, make sense? It’s pretty much the same deal that was soundly rejected by Greek voters less than a week ago. The voters clearly knew something that the government didn’t — this is a lousy plan for the Greek economy, and a government stacked with economists surely could have come up with something better.

In order to receive more money from the European Union and an extended payment schedule (or even, — gasp — debt relief) from the International Monetary Fund, Greece once again has agreed to a laundry list of new policies, some of them implying yet more sacrifices in the short term. In talks this weekend, the eurozone’s finance ministers have asked for more as a show of good faith. To borrow a metaphor from a story told in ancient Greek, there are many stations of the cross on this road — yet salvation may seem just as distant at the end. Even if Greece promises to submit to this new ordeal, the growth and debt relief it really needs may not arrive in time.

Here are the general points of the proposals and what they’re likely to do for Greek’s economy and its fiscal position. It’s not pretty.

Primary budget surpluses from 2015 through 2018. The Greek government would commit to spending less than it collects from taxpayers and lenders in each year: 1 percent of gross domestic product in 2015, then 2 percent, 3 percent, and 3.5 percent in 2016, 2017, and 2018 respectively. With modest growth, even that 3.5 percent surplus would amount to about 10 billion euros. But for its latest bailout, Greece is requesting 53 billion euros in new loans spread over three years. Essentially, the bailout lenders are providing the surpluses; they’re giving money to the Greek government conditional on the promise that the government will not spend all of it.

This is obviously ridiculous; it’s like a test to see if a child can resist eating a cookie placed in front of him. It’s also economically toxic. Greece should only run budget surpluses if its economy is growing at a healthy pace, and there’s no guarantee that it will be growing in the next couple of years — especially given the rest of the points on the list.

Tax reform. Greece has a complex tax system that has helped to create a large shadow economy. The proposal includes a bevy of changes designed to streamline the system and raise more revenue. From an economic perspective, anything that makes paying taxes easier — and avoiding them more difficult — will raise revenue somewhat while potentially freeing up taxpayers’ time for more productive activities. So making the system simpler and more transparent, for example by instituting an almost-uniform value-added tax rate, may raise revenue without harming economic growth.

But the proposal also includes a number of tax increases, not just to the value-added tax, but also the tax on corporate profits and the tonnage tax on shipping. The value-added tax, at 23 percent for most goods and services, will be one of the highest in the European Union. Corporate taxes have fallen steadily across the European Union in the past decade, and Greece’s new rate of 28 percent would again be on the high side for the entire union and a couple of percentage points above average for the eurozone. These changes could indeed affect growth; under normal conditions, they would be expected to slow the economy’s expansion.

The bet here is that by balancing its budget, Greece will attract investment and return to growth. But to the extent the budget is balanced via higher tax rates, Greece will be sailing against the wind.

Pension reforms. Greece’s public pension system, like its public debt, is unsustainable. The retirement age has already risen twice since the crisis began, from 57 to 66. The new proposal would increase it to 67 and inflict more cuts on benefits while attempting to collect more contributions from working Greeks.

Raising the retirement age could increase economic output if it boosts the total number of employed people. But if keeping older Greeks in their jobs longer just makes it harder for younger Greeks to find work, then the effect could be the opposite. Moreover, collecting more contributions by changing how incomes are measured and eliminating exemptions could put a dent into Greek households’ spending. Though many of these reforms are undoubtedly necessary, the bet is the same again: that renewed confidence among investors and consumers will outweigh the policies’ contractionary effects.

Labor and product markets. The Greek government made no specific commitments on its labor market, which has already undergone substantial reforms. But it did offer to open up several markets for goods and services by removing licensing requirements and reducing paperwork. These are positive steps that will increase economic activity and improve Greece’s attractiveness to investors, especially from elsewhere in the European Union.

The government would also eliminate subsidies on diesel for farmers and cut heating-oil subsidies in half. Once again, these are likely to be useful measures for increasing the efficiency of the Greek economy in the long term, but they could depress growth, albeit only slightly, in the short term.

Privatization. Airports, seaports, and several other assets would be sold to private investors under the proposal. These sales could raise several billion euros, but that would only be enough to take a few chips out of Greece’s enormous public debt. The significance of these sales would rest more on the potential of private owners to encourage greater economic activity through more dynamic management of these assets and further investment in their development. Of course, this is no sure thing.

Governance and corruption. The proposal contains a variety of pledges to adopt European Union norms and best practices for the functioning of public services and the control of corruption. Notable among the promises is one to make political parties’ financing more transparent and to protect investigations of corruption from political interference. These are worthwhile initiatives for the most part and also not particularly costly. If implemented faithfully, they would help the economy to grow in the long term.

The eurozone’s finance ministers are discussing Greece’s proposal late into the night on Saturday, with some, including the group’s leader, having expressed skepticism already — despite the fact that the proposal is so similar to the one put forward earlier by the creditors themselves. Then, if they are satisfied, there will be more talks, perhaps on debt relief as well. But these delays are for political posturing and little else; the reality remains that the proposal, whoever wrote it, is far from optimal in economic terms.

Yet Greece will have to keep suffering under austerity and repaying its creditors for several years before these and other pro-growth policies have their full effect. Too many points in the proposal imply short-term pain for long-term gain; the most important step toward the control of Greece’s debt is a return to rapid growth as soon as possible. Ideally, the timing of the reforms would put the least costly policies first and make the most costly policies contingent on growth rates in the future. The last thing Greece needs is another bundle of policies whose immediate effect will be to deepen its depression.

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