Can Greece Cut Its Deficit by 10% of GDP?

Greece needs money fast. The International Monetary Fund (IMF) and members of the Euro-zone have that money. But before they lend it to Greece (at very favorable interest rates), they are demanding that Greece get its fiscal house in order.

As a result, Greece is proposing an austerity plan that would reduce its out-of-control budget deficits (currently standing at more than 13% of GDP) by at least 10-11% of GDP.

You might wonder whether that’s possible. History suggests the answer is yes, at least in principle. Indeed, several countries have achieved even larger deficit reductions.

According to an IMF study that I discussed a few months ago, the past three decades have witnessed at least nine instances in which developed nations have cut their structural deficits by at least 10% of GDP:

  1. Ireland (20%, 1978-89)
  2. Sweden (13%, 1993-2000)
  3. Finland (13%, 1993-2000)
  4. Sweden (13%, 1980-87)
  5. Denmark (12%, 1982-86)
  6. Greece (12%, 1989-95)
  7. Israel (11%, 1980-83)
  8. Belgium (11%, 1983-1998)
  9. Canada (10%, 1985-99)

This list demonstrates that large-scale budget improvements are possible. But they don’t always stick. Sweden, for example, makes two appearances in the top nine. Its gains in the 1980s were undone in the financial crisis of the early 1990s, so it had to undertake a second round of austerity. And Greece itself is a repeat offender, as its gains from the early 1990s have all been lost.

Greece faces enormous practical and political challenges in its austerity efforts, and success is hardly guaranteed. The nation can take some encouragement, however, from the fact that other nations have addressed even larger budget holes.

With some hard work and luck, perhaps Greece will join Sweden as a two-time member of the Large Deficit Reduction Club.

Greece, the Other PIIGS, and “The Chastening”

Several colleagues recently suggested that now is a propitious time to read (or re-read) Paul Blustein’s “The Chastening.” The book recounts how the International Monetary Fund (IMF) and the G-7 nations struggled to combat the Asian, Russian, and Latin American economic crises of the late 1990s.

Having read the book while flying back and forth across the nation, I heartily agree. The Chastening is a great read if you want to get up to speed on many of the issues now posed by the “PIIGS” (Portugal, Ireland, Italy, Greece, and Spain).

I particularly enjoyed (if that’s the right word) the number of characters, familiar from today’s Greece debacle, that appear in the book. For example:

* The government that used derivatives to hide its perilous financial situation (Thailand)

* The German leaders who denounced the moral hazard created by sovereign bailouts (most notably Hans Tietmeyer)

* The policymakers facing doubts (often well-founded) about whether assistance packages could really help or were just postponing the inevitable (and, in the meantime, bailing out some unsympathetic creditors).

With the benefit of ten years more hindsight, readers can also enjoy a certain “you ain’t seen nothing yet” thrill from passages about how scary the financial world looked during the crises of the late 1990s.

[Alan Greenspan the] Fed chief told the G-7 that in almost 50 years of watching the U.S. economy, he had never witnessed anything like the drying up of markets in the previous days and weeks. (p. 334)

Unfortunately, we were all in for even worse in less than a decade. And now Greece is following in many of the steps of Korea, Thailand, Indonesia, Russia, and Brazil.

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Good news for international readers: Thanks to Google Translate, you can now read this blog in several dozen languages. Just click on the language you want in the box to the right.

(For those of you reading this via email, Google Reader, etc., here are some example links: German and Spanish.)

P.S. Kudos to the WordPress member who wrote the code for this.

Greece Starts Selling … But Not Corfu

Greece is ready to start selling assets, according to the Wall Street Journal, but Corfu and the Parthenon are not on the auction block (no surprise there).

Instead, the government figures that by selling its stakes in a bank and a betting company, as well as its share of the national telecommunications company, it can raise €2.5 billion ($3.76 billion)—the equivalent of 1% of gross domestic product, its target for this year. That would only scratch the surface of Greece’s debt—which has surpassed the country’s €250 billion-a-year GDP—but would underscore for financial markets that Athens is serious about fixing its public finances.

The government also may put up for sale its shares in 15 other companies, including the water utility in Athens, a leading oil refiner, and several casinos. The Finance Ministry also wants to get rid of some Airbus A340 planes that it owns from the years before the country’s debt-ridden national carrier, Olympic Airlines, was privatized.

P.S. I love the transliterated name of the betting company: the Organization for Prognostication on Soccer Matches.

The Legacy of the Economic Crisis

In its recent Going for Growth report, the OECD concludes that the economic and financial crisis will leave an unwelcome legacy: a permanent reduction in economic activity. This loss averages about 3% of potential GDP across the 20 member countries for which the OECD was able to make these estimates.

As the following chart shows, those losses differ greatly across countries:

Ireland and Spain are the clear losers, with the crisis cutting economic activity by more than 10%. Despite being a catalyst for much (but by no means all) of the crisis, the United States faces one of the smallest losses. The 2.4% reduction in potential U.S. GDP is a sobering hit, but is less than that faced by 16 of the other nations.

Why does the United States appear to be on track for comparatively moderate output losses? Continue reading “The Legacy of the Economic Crisis”

Living Standards, Labor, and Productivity

This week the Organization for Economic Cooperation and Development released its annual Going for Growth report. The purpose of G4G is to benchmark economic performance among the OECD member countries and suggest pro-growth policy reforms.

My favorite chart in the report examines how GDP per capita differs so much across countries:

The first column of bars shows how GDP per capita in each country stacks up relative to a benchmark equal to the average level of the 15 richest OECD countries in 2008. (Fun fact: In prior years, the OECD used the United States as the benchmark.) As you can see, the United States has the third highest level of per capita income, topped only by Luxembourg and Norway. Looking lower down, you can see that, on average, the GDP per capita of the EU19 countries is more than 20% lower than the benchmark and more than 30% lower than in the United States.

There are two basic ways that a country can achieve a high level of GDP per capita: People can work a lot (i.e., high labor hours per person) or people can work productively (i.e., high output per hour worked). The second and third columns of bars disaggregate the income differences into those two components.

The second column shows that there are significant differences among the countries in the average number of hours worked per person. As you might expect, people in the United States work slightly more than the benchmark average of the richest 15 OECD countries. People work substantially more, on average, in some nations, most notably South Korea, Iceland, and the Czech Republic. People work substantially less in Turkey, France, and Belgium. (Keep in mind that these figures are average hours per person, so they are influenced by the age distribution of the population as well as the number of hours worked by working-age people.)

The third column shows that there are even larger differences among the countries in productivity. Most notably, all of the countries with low per capita incomes have relatively low productivity.

OECD researchers repeated this analysis for a group of emerging economies:

The productivity comparisons are striking: China, Indonesia, and India are 90% less productive than the 15 richest OECD countries. That’s an enormous gap.

Are Chile’s Building Codes Getting Too Much Credit?

Many commentators have pointed to Chile’s stringent building codes as a key reason why the death toll from its earthquake (in the hundreds at this writing) has been so much lower than in Haiti (in the hundreds of thousands).

Unfortunately, much of this commentary confuses two separate concepts: building quality and building codes. Building quality clearly played a key role in minimizing death and damage from the earthquake. Indeed, Chilean buildings are well-known for incorporating earthquake resistance techniques such as the strong columns, weak beams system.

That doesn’t imply, however, that building codes deserve credit for the quality of the buildings. Indeed, I can think of three other factors that likely deserve some credit as well:

  • Chile’s wealth. In 2009, per capita income in Chile was eleven times higher than in Haiti. Even in the absence of any building codes, the relatively rich Chileans would not be living in buildings as fragile as those in Haiti.
  • Chile’s history of earthquakes. In 1960, Chile suffered the largest earthquake on record (9.5), killing several thousand people. Even in the absence of any building codes, memories of that quake would have encouraged Chileans to construct more earthquake-resistant buildings. In Haiti, in contrast, the last major earthquake was in 1842, before the memories of any living Haitians.
  • Chile’s enforcement of building codes. Building codes are just pieces of paper (or their electronic equivalent). Governments can create all the codes they want, but if unscrupulous officials don’t enforce them—or get bribed to look the other way—they can be next to useless. Chile ranked among the 20 least corrupt nations in the world in 2009; Haiti was among the 12 most corrupt.

My point is not that building codes had no effect. I bet they did. But that’s not the whole story when it comes to building quality. Chileans would have built better buildings than Haitians anyway.  And Chileans live in a society where building codes actually get enforced. For both those reasons, we shouldn’t overstate the importance of building codes alone in explaining Chile’s resilience and Haiti’s devastation. Nor should we leap to the conclusion that the way to deal with Haiti’s future earthquake threats is to import Chile’s building code.

My second point is a scientific one. In principle, Chile’s earthquake provides an opportunity for researchers to evaluate just how important building codes have been in protecting Chile’s buildings. Enterprising analysts should look for situations that allow us to identify the effect of building codes versus other factors. For example, much has been made of the building code revisions that Chile adopted in 1995. That suggests one empirical strategy: compare what happened to buildings that were constructed in 1994 to buildings that were constructed in 1996. Did the 1996 ones perform much better? That would suggest that the building codes really helped. Or did 1994 buildings do just as well as the 1996 ones? That would suggest that the codes had little effect, perhaps because they were just capturing practices that were already in use by Chilean builders.

For related discussions, see this piece from Fast Company and this piece from the Infrastructurist. The comments on the second piece include an interesting discussion of the extent to which Chilean buildings would have been earthquake resistant in the absence of building codes. One commentator offers the extreme view that the building codes had no effect, while others offer the other extreme. I think the truth is in the middle.

The Spectre of Creative Bookkeeping

A spectre is haunting Europe — the spectre of creative bookkeeping.

In an article in this morning’s Wall Street Journal (“Debt Deals Haunt Europe“), Charles Forelle and Susanne Craig provide more examples of the “aggressive” bookkeeping that European nations have deployed to satisfy the deficit and debt targets of the Growth and Stability Pact.

Greece, of course, takes honors in the field, not just for its recent use of derivatives to hide liabilities (see my earlier post), but also for other creative moves in the past. For example, the authors report that Greece:

insisted to the Eurostat statistics authority that large portions of its military spending were “confidential” and thus excluded from deficit calculations. In 2000, Greece reported that it spent €828 million ($1.13 billion) on the military—about a fourth of the €3.17 billion it later said it spent. Greece admitted to underreporting military spending by €8.7 billion between 1997 and 2003.

Such shenanigans are hardly unique to the Greeks. Other players include:

  • Portugal, which “classified subsidies to the Lisbon subway and other state enterprises as equity purchases” in 2001, and
  • France, which “arranged a deal with the soon-to-be privatized France Telecom in 1997 under which the company paid the government a lump sum of more than €5 billion. In return, France agreed to assume pension liabilities for France Telecom workers. The billions from France Telecom helped narrow France’s budget gap.”

Although dated, these examples illustrate some basic strategies that governments use to conceal the size of their deficits and debts: pretend the spending does not exist (Greece), pretend that spending is really an investment (Portugal), or pretend the future pension liabilities aren’t real (France).

A topic for another day is how these strategies may have been used in the United States. Suffice it to say that strategy three–ignoring future pension costs–is widespread both in governments and the private sector.

The Wonders of Costa Rica

On Thursday, New York Times columnist Nicholas Kristof had a wonderful piece about Costa Rica, home of “The Happiest People“) (ht Catie).

Kristof reports that Costa Ricans are the happiest people in the world, at least according to three broad surveys. Why? Kristof offers the following hypothesis:

What sets Costa Rica apart is its remarkable decision in 1949 to dissolve its armed forces and invest instead in education. Increased schooling created a more stable society, less prone to the conflicts that have raged elsewhere in Central America. Education also boosted the economy, enabling the country to become a major exporter of computer chips and improving English-language skills so as to attract American eco-tourists.

I’m not antimilitary. But the evidence is strong that education is often a far better investment than artillery.

In Costa Rica, rising education levels also fostered impressive gender equality so that it ranks higher than the United States in the World Economic Forum gender gap index. This allows Costa Rica to use its female population more productively than is true in most of the region. Likewise, education nurtured improvements in health care, with life expectancy now about the same as in the United States — a bit longer in some data sets, a bit shorter in others.

I like this hypothesis, but being an empirical guy, I should note another possibility: maybe one of the keys to happiness is whatever allowed Costa Rica to eliminate its military in the first place?

Over the holidays, I did some field research (aka vacation) in Costa Rica and am happy to report that the area we visited (the Guanacaste province) is indeed lovely. I won’t torment you with my travelogue here–my wife and I have another blog for that–but here are a couple photos of the local fauna:

Yes, It Is Possible to Cut Deficits

A couple weeks ago, I highlighted an IMF report that compared the fiscal challenges facing developed economies. Not surprisingly, the IMF concludes that the United States has one of the largest structural deficits. To get our national debt back down to 2007 levels (relative to the economy), the IMF believes that we need to undertake a major fiscal adjustment–equivalent to a whopping 8.8% of GDP.

I have some quibbles about that figure, not least because the United States could avoid a fiscal crisis without getting the gross government debt all the way back to 2007 levels. But the basic message is sound: we face an enormous fiscal challenge.

However, we should not give up hope. As I discuss in a new piece over at e21, the IMF report also provides some reason for optimism: history provides numerous examples of developed economies that have successfully undertaken major fiscal adjustments. Indeed, the IMF finds 30 instances during the past three decades in which countries made adjustments of at least 5% of GDP, and nine cases in which the adjustments were even larger than the IMF currently prescribes for the United States:

The United States itself makes the list, with a fiscal adjustment (i.e., reduction in the cyclically-adjusted primary budget deficit) of 5.7% back in the 1990s.

Looking through the list, you will notice that many of these large adjustments occurred, at least in part, during the economic boom of the late 1990s. That isn’t surprising: fiscal adjustment is much easier if strong economic growth reinforces responsible fiscal policies.

P.S. For related posts, see this and this.