Blanchard’s tales of woe

The chief economist of the IMF, Olivier Blanchard, summarizes in his blog the situation in Greece, explains why the IMF did what it did and suggests a way forward. It should be based on a”more explicit recognition of the need for more financing and more debt relief” he says.

Well, let us stop right there.  That is exactly what a way forward should not be based on, more money, as more financing is not required. We should all recognize instead, that the IMF and its other public sector creditors just need the money for rolling over the previously advanced debt. Greece does not need more financing, its taxes cover its expenses, apart from the interest on its loans.

Greece does not need more money

Greece does, however, need more debt relief. Blanchard is right there. Debt relief is what the IMF and its other creditors should offer Greece on the 320bn of debt, when they meet to discuss the latest set of proposals this weekend. In fact, the IMF should really refuse to sign an agreement with its co-creditors and Greece unless debt relief is granted, if they see it as such an important step.

We all know how bad the situation is in Greece. GDP is down by 25%, a pretty severe fall and comparable to an economy after a war. What is the explanation?

That is how Mr. Blanchard sees it.

…fiscal consolidation explains only a fraction of the output decline. Output above potential to start, political crises, inconsistent policies, insufficient reforms, Grexit fears, low business confidence, weak banks, all contributed to the outcome.

All true, Grexit fears, low business confidence, who would want to invest in Greece when these obstacles remain? And when its own creditors (the EU and ECB, not the IMF) pour petrol on the flames, denouncing the recent referendum “No” vote as a vote for Grexit. Or force Greece to close its banks by not providing enough liquidity. Blanchard forgets to mention fears about sustainable debt levels (a future tax liability to potential investors), or the mere fact that after 5 years of adjustments, the IMF is still in country, having missed its own Grexit by a long shot. A huge problem to potential investors.

Now, let us go back to that misleading statement from the beginning, that Greece has a “need for more financing.” Will that help or hinder business confidence, if potential investors learn that another 50bn in funding is required, now, after already five years of funding? Maybe it would help Greece’s case if the IMF stated the situation accurately, and admit that Greece does not need more financing. “The IMF says Greece can stand on its own feet again”, surely would not only increase business confidence, but have the additional advantage of being closer to the truth. That statement alone, by the IMF, could diminish Grexit fears and increase political certainty. It could draw in investors all by itself.

Let us remind ourselves that the Euro 50bn shortfall (and the alleged 50 bn new financing need) is almost entirely due to missed privatisation receipts. The IMF ludicrously predicted sales of 50bn of Greek state assets by the end of 2015, in reality only just over 2bn were sold. Greeks are reluctant to sell in a depressed market, naturally. So the IMF forecasts were wrong, that is why the debt will need to be rolled over.


I hope we cleared that up once and for all.

TINA – There is no alternative to fiscal consolidation

Now we come to a much more important point. Mr Blanchard says, that “fiscal consolidation explains only a fraction of the output decline.” That is indeed true, but the fraction is probably around 2/3, by my rough estimate, as a reduction of a primary deficit of 20% to a small surplus will account for most of the the GDP decline. Could nothing else have been done? Blanchard thinks not:

Fiscal austerity was not a choice, but a necessity. There simply wasn’t an alternative to cutting spending and raising taxes. The deficit reduction was large because the initial deficit was large. “Less fiscal austerity,” i.e., slower fiscal adjustment, would have required even more financing cum debt restructuring, and there was a political limit to what official creditors could ask their own citizens to contribute.

TINA rears her ugly head again, there is no alternative to what we are doing, says Blanchard. But we know that Greece’s predicament results not just from excessive state budget deficits, but also excessive current account deficits. Greece was importing more than it was exporting.

Twin Deficits

(charts: IMF)

The terrible twins, budget deficits and current accounts, accumulated up to 2010, are at the root of Greece’s current situation.

Let us once again look at these deficits in the years to the IMF coming in.

Budget deficit:

2007: -7%

2008: -10%

2009: -16%

Current account deficit:

2007: -15%

2008: -15%

2009: -11%

Let us now go back to that equation, which explains the relationship from macro-economic national income accounting, and the relation between the budget deficit, and the current account deficit. (More info here)

G-T = S-I – (X – M)

This means that the budget deficit (Government Spending – Taxes)

= the net savings in an economy (Savings – Investments) minus the current account surplus (eXports – iMports)

By plugging in the numbers in the equation we get the following

2007: -7% = S-I -(-15%)

2008: -10% = S-I -(-15%)

2009: -16% = S-I -(-11%)

(all numbers expressed as part of GDP)

What is the point of doing looking at these numbers?

First of all, we see that the situation was dire for years, well before the IMF came in. The budget deficit was highest in 2009 with 16%, as in that year the Goldman Sachs sold derivatives became due which had hidden the fact that Greece’s budget deficit was actually bigger than previously reported.

In fact these deficit numbers exceeded the Maastricht criteria of 3% by a factor of 2, 3 and 5 (!) in the years shown here. The current account deficits were equally unsustainable, in the years before 2010 up to 15% of GDP. That is untenable, effectively indicating that foreign indebtedness doubles every 7 years.

Remember, these numbers come from the equation: G-T = S-I – (X – M)

The IMF has exclusively concentrated on fiscal adjustments, cutting government spending G, or raising taxes T, according to Blanchard. Where he is wrong, though, is that there is no alternative. The above equation shows you that there is.

The IMF could equally have said, it wants to increase eXports, or decrease iMports. Both would have resulted in the same outcome, an automatic reduction of the large state deficit. Or:

The smaller the current account deficit, the smaller the budget deficit.

And the higher the current account surplus, the smaller the budget deficit.

When X-M becomes bigger, G-T becomes smaller.

(Always assuming that S-I does not change, all other things being equal, ceteris paribus).

Or, to put it another way, Greece should have moved away from consuming too much (usually imports), and producing more for others (exports). So, the IMF could have helped Greece to directly increase exports and reduce imports.

The simplest way to have done so would have been to add an import tax to all Greek imports. Undoubtedly, a 40% import duty would have changed Greece’s current account deficit to a surplus quite quickly. It would, of course, also have raised much needed revenue, which would have closed the budget deficit automatically. All without cutting other government spending or raising taxes.

Import taxes are, of course, frowned upon when following the free market dogma which rules the thinking behind the IMF’s policy advice. They might well be illegal under trade agreements and in the EU common market, and are therefore not suggested. But we are not in a normal situation. The IMF comes only in to help adjust a country which has a severe problem, usually to eliminate a current account deficit and a foreign exchange shortage. Only countries in need of intensive care get IMF help. Exceptionally, a high import duty could help a country to adjust over time. The import tax should not to be there forever. An initial 40% tax could be eliminated at 4% a year, over 10 years.

Had Greece introduced such a high tax, imports would have immediately reduced, and Greeks would have had a chance to substitute their own products for imported ones. Behind a hypothetical initial 40% barrier, introduced in 2010, olive farmers could have successfully produced and bottled their own olive oil, and competed with previously cheaper imports. With successful sales, they could have invested in the machinery to make oil production cheaper, due to economies of scale. By the time the import duties would have run out, 10 years after their introduction, they would have been successfully competing with other European olive oil producers.

Or, alternatively, to get around the import tax problem, the IMF could have suggested the following. In order to adjust the economy in a more balanced way, import and export certificates must be presented by importers and exporters. They are available from the government. The exports certificates come with a monetary value which will become payable to the exporter (20 cent per Euro of exports), and the import certificates will have to be bought by the importer (20 cents per Euro of imports). Again, these certificates should only be valid for 10 years, tapering each year to a lower value, to give the country time to adjust. Whereas an import duty would have led to domestic substitution of previously imported good, the trade certificate idea does the same, but also makes it cheaper to export.

Greece’s major export is tourism, thus an initial 20% reduction in costs for tourists, allows Greece to compete more successfully with its cheaper neighbour Turkey. Had the IMF introduced that in 2010, hotels in 2011 would have been full. Instead, they had spare capacity. Unlike the import duty, the trade certificate solution does not close a hole in the deficit directly by generating a tax. Exporters get help from importers to sell their goods abroad. So if a current account surplus is desirable, as it is in Greece, to pay interest on its foreign loans, adjusting the cost of the respective certificates could help to achieve that current account surplus. Greece could have aimed for a current account surplus of 4-5% quite quickly. As it is, it took five years to reach a 1% current account surplus. In any case, as we can see in the above equation, if the trade surplus increases, the budget deficit reduces.

Increasing exports is a good and sustainable way to reduce the deficit. Ceteris paribus, of course.

Or, to put it more succinctly, artificially increasing exports and reducing imports results in an internal devaluation without the unemployment.

Import/Export measures compared to State Government spending/Taxing

The difference is huge. Increasing taxes and reducing spending will immediately lower GDP and increase unemployment. (As will, incidentally, the increases in VAT tax and pension contributions which are in the new agreement to be decided upon.) The costs to society are huge, creating a debt deflation spiral.

In contrast, reducing imports and substituting domestic production or increasing exports will move jobs from the import sector to the export sector. GDP increases, jobs are safeguarded. So, Blanchard is wrong, there would have been an alternative to the savage fiscal adjustment program. The IMF should have concentrated on the current account only, and suggested measures, such as the ones set out above.

Only if government deficits had still remained, would it have been necessary to adjust the fiscal levers.

The IMF programme, a complete and utter failure?

For some reason, and I do not know why – did he simply forget? –  Mr Blanchard fails to highlight the only redeeming feature of the IMF programme, he does not even mention it. It is a huge benefit to Greece, although at the moment it does not feel like that. If we look at the competitiveness of Greek workers to their German counterparts, since the introduction of the Euro in 2001, German workers became more productive relative to the Greeks. Greeks wages and inflation went up far too quickly. German wages fell or stayed the same. But only until 2010, since then there has been a sharp fall in Greek wages, brought about by the savage IMF cuts. German wages have recently gone up. That has resulted in Greek workers almost being competitive with German workers again, for the first time since the early 2000s.

Unit Labour Cost Greece

That is a huge advantage, as it is now, for the first time in 15 years, again more attractive to invest in Greece, rather than in Germany again, based solely on unit labour costs.

The problem is, that in the early 2000s Greece’s unemployment rate was 11%, now it is 26%. Why the difference?

Again, we have to go back to the factors above, business confidence, Grexit fears, indebtedness, IMF intensive care, and also still some outstanding structural reforms.

To which we now could add an unhealthy concentration on fiscal adjustments, with a reluctance to boost the export sector, which would have been an alternative. Would wages in Greece have fallen as fast, had export boosts been featured more prominently? Of course not, but increased growth could have been allocated to debt servicing, and wages could have had only minor downwards adjustments. Productivity would still have increased.

What could have been done

Having highlighted only a few of the issues, it becomes clear that Blanchard blog post is an attempt to justify the huge failure of the IMFs programme in Greece. It is a self-referential work which yet again ignores the real issue here, Greece, and how to get Greeks back into work.

  • The IMF is a government agency sent in in 2010 to help Greece sort out its problem. It really works on behalf of the Greek people, not its co-creditors which arm-twisted it into the job in 2010. Its justification therefore here should be to the Greek people, why it is necessary, in its view, to have huge unemployment over the past years? It should explain how it will get the Greeks out of this predicament. None of this is addressed.
  • So now Blanchard knows there is an alternative, he could support a programme to increase exports, as they will be essential if Greece is ever to repay any of its debts as set out in the “primary surplus” targets currently being agreed. An import duty (or trade certificates) could still be on the table, to aim for current account surplus of 4-5%.
  • The IMF’s other job, as an agency working on behalf of the Greek people, is, of course to paint the best picture possible of Greece. With a similar zeal as the Greek Tourist Office, it should attempt to lure investors into the country, and mention its benefits in terms of already implemented reforms. Record reductions in the twin deficits over five years, for example. That is impressive.
  • The IMF should state that the prospects are excellent, as no other country has had such a drop in wages, or such easy labour regulations. It should highlight, that until the recent stand-off, resulting in a missed Euro 1.5 bn payment by Greece, Greece had paid all its loans back to its creditors, without receiving a cent in the last year.
  • The IMF should pat itself on the back the wage reduction strategy (the very hard internal devaluation) has worked, and that Greek workers are competitive again with its peers. Or the allegedly more productive Germans. While, of course, apologizing for the hardship caused in Greece.
  • And the IMF should come clean on why the 50bn is not really any additional money, just a roll-over of agreed funds, because its projections were unrealistically optimistic. A statement such as “Greece is self-sufficient” would draw in more German investors than anything else. And so would a moratorium on the word “Grexit” by the EU, and a credible “whatever it takes” by the ECB to keep the banks in Greece open.
  • Finally, the IMF should not be dithering about debt restructuring, but suggest a sufficiently large amount, that would be helpful to Greece. The other creditors’ view might differ, but the IMF must know what its recommendation is, and that should be put out into the open.

Maybe all that could be the subject of Mr Blanchard’s next post about Greece.

If Greece is to have a chance, the rhetoric has to change. Blanchard will need to praise Greece, not bury it.


2 thoughts on “Blanchard’s tales of woe

  1. Excellent point. The sooner we end the failed focus on fiscal deficit and move the debate to attack the trade deficit the sooner this crisis will be over.

    As you say, the current account deficit circumscribes the fiscal deficit. If money constantly leaves Greece even perfect fiscal discipline won’t stop it. If money accumulates in Greece even leaky tax collection will eventually capture it. Getting the current account to surplus would either balance the fiscal by itself or leave fiscal problems small and easily manageable.

    Also, nobody has to be lazy, profligate, or otherwise reprehensible to have ended up with a trade deficit. Having an economy where

    (domestic + importers) / (exporters) > 1

    is a sufficient explanation. Whether all these domestic dentists, lawyers, teachers, waiters, etc. are competitive or not is irrelevant. They’re probably very competitive, but there’s too many of them in Greece relative to the exporters.

    Shifting people from the non-tradable domestic sector to the export sector is the obvious, wealth creating, and non-moralising solution.


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