NEWS - The IMF is Not Asking Greece for More Austerity - Posted on December 12, 2016 by iMFdirect - By Maurice Obstfeld and Poul M. Thomsen
Greece is once again in the headlines as discussions for the second review of its European Stability Mechanism (ESM) program are gaining pace. Unfortunately, the discussions have also spurred some misinformation about the role and the views of the IMF.
Above all, the IMF is being criticized for demanding more fiscal austerity, in particular for making this a condition for urgently needed debt relief. This is not true, and clarifications are in order.
The IMF is not demanding more austerity. On the contrary, when the Greek Government agreed with its European partners in the context of the ESM program to push the Greek economy to a primary fiscal surplus of 3.5 percent by 2018, we warned that this would generate a degree of austerity that could prevent the nascent recovery from taking hold. We projected that the measures in the ESM program will deliver a surplus of only 1.5 percent of GDP, and said this would be enough for us to support a program. We did not call for additional measures to achieve a higher surplus. But contrary to our advice, the Greek Government agreed with the European institutions to temporarily compress spending further if needed to ensure that the surplus would reach 3.5 percent of GDP.
We have not changed our view that Greece does not need more austerity at this time. Claiming that it is the IMF who is calling for this turns the truth upside down.
Making the Greek budget more growth-friendly and fair
But this does not mean that there is no further work for Greece to do on the fiscal side. Greece still needs to reform the structure of its taxes and spending—how the government raises its money and what it spends it on—because both are highly unfriendly to growth and equity. But the point of the measures we are calling for is not to generate more austerity and a higher primary surplus. To the contrary, the gains from these reforms should be used fully to increase spending or cut taxes to support growth. In our view, reforms like those we propose are indispensable: we do not believe that Greece can come close to sustaining even a modest primary surplus and realize its ambitious long-term growth target without a radical restructuring of the public sector. This should not—and cannot—happen overnight, but it is critical that a plan to create a more growth-friendly and equitable structure of the public finances over the medium term is adopted now.
Why is the currently agreed budget unfriendly to growth? While Greece has undertaken a huge fiscal adjustment, it has increasingly done so without addressing two key problems—an income tax regime that exempts more than half of households from any obligation (the average for the rest of the Euro Zone is 8 percent) and an extremely generous pension system that costs the budget nearly 11 percent of GDP annually (versus the average for the rest of the Euro Zone of 2¼ percent of GDP). Instead of tackling these difficult problems, Greece has resorted to deep cuts in investment and so-called discretionary spending. It has done so to such an extent that decaying infrastructure is hampering growth and the delivery of basic public services such as transportation and health care is being compromised.
We think that these cuts have already gone too far, but the ESM program assumes even more of them, with an increase in the primary surplus to 3.5 percent of GDP achieved through further cuts in investment and discretionary spending. Perhaps through a Herculean effort Greece could manage the spending cuts needed to achieve a 3.5 percent of GDP deficit in the short run. But experience has shown that they cannot be sustained and are inconsistent with Greece’s ambitious long-term growth target.
Greece’s economy needs far-reaching modernization across the board. Above all, Greece does not have the kind of unemployment compensation and other well-targeted social benefits that are commonplace elsewhere in Europe and that are critical for broad social support in a modern market-oriented economy. A case in point is the Government’s reluctance to lift the restriction on collective dismissals—an outdated pre-approval requirement that does not exist in most other European countries. Its hesitation comes not because the dismissal restriction is a good idea in itself, but because Greece has no adequate unemployment compensation. Rather than provide support to dismissed workers, the government instead restricts the ability of firms to dismiss them. Simply put, Greece cannot modernize its economy by boosting funding for infrastructure and well-targeted social programs while exempting more than half of households from income taxes and paying public pensions at the level of the richest European countries.
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