Greece’s reform labors are only half complete

Hercules famously completed 12 labors. Today’s Greece resembles the mythological hero when he was halfway through his tasks. The country has done a lot of work to rebuild itself after its debt crisis, but still needs to finish the job.
Hercules famously completed 12 labors. Today’s Greece resembles the mythological hero when he was halfway through his tasks. The country has done a lot of work to rebuild itself after its debt crisis, but still needs to finish the job.

Greece’s large current account deficit and domestic corruption undermine its attraction as an investment destination. But it’s far from clear that Kyriakos Mitsotakis will do what’s needed to boost savings and improve the rule of law if re-elected as prime minister.

Greece is no longer the problem child of the euro zone which a decade ago threatened to bring the single currency crashing. Investors are enthusiastic about the prospect of Mitsotakis’ center-right New Democracy party winning an overall majority in the second round of elections, due to be held on June 25. Ten-year Greek government bonds yield just 3.7% , only 1.4 percentage points more than equivalent German debt .

The issue, rather, is whether Greece will be able to attract investment in the quantities needed for it to fulfil its potential. This will require reforms which won’t be easy.

While Mitsotakis is rightly credited with attracting investment and pushing forward the digitalization of the government, he didn’t do much to tackle the country’s other problems. Tax evasion is still rampant and the justice system is weak.

What’s more, Mitsotakis has shown little desire to investigate why the phones of Greek politicians, journalists and other prominent figures were bugged with spyware called Predator. Mitsotakis says his government was not involved.

It is true that the Greek economy has enjoyed a speedier rebound from the Covid-19 pandemic than most European Union countries, growing a cumulative 15% in the past two years. But this is partly because the country was benefitting from reforms that the International Monetary Fund and EU imposed as the price of three debt bailouts.

Growth has also been strong because Mitsotakis poured large amounts into various handouts in recent years. For example, funding to shield consumers and firms from the energy crisis has been one of the highest in the EU at 5.2% of GDP, according to the Bruegel think tank. The government’s fiscal deficit was only 2.3% of GDP last year while debt fell to a still eye-popping 171% of annual output. This was the result of inflation which boosted tax revenue and nominal GDP.

In any case, the easy rebound is over. From now on, high growth will either fuel inflation or suck in imports, unless the underlying capacity of the economy also expands rapidly.

Achilles heel

Greece’s current account deficit last year was 9.7% of GDP. The spike in energy prices accounts for about 40% of this, according to the Bank of Greece, the country’s central bank. But that still means the underlying deficit is about 6%.

Greece is living beyond its means again. This time, it’s the private sector that is running up debt at a rapid rate. Consumption is 67% of national income, compared to the EU average of 50%.

What’s more, investment is still only 14% of national income, even though this measure expanded during Mitsotakis’ first term as prime minister. One of the brightest hopes is that investment will rise to closer to the EU average of 23% in his second term, thereby underpinning the country’s long-term growth prospects. The central bank expects various EU funds to be a big contributor, injecting a total of about 70 billion euros by 2026.

But in the long term the country will not be able to sustain a much higher investment rate unless it saves more. Otherwise, Greece will continue to run a high current account deficit. This could be risky in a world of higher interest rates and jittery global banks.

Mitsotakis could fix the issue. For a start, he could wean the public off handouts, focusing government help on the neediest. He could also crack down harder on tax evasion – not just by the self-employed but also by well-connected oligarchs. But it’s unclear whether he will tackle this particular task. After all, he gave what amounted to an amnesty to large tax evaders during his first term in office.

Reforms would lower the amount that the private sector has to spend. They would also eliminate the budget deficit, enabling the government to keep bringing down debt as a proportion of national income. Well-designed tax and benefit reforms could even reduce the country’s unemployment rate, which is currently 12%, thereby increasing its productive potential. All this would provide a buffer if Greece or the world economy is hit by further shocks in coming years.

Augean stables

Mitsotakis says he needs a big majority to press ahead with reforms. A prime focus should be a clutch of problems that come under the “rule of law” banner: the unofficial economy, the spyware scandal, corruption and issues with the justice system.

Greece ranked 51st in Transparency International’s Corruption Perceptions Index last year. That’s an improvement from 60th place when Mitsotakis took power, but still one of the lowest in the EU. This acts as a brake on investment. The center-right leader has promised to speed up the processing of cases through the courts. After all, slow justice is no justice.

Mitsotakis should make zero tolerance of corruption within the government one of its top priorities, says one adviser. And he could confound expectations by launching a thorough independent investigation of the spyware scandal.

One of Hercules’ tasks was to clean the horrendously messy Augean stables. Mitsotakis has a great opportunity to do the same for Greece. It remains to be seen whether he will grasp it.

tags: Economy Greece