Tag Archives: Government spending

Greece About To Enter The Death Spiral

Tensions in Greece are rising to new heights as the EU-imposed austerity measures backfires. The measures that were supposed to fix nation’s problems are instead dragging down the country’s economy. Stores are closing, tax revenues are falling and unemployment has hit an unbelievable 70 percent in some places. Frustrated workers are increasingly making threats to fight back.

“If you take away my family’s bread, I’ll take you down – the government needs to know that. And don’t call us anarchists if that happens! We’re heads of our families and we’re desperate.”

Nikos Meletis


The feast of the Assumption of Mary on August 15th is the high point of summer in the Greek Orthodox world. Believers fall on their knees and pray to the Virgin for mercy. The Greek newspaper Ta Nea recommend that the Greek government adopt the same approach – the country’s leaders have to hope that Mary comes up with a miracle to save them from a serious crisis. Without divine intervention,  it will be a very difficult autumn for the Mediterranean state.

This dire prognosis comes even despite Athens’ massive efforts to sort out the country’s finances.

The government’s draconian austerity measures have managed to reduce the country’s budget deficit by an almost unbelievable 39.7 percent, after previous governments had squandered tax money and falsified statistics for years.

The measures have reduced government spending by a total of 10 percent, 4.5 percent more than the EU and International Monetary Fund (IMF) had required.

The problem is that the austerity measures have in the meantime affected every aspect of the country’s economy.

The Real Austerity Effect

Purchasing power is dropping, consumption is taking a nosedive and the number of bankruptcies and unemployed are on the rise.

The country’s gross domestic product shrank by 1.5 percent in the second quarter of this year.

Tax revenue, desperately needed in order to consolidate the national finances, has dropped off a cliff.

A mixture of fear, hopelessness and anger is brewing in Greek society.

The austerity measures that were supposed to fix Greece’s problems are dragging down the country’s economy.

Stores are closing, tax revenues are falling and unemployment has hit an unbelievable 70 percent in some places.

Frustrated workers are increasingly making threats to strike back.

How the leaders of Greece – and of the EU/IMF – have been able to ignore these signs for so long, is beyond this writers comprehension.

Fear, Hopelessness And Anger

The Greek government’s draconian austerity measures have managed to reduce the country’s budget deficit by an almost unbelievable 39.7 percent, after previous governments had squandered tax money and falsified statistics for years.

The graffiti reads, "IMF out"

The measures have reduced government spending by a total of 10 percent, 4.5 percent more than the EU and International Monetary Fund (IMF) had required.

The problem is that the austerity measures have in the meantime affected every aspect of the country’s economy.

Purchasing power is dropping, consumption is taking a nosedive and the number of bankruptcies and unemployed are on the rise.

The unemployment rates are about 70% in some parts of the country.

The Greek gross domestic product shrank by 1.5 percent in the second quarter of this year. Tax revenue, desperately needed in order to consolidate the national finances, has dropped off a cliff.

A mixture of fear, hopelessness and anger is brewing in Greek society.

Don’t tell me that the economists fancy models haven’t been able to figure this out…

Unemployment: 70%

Nikos Meletis is neatly dressed, and his mid-range car is clean and tidy.

Meletis used to earn a good living at a shipbuilding company in Perama, a port opposite the island of Salamis.

Nikos Meletis

“At the moment, I’m living off my savings,” the 54-year-old welder says, standing in front of a silent harbor full of moored ships.

Meletis is a day laborer who used to work up to 300 days a year; this year he has only managed to scrape together 25 days’ work so far.

That gives him 25 health insurance stamps, when he needs 100 in order to insure himself and his family — including his wife, who has cancer. “How am I supposed to pay for the hospital?” Meletis asks.

Unemployment benefits of at most €460 ($590) per month are available for a maximum of one year — and only if he can produce at least 150 stamps from the past 15 months.

There’s hardly a worker in the shipbuilding district of Perama who could still manage that.

Unemployment in the city hovers between 60 and 70 percent, according to a study conducted by the University of Piraeus. While 77 percent of Greek shipping companies indicate they are satisfied with the quality of work done in Perama, nearly 50 percent still send their ships to be repaired in Turkey, Korea or China.

Perama Shipyard

Costs are too high in Greece, they say. The country, they argue, has too much bureaucracy and too many strikes, with labor disputes often delaying delivery times.

Perama is certainly an unusually extreme case. But the shipyards’ decline provides a telling example of the Greek economy’s increasing inability to compete.

Barely any of the country’s industries can keep up with international competition in terms of productivity, and experts expect the country’s gross domestic product to fall by 4 percent over the course of the entire year.

Germany, by way of comparison, is hoping for growth of up to 3 percent.

Sales Dropping Everywhere

Prime Minister George Papandreou‘s austerity package has seriously shaken the Greek economy.

The package included reducing civil servants’ salaries by up to 20 percent and slashing retirement benefits, while raising numerous taxes. The result is that Greeks have less and less money to spend and sales figures everywhere are dropping, spelling catastrophe for a country where 70 percent of economic output is based on private consumption.

A short walk through Athens’ shopping streets reveals the scale of the decline:

Fully a quarter of the store windows on Stadiou Street bear red signs reading “Enoikiazetai” — for rent. The National Confederation of Hellenic Commerce (ESEE) calculates that 17 percent of all shops in Athens have had to file for bankruptcy.

And things aren’t any better in the smaller towns.

Chalkidona was, until just a few years ago, a hub for trucking traffic in the area around Thessaloniki.

Two main streets, lined with fast food restaurants and stores catering to truckers, intersect in the small, dismal town.

Maria Lialiambidou’s house sits directly on the main trucking route. Rent from a pastry shop on the ground floor of the building used to provide her with €350 per month, an amount that helped considerably in supplementing her widow’s pension of €320.

These days, though, Kostas, the man who ran the pastry shop, who people used to call a “penny-pincher,” can no longer afford the rent. Here too, a huge “Enoikiazetai” banner stretches across the shopfront.

No one wants to rent the store. Neither are there any takers for an empty butcher’s shop a few meters further on.

A sign on the other side of the street advertises “Sakis’ Restaurant.”

The owner, Sakis, is still hanging on, with customers filling one or two of the restaurant’s tables now and then. “There’s really no work for me here anymore,” says one Albanian employee, who goes by the name Eleni in Greece.

“Many others have already gone back to Albania, where it’s not any worse than here. We’ll see when I have to go too.”

The Death Spiral

The entire country is in the grip of a depression.

Everything seems to be going downhill.

The spiral is continuing unabated, and there is no clear way out.

The worse part, however, is the fact that hardly anyone still hopes that things will improve one day.

“Everything is getting more expensive, I’m hardly earning any money, and then I’m supposed to pay more taxes to help save the country? How is that supposed to work?” the shipbuilder  Nikos Meletis asks.

His friends, gathered in a small cafeteria on the pier in Perama. They are all unemployed, desperate and angry at the politicians who got them into this mess.

There is no sympathy here for any of the political parties and no longer any for the unions either.

“They only organize strikes to serve their own interests! The only thing that interests me anymore is my daily wage. A loaf of bread is my political party,” one man shouts.

“If you take away my family’s bread, I’ll take you down – the government needs to know that. And don’t call us anarchists if that happens! We’re heads of our families and we’re desperate,” Nikos Meletis says.

“Things are starting to simmer here,” he says. “And at some point they’re going to explode.”

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But regular readers of the Econotwist’s Blog knows this, and we have seem it coming for quite some time now.

(Source of article: Der Spiegel)


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G20: Another Meaningless Summit

This is one of those rare occasions when reporters, commentators and professional analysts completely agree; the result of the G20 meeting this weekend is absolutely meaningless. In summary, the G20 countries played down their commitment to implement new bank rules, but committed to halve their budget deficits by 2013 and stabilize their debt to national income ratios by 2016, as they’ve done several times before.

“These targets are not likely to require new policy action because G20 countries are already planning austerity measures on this scale.”

Financial Times


Expectations were limited ahead of the Toronto session, largely because most of the issues of financial regulation weren’t scheduled for completion until the end of the year at the Seoul summit. But the conference became a way for major nations to try to address fears in the market that government spending was spinning out of control.

However, the G20 targets are non-binding, and there will be no sanctions for countries who fail to do so.

Senior G20 sources says they hope it will send a signal to financial markets that the global community is serious about deficit reduction.

Personally, I can’t see any reactions in the financial markets today that suggest that investors feel more reassured.

The bank stocks are pulling the stock market higher, probably as a little relief rally since the threat of tighter regulations have been pushed further out in time.

The G20 countries continue to insist on tougher capital rules in principle but there were considerable differences over what a capital buffer means and the speed of adoption. They came up with a least common denominator on adoption, with the previous target date of 2012 no longer a “target” but an “aim” and allowing a phasing-in of the new rules.

Final agreement on the rules and its adoption is left for the summit in Seoul in November, after the BIS presented its roadmap.

Not Out Of The Woods

“We are in a holding pattern. The market certainly waits to see what impact does fiscal tightening have on the economy. People are definitely cautious,” Peter Dixon, economist at Commerzbank, says according to CNBC.

Peter Dixon

Peter Dixon

“We are not out of the woods on this,” he says, referring to the conclusions of the weekend meeting of G20 leaders in Toronto.

“There is still some possibility that further down the line we are going to come up with much more stringent rules, such as the absolute size of the banks, which will put a brake on the ability of bigger banks to leverage their balance sheets the way they have done.”

G20 countries agreed on Sunday to take different paths for cutting budget deficits and making their banking systems safer, a reflection of the uneven and fragile economic recovery in many countries.

In a reversal from the unity of the past three crisis-era Group of 20 summits, the leaders left room to move at their own pace and adopt “differentiated and tailored” policies.

“There are some legitimate doubts. Government finances in most of the mature economies are really in trouble, so we have to do something about that. But it will probably pressure growth,” says Luc Van Hecka, chief economist at KBC Securities.

Here’s a copy of yesterday’s communique from the G20 leaders.

Not Newsworthy

“The G20 meeting in the weekend did not result in any real, market-moving news. Asian share prices were approximately unchanged last night. The US dollar has weakened somewhat vs. the euro and the yen. From its weakest on Friday afternoon, the krone has strengthened, trading below 8 vs. the euro,” senior economist Bjørn-Erik Orskaug at DnB NOR writes in his Morning Report.

Bjørn-Erik R. Orskaug

Bjørn-Erik R. Orskaug

“One of the headlines from the G20 meeting is that countries have reached agreement on fiscal policy going forward. In reality, this is not really newsworthy. In the communiqué, the risks associated with a synchronised fiscal tightening (i.e. a double dip) are highlighted. However, the risks associated with a too slow pace of consolidation are also emphasised. A common goal now is to reduce fiscal deficits in advanced countries by half within 2013 and to stabilise the debt to GDP-ratio by 2016. Such a deficit reduction is already in the budgetary plans of most of the large advanced countries, including the US. The doubt is rather how in practice this deficit reduction will be attained. Moreover, the need for consolidation varies strongly among countries. For some, the deficit will have to be reduced by more than half. The G20-meeting did not give anything new in terms of how the deficits will be reduced or which countries will have to do the most,” the Norwegian analyst writes.

Here’s a copy of the full analysis and Morning Report from DnB NOR Markets.

A Total Failure

The strongest critique is being provided by Financial Times columnist, Clive Crook, who calls the Toronto Summit for a “total failure”.

Clive Crook

Clive Crook

“The first Group of 20 summit in November 2008 proclaimed a new era of “global solutions to global problems”. Less than two years later, with the economic crisis barely contained, the partners are at odds. Reaching agreement was not the main challenge in Toronto this weekend. They knew that was not going to happen. Mainly, they hoped to put the best face they could on disunity,” he writes.

Adding: “How much do these divisions matter? The main bone of contention in Toronto was fiscal policy. Here, I would argue, simple ineptitude seems to be a bigger problem than disinclination to co-operate.”

“In 2008 and 2009 it was obvious that powerful fiscal and monetary stimulus was necessary everywhere. When everybody wants the same thing, co-operation is easy. How easy? You would have got the same result without it. Last year, co-operation cost nothing and, as compared with the alternative, achieved nothing. In 2010 circumstances have changed. Some countries still have room for fiscal manoeuvre. Others have less and some have none. Co-operation is therefore more difficult – and, you could argue, more necessary.”

“In a world of suppressed demand, where cross-border flows of saving and investment need rebalancing, the textbook case for fiscal co-ordination is clear. Countries with external deficits and encroaching borrowing constraints should rein in fiscal stimulus; countries with external surpluses and untapped debt capacity should maintain or increase it. With agreement on which country falls under which dispensation, governments could optimise fiscal adjustment and support better-balanced growth. Disagreement, which is what we have, increases the risk of another global downturn,” Clive Crook points out.

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Goodbye Keynes – Hello Ricardo!

The world have been fighting the financial crisis by using every possible trick according to John Maynard Keynes‘ playbook. But, as The Great Depression taught us, extreme government spending tends to cause about as much problems as it solves. Perhaps it’s time to put Keynes back on the bookshelf, and pull out the 200 year old theories of David Ricardo.

“While budget stimulus measures are intended to boost demand from financially constrained consumers, it may for others – the majority – result in the emergence of Ricardian behavior.”

Philippe d’Arvisenet


For those not too familiar with economic theories; Ricardian behavior is basically increased  consumer savings due to expectations of higher taxes in the future. This effect has been shown to emerge more widespread in countries with large governmental debt, and lead to significant difference in the recovery process among nations.

The increase in public debt registered over the last few years is without precedent.

In each of the main OECD countries, public debt is not on a sustainable path, BNP Paribas chief economist, Philippe d’Arvisenet writes in a research paper.

This contrasts with past periods, during which emerging markets have appeared more at risk from this perspective.

The majority of developed countries will have a public debt ratio in excess of 90% in the middle of the decade, BNP Paribas estimates.

However, according to the IMF,  from 2007 to 2014, the debt ratio in these countries is expected to rise by an average of more than 30 points of GDP, reaching an average of 110% of GDP.

Philippe d’Arvisenet points out that of this increase, 3 points will be related to supporting the financial system.

* 4 points to the increased cost of debt.

* 10 points to automatic stabilizers.

* 3.5 points to budget stimulus measures.

* 9 points to losses of tax revenues relating to the decline in asset prices.

“The widening of deficits is largely structural in nature. The deficit ratio adjusted for cyclical variations is 4.4% in the euro zone out of a total deficit of 6.7 points, with 9.8 points in the UK (out of a total of 13.3 points) and 8.8 points in the US (out of a total of 10.7 points). In the past, this structural deficit has shown a strong tendency to persist,” the french chief economist writes.

For the time being, surplus production capacity limits the risk of public debt having a crowding-out effect on private investment.

Ricardo, Who?

About 200 years ago British economist David Ricardo presented his “theory of equivalence” in a newspaper essay.

In Ricardo’s view, it does not matter whether you choose debt financing or tax financing, because the outcome will be the same in either case. Flip a coin if you like, because in terms of the final results, raising taxes by $1,000 is equivalent to the government borrowing $1,000.

According to traditional economic theory, like the Keynesian, public debt has a significant effect on the overall economy because consumers regards public debt as net wealth.

The Ricardian equivalence theory, on the other hand, suggest that is has no effect so ever.

While budget stimulus measures are intended to boost demand from financially constrained consumers,  in their case  the classic system of budgetary multipliers (Keynesian style economics) takes full effect.

But for others – the majority – the result will most likely be widespread emerging of so-called Ricardian behaviour.

Ricardian behavior is a term economists use to describe growth in consumer saving to cope with the costs of expected increasing taxes in the future.

The consumers expectations are usually fulfilled, and often extended, later research have shown.

In most cases, government borrowing ends up being more expensive for the citizens when inflation, higher borrowing costs and interest rates are taken into account.

The theory of Ricardian behavior is controversial, as it assumes that people think and behave financially rationally.

We know we don’t.

But other factors can trigger similar behavior, like lack of transparency in the state finances and mistrust in the governments economic policy.

In any case; Ricardo’s main point that government borrowing is nothing more than a way of delaying tax hikes, seems to be accepted by many leading economists today.

No More Free Lunch

It should be clear by now that the public finance situation calls for credible recovery measures.

“While the conventional crowding-out effect does not have an impact, the budget situation – contrary to the situation before the financial crisis – now affects the assessment of risks and may inflate risk premiums. This results in a higher cost of debt, making adjustment even more difficult,” Mr. d’Arvisenet writes.

Adding that this situation could make an end to the until now observed developments characterized by rising debt with no impact on interest payments because of falling interest rates – a kind of “free lunch”.

“A high level of debt increases the probability of an interest rate or growth shock resulting in unsustainable debt, with higher debt ratios and a widening gap between the apparent real interest rate and the rate of growth. This configuration makes adjustment even more difficult and in any case presents a number of threats (snowball effect of debt).”

Recent data clearly call for immediate action.

BNP Paribas points to the fact that, as a direct consequence of the financial crisis – with an increase in the cost of capital and structural unemployment and a decline in economic activity – the potential level of GDP in the OECD region is around 3.5 points below the pre-crisis level.

In addition, unless there is an increase in taxation, the higher cost of debt means that some public services will have to be sacrificed.

An increase in taxation is frequently synonymous with fiscal distortions that can harm growth.

Debt then eliminates the ability to implement new support measures if needed.

A Credible Exit Strategy; Fact Or Fiction?

Ricardo’s theories might very well be correct,  but only in a perfect economy with free markets and responsible, rational people.

However, by understanding Ricardo’s line of arguments, it becomes more clear what’s wrong with the current economic policy.

BNP Paribas chief economist writes:

“In addition to purely budgetary considerations, deterioration in public finances is a potential challenge for central banks. The level of debt may result in not only increases in inflationary anticipations, but also uncertainties about the success of consolidation measures, making steering of monetary policy more complicated (what is the appropriate interest rate?). The weighting of the cost of debt may result in pressures favoring monetisation, casting doubt on the independence of central banks, not taking account of the fact that these institutions – which have increased the share of public debt securities in their balance sheets – are therefore exposed to greater interest rate risks.”

According to the IMF, a primary structural surplus of 8 points of GDP from 2011 to 2020 (from -4.3% to +3.6% of GDP) would be necessary in order to bring the debt ratio to 60 points of GDP in 2030, although with significant differences between countries: one-fifth of developed countries would have to make an adjustment of more than 10 points and two-thirds would have to make an adjustment of less than 5 points.

The adjustment would be halved for a target of stabilizing the debt ratio at the 2012 level.

The IMF estimates that over 10 years, and assuming growth of 2%, the end of stimulus measures could contribute 1.5 points of GDP.

In addition to the freeze on public spending excluding health-care, which implies priorities and efforts to improve efficiency, stabilization in expenses relating to the aging of the population proportional to GDP would provide a contribution of 3-4 points of GDP and tax deductions would provide a contribution of around 3 points.

“In the shorter term, as suggested by recent research, displaying a credible budgetary consolidation policy concerning primarily expenditure can enhance the effectiveness of support measures in place, by means of both consumer behavior (Barro-Ricardo effect) and also interest rates,” Philippe d’Arvisenet writes.

The Ricardian Union (Formerly Known As E.U.)

Research by Antonio Afonso at Universidade Tecnica de Lisboa, published in 2001, concludes that debt hardly will become neutral. And he’s probably right.

But Afonso’s finding, based on studies of 15 European countries, indicates that government debt has a considerable stronger effect on consumer spending in highly indebted countries, as compared to the less indebted nations.

There seems to be a limit around 50% of GDP; a debt-to-GDP ratio over 50 tends to make people more aware, and cautious, about their financial situation. They become Ricardian.

The prospect of a return to sustainable debt allays fears of inflation and therefore anticipations of a hike in interest rates, which helps to contain the rise in long-term rates, BNP Paribas argues.

“A budgetary exit strategy is a difficult exercise. The change in the primary balance needed to ensure a similar level of debt to that observed before the crisis – which would avoid transferring the consequences of the crisis to future generations – is considerable but not unprecedented.”

“Recourse to inflation” as dreamed of by some, does not seem to be the solution, according to BNP Paribas, refering to analysis of successful experiences of budgetary consolidation shows that a significant reduction in the debt ratio has been achieved in 10 or so countries, mainly by means of the primary balance.

The contribution of growth was negligible in this respect (apart from in Spain and Ireland), chief economist Philippe d’Arvisenet says.

“We can therefore see that consolidation measures are taken with a long-term view – one or two years has not been enough. This does not mean that it is not necessary to continue with the reforms intended to support growth,” he adds.

However, there are just too many uncertainties relating to this matter to be able to count considerably on this factor.

What About Fiscal Illusions?

Among the uncertainties are another – rarely mentioned – theory called “fiscal illusion.”

“Fiscal Illusion” is a public choice theory of government expenditure first developed by the Italian economist Amilcare Puviani in 1897.

“Fiscal Illusion” suggests that when government revenues are unobserved or not fully observed by taxpayers then the cost of government is perceived to be less expensive than it actually is.

Examples of fiscal illusion are often seen in deficit spending.

CATO Institute economist William Niskanen, has noted that the “starve the beast” strategy popular among U.S.  conservatives wherein tax cuts now force a future reduction in federal government spending is empirically false.

Instead, he has found that there is ‘a strong negative relation between the relative level of federal spending and tax revenues.

Tax cuts and deficit spending, he argues, makes the cost of government appear to be cheaper than it otherwise would be.

Paulo Reis Mourao at Australian National University presented in 2008 an empirical attempt to measure fiscal illusion for almost 70 democracies since 1960.

The results obtained reveal that Fiscal Illusion varies greatly around the world.

Countries such as Mali, Pakistan, Russia, and Sri Lanka have the highest average values over the time period considered, while Austria, Luxembourg, Netherlands, and New Zealand have the lowest.

But, as you know; some illusionists are better than others.

The French Solution

The greatest increase in public debt forecast for the next few decades relates to the aging of the population, BNP Paribas concludes.

“The matter of health-care and pension reforms is crucial (without reform, the associated cost would be 4-5 points of GDP between now and 2030,” according to the French banks research.

“Reforms in this area are even more important as their effects become more significant with time and their initial cost is limited.”

Based on lessons of other recent research, BNP Paribas notes:

“The greater effectiveness of rules that are easy to implement (public spending versus deficit), as demonstrated for example by the failure of the Gramm Rudmann Hollings Act of 1985 and the success of the Budget Enforcement Act that succeeded it;”

* The increased effectiveness of automated mechanisms, compared with discretionary practices such as those relating to sanctions for excessive deficits in the euro zone;

* The appeal of anti-cyclical measures (rainy day funds etc.).

The bank make the following suggestions:

(1) To stabilize the public debt ratio (debt to nominal GDP), it is necessary to generate a primary balance equal to the product of the debt ratio by the difference between the real rate of interest on debt and the rate of growth.

(2) Not forgetting that inflation is not manifesting itself and that inflationary fears alone are likely to provoke a rise in real interest rates.

(3) From this viewpoint, the change in retirement age has substantial effects both directly (increase in tax revenues, reduction in expenditure) and indirectly on potential growth (working-age population and participation rate).

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