The Greek stockmarket slumped further overnight as investors continue to digest Prime Minister Antonis Samaras' decision to call a snap presidential election. Greek stocks fell a further 7 per cent, bringing the market's loss for the year to 29 per cent.
Oliver Marc Hartwich commented in Business Spectator earlier this week that the election might "allow the radical anti-austerity forces to gain power. This would not only dash any hopes of a Greek recovery, it would also force the eurozone to make a choice between the lesser of two evils: to expel Greece from the monetary union and let it default on its debt, or to continue supporting it financially, despite an end to fiscal consolidation". (Greece’s presidential gamble could trigger the next eurozone crisis, December 10.)
If, as appears likely, the leftist Syriza Party takes over in Greece, Hartwich lamented that “then, whatever may have been achieved on budget consolidation and reform in the meantime will not be worth much anymore.”
This assumes that “whatever may have been achieved on budget consolidation and reform” was worth something in the first place. So let’s stop assuming and check the data. Figure 1 shows Greek GDP since 1996, and it has clearly collapsed since the policy of austerity was imposed. If the Greeks feel inclined to kick out the incumbent government after a more than 25 per cent fall in nominal GDP over the last six years, could you really blame them?
Supporters of austerity, such as Hartwich, point to the tiny uptick in GDP in the last six months as a sign that austerity is working. But the original proponents of austerity actually argued that it would cause the economy to grow, not shrink.
Some growth. Austerity began in February 2010 in Greece (as marked on Figure 1), and since then the economy has shrunk by almost 25 per cent. Unemployment rose from 10 per cent when the policy began to a peak of 27.5 per cent -- worse than the US experienced during the Great Depression. Rather than seeing the slight recovery in the last six months as signs of success, supporters of austerity should be asking why their policies failed so abjectly.
Figure 1: Greek GDP has collapsed since the crisis began
And fail they did: on their own terms and by their own measures. Here’s the EU’s forecast in late 2010, predicting that the decline would end in mid-2011:
"Successful and credible fiscal adjustment efforts should boost confidence and improve sentiment. Credibility gains are expected to compensate for the economic cost of adjustment and lead to the beginning of a recovery in the second half of 2011." (Rebalancing growth amidst ongoing fiscal consolidation, EU Autumn 2010)
It came with the handy little graph shown in Figure 2, indicating where they thought growth would come from -- and showing that positive growth would return in 2012. Trust us…
Figure 2: EU forecasts for the impact of austerity on Greek growth
Even for the pathetic standards of forecasting in economics, that forecast was a doozy. Actual growth in 2012 was not plus 1 per cent but was instead close to minus 10 per cent (see Figure 3).
The sequence of EU reports on Greece would actually make for good comedy, had not so many people had their lives made a misery by austerity. Here’s the Autumn 2011 report:
The progressive rebalancing of the economy as well as growth-enhancing reforms and improving medium-term prospects abroad are expected to move the economy back onto stable footing from 2013 onwards, provided that the current adverse climate improves. (“Painful adjustment”, EU Autumn 2011)
“Provided that the current adverse climate improves?” So “things will get better if they get better?” The mood must have been upbeat in Brussels when that line was penned.
Figure 3: Actual real GDP growth in Greece
So what went wrong with austerity?
Apart from the fact that, like almost all mainstream economic theories, it is based more on fantasy than on logic or empirical realism, it ignored the dynamics of private debt while obsessing about government debt.
Like virtually every other country in the OECD, Greece had a private debt bubble, with its start roughly coinciding with the introduction of the euro. I expect that German and French banks were at the forefront of the lending. Private debt, which had flatlined for the previous 30 years, rose by 60 per cent of GDP from the introduction of the euro till the start of austerity. Though Greece’s private debt level is actually less extreme than the rest of the OECD, its pre-crisis growth rate was higher. This was ignored by mainstream economists because, in their mythical world model, private debt is economically unimportant.
Figure 4: Greek debt ratios--blowout in private debt before crisis ignored
They’ve continued to ignore private debt after the crisis, but its dynamics are as responsible for the downturn now as they were for the preceding boom. The real reason that austerity has failed is because the harsh pressure of government spending cutbacks to private cash flows has motivated the private sector to continue deleveraging, reducing its debt by as much as 15 per cent of GDP in one year (see Figure 5). The slowdown in the rate of deleveraging since then is probably the main reason that the economy has recovered slightly.
Figure 5: Private sector deleveraging drives Greek employment down
So the Greek populace has every right to reject the failed policies of austerity. Now the question is: what will happen when Syriza comes to power and, as it promises, refuses to continue implementing the EU’s failed policy prescriptions? Will the EU refuse to fund Greece’s deficit, and thus trigger a Greek default and probably also an exit from the euro? Or will the EU blink and finally concede that its policies have been disastrous?