High primary fiscal surpluses and risks to Greece’s recovery

The agreement reached back in the summer of 2015 between the populist Syriza government and creditors included an obligation that binds the Greek government until at least 2025 to achieve a primary fiscal surplus of 3.5 percent of GDP. Securing such a target will entail higher taxes and big cuts in government expenditures—in other words, a restrictive, pro-cyclical fiscal policy that will put sand in the wheels of economic recovery. Given that a haircut or even a generous rearrangement of the public debt (to the detriment of the European taxpayers) is out of the question, the International Monetary Fund is not willing to participate unconditionally in the country’s third economic adjustment program, which started on August 19, 2015, and is scheduled to run through August 20, 2018.

The IMF points out in particular that the 3.5 percent primary surplus is needed to serve the goals of the program in the absence of debt restructuring. But such an ambitious target may be antithetical to achieving the high growth that is desperately needed if the program is to have any chance of succeeding. This is conundrum explains why the second evaluation of the third program was delayed for so long.

In a December 12 blog post, “The IMF is Not Asking Greece for More Austerity,” followed by a second question and answer note last week to clarify specific views of their initial post, IMF Director of the European Department Poul Thomsen and IMF Economic Counsellor and Director of Research Maurice Obstfeld pointed out that, if the Fund is to participate in the program, major reforms are needed in Greece’s personal tax rates, as they are considered to be counterproductively high and have spawned a high level of tax exemptions. Similarly, the IMF considers the pension system too generous compared to Eurozone peers, both in terms of the gross replacement rate and the government subsidy to the pension system, which amount to 11.5 percent of GDP in Greece versus 2.25 percent for Eurozone peers. IMF experts assert that such reforms are essential if the 3.5 percent target is to be met. But Greek Prime Minister Alexis Tsipras’ response was to give extra bonus money to pensioners in an effort to tell the voters that, if he would have been set free from the creditors, he would have flooded voters with helicopter money. This is maybe a cold-blooded, cynical populist interpretation of Tsipras’ motives, but it fits well in the context of our populist, authoritative, post-truth times.

In particular, in a classic clientelistic political maneuver, Tsipras decided to distribute 617 million Euros to 1.6 million pensioners without first notifying the Troika. The prime minister asserted that he was tapping an “extra-surplus” achieved from the 0.53 percent surplus of GDP target reached in 2016, which Tspiras claims out of fairness should have been given back to senior citizens. He also said in a “Maduro style” announcement that IMF technocrats who disagree with him are simply foolish (one assumes he meant Obstfeld and Thomsen)!

Politics aside, how hurtful to growth is a 3.5 percent of GDP primary? In fact, high primary fiscal surpluses are predicted in the program, but only along with simultaneously robust growth rates, a standard assumption borne out in the relevant literature. Primary fiscal surpluses are generated by strong growth rates, while it is wrong to believe that they just hamper economic growth. It is little known that, throughout the second half of the 1990s, Greece enjoyed a 3 percent average primary surplus along with high growth rates, as did the U.S., Belgium, and other countries.

Optimistically, if Greece’s economy can surpass the projected growth rate laid out in the 2017 draft budget by 1-2 percent annually, then the 3.5 percent primary budget surplus (as a percentage of GDP), along with a 4-4.5 percent growth rate, would translate in absolute terms to billions of euros that could be used not for buying votes, but for investing in the future of the country.

But the question of whether the 3.5 percent primary surplus is pro-cyclical or not still remains especially for those believing that, as Greece is currently in stagnation, high primary surpluses do impair the prospect for recovery. Keep in mind, however, that the overall budget balance is still in deficit, while public expenditures are at the colossal level of 55 percent of GDP. Fiscal policy, thus, still seems to be much more expansionary than is widely believed.

The final point relates to the government claim that Greece has a “budgetary surplus” of 8 billion euros for 2016. Well, that is already a 4.5 percent of GDP primary surplus! The government, thus, has already achieved, and in fact overcome, the primary surplus target in 2016 (assuming the number holds true). So, if the 3.5 percent was relatively easily achieved in 2016 why all the hand-wringing about making it permanent until 2025?

From the vantage point of the Syriza government, one has to take into account that bankrolling money is indispensable for political survival in the absence of an enduring recovery. The 617 million euro Christmas bonus to pensioners/voters aligns with this view. As for the IMF, maybe insisting on something that is not politically feasible is a convenient pretext to avoid participation in the third program.