The answer to Greece’s economic woes lies in it adopting the right structural reforms as no amount of debt restructuring or debt forgiveness, will suffice to achieve prosperity, says Edmund S Phelps
SOME economists overlook the modern idea that a country’s prosperity depends on innovation and entrepreneurship. They take the mechanistic view that prosperity is a matter of employment, and that employment is determined by “demand” – government spending, household consumption, and investment demand.
Looking at Greece, these economists argue that a shift in fiscal policy to “austerity” – a smaller public sector – has brought an acute deficiency of demand and thus a depression. But this claim misreads history and exaggerates the power of government spending.
Much of the decline in employment in Greece occurred prior to the sharp cuts in spending between 2012 and 2014 – owing, no doubt, to sinking confidence in the government.
Greek government spending per quarter climbed to a plateau of around €13.5bn ($14.8bn) in 2009-2012, before falling to roughly €9.6bn in 2014-2015. Yet the number of job holders reached its high of 4.5m in 2006-2009, and had fallen to 3.6m by 2012.
By the time Greece began to cut its budget, the rate of unemployment – 9.6% of the labor force in 2009 – had already risen almost to its recent level of 25.5%.
These findings weigh heavily against the hypothesis that “austerity” has brought Greece to its present plight. They indicate that Greece’s turn away from the high spending of 2008-2013 is not to blame for today’s mass unemployment.
Another finding casts doubt on whether austerity actually was imposed on Greece. Government spending has certainly fallen – but only to where it used to be: €9.6bn in the first quarter of this year is, in fact, higher than it was as recently as 2003. So the premise of austerity appears to be wrong.
Greece has not departed from past fiscal norms; it has returned to them. Rather than describing current government spending as “austere,” it would be more correct to view it as an end to years of fiscal profligacy, culminating in 2013, when the government’s budget deficit reached 12.3% of GDP and public debt climbed to 175% of GDP.
The “demand school” might respond that, regardless of whether there is fiscal austerity now, increased government spending (financed, of course, by debt) would impart a permanent boost to employment.
But Greece’s recent experience suggests otherwise. The huge rise in government spending from 2006 to the 2009-2013 period did produce employment gains, but they were not sustained.
The real sticking point is that the government would have to issue bonds to finance its extra spending. Assuming a limit to foreign investors’ willingness to buy these bonds, Greeks would have to buy them. In an economy unequipped for growth, household wealth relative to wages would soar, and the labor supply would shrink, causing employment to contract.
So spending more is not the remedy for Greece’s plight, just as spending less was not the cause. What is the remedy, then? No amount of debt restructuring, even debt forgiveness, will suffice to achieve prosperity (in the form of low unemployment and high job satisfaction).
Such measures would only help Greece to revive government spending. Then the economy’s stultifying corporatism – clientelism and cronyism in the public sector and vested interests and entrenched elites in the private sector – would gain a new lease on life. The European left may advocate that, but it would hardly be in Europe’s interest.
The remedy must lie in adopting the right structural reforms. Whether or not the reforms sought by the eurozone members raise the chances that their loans will be repaid, these creditors have a political and economic interest in the monetary union’s survival and development. They should also be ready to help Greece with the costs of making the necessary changes.
But it is Greece itself that must take charge of its reforms. And there are encouraging signs that Prime Minister Alexis Tsipras is willing to take up that cause. But he will need a sense of the required reforms. Greece must dismantle corporatist arrangements and practices that obstruct whatever innovation and entrepreneurship might emerge. Nurturing an abundance of imaginative innovators and vibrant entrepreneurs requires embracing a vision of venturesome lives of creativity and discovery.
Edmund S. Phelps, the 2006 Nobel laureate in economics, is Director of the Center on Capitalism and Society at Columbia University and author of Mass Flourishing.
Copyright: Project Syndicate, 2015.
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