Category Archives: Greece

5/2/19: The Myth of the Euro: Economic Convergence

The last eight years of Euro's 20 years in existence have been a disaster for the thesis of economic convergence - the idea that the common currency is a necessary condition for delivering economic growth to the 'peripheral' euro area economies in the need of 'convergence' with the more advanced economies levels of economic development.

The chart below plots annual rates of GDP growth for the original Eurozone 12 economies, broken into two groups: the more advanced EA8 economies and the so-called Club Med or the 'peripheral' economies.

It is clear from the chart that in growth terms, using annual rates or the averages over each decade, the Euro creation did not sustain significant enough convergence of the 'peripheral' economies of Greece, Italy, Portugal and Spain with the EA8 more advanced economies of the original euro 12 states. Worse, since the Global Financial Crisis onset, we are witnessing a massive divergence in economic activity.

To highlight the compounding effects of these annual growth rates dynamics, consider an index of real GDP levels set at 100 for 1990 levels for both the EA8 and the 'peripheral' states:

Not only the divergence is dramatic, but the euro area 'peripheral' economies have not fully recovered from the 2008-2013 crisis, with their total real GDP sitting still 3.2 percentage points below the pre-crisis peak (attained in 2007), marking 2018 as the eleventh year of the crisis for these economies. With Italy now in a technical recession - posting two consecutive quarters of negative growth in 3Q and 4Q 2018 based on preliminary data, and that recession accelerating (from -0.1% contraction in 3Q to -0.2% drop in 4Q) we are unlikely to see any fabled 'Euro-induced convergence' between the lower income states of the so-called Euro 'periphery' and the Euro area 8 states.

5/2/19: The Myth of the Euro: Economic Convergence

18/11/17: ECB Induces Double Error in the EU Policy Markets

In economics, two key market asymmetries/biases lead to the severe reduction in markets efficiency often marking the departure from theoretical levels of efficiency (speed, with which markets incorporate new relevant information into pricing decisions of markets agents) and the practical outcomes. These asymmetries or biases are: information asymmetry and agency problem.

For those, uninitiated into econospeak, information asymmetry (sometimes referred to as information failure), is a situation, in which one party to an economic transaction possesses greater knowledge of facts, material or relevant to the decision, than the other party. For example, a seller may know hidden information about a car on offer that is not revealed to the buyer. In more extreme example, a seller might actively conceal such information from a buyer. This can happen when a seller 'prepares' the car for sale by cleaning the engine, thus removing leaks and accumulations of oil and / or coolant that can indicate the areas where the problems might be.

The agency problem, also referred to as principal-agent problem, arises when an agent, acting on behalf of the principal, has distinct set of incentives from the principal. The resulting risk is that the agent will act in self-interest to undermine the goals and objectives of the principal. An example here would be a real estate agent contracted by the seller, while taking a commission kickback from the buyer. Or vice versa.

Occasionally, both problems combine to produce an even more powerful distortionary result, pushing the markets further away from finding a 'true' (or fundamentals-justified) price point.

Today, we have an example of such interaction. As reported in Euractiv, the ECB has denied the EU Court of Auditors access to data on Greek bailout. (Full story here: http://www.euractiv.com/section/all/news/ecb-denies-eu-auditors-access-to-information-on-greek-bailouts/) The claimed justification: banking secrecy. The result:

There is now clearly an asymmetry in information between the EU, the Court of Auditors, and the ECB when it comes to assessing the ECB actions in the Greek bailout(s). The 'car salesman' (the ECB) has scrubbed out information about the 'vehicle' (the bailout(s)) when presenting it to the 'buyer' and is refusing to show any evidence on pre-scrubbed 'car'.
And there is an agency problem. The ECB is an agent for the EU (and thus an agent relative to the principal - the EU Court of Auditors, which represents the interest of the EU). As an agent, the ECB has a contractual obligation to act in the interest of the EU. But as a part of the Troika in the case of the Greek bailout(s), the ECB is also contracted into a set of incentives to act in concert with other players: the sub-set of the EU, namely the EU Commission and the EFSF/ESM funds, and the IMF. At least one of these agents, the IMF, has a strong incentives to avoid transparent discovery of information about the Greek bailout(s) because these bailout(s) have, potentially, violated the IMF by-laws in lending to distressed countries. Another agent, the EU Commission, has an incentive to conceal the truth about the same bailout(s) in order to sustain a claim that the Greek bailout(s) are(were) a success. The third set of the agents (various EU funds that backed the bailout(s)) has incentives to sustain the pretence that the Greek bailout(s) were within the funds' bylaws and did not constitute state aid to the insolvent government.

In simple terms, the ECB refusal to release information on Greek bailout(s) to the EU Court of Auditors is a fundamental violation of the entire concept of the common market principle that overrides any other consideration, including the consideration of monetary policy independence. This so because the action of the ECB induces two most basic, most fundamental failures into the market: the agency problem and the asymmetric information problem, which are (even when taken independently from each other) the core drivers for market failures.

22/5/17: Eurogroup and Greece: Wrestling Defeat from the Claws of Victory

Today's Eurogroup meeting on Greece ended in no agreement and extends the current tranche negotiations into June 15, the date of the next Eurogroup meeting.

For the background:

Greece is an economy brought to its knees by the Eurogroup and the ESM, as detailed in a range of facts well-summed up here: http://blogs.lse.ac.uk/eurocrisispress/2017/05/01/greece-any-better-times-or-more-pitfalls-ahead/; and
Greece is now back in a recession, with dire consequences for both, the economy and the Greek society, and for fiscal targets and programs previously agreed by the Eurogroup: http://trueeconomics.blogspot.com/2017/05/18717-greece-in-recession-again.html.

The key sticking point so far is the scheduling of future primary surpluses (budgetary surplus before the debt servicing costs are factored in). The Eurogroup insists on these surpluses running at 3.5% of Greek GDP for the first 5 years following 2018, declining to 2% or 2.2% (depending on the version of the draft agreement) for 2023-2060.

In very simple terms, such commitments are absolutely bogus (and dangerous). They are bogus because there is absolutely no way anyone can project growth rates out to 2060 from today that can be in any way reasonably accurate to predict primary surpluses. They are dangerous, because they will shackle Greek governments to running buffer funds to compensate for possible recessionary and non-cyclical shocks to the primary surpluses. These buffers will imply underinvestment within the Greek economy (public investment) over the long term. Which, of course, will damage the Greek economy and increase the risk of non-compliance with the deficit rules.

Here is how unrealistic the current proposed targets are. Consider, first, IMF projections (April 2017 data) for primary surpluses over the next 5 years (2018-2022). Remember, Greek target (grey line) is 3.5% for that period:

With exception of Italy, no other advanced euro area economy comes even close to the proposed target. And no one is making a case that Italy running these surpluses is somehow consistent with structurally strong growth expectations over the period.

Now, consider past and present performance, based on 10 years windows. For 10 years window, Greek target surplus is 2.85% per annum:

The view is a bit brighter.

In the 1990s, two countries managed to run surpluses at or above the target set for Greece forward: Belgium and Ireland. Both countries were recovering from substantial fiscal crises of the late 1980s-early 1990s. But, unlike Greece today, both countries benefited from exogenous shocks that boosted significantly their surpluses and growth: Belgium gained substantial income transfers from growth of the EU institutions, and Ireland gained from a large scale FDI boom. Neither country needed to run large scale public investment programmes financed from own (internally-generated) funds.

In the 2000s, Belgium continued to run large surpluses and it was joined in this by Finland. Belgium surpluses drivers remained the same, while Finland carried out substantial fiscal consolidation in the wake of the early 1990s crisis timed perfectly to coincide with rapid economic growth in the economy.

In simple terms, no advanced euro area economy has managed to run surpluses expected of Greece at the times of adverse economic growth conditions or immediately after a major recession.

As I noted in the earlier post on the Greek economy (see http://trueeconomics.blogspot.com/2017/05/18717-greece-in-recession-again.html), the state of Greek economy has been so highly uncertain over the last few years, that any projections 3-4 years out from today are simply an example of a delirious wish-for-thinking. In this environment, setting targets out to 2060 is absurd, and dangerous, for it commits Greece to targets that may or may not be to the benefit of the Greek economy and sets up the euro area fiscal policy architecture for a failure at the altar of extreme conviction in technocratic targeting.