What Really Happened to Greece

The IMF’s Changing Role in the Greek Crisis

by Elliott Morss, Morss Global Finance

Introduction

The IMF has changed its position on what Greece should do several times since engaging with the powerful EU countries lead by Germany (hereafter referred to as “EU”) to save Greece. Since 2010, the Fund has had almost as many disagreements with the EU over what should be as with Greece.

Below, I document this with a timeline on changing IMF policies and conflicts with Greece and the EU. I go on to indicate the extremely important role for the IMF as the Greek crisis deepens.

Stage One – Austerity

Back in 2010, the IMF was working in lock step with the EU. Germany and the IMF agreed: austerity was the answer. And Germany knew the IMF would be the perfect enforcer. The IMF ended up negotiating an agreement with Greece that went far beyond austerity. In all the years I have been covering the IMF, I have never seen such a long list of policy changes being demanded of any country.

The general categories included: fiscal reforms, pension reforms, health sector reforms, Social Security reforms, government performance reforms, and economic system reforms. In order to achieve those objectives, the Greek government agreed to foreign technical assistance in more than 20 different fields. The reforms demanded by the IMF with full support from the EU were intended to make Greece competitive with Germany!

The hope was that if Greece did everything on the IMF list, it could remain in the Eurozone and compete with the Germans.

What Went Wrong

The IMF is often criticized for not giving enough attention to the unemployment consequences of its austerity packages. It consequently did its own research on the subject. It concluded that a fiscal consolidation of 1% of GDP generally results in an increase of 0.3 percentage points in the unemployment rate.[1] However, Table 1 indicates that its 2010 estimates made in preparing the austerity+ package for Greece were horribly wrong. In 2010, it projected Greek unemployment to be 13.1% and 13.4% in 2011 and 2012, respectively. They turned out to be 17.9% and 24.4% Caused in part by the draconian reductions in the government deficit insisted on by the IMF/EU combine.

Table 1. – Greece: IMF Estimates and Actual Outcomes

Source: IMF Documents

In 2012, Oliver Blanchard, the chief economist of the IMF and Daniel Leigh, another IMF economist, reviewed the IMF’s earlier research findings on the unemployment effects of reducing government deficits. They concluded the earlier unemployment multiplier estimates were too low. Their new research suggested that a 3% fiscal consolidation would result in as much as a 1.8 percentage point increases in unemployment. But even this doubling of the unemployment multiplier does not explain the huge unemployment expansion in Greece. The Greek economy was in a free fall.

To its credit, the Fund saw what was happening in Greece and gave up on it. This caused a serious rift between the IMF and Germany. In early 2012, Andy Dabilis wrote a piece documenting growing friction between the IMF and Euro countries over the Greek program. He said the Fund was upset that Germany and other EU countries has focused almost completely on getting Greece to reduce its government deficit. The Fund insisted this one dimensional approach had failed. Dabilis reports that the IMF was

“attempting to distance itself from a ‘counterproductive set of austerity measures’ imposed on the country under the insistence of the EU.”

While the Fund “technicians” had backed away from austerity, the IMF politicians took a different approach. The Fund’s Managing Director Lagarde called on Europe to create a much larger “buffer/rainy day” fund. This was more of a “put your head in the sand” approach rather than a serious effort to resolve the problem.

In 2012, I said:

“The EU is sleepwalking. It is acting as if all they have to do to “make things right” is to force “weak sisters”’ government deficits down and bail out the banks that made foolish loans to their governments.”

An example of this lunacy is the following quote from Jean-Claude Trichet, the president of the European Central Bank, reflecting the views of Germany and other EU members:

“the idea that austerity measures could trigger stagnation is incorrect….a credible fiscal-consolidation plan will restore confidence and foster economic recovery.”

Stage 2 – Debt Reduction and Competitiveness

Having given up on austerity, the Fund staked out a position of its own. It argues that even though Greece had already negotiated and gained a debt reduction of 70%, more was needed. It now argues the Greek debt approximating 176% of GDP is not sustainable and must be lowered to 110% of GDP by 2022. However realistic this position might be, it is not what the EU countries and the European Central Bank want to hear. It will mean another Greek default and European banks taking another hit.

The Fund also insists Greece must take steps to increase its competitiveness. I quote from an IMF press briefing last Thursday:

“Pensions and wages account for 80 percent of Greece’s total government spending. So it’s not possible for Greece to achieve its medium term fiscal targets without reforms and especially of pensions. The Greek pension funds receive transfers from the budget of about 10 percent of GDP annually. This compares to the average in the rest of the Euro zone of 2.5% of GDP. The standard pension in Greece is almost at the same level as in Germany and people retire almost six years earlier in Greece than in Germany.

On taxes, the policy of increasing already high rates on a low tax base is not sustainable. So it’s crucial to significantly broaden the tax base in Greece. Greece has among the largest gaps in the European Union on VAT revenues that are actually collected versus VAT revenues that should be collected given the rates.”

But these two items – pensions and taxes – are only the tip of the iceberg on what the IMF wants Greece to do. For anyone interested, the details can be found in the Fund’s 286 page 5th review of its Extended Fund Facility with Greece. I view the Fund’s competitive requirements as unworkable. Most of them will require either a reduction in government expenditures or an increase in taxes which brings us back to austerity.

The Next IMF Role

Details on the future are unclear. But one thing is certain: this will not end well. And that brings me to the next role for the Fund. I quote again from the IMF spokesman referenced above: “Let me emphasize again what the objective is here. The objective is to help Greece, support Greece, get back on the path of sustainable growth, jobs, and better living standards for the Greek people. That’s what all of this is about.

Consider next the Fund’s mandate. Article 1 of its mandate call for it to:

• Promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.
• Give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
• Shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

Since 2011, I have argued that Greece will never be able to compete with Germany and consequently should exit the Eurozone. It appears that slowly and painfully this is in the process of happening. As this crisis moves forward, there will be several new roles for the IMF. Greece is a dues paying member of the IMF. Consequently, the IMF is obligated to assist Greece to avoid disruptions in the international financial system. And what in all likelihood will this mean?

1. Greece will default on its debt;
2. Greece will withdraw from the Eurozone, and
3. Greece will issue its own currency.

The IMF is mandated to assist Greece on all these actions.

[1] “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation”, Chapter 3 of the IMF’s October 2010 “World Economic Outlook”.