Analysis: Greece heads for record books as economy slumps

LONDON Wed Feb 15, 2012 1:33am EST

The defaced facade of the Bank of Greece is seen after a night of violence which followed the Greek parliament approval of a deeply unpopular austerity bill in Athens, February 13, 2012.  REUTERS/John Kolesidis

The defaced facade of the Bank of Greece is seen after a night of violence which followed the Greek parliament approval of a deeply unpopular austerity bill in Athens, February 13, 2012.

Credit: Reuters/John Kolesidis

LONDON (Reuters) - Entering the fifth year of recession, Greece is writing its name in the book of unwanted records for one of the deepest economic slumps of modern times.

The Greek economy shrank 6.8 percent in 2011, leaving the level of output an estimated 16 percent below its pre-crisis peak. Unemployment has soared to more than 20 percent from 7.7 percent in 2008.

Argentina suffered a 20 percent peak-to-trough drop in output as it defaulted on its debts in 2001, while Latvia's economy contracted by 24 percent because of the 2008 global financial crisis.

With more belt-tightening in store in return for a proposed 130 billion euro ($172 billion) international bailout, Athens is on course to join their ranks, and possibly overtake them, said Uri Dadush, an economist with the Carnegie Endowment in Washington, a think tank.

"On the current path - which is not sustainable in my view - we may very well see Greek GDP go down 25-30 percent, which would be historically unprecedented. It's a disastrous crisis for them," Dadush, a former senior World Bank official, said.

For ordinary Greeks, the outlook is dire. Some civil servants have seen their salaries cut by half. Retirement before the age of 65 is a fading dream for those still in work. Some drugs are now in short supply. Couples with children are being forced to move back in with their parents to save money. And across Greece, businesses are closing every day.

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For a graphic on austerity link.reuters.com/fub66s

Interactive timeline link.reuters.com/muq56s

Euro zone crisis in graphics r.reuters.com/hyb65p

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A LONG NIGHTMARE

World Bank figures show that Russian output dropped 44 percent between 1989 and 1998, dwarfing the 29 percent drop in the United States during the Great Depression.

But since Russia's economic reversal was compounded by the break-up of the Soviet Union, analysts tend to exclude the episode when examining recent recessions.

Comparing crises is like comparing apples and oranges. Every country is different, economically and politically.

However, Greece stands out in one important respect: its downturn has already lasted twice as long as the average crisis and yet there is no end in sight, according to Mark Weisbrot, co-director of the Center for Economic and Policy Research, a think tank in Washington.

"They're suffering. It's nasty," said Weisbrot, who has studied the lessons to be learned from economic crises in Latvia and Argentina. "If you could say with a reasonable probability that the worst was over, then that would be different. But you can't say that. They're in for a long nightmare."

Athens has repeatedly frustrated the European Union, the International Monetary Fund and the European Central Bank - the troika - by failing to implement the reforms it promised in exchange for its first bailout, for 110 billion euros, in 2010.

Apart from missing targets for reducing its budget deficit, Greece has dragged its feet on laying off workers from its bloated public sector, privatizing state assets and opening up closed trades and professions to competition.

Yet one critical measure, the primary budget balance, which excludes interest payments, shows Athens has made serious adjustments by raising value added taxes and cutting pensions, salaries and public services.

The primary balance was in deficit in 2009 to the tune of 10.4 percent of GDP. This year, it is projected to show a surplus of 0.2 percent.

"Although they're not given much credit for what they've done, there are not many countries that have brought their primary deficit down as quickly as Greece has," said Andrew Kenningham of Capital Economics, a consultancy in London.

RUNNING FASTER TO STAND STILL

And yet Greece will still have an overall budget deficit of 4.7 percent of GDP this year because of a huge interest bill.

This is estimated at 4.9 percent of GDP, rising to 6.3 percent of GDP in 2013, even assuming that a deal is clinched to write down the bonds owned by Greece's private-sector creditors by 70 percent.

To reduce the overall deficit, the EU and IMF are prescribing an increase in the primary budget surplus to 5.0 percent of GDP in 2014 and 2015.

"What the troika is effectively working into its plans is an adjustment in Greece that will go on for many years," Dadush said.

Weisbrot said the planned interest burden was the highest in the world, except for Jamaica: "These guys are going to squeeze them forever. There's no light at the end of the tunnel."

Figures compiled by Reuters show that government expenditure and real disposable incomes in Greece have already fallen much further since the onset of the crisis than in fellow euro members Portugal and Ireland, which have also received EU/IMF bailouts.

Private consumption has also declined more steeply than it did in Ireland. Yet the IMF and the EU have built into Greece's economic program an assumption that consumption will drop by a further 4.7 percent in 2012 and 1.4 percent in 2013.

Unemployment will still be at 18 percent in 2015.

And the risks - acknowledged by the IMF in its December review of Greece's progress - are on the downside. If austerity crimps growth and squeezes tax revenues, the budget deficit will be forced higher, requiring a fresh round of belt-tightening.

That is what happened in 2011. The 6.8 percent drop in GDP reported on Tuesday exceeded the 6.0 percent fall that the IMF had penciled in as recently as December. Which itself was a revision from an earlier forecast of a 4.5 percent contraction.

TO STAY IN THE EURO OR QUIT?

Countries typically break out of such a vicious circle by devaluing. Output and employment initially fall hard but recover rather quickly, as the examples of Argentina, Russia and the countries hit by the 1997/98 Asian financial crisis showed.

Indonesia's currency fell by more than three-quarters after it devalued. Swathes of the banking system were wiped out. Millions were plunged into poverty. Yet its peak-to-trough drop in output was milder than Greece's. Today, the country is thriving and enjoys, unlike Greece, an investment grade rating.

These and other examples are keeping the question alive whether Greece should quit the euro zone and devalue.

Ireland and Latvia, whose currency is pegged to the euro, have shown that devaluation is not the only way out. Competitiveness can also be regained through budget and wage cuts, a so-called 'internal devaluation'. Portugal, Spain and Italy are ploughing the same furrow.

But Weisbrot believes Greece's plight is now so serious it should take the risk and abandon the euro.

"My prediction is that if Greece left they would do quite well, just like Argentina. They would have a brief crisis and would come out of it and grow very rapidly," he said.

Zsolt Darvas, a researcher at Bruegel, an influential think tank in Brussels, acknowledged that Greece could be facing one of the deepest falls in output on record.

But he said the chances of Greece's quitting the euro were low because of the chaos that would ensue.

Not only would the government go bankrupt as international lenders withdrew aid, but banks and most of the private sector would collapse as a steep devaluation of the 'new drachma' would make it impossible to service huge euro-denominated liabilities.

"So from a purely economic perspective, for Greece it is still preferable to say inside the euro even if the suffering continues for another five years or even longer," Darvas said.

Ultimately, though, he added, the question is one for the Greek people and their politicians. How long will they put up with austerity? Economic comparisons cannot answer the question.

Dadush, reflecting on the running battles between police and rioters on Sunday as flames engulfed downtown Athens, said Greece had stared into the abyss at the weekend.

"A lot of people were ready to jump. They didn't. But give them another year or two of rising unemployment and so on and the political configuration will move in that direction," he said.

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