“Why can’t Greece be more like us?”

Why can't a woman be more like a man?
Men are so honest, so thoroughly square;
Eternally noble, historically fair;
Who, when you win, will always give your back a pat.
Why can't a woman be like that?...

Henry:
Well, why can't a woman be like us?[1]

So the first steps in the third bail out of Greece were taken last weekend.  The terms of this new deal are hard and grating on the Greeks, but the perspective of lending up to €90 billion to a country which has caused private creditors to lose €105 billion in 2012, and which will likely need tens of billions of debt forgiveness from eurozone members should also be grating on European taxpayers.

Above all, there is little trust that, this time around, Greece will change its economic model to fit in the eurozone, relying instead on the reluctance of other members to pull the plug. The Greeks already went through a lot of pain, yet they have nothing to show for it.  PM Tsipras declared that he didn’t believe in the reforms which were demanded of Greece. 

Chancellor Merkel could be forgiven if asked, “Why can’t Greece be more like us?”

Contrary to most commentaries, the main problem of Greece is not the excessive burden of its public debt but its lack of economic competitiveness.  As explained in a previous post, its debts mature over 30 years, interest rate thereon is very low and payment thereof is partly deferred; that is not much of a burden.  Besides, Greece has had a primary budget deficit, that is a deficit before taking into account the payment of interest on its debts.

This time around, the euro safety net has grown so tenuous that either Greece accepts to make big changes now, or it is forced to leave.  Even then, absent changes, it would experience a painful drop in living standards.

The needed changes are huge, the government is ideologically opposed to them, the Greek population is no more enthusiastic, and time is short.  Yet Greece could find examples of small countries within the eurozone which successfully reformed their economies, and did so with far less outside financial assistance and in a relatively short period of time. 

I am talking of the Baltic States: Estonia, Latvia and Lithuania.  Having won their independence from the USSR, these countries switched from a centrally planned soviet economic system to one open to the rest of the world.

What is remarkable however is that the bulk of the reforms took only five years (1992-1997)!

The essential policies that allowed the “Baltic Miracle”, with some variation in emphasis and timing, can be summarized as follows:

·        Anchoring the currencies either via a peg[2] (Latvia, Lithuania) or a currency board[3] (Estonia), to control inflation;

·        Reforming and simplifying the tax system with a combination of lower - sometimes single flat - income tax rates for individuals and corporations[4] and of VAT taxes.  This, combined with prudent public spending helped bring budget balance close to equilibrium[5];

·        Liberalizing prices and markets, and in the case of Estonia, opening up its economy to imports by eliminating tariffs and quotas[6];

·        Privatizating state enterprises to reduce the overwhelming size of inefficient public sectors, make the transition to free markets difficult to reverse, and bring fresh capital into the economy.  In Estonia, privatization was carried out via international tenders to choose a core/majority investor for a given company and then via the voucher system to attract minority shareholders.  Lithuania used the voucher system.  On average, over the 1993-1997 period, annual government revenues from privatizations averaged of 3.4% of GDP.

·        Reforming the pension systems, between 2001 and 2004 with a combination of (1) a solidarity scheme based on Social Security contributions, (2) mandatory personal funded retirement accounts, and (3) discretionary personal retirements accounts.

Critics will point out that the Baltic States’ economies shrunk more that the rest of Europe’s in 2009.  They did.  Clearly they had allowed bubbles to grow, and they were constrained by their strict monetary systems[7].  But that doesn’t take anything away from the remarkable and successful efforts undertaken in the 1990s, before some complacency crept in.

Furthermore, one should note that the Baltics also responded positively to the 2009 crisis by pushing forward deeper reforms in their pension systems and keeping a lid on their budgets. 

By 2014, Estonia, Latvia and Lithuania’s budget balances were +0.6%, -1.4% and -0.7% respectively.  This compares favorably with France (-4%), Greece (-3.5%), Italy (-3%), Portugal (-4.5%) and Spain (-5.8%) for example[8].

Today, the Baltics enjoy faster economic growth, far lower debt levels and healthier employment than Greece.

In conclusion, small democratic countries can and indeed have made profound reforms in their economies, with great success.  The key ingredients were:

1.     Facing an even greater danger (Russia for the Baltics, implosion for Greece?),

2.     Having the support of their population,
3.     Ensuring that their governments and technocrats believed in free-markets,
4.     Applying shock therapy and speed.

Greece has #1.  It lacks #2 and #3, but it is its choice whether to change or not.  Smaller, worse off European countries did.  And in Athens, economic advisers from  Tallinn will be more welcome than those from Frankfurt.

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[1]   My Fair Lady – An Hymn to Him.

[2]  Latvia pegged its currency to the SDR while Lithuania pegged his to the US dollar.

[3]  Here the anchor was the German Deutsche Mark.

[4]  In 2000 the Estonian system was modified to tax corporations only on their distributed profits (as Chile did in the 1980s).  Lithuania adopted an income tax abatement on reinvested corporate profits.

[5]  Except for the period 2010-2012 where the deficit grew to around 9%.  However the same policies greatly helped bring the budget deficits to around zero in 2014.

[6]  In subsequent years, Estonia negotiated bilateral agreements and joined the EU which watered down this policy a bit.

[7]  Estonia joined the eurozone in 2011, Latvia in 2014 and Lithuania in 2015.

[8]  Source: Eurostat.