Having successfully pulled Greece from the brink last summer and subsequently stabilized the economy, the government of Alexis Tsipras is now discussing with its European partners and the IMF a comprehensive multi-year program that can secure a lasting recovery and make debt sustainable. While discussions continue, there have been some misperceptions about the International Monetary Fund’s views and role in the process. I thought it would be useful to clarify issues.
It is argued that the IMF has made its participation dependent on socially draconian reforms, especially of the pension system. This is not the case. Ultimately a program must add up: the combination of reforms plus debt relief must give us and the international community reasonable assurances that by the end of Greece’s next program, after almost a decade of dependence on European and IMF assistance, Greece will finally be able to stand on its own. This implies an inverse trade-off between ambition of reforms and strength of debt relief—we can certainly support a program with less ambitious reforms, but this will inevitably involve more debt relief.
This said, no amount of pension reforms will make Greece’s debt sustainable without debt relief, and no amount of debt relief will make Greece’s pension system sustainable without pension reforms. Both need to come about. There is no doubt that both Greece and its European partners will face politically difficult decisions in the coming months to arrive at a program that is viable—one that adds up.
Such difficult decisions cannot be “kicked down the road” through unrealistic assumptions. While there is much scope for increasing productivity through reforms, the past six years have shown that the scope and pace of reforms acceptable to the Greek society is not commensurate with an early improvement of productivity and sustained high growth. Thus, assuming that Greece can simply grow out of its debt problem without debt relief—by rapidly transitioning from the lowest to the highest productivity growth within the euro zone—is not credible. Similarly, the very limited success in combating Greece’s notorious tax evasion—to make the well-off pay their fair share—means that pension reforms cannot be avoided by simply assuming higher tax collections in the future.
Why the focus on pension reforms? Despite the pension reforms of 2010 and 2012, Greece’s pension system remains unaffordably generous. For instance, the standard pensions in nominal Euro terms are broadly similar in Greece and Germany, even though Germany—measured by the average wage—is twice as rich as Greece. Add to this that Greeks still retire much earlier than Germans and that Germany is much better at collecting social security contributions. The result is that the Greek budget needs to transfer some 10 percent of GDP to cover the gaping hole in the pension system, compared to a European average of some 2½ percent. Clearly, this is unsustainable.
But can’t Greece protect pensioners by cutting somewhere else or increasing tax rates? There is some scope for those measures, but it is very limited. Most other spending has already been cut to the bone in an effort to protect pensions and social payments, while the failure to broaden the base and improve compliance has already caused too much reliance on high tax rates. To reach its ambitious medium-term target for the primary surplus of 3½ percent of GDP, Greece will need to take measures in the order of some 4-5 percent of GDP. We cannot see how Greece can do so without major savings on pensions.
Pension reforms will of course be socially challenging for the Greek people, which have seen exceptional hardship in recent years. In fact, social pressures have already forced reversals of course—under both the previous and the current government—and Greece is unfortunately much further away from its medium-term goals than it was in mid-2014, before a major fiscal relaxation erased what proved to be only a temporary primary surplus. In this regard, the government is right to point out that pensions in Greece have a broader social function. But using pensions in this way is not a durable solution. What is needed—and what the IMF has argued for—is a modern social safety net that is sustainable over the medium term.
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