Glass Houses and Greece’s Tragedy

The Greeks seem to hope that, poof, all those nasty debts will disappear, presto-no-chango, no one really needs to pay taxes and that hypnotized creditors will keep lending Greece money. Good luck with that.

David Rosenberg
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Greek stock prices move across a ticker screen inside the Hellenic Stock Exchange as the euro region backs an extension of aid in Athens, Greece, on Feb. 24, 2015.Credit: Bloomberg
David Rosenberg

From our side of the Mediterranean, it’s easy to gloat over Greece’s economic woes and the humiliation its ruling Syriza Party suffered at the hands of the country’s German paymasters this past week.

While Greece is struggling with debt equal to an astounding 185% of its economy and rising, we in Israel are doing quite comfortably with just 63% and falling, and among the lowest in the developed world. The Greek economy has shrunk by a quarter in the last five years, while ours has grown by about the same magnitude.

Greek unemployment is 25.8% while Israel's is 5.7%. The Greeks are being told by their creditors how to spend their money and manage their economy, and their mini-rebellion fomented by Syriza this month was quickly quashed.

Meanwhile, Israelis bask in the praises of the International Monetary Fund and ignore its recommendations because we owe them nothing.

Jerusalem, be not proud

A little bit of humility is in order. Thirty years ago, we were in the midst of an economic crisis of the same magnitude as Greece is suffering now and went through a painful recovery process, too.

Unlike in Greece, Israeli inflation was raging at 400% a year in the first months of 1985. The government was running deficits that were bigger than Greece’s in the run-up to its crisis, and Israel’s debt as a percentage of the economy was about the same as Greece’s, at plus/minus 145% of GDP.

Both economies were growing before their respective crises erupted, but that was because of generous government spending and easy money, not because either economy was internationally competitive.

Peres overcomes politics

Where we can show a little more pride compared to Greece is in the solution. The Reagan administration, in particular U.S. Secretary of State George Schultz, was anxious that the economy of a key ally in the Middle East was careering to disaster, but it was Israel itself after much delaying that took the initiative.

Senior economists in the government understood perfectly well how serious the problem was and that it needed to be fixed. Israel’s politicians were slower to come around, but in the end the most intelligent of them, most notably Prime Minister Shimon Peres, set aside short-term political considerations.

Israel’s Economic Stabilization Plan, adopted by the cabinet in July 1985, cut the budget by an amount equivalent to 7% of gross domestic product and devalued the shekel by 19%. Wage and price controls were imposed and the Bank of Israel could no longer print money at will.

Israel got a dollop of American aid – $1.5 billion at the time, or $3.3 billion in today’s money – which seems quaint compared with the 240 billion euros ($273 billion) in bailouts the Greeks have gotten.

Between the devaluation and the budget savings, which came in the form of subsidy cuts, prices spiked 28% higher in the month after the Economic Stabilization Plan was adopted. Wages fell 9% that year.

But inflation was conquered, or at least cut down to double-digit size from three digits. Israel’s economy didn’t slip into recession, thanks to falling world oil prices and the army’s withdrawal from Lebanon. When the slowdown did come in 1988-89, Israel emerged from it pretty quickly as Russian immigrants poured into the country, spurring demand for housing, products and services.

On the whole, Israelis didn’t suffer as much as Greeks have from their financial crisis, but they suffered enough. Yet they didn’t fight the medicine: There were no protests or riots, and the government wasn’t voted out of office.

Greek narrative: Who, us?

The fact that Israel itself took the initiative to reform is an important difference. It designed its own program, taking into account its special needs, and thus had the backing of politicians, business and even (grudgingly) the unions.

By contrast, economic discipline was imposed on Athens on Europe’s terms. The five years of bailouts, austerity and shrinking output that followed have done little to convince the Greeks that anything needs to change unless they are ordered to by their creditors, at which point you kick and scream and do as little as possible. Indeed, the Greek narrative is that problems are someone else’s fault – namely, Germany’s.

The Greek people – and we’re not just talking about politicians and oligarchs – are pining to return to the good old days like magic, which is why they elected Syriza last month. The idea is, poof, all those big, nasty debts will disappear. Poof, the government can begin spending again on a bloated and useless bureaucracy. Presto-no-chango, no one really needs to pay taxes. The crony capitalism that enriched the wealthiest and the straitjacket of regulations that protected the middle class can stay in place. And, for a final act, an endless stream of hypnotized creditors will keep lending Greece money at low rates of interest to pay for it all.

Humility isn’t the only lesson we can learn from the two countries’ economic crises.

Fiscal aspirin

The other is that the fiscal medicine of austerity doesn’t really cure the patient.

Even if Israel’s economy didn’t go into freefall from the impact of the Economic Stabilization Plan, there was little in the plan to spur growth. The fact that Israel’s post-ESP recession was brief was a matter of good luck, not good strategy.

The structural aspect of the turnaround would come in dribs and drabs over the next two decades with the freeing of the capital markets and foreign trade, creating competition and privatizing companies, which preserved the achievements of the ESP.

Greece, to its misfortune, got into trouble just as the rest of the developed world was sliding into the worst recession in decades. But it also has done almost nothing to make its economy more competitive by instituting structural reforms.

One indicator of its failure is that even as wages have plummeted, making its industries more competitive, Greek exports haven’t risen in the past five years.

Another lesson is that punishment has its uses. Paul Krugman chides austerity proponents for framing Greece’s problems as a moral issue and comparing countries to households that should live within their means, and pay the price if they don’t.

Expressed in those schoolmarm-like terms, Krugman is correct, but economics isn’t called the dismal science for nothing. There would have been a lot less suffering if a severe austerity regime hadn’t been imposed on Greece – but then, there would have been no incentive for Greece to abandon its bad old ways. If Greece is going to benefit from debt forgiveness, why not Spain, Ireland, Portugal and Cyprus? What’s to stop other countries from being as irresponsible if there is little or no price to pay?

The most important lesson of all this is that Israel doesn’t have the luxury of playing fast and loose with its finances. One of the other reasons economics is a dismal science is because economic success usually fails to win much respect.

If, like in Israel, the government manages a proper fiscal policy, restraining spending, taxes and the deficit, the positive effects it has on the economy are taken for granted (for instance, the absence of a financial crisis), while its costs are critiqued in great detail (a parsimonious welfare state). The temptation to spend more is ever present – but so is the risk.

As much as Greece resents its bailout, at least it was able to access one thanks to its membership in the eurozone. Way off in the Middle East with few friends, we don’t have even a stern and unforgiving uncle like Germany to turn to.

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