The case for less Government (in Greece)

Its standard textbook stuff that during a recession it is inconceivable to reduce the government deficit as this withdraws government stimulus from the economy and leads to a deeper recession. So many countries tend to increase government spending and thus expand an existing deficit during recessionary times and it is hoped this will be reversed during the boom cycle as tax receipts increase and the deficit is automatically reduced eliminating any increase that was thereby created.

Now lets take by way of an example the US and its reaction to the great recession. The government deficit ballooned as the government decided to bailout its banking system which incidentally was to a large extent responsible for the great recession. To avoid world Armageddon the government together with the Fed embarked in an infinite addition of liquidity by stepping in and buying all distressed assets. This the US could do whilst running an existing large deficit and debt because of two reasons.1-The technical reason- It had its own currency and the Fed could expand its money supply theoretically without limit and the government could issue as much debt as it wished as long as the market had the appetite for it and it did 2- The practical reason- The market was not adversely affected by its actions namely a-A potential rise in interest rates if the market perceived an irresponsible Fed and government driving inflation and inflationary expectations to the roof  b- A collapsing dollar as the market lost confidence in the stability of the US economy and c- The ability by the US government to finance its expanded deficit, in other words will there be the required demand to absorb this new issuance without adverse consequences? The answer to all these questions was a resounding yes. The Government and Fed successfully financed their increased balance sheets without driving rates higher, on the contrary rates fell as the economy experienced a liquidity trap, the financial system was saved, the economy stabilised and it is currently on a slow growth tragectory, restructuring but on a much healthier footing.

Time to visit Greece. Like the rest of the world Greece experienced the great recession but during an inevitable hangover following the more than 7 years of partying. The result an overhang which amounted to a deficit of 15% and a debt of  150% of GDP. To make matters worse it had lost its independence in terms of having its own currency for it chose to embrace the euro stability and the government was soon faced with the inability to borrow in international markets to finace its unsustainable deficit. Greece had then two options either default and exit the euro very much along the route taken by Iceland or resort to a rescue engineered by the Troika and it chose the latter. It was then forced to shrink its deficit to a euro wide acceptable level and reduce its debt by a combination of haircuts, privatisations and restructuring. The problem with this recipe is that it goes contrary to economic dogma as outlined above. This shrinkage in the deficit would throw Greece into a worse recessionary trend with adverse effects on both the deficit itself but also steepen its negative growth trajectory and it did. Clearly there was no alternative Greece had outstretched its finances and had to realign itself with the rules like other more prudent members of the economic club it had chosen to be a party of. But did it at least follow the right recipe? This is where, I believe, the mix of policy ingredients was mistakenly chosen. The government decided to cut government spending to some degree, reducing wages and salaries in the public sector but not enough, embarking in a tax raid out of all proportions particularly with respect to the sensitive property sector to fill the void. But since the government had its hands tied and it had to shrink the deficit why did it decide to tax as opposed to cut government spending? It was clearly a political decision unable or unwilling to confront the government employee rage and the self inflicting wounds that would have resulted from the redundancies created in the public sector. Purely put the civil servants were opposed to the loss of their own privileges associated with their positions so they chose the road of least resistance with the help of their well entrenched propaganda. The problem with taxation as a tool to reduce the deficit is that 1- It is deeply recessionary whichever part of the economy it is imposed upon whether capital, income or profits 2- It is a major disincentive for new investment whether local or international and thus future growth is impaired in an already highly recessionary environment.The importance of investment cannot be overemphasized for it is this that is the driving engine for long term growth and finally  3- It increases tax evasion as already outstretched businesses and households try to make ends meet. So in part it is self defeating.

So what is the alternative? A policy aimed at reducing more aggressively government spending and laying off public sector employees and the redundant institutions established by the ruling paties to earn them votes but which serve no productive purpose may seem a difficult approach but it has enormous benefits. Instead of increasing taxes the government, because of a decline in spending,  is now in a position to start reducing taxes particularly if focused in areas where Greece has its comparative advantages, tourism, agriculture, shipping, etc thus providing incentives for PRIVATE capital to replace the shrinking government sector. The magnitude of this private investment can be extraordinary and can exceed in many multiples any loss in deficit spending with highly expansionary effects for the Economy. Thus private investment is mobilised from 1- domestic sources being money transfered abroad in search of security from taxes and bankruptcy and 2- international sources as Greece becomes an investment destination for international investors. It also allocates factors of production, in this case public employees much more efficiently. They leave their generally acknowledged unproductive public jobs and train to become semi skilled or skilled workers and be absorbed by the expanding private sector. This way they now serve a productive private enterprise and thus allocate their labour much more efficiently. It also improves individual freedom as power is decentralised and the freedom to create is enhanced.

Clearly therefore if Greek Politicians want their country to prosper they should stop serving their narrow minded self interests and look at the country's long term prospects.   

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