Elgar Debates: Lessons from Greece – “to restore growth and address the issue of social inequality there is an urgent need to attract private investment”

In the third part of this Elgar Debates series, former Minister of Finance Dr. Philippos Sachinidis replies to Professor Steve Keen. To follow this debate from the beginning, read the first and second letters.


Dear Steve,

I would agree with you in that in order to understand the nature of the current Greek crisis one has to focus on the structural problems that led to the chronic current account imbalances rather than on the causes of the general government imbalances.

It is also correct to argue that the sharp fiscal consolidation deepened and prolonged the recession. Note, however, that Greece was in a recession since 2008 i.e. two years prior to the adoption of the adjustment programs.

In fact that was the main point of my letter; in order for Greece to restore growth and address the issue of unemployment and social inequality there is an urgent need to attract resources i.e. private investment in the tradable sector of the economy.

That would allow the Greek economy to revive its productive potential and capacity that was ruined during the period of the crisis, and to restore its price competitiveness that was lost after joining EMU.

Historically Greece suffered from chronic current account imbalances that, after the collapse of Bretton Woods, were mainly corrected, as mentioned in my first letter, by a combination of competitive devaluations and short-lived painful adjustment programs.

These imbalances triggered a number of crises in the 1980’s and 1990’s rather than the increase in private debt as you emphasize in your first letter, since private debt was then well below 40% of GDP one of the lowest among EU countries. These crises reflected the deep structural problems of the Greek economy.

Current account imbalances widened since Greece joined EMU because there was no corrective mechanism in operation as was the case when Greece had its own national currency.

To many observers the current account imbalances of a country member of a monetary union was not an issue for concern; is the current account deficit of the state of Massachusetts a concern?

This may explain why markets paid no attention to the widening current account deficit of Greece after joining EMU. It is only now, in the context of the New Stability and Growth Pact, that the European Commission explicitly takes note of these imbalances through the adoption of Macroeconomic Imbalances Scoreboard (MIP). This procedure explicitly monitors both internal and external imbalances.

However, from what we have experienced it looks as if the EMU resembles the gold exchange standard in that the only corrective mechanism to restore external imbalances is deflation, recession and huge unemployment.

In other words I am arguing that even without the fiscal crisis of 2009, when the fiscal deficit reached 15.5% of GDP and caused Greece to lose access to international capital markets, the Greek economy would have to restore its current account imbalances: there was no other way.

The only corrective mechanism would have been for Greece to run a lower inflation than the rest of the Euro area in order to restore its price competitiveness. And of course apart from being painful, this adjustment path usually takes time to deliver a sustainable level of competitiveness.

However, the very low inflation rate in Eurozone, much lower in fact than the 2% ECB target, forces the Greek economy to correct its imbalances through deflation rather than lower inflation. This inevitably has adverse effects on the economy through various channels as private and public debt become more difficult to service. Fisherian effects are in operation.

It was only a matter of time for markets to change their perceptions on the resemblance of EMU with USA or Canada. That happened after the collapse of Lehman Brothers when the spread of the Greek 10-year bond vs German 10-year bond increased by more than 270 basis points between late 2008 and early 2009. What I want to emphasize is that the increase in spreads took place well before markets realized that fiscal sustainability in Greece was out of reach.

The main point of my analysis regarding the Eurozone crisis and subsequently the Greek crisis is that the Eurozone crisis is the combined result of shortcomings of the institutional framework of the Eurozone -deficiencies that were known from the time of its inception- and the failure of the financial markets.

The lack of a federal agency to supervise European banks, the lack of a central fiscal agency responsible for a common unified EMU budget and for performing fiscal transfers between EU Member-States, the institutional prohibition of the ECB to act as a lender of last resort in order to stabilize bond markets and banking systems, the failure of the European institutions to monitor closely the economies of the Eurozone member countries, were among the factors that contributed in the emergence of the crisis. The crisis will be resolved only when EU will be ready to address these deficiencies in full.

In order to address the growth problem in Europe -especially in countries under program- it is urgent to reconsider the growth strategy at both European and Greek level. Europe should increase spending through inter-European investment projects.

Greece needs to introduce a program of structural reforms and enhance its tradable sector by attracting private investment. Although structural reforms are necessary to improve growth prospects, they need time to deliver results. According to OECD, Greece was among the countries that introduced a lot of structural reforms over the last years but in the same period the recession became deeper and deeper. As a result, citizens lost their faith on the effectiveness of the economic program to pull the Greek economy out of the recession.

An effective structural reform agenda must be internally consistent. It has to be an integral part of a coherent restructuring strategy that aims to change the economy’s growth model in a sustainable way. In this respect, a simple cherry picking of “convenient” structural reforms from large un-weighted tool-kits or fragmented domestic reform initiatives is unlikely to deliver material growth returns.

With regard to future fiscal policy, Greece should target at lower primary surpluses in the next years. This will speed the exit of the economy from the vicious recessionary path it finds itself in. Returning to positive growth rates will make fiscal consolidation easier and will change the market perception on the sustainability of the fiscal stance.

Yours sincerely,


Dr Philippos Sachinidis is a former Minister of Finance for Greece.  He is a member the Movement of Democratic Socialists.

To follow this debate from the beginning, read the first and second letters.

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