After the Eurogroup, some questions remain

After the deal at the Euro-Summit, there are still questions that puzzle me.

The first is the question related to growth. At which moment in the future can we imagine a growth take off in Greece? There are some minor measures on competition (shops open on Sunday and liberalization for pharmacy ownership and bakeries) and on the labor market. They can improve the situation but will not create a boost that will be able to change the global picture.
Last Thursday, Alexis Tsipras mentioned that the target for primary surplus was 3.5% of GDP in 2018 versus less than 1% this year. This means that an extra saving of 2.5% will be needed in the 3 year to come. It will come from higher VAT rate and lower pensions. This will lead to lower internal demand and then to a poor GDP performance.
In 2014, austerity was a bit lighter and we saw the beginning of a rebound in activity and in jobs at the end of the year. The phenomenon was the same than in the UK and in Spain since 2013: less austerity implies stronger growth momentum.
Since the beginning of the year the situation was messy with the arrival of Syriza at the government but we cannot expect a rapid improvement after the measures Greece will have to take.
In other words, after a deep drop in GDP during the last five years, we do not expect a rapid recovery. Probably, recession will remain the main word to describe the Greek outlook.
The retirement reform that is expected to be presented at the end of October will have the same effect. With the large drop in GDP, the reform will scale down contributions and pensions to the lower level of activity. This will also penalize growth.
Two questions are associated with this issue
The first is related to the sustainability of the public debt. The convergence to a 3.5% primary surplus in 2018 and the weak GDP growth momentum will not allow an improvement of the Public Debt to GDP ratio. The question of debt relief, debt restructuring and haircut will come back rapidly on the table.
The second point is that unemployment will not decrease. After the measures accepted by Tsipras, we can imagine some social unrest.

The second point I wanted to mention is the disappearance of the moral hazard issue. After the deal, no country is expected to deviate and take the risk of strong constraints on its behavior. It can be important at a political level just before major elections in Spain.
Nevertheless this creates new questions: if there are incentives not to deviate, this can reflects the fact that the main target for fiscal policy is a kind of balanced budget scheme in the Eurozone. The target then could be to imagine that the kind of budget neutrality this situation will imply is sufficient to limit global imbalances. It’s probably false. In the US and in Germany there are strong constraints on States and on Lander but there is a federal budget that is able to allocate resources from on entity to another one. And that’s one important reason of the good track record of these economies. Without a federal budget it won’t work.
But it seems that it is the scheme, fiscal neutrality, Eurozone will converge to. It is not optimal because it will not help to amortize asymmetric shocks and it’s not optimal either because the only regulator will be monetary policy. In an Optimal Currency Area, there is a need to have both fiscal and monetary policies.
In a more flexible system we had in the Eurozone before the crisis, large disequilibrium have appeared (see private indebtedness in some countries and large current account imbalances), how will we be able to reduce them in a more constrained environment? May be to exclude countries that are not able to follow this strategy, but I can’t imagine that.

The third point I wanted to mention is that for many negotiators, the impact of the negotiation was perceived as more important for internal issues than for the global Eurozone equilibrium. A large number of people have thought that the situation of their country was more important that the global euro Area. That’s problematic.
For long I haven’t heard a speech on the European construction and on its goal. I could have been a good idea after the referendum or before the start of the Eurogroup. But no one has spoken on Europe, neither Angela Merkel, nor Francois Hollande or Donald Tusk. It would have been important at a moment where centrifugal strength inside each country is a menace for the European stability.

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