Greek Crisis and the Dark Clouds Over the American Economy: An Interview With Dimitri B. Papadimitriou

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Is the Greek crisis nearly over as the International Monetary Fund, the European Commission and the Greek government like to proclaim because of the sharp decline in Greek bond yields, the attainment of a primary surplus and an increase in foreign tourism? If so, what about the 27.2 per cent of the population that remains unemployed and the widespread poverty across the nation, the ever growing public debt ratio and the dismal state of Greek exports? And what about the United States? Is America on the way to becoming Greece as many Republicans claimed a couple of years ago? Dimitri B. Papadimitriou, executive vice president and Jerome Levy professor of economics at Bard College, and president of the Levy Economics Institute at Bard, who foresees Greece emerging into a debt prison and a rather gloomy economic future for the United States, discusses these questions in an exclusive interview for Truthout with C. J. Polychroniou.

C.J. Polychroniou for Truthout: According to some sources, including European Central Bank’s (ECB) President Mario Draghi, Greece’s economy is finally showing clear signs of recovery. However, unemployment rates remain stubbornly at record levels (over 27 percent) and the debt/gdp ratio continues to rise (over 175 percent) despite a 58 percentage point, debt-relief scheme in 2012. Could the alleged signs of recovery be nothing more than an indication that Greece’s economy has finally hit rock bottom?

Dimitri B. Papadimitriou: No one really knows if the economy has hit bottom. The latest data from the Hellenic Statistical Authority (Elstat) show the economy is still enduring a recession – by now 24 quarters of continuing negative growth in output. The third quarter of this year might show zero or even some miniscule positive growth, but this is no cause for celebration since the economy is based on shaky foundations, with an undeveloped industrial sector and much lower than expected exports. Moreover, any reversal due to either a domestic or Europe-wide shock will only throw back the economy to a deeper negative territory.

We should be reminded that both Germany and Italy just recently showed negative growth of output, while France is stagnating. Both the International Monetary Fund (IMF) and the European Commission (EC), in their assessments of the performance of the Greek economy, appear more optimistic on the future of Greece because of the deceleration of the negative growth and a very slight decline of the unemployment rate, even though this was due to using statistics based on the new census that has resulted in demographic adjustments and not due to growth in employment.

An artificial positive sign on Greece that indicates nothing about Greece’s economic condition, yet it was celebrated as a sign of recovery, was the primary budget surplus and “going back to the financial markets” for a new issue of bonds. The budget surplus was achieved at the cost of creating many damaged lives. On the other hand, going back to the markets was purely a public relations exercise since the interest cost of almost 5 percent of the new bonds was much higher than that paid on the bailout funds. Moreover, the bonds were implicitly guaranteed by the ECB because they could be used as collateral to the ECB for lower-cost bank borrowing. Finally the demand for these bonds reflected the current state of excess global liquidity available and not because investors considered Greek bonds as a good risk. The latter is in concert with the well-known adage in Wall Street that at times of “excess liquidity, even turkeys can fly.” All in all, even if the economy were to have hit bottom, this does not necessarily mean it is out of the woods and to a better outlook for its future.

The Greek export situation is dismal, as noted in a recent European Commission publication titled “The Puzzle of the Missing Greek Exports,” in which the authors suggest that Greece’s exports fall short by 33 percent of potential. Yet, virtually every structural adjustment measure enforced so far by the troika is allegedly made to create a boost in Greece’s export capacity. With exports having increased rather substantially in the other peripheral nations of the eurozone, why is Greece failing on the export front as well?

There is no puzzle in the “Missing Greek Exports.” As the data long showed, Greek exports are not dependent on the unit labor costs that the troika thought it could lower with the violent suppression of wages that happened gradually both in real and nominal wages. Even the OECD shows that by 2012, Greek labor – save for Germany – had become the most productive in the Eurozone. We should remember that Greece’s main exports were and are services, agricultural products, ships and oil-refined products. Most Greek exports are destined for outside the Eurozone countries – to Turkey, Bulgaria, Italy, the United States – and the oil refined products back to Libya and other oil-producing economies from which we import crude oil and export it refined.

Unlike the other Eurozone periphery countries, Greece’s industrial base is still undeveloped and still controlled by the very few. So, in economic terms, the net export elasticity is much lower than the comparable one of the other periphery countries. The report you mention suggests the decline of exports to be due to “underlying institutional deficits,” meaning the disregard for rule of law, property rights, inability to enforce contracts, deteriorating physical infrastructure, lack of regulatory transparency, customs formalities and lack of flexible labor market arrangement. I would argue that with the exception of the flexible labor market arrangements deficit, improvements in the rest are necessary. As to the flexibility of labor, as we all know, this has been achieved in spades and far beyond the troika’s targets, yet the stagnation in exports continues. To be sure, net exports have dramatically declined, but this is due to the deep recession the country is enduring for six years that has caused the precipitous decline in imports.

Given that Greek export prices measured relative to the euro area partners are increasing rather than decreasing over the last few years, isn’t this undeniable evidence that wage compression hasn’t led to price competitiveness while it does have a substantial impact on domestic demand and has sharply reduced the living standards of most Greeks?

The short answer is yes, most definitely. As I indicated above, Greek export prices aren’t a function of unit labor costs that are based on wages. The most important factor is the exchange rate, especially for Greek exports that are destined primarily outside the Eurozone countries, and the euro still maintains its strength vis à vis the US dollar, Turkish lira, etc.

On the other hand, the continuing stagnation of exports limits production and employment, affecting both incomes and the standard of living, which in their turn dramatically reduce domestic demand, which via a feedback loop reduces incomes and employment, further leading to a downward spiral. This can only be stopped via a sharp rise in investments – either public or private. But both public and private sectors have been tapped out: the public due to its forced fiscal consolidation, the private due to its process of deleveraging because of its over-indebted state and more importantly from the lack of liquidity. And even those private businesses, old or start-ups, find it impossible to borrow – either because they don’t qualify or the terms of credit are prohibitively expensive despite the lowest interest rate established by the ECB. Real interest rates in Greece are the highest since joining the Eurozone. Public officials are counting on tourism saving Greece. As a recent Levy Institute study focusing specifically on this showed, this is very unlikely to be a major contributor for significant output and employment growth while the government continues being biased toward producing a budget surplus.

Much of the bailout money provided by Germany and other European Union (EU) countries has gone to German and other European banks. Who exactly is being bailed out?

It is by now common knowledge that the bailout programs were put in effect to save the overextended German, French and other European banks that had purchased a lot of Greek government bonds because of the relatively higher interest. There was clearly a case of underpricing risk because the thinking was that Greek bonds are similar to other Eurozone country bonds irrespective of the divergence of the underlying real economies. The bailout money provided time for these banks to unload them at lower prices. These bonds ended up in the portfolios of mostly the large Greek and Cypriot banks and some private hedge funds. Imagine what would have happened if these bonds were still in the portfolios of the European banks, and Greece was unable to service them without further borrowing if such were available. Ultimately the entire European and American financial system, because of the interconnectedness of finance, would have been in serious peril. By arranging these bailouts, Greek banks and the systemic risk they posed were ring-fenced. It was the banking sector that was primarily bailed out. No doubt about that.

Greek debt is unsustainable, but in his recent visit to Greece, incoming European Commission President Jean-Claude Juncker played down the option of an outright write-off. What do you think are the reasons Europe is refusing to address Greece’s debt problem?

It is politically difficult for the Eurozone countries to have their respective Parliaments approve a write-down of Greece public debt – especially after they have portrayed Greece and its citizens as a profligate state with lazy Greeks. So they are trapped. It is their own original PR campaign that they cannot easily undo. They are therefore against the IMF’s strong cries for yet another haircut. The IMF funds are senior obligations and not subject to write-down. The division of house in the troika might lead to the purchase of the IMF’s position in the bailouts enabling the EC to develop its restructuring of the Greek public debt that will most likely be extended in maturity with even lower interest rates. This is not a panacea for Greece because it will need to become either Germany or China to produce a budget surplus adequate to service its debt. What I foresee then is a very long time of debt prison – to use the Dickensian analogy of an early era in Great Britain.

Greek banks remain fragile and undercapitalized, thus unable to help the economy recover. A recent Levy Economics Institute publication strongly endorses co-operative banking for Greece as a much-needed alternative financing model for start‐up and existing small enterprises and as an all-important poverty policy alternative. Does the American experience with co-operative banking support this recommendation for Greece?

In the United States, there are no cooperative banks per se. There are what we call Credit Unions and Community Development Banks. Credit Unions have been established throughout the United States and are very successful and mostly unaffected by the subprime financial crisis of 2007-09. They were originally established to serve customers who possessed some common characteristic, i.e. employees of a large organization such as the UN, or big business – IBM – or a locality, Hudson Valley in upstate New York and so on. By now depositors do not need to share a common characteristic. The present credit unions are not very big and serve their local customers since they are geographically focused. Community development banks are very similar and provide banking services to individuals and businesses with limited credit history, such as start-up businesses, firms in agricultural and remote regions, or to inner cities that big banks do not find it profitable to extend their services to. They are doing quite well serving the interests of the unbanked.

Co-operative banks are mostly a European phenomenon and some have become very important in their respective countries and quite large. Others continue their mission of providing services, especially depository and lending functions, to people and areas that large banks shy away from. The most successful are in Germany. There is serious interest from these German cooperative banks to establish their model and operation in Greece. We don’t really need them. We can establish the Greek cooperative bank system very much different than the one we now have which did not perform well all the time. Our proposal for cooperative banking in Greece incorporates a strong regulatory and supervisory structure, fully transparent, guided by a strong and professional board that will serve the liquidity needs not in the form of “red loans” (κόκκιναδάνεια), but to promote regional entrepreneurship. These banks would contribute to restarting the engine of economic growth, especially within the European framework of the social economy. It has been shown that the large systemic banks in Greece are still in the process of strengthening their balance sheets and have created the credit crunch I mentioned earlier.

In the course of the last four years, Greece has moved from being a developed nation to an emerging economy, with unemployment, poverty and inequality rates resembling those that used to be posted by Third World countries in the 1970s. Given that the current political climate in the EU is unlikely to change any time soon, and Greece will most likely remain trapped in a vicious debt cycle, which implies that it has no way of escaping the state of peonage imposed by a German-led Europe, why shouldn’t a new government consider the option of leaving the eurozone?

Being categorized as an emerging market is only important to financial markets and investors to be aware of the potentially higher risks investing in them. Greece is in a particular fix exhibiting the features, as you correctly point out, of a developing economy. If the current fiscal policy continues, as this government appears it would follow, it will take many years – more than a decade – to return to pre-crisis output and employment levels “having lost two decades” and still be over-indebted. It is therefore natural to ask why stay in the Eurozone with such limited fiscal and monetary policy space.

Exiting the Eurozone entails serious repercussions that may be very difficult to overcome at least for several years. But as I have argued earlier, it is possible to deal with some of these difficult issues by introducing flexibility in the fiscal and monetary policy space with the introduction of a parallel financial system without exiting the euro. It requires a carefully planned program under the supervision of the Bank of Greece coordinated by the ECB that would control inflationary pressures and could alleviate the problem of the unprecedented levels of unemployment and provide liquidity to small businesses including startups. The idea of a parallel financial system is not new; it has been suggested by mainstream and heterodox economists – and bankers alike – as one of the solutions in igniting the motor of growth for the economy of Greece. As you will conclude I am not in favor of exiting the Eurozone, but the solution is not to continue the present public policy.

Are you optimistic about the future of the eurozone?

The euro project is incomplete and with many design flaws. If it remains that way, I doubt it will last very long. The Eurozone is the largest experiment that separates governments of countries responsible for fiscal policy from their currency. It has never succeeded before, and it won’t succeed now. Even the father of the idea of the euro, Robert Mundell, has agreed to this assessment of the design flaw of the euro. The difficulty is that until now, the euro has been a real bonanza for Germany and a few other countries of the European North. Germany, in particular, has become the lowest cost producer and has managed to operate in a common currency regime that is overvalued for the European South, but very cheap for the countries of the European North, most importantly Germany. If the design flaws were to be corrected so that the Eurozone is a true union of countries both fiscally and monetarily, it will no longer be as beneficial as it is currently for Germany. There is then strong resistance from Germany to reforming and completing the euro project. But there may be some recent hopeful signs especially from France urging the ECB to undervalue the euro so that a resurgence of European exports can be achieved. Other hopeful signs for urgent reforms may paradoxically come from the recent declines in growth from the largest economies, France, Italy and especially Germany.

In the recent past, the United States was afraid of becoming Greece, with the Republicans using the economic catastrophe in Greece as a pretext for demanding sharper budget cuts and more European-inspired austerity. Isn’t it the case, however, that the United States and its economy is in a process of “Third Worldization” in terms of such things as the state of the infrastructure, the gap between the haves and the have nots, and the continuous shift in the polity from a democracy to a plutocracy?

The United States is still for now a rather strong economy despite its decaying physical infrastructure, its budget cuts in health care, education and research and development. The question that arises is for how long? It is true that if comparisons about physical infrastructure are drawn between China and the United States, the conclusion may end up that the United States is the developing economy as opposed to China. But of course there is more than that. The deficits in education, health care, physical infrastructure, basic research and development, together with the unfunded liabilities of social security and the explosion of student loans are the dark clouds in the horizon. As for the analogy of the United States becoming Greece, that was a totally false comparison because – most importantly – the United States has its own sovereign currency.

A country that uses its own currency can never become bankrupt unless it is tied to another currency. So that was plain Republican propaganda. And, lest we forget, the Republican Party is anti-budget deficit when it is not in power, but changes views when it is in the White House. American economic history demonstrates that higher budget deficits have occurred during Republican administrations and not during Democratic administrations. Still, the most important issue confronting the United States, to wrap up my answer to your question, is the ever-increasing inequality of income and wealth, and, if it continues unabated, it may be a serious challenge to economic growth. Private interests associated with plutocracy and big businesses are very strong in the United States, posing a strong challenge to democratic institutions – but the highest court has decided otherwise.

The American economy remains weak five years after the recovery of 2009 from the global financial crisis of 2007, having shrunk at a 2.1 percent annual pace the first three months of the year, according to the Bureau of Economic Analysis. There is also lots of labor market slack and very slow wage growth. In addition, QE (quantitative easing) may be coming to an end. In the light of all this, what will it take to put the American economy on a course of sustainable recovery?

The data for the second quarter of 2014 showed a renewed growth for the US economy, reversing the negative signs of the first quarter of the year. The unemployment rate seems to have been stuck at the approximately 6 percent level – which is still high if one compares it with the less than the 4 percent during the Clinton era. The Federal Reserve is keenly aware of this, and it continues its relative easy money policy, otherwise known as quantitative easing. When this Fed policy tapers out, it will mostly affect the financial equity and bond markets and not so much the real economy.

Inflation is still at the lowest levels, so no interest rate change will be on the radar screen for some time to come. It is fiscal policy, however, that is the most potent for economic growth and that the Republican-dominated Congress still opposes. How will this evolve is anybody’s guess. The Obama Administration seems to be currently preoccupied with urgent issues of foreign policy in many trouble spots around the globe. Another phenomenon that requires serious consideration is the declining labor participation rate caused because many workers have dropped out of the labor force, especially women. The economic outlook for the US economy, at least for the intermediate term, is not very bright because the economy will be growing below its potential with a relatively high number of unemployed. Empirical evidence has shown that economic growth requires government budget policy to be biased toward small deficits that create stronger foundations and assets for growth sustainability and not toward surpluses that eventually lead the economy to a downturn.