The Scale of the adjustment for Greece, consider Latvia’s experience.

Yesterday the 11th March saw industrial unrest and strike action in Greece. This was the third general strike during this current crisis and led for example to schools and hospitals being closed and a strike by air traffic controllers closing her skies. According to the BBC there was a protest march in Athens of approximately 25,000 people which ended with stone throwing on one side and tear gassing by the police,so there is civil unrest too. Thursday’s strike was called by Greece’s main private sector union, GSEE, and its public sector sister union, ADEDY, which together represent half of the country’s five million workers. There is another general strike called for the 16th March (Tuesday) and we will have to see how that plays out. However one signal is clear the main unions appear determined to test the resolve of Mr. Papandreou’s government. So far its resolves appears to be holding.

If we look at the current position then it is Greece’s fiscal deficit estimated at just under 13% of Gross Domestic Product (GDP) and her national debt of 113% of GDP (300 billion Euros) and rising that have led to this crisis. This has also been associated with balance of payments problems but her other indices where unemployment is 10% and inflation is 2.8% are not good but they are not yet disastrous (I say this with apologies to anyone who is unemployed I am referring to the economy as a whole). This crisis has seen her government respond with a rather severe austerity programme designed to reduce her fiscal deficit by 4% of GDP this year and to hit the Euro zone target of 3% of GDP in 2012/13. This is what I wish to concentrate on and the implications of this austerity programme I have mentioned in my previous articles on this subject. As an aside it appears that Germany is putting a lot of pressure on Greece, however under current plans Greece’s fiscal deficit will be below the Euro zone 3% limit before Germany’s is which gives me a wry smile.

Step Forward Latvia

There is an example of a European country that has been going through an International Monetary Fund austerity programme and gives a signal for what might happen to Greece and it is Latvia. So we need the reverse of Neville Chamberlains words on Czechoslovakia (” a far away place of which we know little”) as Latvia’s experience has much to tell Greece. You see over her austerity programme Latvia’s GDP has fallen by some 30%. Latvia has been unlucky in that her austerity programme has come at a time when world economic output was falling but the scale of her adjustment has been so severe that it cannot be ignored. Indeed some economists usually at the harder end of the Keynesian style philosophy are using its experience as a criticism of IMF style austerity programmes. However I feel that to do a proper analysis you have to go back in time to see how Latvia got into a mess and the timetable was.

1. Accession to the European Union in 2004.

2. A debt fuelled spending spree by consumers combined with loose government fiscal policy and a housing market bubble (my article of yesterday is again relevant here of how a housing bubble can contribute to a fiscal crisis).

3. The economy peaked at a growth rate of 12.2% in 2006

4. This overheated economy found that international markets were abandoning her as inflation for example peaked at just under 18% in 2008 and on February 2009 Standard and Poors downgraded Latvia to junk status (BB+/B). In the 4th quarter of 2008 GDP shrank by 10.5%. Ouch.

So in December 2008 the IMF was called in to help and loans of 7.5 billion Euros were provided. There is an interesting aside to this as of the loan some 1.8 billion Euros was provided by the Nordic countries, the reason for this is that their banks were heavily involved in the housing boom and this is a theme I will do a full article on at a later date as there are considerable implications from it as Latvia is far from the only country where this happened. So Latvia was in an economic mess and the IMF medicine was an austerity programme. Now here is the real issue GDP was expected to fall by 5% in 2009 but it actually fell by 12.2%. So my fear of a downward spiral for Greece actually happened for Latvia.

As to the IMF whilst there are issues over its austerity programmes (there was a complaint recently from  a Finance Minister that when he consulted the IMF for help he got a faxed copy of someone else’s rescue plan i.e implying the IMF only has one plan) it was not the cause of Latvia’s problems and at the time Latvia was in an utter mess which on its own may well have exploded even more spectacularly.

Applying this to Greece

Now whilst at this stage Greece does not face the scale of adjustment required for Latvia the principles are very similar. Her government is predicting a fall in GDP of 0.3% for 2010 and I have written before that in my opinion she will do worse than this. Deutsche Bank have done some research on this and have estimated that this adjustment will be “Herculean”. They feel that the Greek economy could contract by 4% in 2010 and the total downward adjustment to GDP over the austerity programme is likely to be around 7.5%. Now they also feel that unemployment which is currently 10% will rise to around 20% as this adjustment takes place. So it will double and if we look at the unrest already in Greece it does not require a genius to calculate what is likely to happen if this takes place.

Our political crisis

One of my themes of the current economic situation is that the democratic countries of the world have somehow manged to elect politicians who are not up to the job. Indeed for some incompetence is the least of their crimes. Well step forward former European Commission President Romano Prodi (who has been Prime Minister of Italy) who spoke this week..

“For Greece, the problem is completely over, I don’t see any other case now in Europe. “

Now please reread the paragraph preceding this one if you are in any doubt of the credibility of this statement.

Market Reaction

Whilst the heady days of a few weeks ago have gone into the past Greek government bond yields have started to edge higher again. Her ten-year government bond yield closed last night at 6.33% and is now double that of Germany’s equivalent. Those who bought the recent bond issue which at the time gave them a nice yield cushion of nearly 1/2% must be starting to wonder if it was such a good idea (assuming they have not sold).


Greek faces a severe economic adjustment of a scale which I believe is not yet suspected by the protesters on her streets. If Europe’s politicians are like Mr. Prodi then I feel that they do not suspect it either. However the European Central Bank must do and for once I feel that the Central Bankers should take the lead and come up with a plan to help Greece through its adjustment as plainly Europe’s politicians are inadequate as their time to respond is now simply too long. Greece will end up rueing the weaknesses in the Euro constitution before this phase in her economic history is over and I would like to wish her well in hard times.

Also Latvia’s example is a further illustration of ratings agencies acting after the event which is another theme of this crisis. As well as a lesson for Greece there is one here to for the UK for those commentators who obsess on this point and consider it of great significance that the UK has not yet been downgraded.


2 thoughts on “The Scale of the adjustment for Greece, consider Latvia’s experience.

  1. Please note that Romano Prodi is a former President of the European Commission. The current President is José Manuel Barroso.

    • Apologies Ian I did miss out the word former and have now put it in its proper place in the article. I believe that he is now about to start a teaching role at the China Europe International Business School in Shanghai.

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