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Can Greece actually be reformed? It's a pretty important question, as the rest of Europe, the IMF, and some private investors are (and have been) throwing rather massive amounts of money at a positive answer. The truth is that the country needs a complete makeover. It suffers from (amongst other things):

  • Political clientelism, there is something of a culture of exchanging votes for favors, like jobs. Reforming the economy means breaking these implicit contracts, which is quite hard to do
  • Insufficient record keeping, making administration very difficult and opening large gaps that can be filled with corruption and bending the rules
  • The lack of records make it extremely difficult to police implemented laws, collect taxes and get parts of the black (and gray) economy above board and thereby broaden the tax base
  • The Judiciary system is not up to the task, so where laws are breached, prosecution is an arduous option and often parties have a mutual interest to keep silent
  • The labor market is way too over-regulated and dealing with this will be extremely difficult as it faces stiff resistance from those with a direct interest. The interests of those are often aligned with politics as well, further complicating the issue.

One wonders how Greece ever came to qualify for the euro. There is a nice BBC article about how this happened, and it involves a 'magician,' an administrator who had the ability to make debts and deficits disappear or make them seem much smaller than they really were. How did they do that?

The Greek railways, for instance, was making a loss of a billion euros a year, it had more personnel than passengers, and a former minister (STefanos Manos) argued that it would be cheaper to send everybody by taxi. In order to make these losses 'disappear,' shares in the railways were sold to the government, so it wasn't counted as expenditures but as a financial transaction.

Politicians knew the real deficit was about 7% (of GDP) bigger than reported, but didn't want to rock the boat just before the 2000 Olympic Games in Greece. Anyway, reforming Greece is a rather daunting task, as we will illustrate below.

Once inside, financing the deficits became an order of magnitude more easy and cheaper, greatly reducing any urge (if at all) to reform. Monetary union did away with the currency risk, hence Greece could borrow at near German conditions instantly, and did so with abandon. That something didn't quite add up (literally) became clear when Salomon Brothers analyst Miranda Xafa pointed out in 1998 that adding up all budget deficits over the previous 15 years amounted to only half the Greek debt.

The IMF wasn't amused when it found out the true scale, as documented by Michael Lewis (in 2010, we now know the situation is considerably worse):

In addition to its roughly $400 billion (and growing) of outstanding government debt, the Greek number crunchers had just figured out that their government owed another $800 billion or more in pensions. Add it all up and you got about $1.2 trillion, or more than a quarter-million dollars for every working Greek. Against $1.2 trillion in debts, a $145 billion bailout was clearly more of a gesture than a solution. And those were just the official numbers; the truth is surely worse. "Our people went in and couldn't believe what they found," a senior I.M.F. official told me, not long after he'd returned from the I.M.F.'s first Greek mission. "The way they were keeping track of their finances-they knew how much they had agreed to spend, but no one was keeping track of what he had actually spent. It wasn't even what you would call an emerging economy. It was a Third World country.

Reforming through syrup
Reforming the country is a bit like wading through syrup. Greece is rife with stories about corruption and networks of mutual favors. For instance, the Ministry of Health has made a map of afflictions with the aim of uncovering rather odd concentrations in afflictions. Indeed it did. For instance, the Viotia region has an unusually high concentration of asthma patients, the island Kalymnos an equally odd concentration of people with psychological problems.

At Zakynthos, the number of blind people increased by an odd 350, according to a report in Dutch quality newspaper NRC Handelsblad. These all turned out to be patient of the same, rather rich doctor.

Professions seem to have considerable leeway with filing taxes, which leaves most of the tax burden (and tax hikes, with the compliments of the other euro zone countries) on the salaried employees. For instance, two thirds of doctors reported incomes under 12,000 euros a year, but few, if any get into trouble for this obvious under-reporting of income. Tax evasion went almost unpunished for decades and is seen as something of a national sport.

Or the primary school system, one of the lowest ranked in Europe, it nevertheless employs four times as many teachers per pupil as the highest ranked (Finland). The political system also has dysfunctional characteristics, where jobs have been granted on the basis of political loyalties. These traditions are very hard to roll back.

There isn't any central computer database of all social security payments, enabling people to claim in different regions for the same condition. Doctors having to assess medical claims sometimes cooperate with local politicians and diagnose in a certain way in order get the votes of whole families in exchange for some social security payment.

The result of all this inefficiency and openness to abuse is that it is extremely resistant to reform, especially by insiders. One basically has to start all over again, and begin with creating databases for all kinds of things, like who pays which taxes, who owns which properties, who enjoys which social security payments, and so forth.

The rule of law and a more flexible labor market, doing away with a myriad of special professional regulations, will increase the investment climate and stimulate entrepreneurship. If contracts cannot be effectively enforced, there is little incentive sinking resources into a venture as one becomes liable to the hold-up problem.

However, reform almost invariably runs into special interests and often cost money at first. For instance, Greece has a rather Byzantine judiciary system, in which it often takes an eternity to settle cases and not all judges seem up to the task. One way of dealing with that (as suggested by economic professor Meghir) is to hire new judges from the best lawyers. This would immediately deal with the backlog of cases and improve the quality of the judiciary system, but it costs money. Higher pay would also attract better people to the profession, but that costs money too.

Greece ranks 154th out of 183 countries in terms of legal protection for investors, and it takes 819 business days on average to resolve commercial disputes (the OECD average is 518 days).

Reforming the labor market is also very necessary, but Greece has some 300 closed occupations, for which you need to apply for a permit. Sometimes the permits are worth so much money that fierce resistance can be expected when liberalisation is tried. In trucking, no new licenses have been issued since 1971.

Even tax increases, probably the easiest (but not the wisest) way (with regards to implementation) to reduce the deficit meets a rather hard reality on the ground in a country where taxes are routinely avoided. The problem again is the lack of centralized records, leaving much to tax collectors arranging affairs in face-to-face contact that invites bribery.

In the mean time, results of necessary reforms are so behind schedule that the Germans asked for more EU powers on the ground (they've since backed down from this position though). This is somewhat understandable, because reforming Greece is a rather daunting task.

There were hopes that Papademos could do a 'Monti' and perform a similar role that the new Italian Prime Minister is filling out in Italy, but the resistance to reforms in Greece is way higher due to the relations between special interests and politics, the lack of an effective judiciary system and perhaps most important of all, the lack of effective record keeping.

Greek banks
And then there is other stuff. Unlike banks of most other EU countries, Greek banks were actually pretty healthy at the eve of the crisis. However, the economic implosion has soured lots of loans. The prospect of a 'haircut' of some 70% on Greek bonds will lead to large losses for Greek banks (although some sort of agreement now seems to have been reached to deal with that.) However, depositors and investors are fleeing from them to safeguard their money.

Needless to say, credit expansion isn't what you hope it would be. Greek banks lost a quarter of deposits through capital flight in two years. This isn't helping trade either. Foreign suppliers now demand cash payments upfront. And you can't even blame them.

Greece promised to sell 50B in assets but the economic implosion and the possibility that Greece will leave the euro doesn't exactly encourage buyers.

Economic situation
The situation on the ground is deteriorating with an alarming rate. Here is the Telegraph:

Greece has been subjected to the greatest fiscal squeeze ever attempted in a modern industrial state, without any offsetting monetary stimulus or devaluation. The economy has so far collapsed by 14pc to 16pc since the peak - depending who you ask - and is spiraling downwards at a vertiginous pace.

Retail sales fell 8.9% in November, after dropping 10.8% the prior month. Unemployment, at 17.7%, is approaching Spanish levels (although that is a bit of a moving target). Despite the rather unprecedented slump, or rather, depression, Greece still has a large trade deficit, indicating its level of uncompetitiveness.

Policy mix
We've argued for some time that the policy mix enforced on Greece has been wrong. It relied too much on austerity and too little on getting the economy, the judiciary and the public administration apparatus functioning better. That error has now sunk in, but the trouble is that the reforms necessary are probably costing money and their returns will only be gradual and over time, whilst the economy slumps and the deficit and debt are ever bigger.

What it needs is for different interests and parties to find common ground, like they're doing now in Italy, or something like what happened in Ireland in the late 1980s (causing a rather spectacular turnaround in its fortunes) or the Netherlands in 1982. Help should be conditional on this but the fear is that since Greece can potentially create lots of problems for the eurozone (through a default and/or leaving the euro) it's implicitly blackmailing the eurozone and there still is too little of a coming together of parties internally to solve the crisis.

No doubt there is the will in many, and many more have made enormous sacrifices, but it doesn't seem enough, it's rather depressing. One idea gives Greece a waiver on the necessity for co-financing projects financed with European money. There are quite a few of these in various states of completion and/or in planning, but from the money that was allocated to Greece out of European structural funds for the years 2007-13, only 28% has been spent. Disbursement of these funds could (actually, should) be made conditional on progress on structural reforms. But by far the biggest effort falls on Greece. It has to pull itself out of the morass by its own hair.

Source: The Greek Tragedy