What Greece Needs Now From Tsipras

Rarely has a new government caused so much economic damage in such a short time. The rise of Greece’s radical left to power has aborted the Greek recovery, paralyzed domestic investment and triggered capital flight of 50 billion Euros within three months, equivalent to almost 30% of Greek annual GDP.

That is even significantly worse than the harm done by German chancellor Schröder jointly with his flamboyant first finance minister Oskar Lafontaine in their first wild months in office (October 1998 – March 1999) and by French president Hollande in his initial tax hike crusade against businesses upon taking power in May 2012.

Fortunately, people can learn from their mistakes. Schröder eventually forced his center-left party to pass the best supply-side reform package Germany has had in 40 years, turning the country from the “sick man of Europe” into the continent’s new growth engine.

Even Hollande, having met the facts of life as represented by France’s dismal employment statistics, is now on the right track, although his actual reforms still fall well short of what is needed.

A chance for redemption

Greek Prime Minister Tsipras has now had a couple of very wild months in office. What would he need to do if (very big if) he decides to get real and put Greece back on track for a lasting economic recovery akin to that of Spain? Easy answer, he needs to:

1. Stop digging an ever deeper hole.
2. Adopt the right kind of pro-growth supply side reforms.

As to stopping to dig a hole, the chart below shows the problem. Although the new Greek government has passed hardly any significant law, its impossible election promises and its subsequent antics in office have dealt a severe blow to business sentiment, investment, financial stability and tax revenues in Greece, in line with what I predicted as the likely consequence of a Syriza victory ahead of the election.

Just why should he care about such concerns as business sentiment and investment? Because that is the only avenue that will allow Mr. Tspiras to fulfill any of the ideas for better social balance over the long haul.

The government’s current approach — to find revenues wherever it can by squeezing the stagnant Greek economy for every cent it can find anywhere — is not sustainable.

In fact, in proposing to raise some taxes instead of the long-term growth potential, Tsipras is not far away from the troika’s initial “austerity first” approach.

Restoring confidence at home and abroad

While sentiment in Spain continues to soar, sentiment in Greece has plunged since the Syriza threat started to materialize last December. To restore business confidence at home, Greece needs to strike a deal with its external creditors fast and dispel the specter of Grexit and further descent into Venezuelan-style populism for good.

With confidence restored, Greece could start to enjoy the tailwinds of cheap oil and a weaker euro that are driving a nice cyclical recovery across the Eurozone. Of course, schmoozing with a Putin who is sending his tanks into another European country is not exactly the best way to go about agreeing to a new deal with Europe.

The Tsipras recession: Greek confidence plunges while Spain soars further

Average of industrial, services, construction and retail in European Commission survey. Source: European Commission

Beyond a cyclical rebound, what Greece really needs is stronger trend growth — that is, serious supply side reforms. A country with an inefficient public administration needs tax laws and regulations that are simple and hence easy to administer. Taking Slovakia as an example wouldn’t hurt.

A country with high unemployment and extremely high youth unemployment needs labor market rules that make it easy, not difficult, to hire people and to register and grow a business. Like Thatcher and Schröder in their time, Spain’s Rajoy is now showing that labor market reforms work.

Some ideas of the new Greek government make sense, for instance using OECD expertise in designing product market reforms. But Syriza’s key ideas in its current talks with creditors, namely a partial reversal of the labor market reforms of the last few years, fewer privatizations and more social spending to be paid for by raising the tax burden, would be precisely the opposite of what Greece needs.

If Greece ends the scary rhetoric and the crippling uncertainty about its fate by striking a sensible deal with its creditors fast, and if it goes for serious pro-growth reforms to the supply side, it would have no need for any further fiscal hit.

Instead, a return to growth and rising tax revenues would eventually open up room for some tax cuts and some targeted spending initiatives.

While Germany’s Schröder wasted his full first term and only turned into a serious reformer at the start of his second term, Greece’s Tsipras will have to make up his mind fast.