Rotten to the Core?
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From Athens to Berlin to Washington, there is one thing about Greece that many seem to agree on: The country’s main problem is a bloated, overpaid, and corrupt state, which is suffocating the private sector.
This diagnosis is only half correct. Some parts of the story are right, but some are factually wrong and others mistake consequence for cause. Greece’s root problem is the concentration of power in the private sector and vested interests, and the social inequality these bring. These conditions have stymied market growth, the creation of the kind of civil service that forms the backbone of all advanced economies, and the social justice that enables political stability. Greece’s maligned state is a symptom of all these problems, albeit one that only makes the outcomes worse.
As acknowledged by many liberal Greeks and outsiders, a group of oligarchs holds disproportional power given the small size of the country (about 11 million). About four business families control the Greek media, and they still receive massive loans for their loss-producing companies. Corporations use connections to channel funding into over-leveraged firms or even personal accounts. The Agricultural Bank of Greece, for example, is mired in criminal proceedings because of 5 billion euros ($5.5 billion) worth of illegal loans. This climate facilitated the credit boom of the 2000s and the laxness that now burdens the economy with 164 billion euros ($179.4 billion) of bad private loans.
These patterns are longstanding, and for decades, Greece has had the second-highest level of inequality in Western Europe (after Portugal)—and that is only counting declared income. Tax evasion is rampant. Greece’s underground economy is estimated to equal 30 percent of the country’s GDP, and is probably higher. The self-employed are major tax evaders. By one estimate, professionals have failed to declare upward of 28 billion euros ($30.6 billion). Wealth has traditionally been used more for consumption than investment.
Moreover, small and medium enterprises account for 86 percent of employment (one of the highest in Europe), many in the retail, manufacturing, and tourism sectors. But management and labor skills are mostly poor, although creative exceptions are constant reminders of the country’s potential. The problems are exacerbated by family-based business structures and the habit of treating employees as underlings. Greece’s labor market participation trails at 53 percent; even Ireland and Portugal are at about 60 percent.
Most Greeks are adamant that the problems are the fault of the state and of corrupt politicians. But parliament is a microcosm of Greek society. Even politicians wanting change face the wall of vested interests. A bribable, discredited state has been helpful to anyone willing to break the rules—oligarchs cannot claim to be “forced” to evade taxes; it’s a choice. The corruption and lack of meritocracy in the state goes hand in hand with the concentration of wealth and power in the few, which extends corruption downwards. These concentrated interests have restricted the market in Greece, as elsewhere, and thus limited work opportunities.
The most important misconception is that the Greek state is “too big.” This is taken to mean that it either spends too much or that it employs too many, or both. These problems plagued Greece in the 1980s, but they don’t today. Insisting on them now only worsens the situation.A restricted market contributed to two key features of Greek society. First, Greeks with low skills or a history of social exclusion turned to the state for employment, especially since the 1980s, and the state obliged by using hiring as a substitute for welfare. This process easily devolved into patronage and vote-buying. Politicians delivered government jobs regardless of whether the recipients were qualified. The result is that corruption and inefficiency in the public sector blocked efforts for reform (which started in the early 1990s).
At the same time, Greeks are renowned for their “entrepreneurial spirit,” and many start their own businesses; others become professionals. But these are typically solitary affairs: Greeks widely admit that no one likes working for others. One-third of the population is self-employed (the highest ratio by far in Europe), with lines of business that are often highly inefficient and prone to tax evasion.
These two conditions produce a toxic mix. Small business owners and the self-employed struggle to survive. Every day, they have to deal with government services that are plagued by nepotism and inefficiency. And the frustration morphs into a virulent hatred of public sector employees and merges with a strident anti-statist ideology. Such ideology also makes it easy to avoid the hard work of reform. Such sentiments only worsen the problem by entrenching two key misconceptions about the state that inhibit progress.
IS THE GREEK STATE BLOATED AND OVERPAID?
The most important misconception is that the Greek state is “too big.” This is taken to mean that it either spends too much or that it employs too many, or both. These problems plagued Greece in the 1980s, but they don’t today. Insisting on them now only worsens the situation.
Despite all the recriminations, Greece’s public expenditures were below the EU average during the 2000s, hovering above average in only a few years. The sharp decline of Greek GDP after 2008 of course increased the rate. But today, the figure is 49.3 percent of GDP, or about the eurozone average. Some salaries, especially in public corporations, were, indeed, scandalous. Pensions have also been a major expense, more due to demographics and early retirements than systematically generous outlays. Healthcare is a major burden. But numbers show that the problem is not that the state is “big.” It is that nepotism and corruption rule, creating distributional inequities and economic inefficiency.
Further, Greek revenue never kept up with expenditure. Greeks think they are overtaxed; indeed many are, but as a state, Greece was never overtaxed—until the current recession—just very badly taxed, now even more so. Finally, Greece simply imported more than it exported: Current account deficits ran at about nine percent throughout the decade (no longer). All this added to the high debt from the 1980s, making Greek debt the second highest in the OECD in 2008, at 117 percent of GDP.
But none of these problems are a result of the public sector being too big today. Confirming numbers remains a problem, but in 2008, even before the crisis, the government employed about 19 percent of the labor force, including public corporations, which was about the OECD average (the United Kingdom had 23 percent). If 300,000 employees had not been hired in the 2000s, the rate would have remained well below the average.
When the state is weak, even reasonable policies are undermined by clientelism.In fact, today, after the reforms, about 300,000 employees are gone (including private contractors, where patronage often reigns); this is almost 30 percent of total employees since 2010. After these cuts, the Greek public sector is again understaffed in critical offices, overstaffed in inessential ones, and inefficient in almost all.
Inadequate and inefficient staff, moreover, have three consequences. Procedures take much longer than they should, employees feel overwhelmed and either underperform or become apathetic, and services are unable to reform procedures or automate them. Often, permit applications languish on desks for weeks or months. Or procedures that could be handled online have to be administered in person at multiple locations. All in all, the system leads to millions of lost labor-hours. That’s a state that is inadequate, not too big.
Finally, the restricted market and weak state explain another stereotype about the “over-privileged” Greek employee: early retirement. Today, the clientelism and fiscal irrationality of the system incites fury. But the logic of early retirement is also applied by the U.S. government: It is used to decrease payroll without firing anyone. An (unskilled) employee who takes on early retirement could open up a position for someone (skilled and) unemployed. In Greece, the trade-off was not used this way and backfired badly: Pensions for early retirees now burden state budgets disproportionately. So, it was a bad policy that did not pay off. But again, the problem originates in Greece’s stunted labor market. When the state is weak, even reasonable policies are undermined by clientelism. But the cuts in early retirements currently imposed will mean fewer openings, and thus more workers seeking work in a beleaguered private sector, with unemployment approaching 26 percent.
IS THE STATE KILLING BUSINESS?
So why did the private sector not hire as much as it could or should before the crisis? The standard response blames the state. Greek bureaucracy and regulations are, indeed, an irrational accretion of measures, the judicial system needs radical reform, and the public sector has idle employees throughout. International measures classify Greece as “bad for business” (although, as we are learning, these measures have many problems). These conditions mean for some that nothing short of a revolution is needed. And the reforms required by the creditors are a Herculean task, which needs both resources and time.
Two facts further complicate the picture, however. When red tape and start-up costs are too high, rational individuals pool resources and share costs, through larger partnerships or firms. Yet, Greece remains one of the West’s highest scorers in micro enterprises and in self-employment, so regulation and cost are obviously not stopping individuals from entering or staying in the market, even in the face of endless hurdles. Greeks complain unceasingly about these burdens and costs. But instead of responding to incentives and pooling resources, they cheat the system or work at a loss.
Some completed reforms seem to have made an important difference in time and cost of setting up a small business and other indicators. But making entry and operation easier will not lead to growth if the pathologies that keep Greek firms small and inhibit collaboration are not addressed. To the contrary; lots of inefficient, failed “mom-and-pop” stores and businesses mean individuals with depleted savings and no social safety net (these failures become classic candidates for continued state nepotism, by the way). This is not the state’s fault. It’s a choice. Where the state has failed is in explaining that some of these costs are meant to be disincentives for those too small to survive in the market alone.
At the same time, the market is truly closed where large actors have oligopolies, for instance in staples like milk. This is partly why the CPI index has risen almost 10 percent since 2008! Only strong state action can take such privileges away and creditor pressure can be catalytic.
Another puzzle is Greece’s “closed professions”—law, engineering, pharmacies, and so on, burdened with multiple regulations and high entry fees. Economists object to closed professions because restricting entry and competition create shortages and make services costlier. Greek services are certainly costlier. Yet Greece has an excess of professionals in closed professions, not a shortage. For instance, the country has 380 lawyers per hundred thousand people, whereas the European average is 140. Same for taxis, doctors, pharmacies and so on.
This situation arose because the Greek state guaranteed minimum incomes to professionals, such as lawyers and secure profits for small businesses like pharmacies without limiting their numbers. Why? Because the professionals lobbied for it; not coincidentally, the majority of members of the Greek Parliament traditionally come from such closed professions.
Reforms aim to eliminate subsidies to these professions, thus preventing too many from choosing them. However, deregulation and the lifting of restrictions, which exist in all advanced economies, can cause anarchy, tax evasion, and fraud. Also, without successful pressure and incentives on other businesses to move beyond the small, manageable scale, job options will remain limited, and those diverted from the closed professions will have nowhere to go.
Greece has, nonetheless, made unprecedented steps to meet external demands since 2009. Tax revenue as a proportion of GDP is approaching the OECD average. All Greek tax returns since 2003 are now online, allowing the state to cross-check information. But since collectable property taxes rose, on paper, from 500 million euro ($546.8 million) to 3.5 billion euro ($3.8 billion) in two years, it is not surprising that actual payments have stalled. Still, reform measures have brought the deficit down from 15.4 percent of GDP to 3.5 percent in five years—a remarkable feat.
This progress has come at enormous cost: in unemployment, poverty, and political instability. Greece’s position in Europe remains in serious danger. Further, the newest fiscal targets considered by Greece’s creditors are widely expected to cause greater recession, which will put reform even more at risk. The Procrustean cuts in the public sector, apart from eviscerating social provisions, are leaving the state with fewer and more demoralized staff to face the increasingly Herculean task of reform. And unless it tackles vested interests and reforms, Greece will miss any targets—and then Grexit would become a real threat.
Without progress, Greece will remain what it has always been, a poor state with some rich citizens.Some incite social resistance by focusing on recent hirings. With almost 26 percent unemployment, some hirings will inevitably substitute for welfare. To meet targets, focus should instead be on procedural savings and efficiency, not leaving more people unemployed. In one estimate, in the pre-crisis era, bureaucratic inefficiencies alone were estimated to cost Greece 14 billion euro (then, $19 billion) per year, almost the size of the Greek deficit in 2007. There has been some progress. For instance, every year, citizens lost tens of millions of labor-hours just waiting in line to pay utilities and tax bills; now all bills are automated. This is just the tip of the iceberg, of course, but seizing potential gains requires time and organization, both of which are lacking.
For genuine reform to happen, Greece needs foremost three things. First, it needs a new vision for its civil service. Working for the state should be an achievement, as in other advanced democracies, not a substitute for welfare. Talented American undergraduates setting their sights on the State Department, for instance, know they may have to go through multiple attempts before they achieve their goal. This means, however, that salaries and benefits must be competitive, too. A market economy requires robust state institutions and you need to pay for these.
Second, Greece needs international help in getting its rich tax evaders to pay their dues and obey rules. It also needs to force its elites to declare their domestic income (current tax incentives for citizens to submit doctors’ receipts, for instance, are not strong enough). Taxing elites does not close all fiscal holes, but when the wealthy dodge taxes, the mass of the population sees no reason to do differently.
Finally, collaboration and efficiencies of scale have to be supported through incentives, for instance fiscal ones. The myth of the budding entrepreneur shackled by a corrupt state is only part of the story. The other part is that if the mom-and-pop stores, small businesses, and professionals that form the backbone of the Greek economy aren’t pushed toward collaboration and efficiencies of scale, hiring will lag, and growth will be uneven and, thus, socially exclusionary.
Without progress on all these fronts, Greece will remain what it has always been, a poor state with some rich citizens.