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Friday, May 13th, 2011

Greece: it’s worse than you thought
posted by Ross Dawkins

It has been apparent for some time that Greece’s finances are a complete horror show (and not in the cool, Clockwork Orange sense).  It’s equally obvious that Greece will not be able to tap the market for funding (at least not at the level it needs) either in the short-term or the medium-term.

Given that the immediate problems are sufficiently pressing, the long-term sustainability of Greek finances is simply not part of the current debate.  This is a perfectly rational approach for bond traders.  If your investment horizon is measured in weeks then the latter simply does not matter — your concern would be a change in the way your peers in the market perceived this.  

However the size of the long-term fiscal gap and the scale of the intergenerational flows implied by the commitments made by successive Greek governments are of interest, I think, in terms of the structural reforms necessary in Greece and the nature of any re-negotiation in its outstanding obligations.  They are also indicative of how far ahead Greece’s political promises to itself have overreached of its economic capacity.  

The following chart highlights the long-term problem. (This chart is drawn from the “Sustainability Report 2009”, published by DG ECOFIN, which assessed the fiscal sustainability of EU Member States out to 2060).  The closer a country is to the top right-hand corner, the greater the adjustment required.  The long-term projections make (necessarily heroic) assumptions about demographic change and the impact of ageing populations.  Over-generous and underfunded pension promises put Greece (“EL” in the chart) high up the vertical axis.  Our current fiscal predicament pushes the UK out to the right. 


Whilst the Greek government has made some progress on unmaking past political promises the starting fiscal position is (much) unhealthier than that presented in the chart. 

In short, Greece’s fiscal position is no more sustainable long-term than it appears today (and possibly less so). And remember that this is a structural problem: simply re-scheduling Greece’s debts or even a write-off of part of them would not alter Greece’s position on the above chart.  Further action to both promote economic growth and to undo past political pension promises are essential components in any rescue plan that is to be successful.