Thursday, 24 February 2011

The Greek situation...

If I am not mistaken there was an announcement from the Greek finance minister that additional measures  amounting at 8% of GDP will be implemented until 2014. But what are these measures going to be?

Well, nobody knows since political cost is a large part of the equation and most of the measures that have led Greece into stagflation were put in place for exactly this reason. But maybe there is no more room for such measures any more.

Among all implemented measures, the most damaging for private consumption was the raising of VAT rates for various groups of goods and services.

Basic economic theory (Laffer-Curve) supports that, when tax coefficients are raised above a certain threshold, any increases of the tax rate results in decreases of tax receipts since it actually affects demand in a negative way. The question is whether VAT rates have been increased at such levels that any further hikes will just decrease tax receipts.

For goods that display high elasticity of demand this is true. To be honest though, consumers had cut back on spending in these particular categories of goods, mostly consumer discretionary, long before the hikes in VAT rates.

But now, even for categories of goods that are not demand-elastic, we have passed this threshold and any further increases in VAT rates will result in reduced tax receipts. The going-ons in the vast majority of the Arab countries has highlighted that food prices inflation can lead to serious social unrest and can indeed be the spark that ignites the already boiling anti-government sentiment (by that I do not mean that food-prices inflation was the only factor that led to the unrest that we are witnessing these days, of course there were other reasons).

The first wide group of goods that seems to be beyond the threshold pointed by the Laffer-Curve is food-alcohol and tobacco. Both retail sales volume and retail sales turnover indices are decreasing at the moment, pointing at declining VAT receipts. The continuing and disrupting strikes by public transport workers in Athens during the past months are not fully reflected here. Of course food and tobacco sales will not be affected by them majorly since most people shop for these items close to their homes. But maybe alcohol sales will be affected a bit more, since the notoriously fun-loving Greek people may have faced trouble when intending to go out. But then, the workers were not on strikes during the weekends. Well, maybe rises in fuel prices have played their part here.


The other category of goods that is not that price elastic is fuel. Here retail sales volume is decreasing (from an already low base, since 2009 fuel sales were especially weak) but retail sales turnover is posting robust increases, so tax receipts probably won’t be declining in this case.


On the other hand the long-lasting decline of sales is having an impact on the sector since anecdotal evidence suggests that gas-pump stations are closing down in numbers.

I think though, that further tax rate increases are best to be avoided since, we are looking at another possible source of social tensions (i.e. heating oil prices). Besides the Greek winter will probably not be in the house for long more so, the effect of further tax increases will not be that big until next season.

All in all, I think that further VAT hikes would be futile and would possibly have the inverse effect of that hoped for, if enacted. 

What scope for other types of measures is there though ? Not much it seems. It is true that the social tension can be felt by all of us here in Greece, so that makes the government reluctant to bring on changes that will ruffle the unions. But maybe we are at a point that there is no more room for measures that don’t do exactly that.

The forbidden word, as far as Greek state workers are concerned, is lay-offs. Even workers that are judged to be surplus to their respective departments’ needs are not going to be sacked but rather moved on to other parts of the public sector. Of course this is not addressing the problem.

There is a sensible counter-argument here, that lay-offs will only deepen the recession right now. Of course letting the surplus workers of the public sector means that maybe VAT rates would be able to be brought down a bit (in theory, since what goes up in Greece rarely goes down, unless we’re talking about the ASE of course). But even, if something like that miraculously materializes what will its incremental effect on consumption be? With Greek people’s morale so low, not much I suspect. So, probably lay-offs are out of the question for now. Of course, the Greek pablic sector is in desperate need of downsizing,but maybe the timing is not perfect right now, especially factoring in the eventuality of unions uprising.

Does that mean that the time for a restructuring of Greek sovereign debt is near? I honestly don't know. If we judge by the way the EU handled the crisis that far (i.e. taking very small and hesitant steps), should something like that be decided, this could mean a lengthening of the maturity of the EU/IMF loan as a first step I don't want to speculate on the probability of any similar actions for the rest of the Greek sovereign debt, I will only say that EU has proved that they take one step at a time...

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