Prosperity Unbound

This op-ed was written by Elena Panaritis back in early February 2010, in response to inaccurate and misleading comparisons made by a number of economists, between Greece of today and Argentina of 2001. In her original piece “Last Tango in Athens”, Elena questions and refines this analogy by offering a more even account of the causes for the crisis in Greece and the larger EuroZone, as well as concrete steps for reform in the medium term.

Today, Greece’s economic outlook looks grim. Bond spreads are climbing as are the country’s risk ratings. Finger pointing is in full-force, centering on the way Greece is managing the crisis. This is hardly fair given the fact that Greece is a member of the EuroZone – a monetary union regulated and overseen by its members. More worrisome, over the past two weeks, have been the comparisons between the Greek experience and that of Argentina in 2001. But is this analogy correct? Are we about to see one last tango in ancient Athens, or are we really in line for a group dance in the courtyard of the EuroZone?

The crisis in Greece became evident last October (2009), when the newly installed government rushed to Brussels to explain that its predecessors had understated Greece’s budget deficit by 7 percentage points of GDP, and that the actual deficit was a staggering 12.7% of GDP, more than four times the allowable level for European Union member states. To make matters worse, the new government had inherited an economy that was contracting even as its deficit was rising. Sovereign bond holders were left to wonder how many other areas of the Greek government were dysfunctional and whether institutional strengths have been overestimated. It wasn’t just Greece that came under scrutiny: the EU surveillance mechanisms also were called into question.

Greece’s original sin, as it is now evident, has been its long history of running budget deficits, averaging 7.5% of GDP for the past 20 years. The crisis in Greece is not about a simple adjustment of macroeconomic fundamentals and is certainly not a dilemma that appeared overnight.  In fact, it reflects a large level of informality in many economic sectors, low productivity growth, weak institutions and a too-large civil service  leading to a large waste of resources.

Is the comparison to Argentina of 2001 instructive?

Many make the mistake of linking present day Greece to Argentina of 2001 (because both gave up their monetary policy and local currency to a stronger different currency; Argentina with the US dollar and Greece with the Euro) and of predicting one last tango in Athens, ignoring the fact that the tango actually is being danced in the EU at large.

When Argentina entered into a Currency Board with the US dollar, it signaled that the country was serious about economic reforms, attracting foreign direct investment and moving toward a sustainable path to prosperity. The currency board allowed Argentina to insulate its monetary policy from any populist or political pressures taming the problem of hyperinflation. The central government and its 23 provinces were bound by the Argentine Constitution to follow US monetary policy. There was, however, no Argentine representation at any meetings of the U.S. central bank. Any increase of the US interest rates would have increased the capital inflow in Argentina creating internal inflationary pressures and reducing competitiveness, as well as the ability of the country to service its debt. In the meantime, the informal sector in Argentina remained at very high levels – informality keeps productive capacity and wealth outside the country’s measurable GDP. Institutional reforms to address the root causes of the country’s weaknesses were not adopted, hindering gains in competitiveness.

If we look closely at that period, we would also notice that Argentina’s provinces engaged in more and more fiscal spending, perhaps under the presumption that Buenos Aires would bail them out if they got into trouble. But what many local governors did not know or preferred to ignore was the fact that a currency board would have made it impossible to pick up the local tab. Argentina could not print US dollars.

In brief, what appeared to be an economic rescue for the country in 1992, namely the peg to the US dollar, in about 10 years had proven deadly for Argentina. Exit from the currency board was not well contemplated, nor were any clauses that could have allowed for the central government to mature and transform its institutions that handle property rights, contract enforcement and transaction costs.

Similar to Argentina, the Euro zone (not Greece alone) has come to face its structural deficits in a painful manner. In this context, the Greek experience resembles those of Argentina’s indebted provinces leading up to the 2001 crisis, with one important difference: unlike Argentina’s local and national government, Greece has a seat at the table and is represented at the European Central Bank.

The main structural problem of the EU as a monetary union is that not all members of the EuroZone were equally ready to adopt the Euro. Institutional differences were assumed away, while informality and the cost of enforcing contracts were underestimated. EU subsidies were used to resolve and compensate for economic weaknesses that were not identified as institutional in nature. In reality, subsidies often exacerbated existing institutional failings in some member countries.  They also increased the lack of transparency in the local public sectors, raised transactions costs and dampened eagerness and political will to deal with structural problems.

This leads us to where we are today: The financial markets are looking beyond Greece and the ability of the Greek government to stem the crisis and are questioning the ability of the European bureaucracy to manage EU members. In fact, Greece may have its unlikeliest hero in the socialist Prime Minister George Papandreou. The mounting crisis is pushing the Greek PM to adopt immediate fiscal measures (such as tightening public spending and fighting tax evasion) along with longer term structural reforms (such making the public sector more efficient and integrating the informal economy). If Papandreou is able to advance tough reforms, he may set the course for an EU structural reform effort, create a social network for the Union’s weaker members, or allow for the issuance of financial products such as a Euro Bond, that might avoid punishing high interest rates.

At the moment, the EU lacks the legal ability to design and implement a bailout for an individual member under duress, including Greece. But legal obstacles can be overcome and the EU clearly recognizes the gravity of the situation.  If Brussels can establish an action plan and lead the support to Greece possibly also enlisting the experience of the International Monetary Fund. In the short-term, the focus should be on finding a viable (if ad hoc) solution for Greece. Such move will provide the EU with some breathing space to design and implement a long-term structural reform of the EuroZone that will allow for sovereign debt restructuring while addressing the issue of member countries’ overextended public debts with an expectation of a bailout.

Education provides an interesting case of institutional reform.  The administration of education requires no overarching agenda.  Reforms can be done piecemeal, tackling one particular problem at a time with reforms accumulating on top of each other in layers …. The means of achieving education improvements tend to contradict each other.  Incentive structures breakdown under complex arrangements of competing agendas.  Sometimes intended incentive structures for reaching high education standards are never established.

The public – at large – feels inadequate to tackle the how’s of education.  Sensing a lack of expertise in the area parents leave the agenda setting to the suppliers of education.  The suppliers of education are represented by teachers’ unions.  Teachers’ unions come with their own set of priorities which are often counterproductive to improving education process (i.e. tenure and job security, resisting performance-based initiatives).

Educational reform pays very minimal dividends for a politician.  A politician needs positive outcomes of reforms to be visible before the next election cycle comes around.  However, a president does gain points by claim to undertaking educational reform during his term.  So while the fundamentals and substance of the reform may not be visible for a decade’s time, the fact of having instigated any semblance of reform gains him higher approval ratings among the public.  Thus, we find education reform guided by the interaction of these two key forces: teachers’ unions and the executive branch.  With each bringing their contravening reform agendas, reform outcomes increase capacity (i.e. more schools, more teachers, and more computers) which is positive for all, and neglect to restructure incentives to improve quality and efficiency, which threaten teachers’ job security.

In the 1990s over a dozen Latin American countries underwent educational reform.  While the objectives of the reforms were to improve quality and efficiency as well as capacity, the reforms generally improved capacity and decentralized administration but failed to make any significant improvements in quality and efficiency of education.  The region, as a whole, scores very poorly on international standard tests, particularly in reading and mathematics.  Major efforts were poured into the educational reforms throughout the 1990s, and presidents across the region could boast of their achievements on the campaign trail.  Twenty years later, we’re recognizing that the reforms haven’t substantiated improvements of quality and content in the process of learning.

Educational reform, then, is an area that very much benefits from Reality Check Analysis.  To disregard existing institutional arrangements, broken incentive structures, layers of reform agendas piled on top of each other, combined with the expectations of making concessions to the parties present at the negotiating table will engender superficial adjustments with outcomes that fall far short of intentions.  But by the time outcomes are realized, a former president might be finished writing his memoirs.

Effective educational reform requires policy entrepreneurs and a reform team combining all the elements affected by education (which might not always be brought to the table) including: parents, administrators, teachers, other regional power players and the executive branch leading the reform.  Step one is to corporately create a vision for where the country wants to be in ten, twenty years.  Looking into the future, it is generally fairly easy to come to a consensus of direction: “we want to improve math and reading skills, to be on par with East Asia”, for example.  Starting from this point effectively commits all parties to the reform team to finding a way to achieve these ends.  It brings a common agenda to the interests of all key players: “we all want to achieve the same ends, bettering our children’s education”.

Secondly, it builds trust among the parties to reform.  For instance, teachers are reassured that the government’s goal is not simply to find a new source of revenue to redirect elsewhere in the budget by cutting teachers salaries, or that administrators want to find an excuse to fire their educators.  The goal instead is to help make teachers the best teachers they ca be.

Third, following Reality Check Analysis, the team must dig into the relevant legislation and explore the nuances of all relevant state and local educational institutions.  the proposed reforms must take the interaction of these power players, their desires to maintain a ‘place at the table’, and discretionary powers.  The goal is two-fold: either replace existing legislation with an entirely new system, or encompass existing regulations into the reform plan.  Secondly, work together to find a win-win situation for everyone.  Teachers’ unions will be more likely to make concessions if they’re given the opportunity to negotiate behind closed doors as part of the reform team than confronted with a completed ‘take it or leave’ reform agenda.

Innovative approaches are possible.  In Washington D.C. Chancellor of D.C. schools Michelle Rhee tried to take on the tenure issue, with an opt-out for teachers: you can either 1) keep your tenure at same pay, or 2) opt out of tenure and agree to performance reviews, with the opportunity to almost double your salary.  The problem: the teachers union would not even let the teachers vote on it.  The union fears the consequences and resulting diminished power of the union.  Maybe a reform team approach, using Reality Check Analysis could help bring consensus to improve the quality of education in our nation’s capital.