Greek tragedy: lessons learned for Timor-Leste

Greek tragedy: lessons learned for Timor-Leste

Cosme da Costa Araujo[1]

May 2013

The financial crisis of 2007-2008 led to a global economic recession, which the world has yet to recover from, and a European sovereign debt crisis, which is not yet resolved. Many consider the last five years as being the most economically challenging the world has faced since the Great Depression of the 1930s. Unemployment rates are high and rising, especially in South-European countries like Greece, and it will be a long and painful journey for these economies to get back on track.

The news of this drama does not claim headlines in remote Timor-Leste. Interestingly, the last five years of dismal development in main economies of the world has coincided with double-digit annual economic growth in Timor-Leste. Since our undeveloped economy still does not have strong trade links with the world markets, we are somewhat shielded from the downturn in global economic activity.

We need to recognize, however, that our strong economic growth in recent years is driven by a significant increase in the spending of petroleum income. Being non-renewable, petroleum income may look high today, but this inflow will stop in the not too distant future. Public expenditures, on the other hand, are difficult to curb, let alone reduce. These prospects set the stage for an evolving “financing gap” that needs to be filled by domestic revenues. Otherwise, we are just living beyond our means and will before long run into serious economic and social problems.

The core of the Government’s Strategic Development Plan is to create a robust and diversified economy with viable jobs that will alleviate poverty and also help provide the Government with sustained incomes to finance its programs. The development plan is bold and necessary, although not risk-free. The outcome may become different. This article looks at how things went wrong in Greece and discusses if there are lessons that Timor-Leste can learn from to avoid unnecessarily falling into known pitfalls.

What caused Greece´s debt crisis?

Important factors behind the Greece debt crisis include; (1) lack of fiscal discipline, (2) ineffective public spending, (3) structural challenges and macroeconomic imbalances, and (4) borrowing.

·         Lack of fiscal discipline is the most important factor behind the Greece debt crisis. Spending more than she could afford, Greece lived beyond her means for decades. According to IMF data, government expenditures were significantly higher than government incomes in all the years since 1980, when the recording started. The financing gap, as measured by the government net borrowing, peaked at EUR 36 billion in 2009, equal to almost 16% of GDP.

·         Ineffective public spending. A large part of the government´s budgets has been allocated to subsidies, wages, pensions and other entitlements. While a natural part of any modern welfare state, recurrent expenditures such as these needs to develop in tandem with the government´s income side, which again depends on economic growth and private sector employment. Instead of facilitating the latter, the government embarked on a dramatic increase in public sector employees, both in central government (ministries) and in municipalities, as well as a significant rise in the relative wage compared with the private sector. This did nothing to improve private sector entrepreneurship and competitiveness. Moreover, productivity-enhancing real investments were lacking. Many argue that the 2004 Olympics price tag of some EUR 7 billion actually triggered Greece´s demise.

·         Structural challenges and macroeconomic imbalances. The oversized public sectors lead to trade imbalances. On average, industrial production fell by 1.6% every year between 2000 and 2012. Without a competitive currency generating export sector to finance the country´s excessive demand for goods and services, the current account deficit ballooned at some EUR 50 billion in 2008, according to IMF figures. Widespread corruption and a business structure run by elites groups lobbying for government projects, cemented the economic malaise.

·         Borrowing for consumption. Not surprisingly, to be able to finance the excess, the government needed to borrow lots of money. Initially intended to finance productive investments, the loans soon became a central financing vehicle of the budget, increasing substantially between 2005 and 2011 from EUR 195 billion (100% of GDP) to EUR 356 billion (170% of GDP). The unsustainability became apparent and the possibility of defaulting approaching. 

Greece´s experience shows how fiscal slippage and ineffective spending lead to structural challenges and macroeconomic imbalances, which paved the way to ill-advised borrowing and misuse of those funds. Eventually, Greece found itself on the edge of the abyss with an agonizing journey ahead.

What price does Greece pay for its mistakes?

Tough austerity measures, meaning strict measures to align expenditures with revenues, are the high price Greece now needs to pay. The government has to significantly tighten its belt by cutting spending, raising taxes or both. Some has argued for Greece leaving the EU to assume more flexibility in its policy tools, but this outcome seems less likely, as it would represent a serious blow to this prestigious political agreement. The EU has provided rescue packages in terms of cheap loans to struggling European countries, including Greece, to prevent them from defaulting. These rescue packages have come with tough conditions, however, to get public finances back on a sustainable footing. Measures in Greece include wage cuts and other unpopular labor market reforms, increased taxes, increasing the retirement age and tightening loopholes in the tax system.

It is difficult, to say the least, to strike the right balance between necessary fiscal tightening in the face of default, on the one hand, and to offer some kind of stimuli to an economy on the slide, on the other. The Greek economy has declined since 2008 and is operating far below its potential with unemployment rates reaching 25% in 2012. This is not a time you prefer to slash public spending, but then again Greece has no choice. Unemployment rates at these levels are not merely an economic issue – it is a serious challenge for the society. People have repeatedly taken to the streets to show their disapproval with government policies. This kind of social unrest reminds us that at the end of the day it is ordinary citizens that have to pay the price for the government´s irresponsible behavior.

What can Timor-Leste learn from the Greece debt crisis?

Every country is different and has to find its own way. Every country will also make mistakes along this way, including Timor-Leste. Still, some mistakes are graver than others and some may be unnecessary, giving a true ring to the Chinese proverb telling us that it is wise to learn from your own mistakes, but it is wiser to learn from those of others. We are fortunate in the sense that experiences of others, either they are good or bad, like the Greece debt crisis, are readily available for us to study. Below are some yardsticks that will benefit Timor-Leste when it is navigating towards its overall goal of being a prosperous and strong nation. The point of departure is that we are currently a poor nation with temporary high income from the petroleum extraction. History has clearly shown that to be a significant challenge in terms of transforming the temporary windfall into persistently improved lives for all citizens.

·         Avoid the resource curse. This should be Timor-Leste´s top priority. Timor-Leste takes seriously the fact that developing countries with abundant natural resources often experience relatively weak economic development compared with countries without natural resources. The most important decision for Timor-Leste to avoid the resource curse is to separate the inflow of petroleum income from it’s spending. We have already done this by establishing the Petroleum Fund (PF). All petroleum incomes first go in to the PF before a suitable amount is being transferred to the state budget. The Parliament decides how much to spend and how much to save every year, taking into account the welfare of both the current and the future generations. The Estimated Sustainable Income (ESI), described below, is meant to help Parliament make that decision.

·         Maintain fiscal discipline. Timor-Leste is the second most oil dependent country in the world, after South Sudan. Petroleum revenue finances more than 90% of government's budget. Without a fiscal rule, it is likely that government spending will be too high. Appreciating that fiscal discipline is a precondition for a stable economic development, as Greece now painfully experiences, our PF framework involves the so-called Estimated Sustainable Income (ESI). In short, the ESI is how much oil money we can spend every year without depleting our wealth. One way to look at the ESI is as the “zero-line” in the budget. If we spend more than the ESI, we are running a budget deficit. That may be ok for a while, while important projects are undertaken (like the government´s Strategic Development Plan), but not for long. Greece ran a budget deficit for decades and that did not go well. Accordingly, Timor-Leste quite soon needs to align spending with ESI.

·         Be careful with borrowing. Timor-Leste has over $13 billion in the PF, so it is no obvious economic reason why the Government should borrow. Usually it is more expensive to borrow than to use your own savings. Sometimes, though, a poor country like Timor-Leste may benefit from concessional terms as well as technical assistance on the project level that makes pursuing the loans worthwhile. We need to remember that the loans have to be paid back, not by us, but by our children. Hopefully we invest the money wisely so that our children are better off than we are now and therefore are better enabled to pay off the debt. The experience from Greece and many other countries warns us that we should go about this very carefully.

           

·         Ensure a lean and efficient public sector. The number of people employed in our public sector has increased significantly since 2005. The increase in staff and their salaries is reflected in the upward trending government recurrent expenditures. There are limits to how many civil servants we need – and, importantly, can afford. We need competent people in our administration, but the public sector should not be the generator of jobs. That is the private sector´s task. The paradox is that if we make it overly attractive to work in the public sector with relatively generous wages and other entitlements, why pursuing a job in the private sector? A key principle to be adhered to in the public sector is putting the right person in the right place. This involves a strict merit based hiring policy and following up by rewarding those who perform well.

·         Boost the private sector and create viable jobs. As laid out in the government´s Strategic Development Plan (SDP), our prospects are dependent on a strong and competitive private sector that generates viable jobs. It is important to facilitate this development by ensuring that basic infrastructure is in place. Equally important, however, is to ensure that the business environment is attractive for foreign and domestic firms. Currently we have a long way to go, as documented in the World Bank’s Doing Business reports. One important avenue forward in pursuing the goals in the SDP is to provide the agriculture sector with readily available technology to increase the yields from its current low levels. This will also improve food security and reduce the drag on economic growth by replacing imports. Increased revenues in the agriculture sector will spread out in the economy and it is important to have Timorese ready to grab the opportunities that is most likely to occur in the service sector. We need to educate our people to make them skilled and ready and have a business environment that encourages firms to engage.

·         Ensure government programs are affordable over time. Pension schemes, for example, tend to appear cheap in the beginning, but become costly later. Being non-renewable, we know that our petroleum income eventually will diminish and cease. We should not put ourselves in a position where our public expenditures start accelerating when the petroleum incomes abate and peter off.  Rather, we need to be responsible and consider long-term sustainability when designing government programs.

·         Make sure every dollar spent counts. We are unlikely to achieve this if we try spending too much too fast. It is like pouring water into a small glass; it will soon spill over. Another way of understanding this is that if we spend more than the economy can absorb, the result will only be higher prices and not more economic activity that would create jobs. Effective spending is not only constrained by the absorptive capacity in the economy, another bottleneck is the capacity of our administration. Let us assume our public administration is able to efficiently process a budget of $1 billion. If we then double the budget over just a few years, it is likely that this will result in more waste. We need to be very thorough in selecting and prioritizing our projects. Our current high petroleum income may be perceived as a “soft budget constraint”, which makes it easier to approve projects with questionable long-term social and economic return.

What is the key take aways?

The main lesson the Greece debt crisis taught us is that we need to keep order in our own house. If we spend more than we can afford, we eventually run into serious problems that affect ordinary people. This is not just a lesson from Greece and the other troubled European countries nowadays, it is an easy-to-grasp key lesson from history; Fiscal discipline is a necessary condition for a sound and stable economic development.

Few, if any, will contest that it is important with budgetary discipline. The challenge in Timor-Leste is that the current big inflow of petroleum income may obscure our fiscal reality. We look wealthier than we in reality are. It is human capital and not petroleum that determines a country´s wealth. That is why Timor-Leste is still a poor country. The SDP is aiming to change that, but we need to sequence correctly. When SDP starts giving results in terms of more viable jobs and more sustainable income for the government, then we can start develop our welfare system accordingly. Anticipating success and in advance reaping the benefits of an assumed outcome is risky. It could cloud the most important condition for us to prosper as a nation – hard work. 

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[1]The opinion express in this analysis are those of the author’s personal opinion, and do not represent any institution the author associates with.

Cosme da Costa Araujo

Greek tragedy: lessons learned for Timor-Leste

Forum-Hakasesuk Publika, 27/07/2013