The IMF certainly wasn’t responsible for Greece’s economic downturn; indeed, Greece only entered an IMF programme (jointly orchestrated with the European Commission and the European Central Bank—the so called Troika) through a Stand-By Arrangement (SBA) agreed in May 2010, 18 months after the collapse of Lehman Brothers in September 2008 (the fulcrum point for the credit crisis).
Nonetheless, the IMF’s track record in both evaluating Greece’s economic risk before trouble hit and in helping craft a set of coherent economic policies that would supposedly build the foundations for renewed growth has been abysmal.
Unfortunately for the IMF, we have a ‘before and after’ comparison in the form of the last two Article IV Consultations (the IMF’s economic health checks) of Greece, the first conducted on July 2009 before the recession bit (here) and the latest conducted in June 2013 after all hell had broke loose (here).
Let’s start with how we always keep score in economics: GDP growth. In the 2009 consultation, the IMF forecast that GDP would contract by 1.7% in 2009, followed by 0.4% in 2010, before seeing a return to 0.6% growth in 2011 and 1.2% in 2012. In their words:
Staff projects negative growth in 2009 and 2010. Greece is feeling the downturn with some delay. Moreover, even with the staff’s weaker outlook relative to the authorities, Greece’s growth decline from peak to trough would still be milder than for the euro-area as a whole.
Milder? The reality was far, far worse: -3.1% for 2009 and -4.9% for 2010. And then far from rebounding, the downturn picked up speed with the economy shrinking an extraordinary 7.1% in 2011. For 2012, the advance estimates have the economy down another 6% plus. This is a stunning forecasting failure: the IMF was off by around 20%—a fifth of GDP!
Similarly with unemployment. Back in 2009, the IMF forecast that the unemployment rate would top out at 10.9% in 2009, before a gradual improvement back into single digits in 2012. In reality, unemployment rocketed to over 24% in 2012 and is still climbing in 2013.
The 2009 IMF ‘Staff Appraisal” (page 33) identified all of the weaknesses subsequently targeted by the Troika’s programme: 1) high wage growth endangering competitiveness, 2) excessive government spending partially caused by a bloated public-sector wage bill and unsupportable pension benefits, 3) an inadequate tax revenue raising system, 4) rigid labour markets and 5) poor data collection and statistical systems. Yet the IMF still abjectly failed to grasp the potential for a major crisis.
One could blame Greece’s terrible numbers (keeping in mind Eurostat’s notorious upward revisions to Greece’s government deficit and outstanding debt in 2010 and 2011), but this is not good enough. Greece already had a horrible fiscal deficit of 5% in 2008 (using IMF numbers at that time) and a huge current account deficit of 14.4%. More important, its banking sector was severely overstretched and under-capitalised, something the IMF completely missed. Here is the IMF’s evaluation of the banking sector in July 2009.
Stress tests suggest that the banking system has enough buffers to weather the expected showdown. Systemic risks appear contained as profits, capital cushions, and provisioning should provide enough resources to absorb impaired loans in Greece and Southeastern Europe. Liquidity policies of the European Central Bank are also helping, debt and interbank markets are slowly opening up, and there remains room under the banking package.
Twelve months later the vast bulk of the Greek banking sector was subject to public-sector bailouts, de facto nationalization and forced mergers. The IMF’s evaluation of banking sector risk was totally and utterly wrong.
The IMF’s inability to grasp reality would not be so bad if it were a one-off event—perhaps the result of being hoodwinked by Greece’s dodgy statistics. Yet even after Greece entered the IMF programme in 2010, and the level of inspection and supervision was ramped up by an order of magnitude, the IMF still repeatedly failed to grasp the severity of the recession. It admits as much in this chart taken from the Ex-Post Evaluation of May 2013 (note SBA means Stand-By Arrangement).
And this for unemployment:
We should also keep firmly in mind the difference between primary economic objectives and secondary ones. Paul Krugman, in his book “The Age of Diminished Expectations” (what I think is by far his best book for a general audience), provides a careful critique of how we should differentiate between the two. The three things that really matter according to him (which I concur with) are GDP growth, unemployment and inequality. Not coincidently, these three things have a large bearing on human contentment according to the academic literature on happiness (if I had to nitpick, it would be with the importance of GDP growth, but that is a different discussion).
The secondary economic considerations (and no nitpicking from me here) are things like inflation, the current account deficit, government financing shortfalls and exchange rates. Of course, these things all have a bearing on the Big Three factors, but they are only important as such. If you run your country so you have a balanced budget, a current account surplus, low inflation and a strong currency, this all counts for nothing if you have zero growth, serious unemployment and mounting inequality.
By contrast, the IMF, in the ex-post evaluation of its lending programme, defines its objective thus:
The primary objective of Greece’s May 2010 program supported by a Stand-By Arrangement (SBA) was to restore market confidence and lay the foundations for sound medium-term economic growth through strong and sustained fiscal consolidation and deep structural reforms, while safeguarding financial sector stability and reducing the risk of international systemic spillovers. Greece was to stay in the euro area and an estimated 20-30 percent competitiveness gas would be addressed through wage adjustment and productivity gains.
Note here that two of the Big Three—’unemployment’ and ‘inequality’—don’t get a look in. Moreover, the economic growth path has been a complete and utter disaster. The IMF pats itself on the back for the achievement of “strong fiscal consolidation” but given that this was an associated cause of the implosion in economic growth (with the prospect of sound medium-term economic growth nowhere to be seen), this is hardly a cause for celebration.
Further, the jury is still out as to whether “spillovers” that might have a “severe effect on the global economy” have been “contained”. As I mentioned in my last post, Greece has actually exhibited amazing socio-politial resilience given its unprecedented contraction. Can we count on this continuing if growth should remain elusive for more years to come? We just don’t know, although I suspect not. This is a dangerous gamble that the Troika is making.
In my next post, I want to dig a bit deeper into the structural reforms and potential for future productivity gains—the foundations for any return to growth and stability—again drawing on my recent experiences of a political tour of Greece. I actually don’t think the IMF (or for that matter the Troika) have any grasp of the headwinds preventing a return to growth in Greece, and this is what I want to address.
Interesting to ponder what Greece’s GDP would have done had the IMF forecast a 20% drop! I see forecasting as much art as science – as is reading a forecast. To me, the key words are “the staff’s weaker outlook relative to the authorities” – ie ‘its going to be worse than you think’ and they were right. Current ‘jobbing backwards’ on forecasts of future oil production is a case in point. Direction of travel not absolute accuracy!
Although the IMF said that its outlook was “weaker than than the authorities” they were only looking at a recession with a total decline in GDP of a little over 2%; in reality, the decline has been over 20% and still counting. This is an order of magnitude higher! In all the years in the markets, I have never seen anything quite like this. Moreover, the entire Troika-mandated programme was built on the incorrect premise of a relatively mild recession (note that GDP is the denominator for most measures of debt sustainability). Forecasts in economics are by definition never accurate, but they should have some connection with reality. The IMF’s forecasts were spectacularly wrong and this led to the incorrect application of policy. I also think that the IMF’s failure here is also a reflection of the failure of traditional theoretical models employed by the IMF and others in a low/post-growth world. I’ll come back to this in another post.