An ambitious government

On 22 July, Prime Minister Kyriakos Mitsotakis’ New Democracy government won a vote of confidence after three days of debate in the Greek parliament. The vote was a formal endorsement of the government’s policy program after the decisive victory in the election on 7 July. With 40 percent of the votes – more than expected – and 158 elected members of 300-seat parliament, Mitsotakis has been dealt a strong hand to push through a substantial reform program. Mitsotakis has applied a new and much more business-like style of government. The change was visible on election night: the necktie is back in Greek politics.

 

The defeated Syriza-government and Alexis Tsipras received 31.5 percent of the votes and clearly outperformed expectations. Combined with small break-aways, including former finance minister Yanis Varoufakis, the hard left actually gained a higher share of the vote than in the September-2015 election. Add to that the unreformed Communists at 6 percent. Tspiras will become a formidable opponent, when he can rail against Mitsotakis’ liberal reforms without the burden of government holding him back.

Syriza deserves some praise

Tsipras deserved praise for returning Greece to something resembling “normal”. Elected a rebel insurgency in January 2015, Syriza took on its creditors. Finance minister Varoufakis tried to force Greece out of the euro but ended up forced out of office. The aid package from the summer of 2015 contained more demands for structural reforms than previously. Since then Greece has become a trusted partner in the EU: not blocking sanctions against Russia as could have been the case, playing a constructive role in handling migration flows, and solving the long-lasting name dispute with Northern Macedonia.

 

Syriza has adhered to the fiscal targets – and overperformed – but has continued to drag its feet on more fundamental reform and privatization. It has used the state – as its predecessors – to favor own constituencies and land plum jobs.

 

The government used its administrative powers to block private projects. Even Chinese Costco has felt the long bureaucratic arm of the state. Its plans for developing Piraeus harbor has been hampered by delays and red-tape; some of the resistance is from local shopholders, who fear competition from new shopping venues. Now the Central Archaeological Council has declared much of the harbor an archaeological zone, further complicating matters.

 

The old Athens airport of Hellinikon remains undeveloped as government ministers have used their powers to block progress. Unsurprisingly, the new government has made the EUR8 billion Hellinikon-project one of its top priorities. Thousands of jobs could be forthcoming, both during the construction phase and later when in operation as a tourist destination.

No grace period

Mitsotakis has taken a very hands-on approach to governance and started work on day one. Government ministers have been given a set of goals and has been told to present a plan for monitoring progress. It is no longer allowed to hire relatives into the civil service or use relative-owned contractors. That is a big deal in Greece. The summer holiday for the parliament has been cancelled, as the government will soon put forward a major tax reform.

 

Mitsotakis has argued that the Greek economy is overtaxed, contributing to loss of economic activity and tax evasion. Self-employed professionals and family-run businesses current face a marginal tax rate of up to 75 percent. The average corporate tax rate is 35.2 percent. VAT has been increased to Northern European levels, which masks a decline in relative consumer prices.

 

The tax plan is central to the economic program and consists of many elements. Among them are:

A reduction in the corporate tax rate of 28 percent to 24 percent this year and 20 percent in 2020 with the dividend tax cut from ten to five percent. Write-offs for capital investments are to become more generous to spur more private-sector (and foreign) investments. A reduction in the lowest tax rate from 22 to nine percent, and reduction of the higher rates, which are currently 29, 39 and 45 percent. Changes to the value-added tax. The property tax ENFIA is to be cut by 30 percent over two year. ENFIA is one of the most hated taxes forced upon Greece, in part because it actually delivers substantial revenue. Previous governments have wanted to removed it but have failed in finding replacement sources of revenue or budget cut.

 

This is also the problem with the current tax plan. While generally supported by European leaders as promoting economic growth, Mitsotakis has so far not been allowed to deviate from the fiscal targets. Hence, tax cuts either have to be financed through cost cutting or by expanding the tax base to make the cuts budget neutral.

 

Indeed, the target for 2019 of a primary surplus (before interest payments) of 3.5 percent already looks challenged, as the outgoing Syriza government handed out pension bonuses and tax cuts prior to the elections. Bank of Greece expects the surplus to decline to 2.9 percent of GDP without corrective measures with the EU only counting on a 2.5 percent surplus. Hence, Mitsotakis not only has to find the funds to pay for the tax cuts, but also find extra savings elsewhere.

 

On paper, more tax compliance could increase tax revenues, even if rates are cut. There are tentative signs in Italy of higher revenues as electronic reporting of retail sales are introduced. However, no one outside Greece believes in better compliance until it has been proven.

 

Mitsotakis will have to create results quickly; more privatizations and approval of pending private projects would be an easy – yet controversial – way to kickstart the reform process. If the euro partners are to relax the fiscal target for 2021 and 2022, Mitsotakis not only has the deliver on agreed reform measures, but also go far beyond to prove his reformist zeal. Reducing bureaucracy and tax evasion would certainly impress Brussels.

Hence, one of the areas of potential savings in the public-sector wage bill. Just an example: Greece has nine diplomatic missions in the US alone; one embassy, six consulate generals, and two consulates. On top of that a strong military representation. While the public-sector wage bill has been kept fairly steady, the employment within public administration has risen by 20,000 to 349,000 since 2017. Mitsotakis has previously not been afraid to cut employment, and his drive for a more efficient state could very well include a much smaller bureaucracy. However, public-sector unions have very strong powers over work conditions, pay and promotions. A move to a more professional civil service based on merits would run into stiff resistance.

The fiscal challenges remain daunting, although a period of stronger economic growth would reduce the titanic task of making the Greek government debt sustainable in the longer run. Public debt stood at 181 percent of GDP end-2018 and is expected to decline to 176 percent of GDP this year. If we assume the debt remains at EUR 333 billion and set nominal GDP-growth to 4 percent, the debt ratio will have declined to 80 percent of GDP by 2040. There is absolutely no room for lower fiscal ambitions.

A long way to go

The more stable political framework in recent years – and strong growth in tourism – has returned the Greek economy to growth. However, the current GDP-growth of less than 2 percent is not what could be expected after such a steep decline. The unemployment rate has declined from 26 percent to 17 percent, but that is mainly due to continued emigration – particularly of young people. The numbers of births is down by 26 percent compared to pre-crisis.

 

Greece continues to face substantial structural problems that goes way beyond a bloated public sector. While Syriza has used the powers of the state to block private enterprise more broadly, it is a long-running tradition to use administrative powers to limit competition in favor of political allies. These are some of the issues Mitsotakis has promised to stop – but also what could become the most challenging part of his premiership. Businesses cheer the prospects of lower taxes, but frown upon changes to promote competition and efficiency. Gains in these areas could – in theory – propel the Greek economic from the current anemic state, but those who now benefit from protected markets stand to lose. Hence, while the prospective gains are huge, the political pitfalls are equally substantial.

 

While Mitsotakis offers a fresh start after en long period of bailouts and decades of abuse of power by previous governments (one previous prime minister is now back in government), it will not be smooth sailing for his plan to reshape Greece into a growth-oriented liberal economy. Domestically, Syriza and vested interests will fight him. Internationally, there is much goodwill towards him but also no trust in the ability to deliver on promises of a smaller and more efficient state, improved tax collection and more privatization. Financial markets have cheered the prospects of a new, business-friendly course. However, Mitsotakis will find plenty of headwinds ahead.