So, Greece needs to prepare the ground for modernising the state with effective short term policies. This would entail the reduction of corporate taxes, incentives for investment and employment and digitisation/automation of public services. Combining those policies with a strong message of change can kick-start economic activity and bring the country back to growth.
The Fight between the Currency and Institutions
Joseph Stiglitz, the Nobel Prize-winning economist, argues in his latest book that the Euro is at the root of the economic problems faced in many European countries. It becomes an obvious conclusion for an economist who has been studying countries coming out of crises by devaluing their currency, to argue against a fixed currency rate in a union of very different economies.
But, is this entirely true? Is the problem in Europe really a currency problem, or a problem of competitiveness and malfunctioning institutions? It is obvious that by attributing economic problems in Europe to the common currency, what economists effectively do is giving EU countries an easy external enemy to blame for their woes. It also provides countries with an alibi to sweep their real structural economic problems under the rug.
One of the best examples of a European country to test those questions against is Greece. The economic problems of Greece are a known quantity to most, and populist politics that have emerged as a result of years of crisis have made the country’s prospects even worse.
For the careful observer Greece is a country that never built a set of modern and credible institutions. The democracy that followed the fall of the military junta in 1974 was largely based on nepotism, favouritism and a rotten political system that exchanged protected jobs and economic rents for votes. The public and private economy were formed around this ill-created system of special interests that reinforced itself in the decades that followed until it collapsed with a fiscal deficit of 15.6% in 2009.
Greece: a Free-Rider State
The lack of sound institutions and trust in the economy made Greece a characteristic example of a free-rider state. A state in which success was guaranteed through highly paid jobs in the public sector and hefty government contracts in the private sector created no real incentives for economic actors to contribute from their incomes to public goods and services. At the same time, employment for life and bad administration in the public sector never created incentives to employees and state enterprises to provide high quality services to citizens and corporations. As a result, free-riding extended across the public and private sectors and its key characteristic was distrust of everyone by everyone.
Ill-created and malfunctioning institutions raised barriers to entry and imposed high transaction costs across the economy, formal and informal (bribery etc). In the latest years of crisis in Greece, free-riding has evolved to take an even more onerous and extreme form. For Greeks, it is no longer a matter of not contributing and thus enjoying public services for free, but rather a matter of not contributing and trying to avoid any form of interaction with the punishing state institutions.
As a result, thousands of companies have fled Greece to avoid the high taxes and onerous bureaucracy. The same happened with highly educated young individuals who move abroad in droves to seek a better future. Those who can are looking to escape from a failing system that distributes poverty and unemployment while draining any healthy economic activity from resources and growth prospects.
On the other hand, the economic actors that maintain their activity in the country have no incentive to engage in long term investment and rather seek to make opportunistic profits through sort time horizons, minimal levels of fixed capital and small scale.
The shadow Economy
Onerous taxation, combined with a lack of sound institutions, apart from leading to opportunistic profits or companies and people fleeing the country, further amplify a chronic problem in Greece, which is the shadow economy. Greece’s shadow economy has been depriving the state from valuable revenues for years but this was naturally exacerbated during the crisis and austerity years. Research by F. Schneider and C. Colin has shown that Greece had the largest shadow economy as a percentage of GDP in the Eurozone back when the currency started circulating in 2002.
Greece’s shadow economy was estimated to be 27.4% of GDP in 2003. Since then it has been declining steadily to 24% of GDP in the last year of available data in 2012. The fact is, only Italy has a comparable shadow economy, at 21.6% of GDP, while the rest of the first 12 Eurozone countries range from low to medium teen levels (10.8%-16.8% excluding Portugal’s 19.4%).
Greece, which needed to suppress corruption and tax evasion more than any of its peers in Europe, has consistently had the biggest shadow economy. The crisis and austerity have made things only worse, compelling the government to keep raising taxes and cutting wages and pensions to produce the required annual primary budget surpluses. The capital controls imposed in 2015 and the consequent reduction in circulating cash has shown some signs of limiting the shadow economy but it is still early days and repeated tax rises across the economy only pull things to the other direction.
To be continued…
 The Euro and its threat to the future of Europe, Joseph E. Stiglitz, Penguin, 2016
 Institutions, Institutional Change and Economic Performance, Douglass C. North, Cambridge University Press, 1990
 The Shadow Economy, F. Schneider and C. Colin, The Institute of Economic Affairs, 2013