GREECE: ECONOMIC PROBLEMS DEFY PAPANDREOU'S SOLUTIONS

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Intelligence
Directorate of Secret
.~;-IASTFIR 1`21L L"
Papandreou's Solutions
Greece:
Economic Problems Defy
State Dept. review
completed
Secret
EUR 83-10071
March 1983
297
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Directorate of Secret
Intelligence
Greece:
Economic Problems Defy
Papandreou's Solutions
This paper was prepared by
Office of European Analysis. Comments and queries
are welcome and may be addressed to the Chief,
Iberia-Aegean Branch, EURA
Intelligence Council.
Secret
EUR 83-10071
March 1983
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Greece:
Economic Problems Defy
Papandreou's Solutions
Key Judgments We believe the Greek economy remains as much a liability for the socialist
Information available government as it was for its predecessor. Prime Minister Papandreou can
as of 14 January 1983 with some justification blame his problems on the world recession and the
was used in this report.
policies he inherited, but he has increased inflationary pressures by hiking
government spending and has discouraged much-needed investment by
alienating the business community with higher taxes, wage increases, price
controls, and threats of nationalization. Weakness in some key categories
of the balance of payments have, to a degree, been masked by drawdowns
of oil stocks and foreign exchange reserves, borrowing abroad, and an
increase in receipts from the EC budget.
Although the Prime Minister may have resigned himself to a more gradual
implementation of his social programs, we think he is unlikely to embrace
corrective measures fully or quickly enough to restore Greece's economic
health. Balance-of-payments problems and an inflation rate already the
highest in the European Community will argue for restraint. But he
probably will meet strong resistance from labor-his major constituency-
to any decline in real wages. We believe that Papandreou will continue
economic policies that fall short of the country's needs, and that popular
support for the government will erode if Greece lags the rest of Western
Europe in the economic recovery.
iii Secret
EUR 83-10071
March 1983
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Greece:
Economic Problems Defy
Papandreou's Solutions
A Meager Inheritance
Greece was experiencing severe economic problems
before Papandreou took office. Indeed, public dissatis-
faction with New Democracy's handling of the econ-
omy was a major factor behind his election. Economic
growth slowed sharply during 1979 and 1980, and in
1981 GNP fell. Meanwhile, the inflation rate hovered
around 25 percent, and the current account deficit
ballooned from $1 billion in 1978 to a record $2.4
billion in 1981. While OPEC price hikes and the
world economic slump exacerbated Greece's prob-
lems, policy mistakes also played a key role. New
Democracy made a bad situation worse with massive
preelection spending that pushed the 1981 public-
sector deficit to an extraordinary 17.4 percent of
GNP. The former government failed to resolve such
structural difficulties as a topheavy and underdevel-
oped banking system, an overstaffed bureaucracy, an
antiquated tax system incapable of coping with wide-
spread evasion, and a sheltered manufacturing sector
made up largely of small inefficient firms.
Papandreou's First Year:
Expanding Government's Role
Although Papandreou has been more moderate than
his campaign rhetoric implied he would be, he none-
theless has significantly increased government inter-
vention in the economy. Taxes and spending are both
up sharply, and the minimum wage has been hiked
substantially. The government has taken over some
firms and kept the exchange rate overvalued. Business
has been hit hard by price controls, higher taxes and
labor costs, and uncertainty about the future of the
private sector.
The government's problems in implementing policy
have stemmed in part from the inexperience of minis-
ters and the unresponsiveness of the bureaucracy.
Papandreou sacked his three main
economic ministers in a cabinet shuffle last July. He
then appointed Gerasimos Arsenis-a technocrat-to
the new post of Minister of National Economy, 25X1
allowing him to retain his position as head of the
central bank.
The 1982 budget signaled the government's intention
to expand the role of the state in the economy by
projecting a 34-percent increase in spending, an in-
crease far in excess of the inflation rate. At the same
time, the budget overoptimistically projected a 56-
percent increase in revenues and a reduction in the 25X1
public-sector deficit. Public utility charges were
raised soon after Papandreou's election in an effort to
reduce the losses of state firms, but official estimates
suggest that the combined deficit of state enterprises
was up 48 percent in 1982. 25X1
In line with the PASOK (Panhellenic Socialist Move-
ment) view that inequitable income distribution is a
major social, economic, and political problem, labor
has been a favored client. In addition to legislating a
partial indexing of public-sector wages (lower income
groups get full compensation for inflation, while those
in higher brackets get progressively less), the govern-
ment has increased the minimum wage an average of
35 percent. Unions have been strengthened by legisla-
tion that, for example, permits sympathy strikes and
protects workers from strike-related dismissals, while
restricting employers' lockout rights. In an effort to
reduce joblessness, Athens is subsidizing industries
that create new jobs for youth, preventing firms from
closing or laying off workers (even if they are losing
money), and boosting employment in the already
overstaffed government sector. 25X1
Agriculture-which still employs about 30 percent of
the labor force-also has been treated well. The
government sharply boosted pensions for farmers and
has proposed higher support prices and low-cost loans.
It is pushing agricultural cooperatives as a means of
sharing the cost of technological improvements and
eliminating the "monopoly of the middleman."
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The situation for business is quite different: profits
have been badly squeezed between, on the one hand,
higher taxes and labor costs and, on the other, price
controls on many products. Although Papandreou's
threatened nationalization of key sectors has not
materialized, government actions and rhetoric keep
the possibility in the spotlight. The Larco steel
company was nationalized, albeit largely to prevent it
from closing and laying off several thousand employ-
ees. Athens tried to portray its buyout of the ESSO
Pappas oil company-the largest single US invest-
ment in Greece-as a first action against the multi-
nationals, although the company initiated the sale. In
addition, the government is insisting on renegotiating
its contract with the North Aegean Petroleum Corpo-
ration (NAPC)-a consortium jointly owned by Cana-
dian, West German, and US firms-touting the move
as part of the effort to reclaim control over Greece's
natural resources. Athens forced NAPC to shut down
its operation temporarily by refusing to purchase oil
from the firm's offshore Prinos oilfield except at
below-market prices and by withdrawing permission
to export oil. The Energy Minister has denied earlier
reports that he had raised the prospect of buying out
the oil consortium, but he has continued to press for a
settlement on pricing and a renegotiation of the 1975
licensing agreement along lines that would give the
state greater control. Finally, Athens forced the trou-
bled Prykal munitions company into bankruptcy by
withdrawing approval for a large Middle East con-
tract and, according to the company, failing to pay a
$7 million bill for materials supplied to the Greek
armed forces. Control of the company
Greece.
The PASOK government scrapped its predecessor's
generous new Investment Incentives Law immediately
upon taking office and kept potential investors on hold
for more than a year before implementing a slightly
more restrictive version. The new law provides govern-
ment grants for investments that meet certain criteria,
such as bringing in advanced technology, providing
jobs, or working for the "social good." Firms receiving
large grants must give the government equity in new
ventures and a voice in their management. The re-
vised law adds new steps to the review process that
may prove complicated and time consuming.
Disappointing Results
The Greek economic situation has deteriorated fur-
ther under Papandreou. With a slump in investment
outweighing the stimulative effects of higher govern-
ment spending and wage hikes for lower income
groups, GNP probably registered another decline in
1982. Manufacturing output plunged 15 percent from
January to August, seasonally adjusted, and for the
first eight months of 1982 averaged 4 percent below
the level a year earlier. Moreover, the construction
sector has been depressed, and the new property tax is
worsening a bad situation.
Athens estimates unemployment in urban areas at
8 percent of the labor force and rising. The labor force
is growing faster than domestic jobs are being creat-
ed, and job opportunities abroad have dropped off
because of the worldwide recession. The net outflow
of workers of the 1970s has been succeeded by a net
influx
While most EC countries have managed to slow price
increases during the past two years, Greek inflation
dipped only briefly in late 1981 before resuming its
rapid pace. Prices rose 21 percent on average in 1982.
This occurred despite the recession, the weak oil
market, and price controls on key products. Higher
wages have added to inflationary pressures. Papan-
dreou's generous wage policies led to a 36-percent
increase in average hourly earnings in the first half of
1982 despite rising unemployment.
Labor unrest has aggravated the economic situation.
Despite Papandreou's favorable treatment of unions,
Greece has been plagued by strikes, including sporad-
ic airline walkouts and a six-week bank strike last
summer that seriously hampered commerce. The
strike was settled by Arsenis's direct intervention, and
even then the concessions to the already well-paid
bank employees exceeded Athens's guidelines.
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Figure 1
Greece: Manufacturing Productiona
105
I 111111111 111111 1 1 1III 111111111 11111 11111II 11111111111 111111111
100 1977 78 79 80 81 82
aSeasonally adjusted.
Danger Signs in the Balance of Payments
The most alarming economic deterioration since
Papandreou took office probably has been in the
balance of payments. The $300 million narrowing of
the current account deficit in the first 10 months of
1982 is misleading: almost all the major categories of
foreign exchange earnings have been doing poorly,
and only a sharp increase in net inflows from the EC
budget and a temporary decline in oil import volume
prevented the deficit from running well ahead of the
previous year's record level. EC transfers were $250
million higher in January-August 1982 than in the
comparable period of 1981 and probably reached
$600 million for the entire year-four times the 1981
level. Total imports were down 11 percent in the first
10 months of 1982. The $900 million drop was due
mainly to a decision to run oil stocks down to a 90-day
supply; nonoil imports declined only slightly.' F--]
' The discussion of the balance of payments is based largely on
official Greek data. We suspect there may be some errors in this
The Greek central bank reports that exports were
down 12 percent in dollar terms in the first 10 months
of 1982, compared with the same period in 1981.
Slumping foreign demand almost certainly was a
factor, but declining Greek competitiveness probably
played an even greater role. Greece's inflation rate
has been considerably higher than those of its main
trade partners, and creeping devaluations had been
insufficient to maintain competitiveness. In inflation-
adjusted terms, the drachma had become overvalued
by more than 20 percent against the West German.
mark and 30 t against the French franc relative
to mid-1980.ercen 25X1
While contributions from the EC budget are up, the
invisibles earnings that Greece normally relies on to
offset its trade deficit have declined. Earnings from
shipping were down 9 percent in the January-October
period as the Greek fleet was hard hit by the decline
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Current account
-2,216
-2,408
-2,200
Trade balance
-6,809
-6,697
-6,300
Exports
4,094
4,771
4,300
Imports
10,903
11,468
10,600
Oil
2,982
3,685
2,800
Nonoil
7,921
7,783
7,800
Invisibles balance
4,593
4,289
4,100
Receipts
6,159
6,495
6,350
Net EC inflows
148
600
Payments
2,206
2,250
Interest and dividends
823
750
Capital account
1,888
2,040
Private inflows
1,310
800
Official borrowing
1,231
2,040
Principal repayment
653
800
Overall balance
-520
-160
Change in reserves
-328
-160
Change in other assets, IMF
140
Errors and omissions
-332
in world trade. Greece is losing its traditional cost
advantage in shipping as seamen's pay moves up
toward the European norm. Emigrant remittances
continue to slide-down 6 percent in the first 10
months of 1982 after dropping 11 percent-between
1979 and 1981. Tourism earnings-the star perform-
er in the balance of payments in the late 1970s-
suffered an 18-percent drop in January-October 1982.
Serious problems have surfaced in the capital account
as well. The net inflow of private capital, which
traditionally covers about half of the current account
gap, was off by 40 percent in the first eight months of
last year compared to the same period in 1981.
Depressed business confidence and statements by
some government officials disparaging foreign invest-
ment have discouraged capital inflows and, despite
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exchange controls, almost certainly caused some capi-
tal flight.2 Finally, much hoped-for investments from
Arab countries have not materialized
These developments have required a greater reliance
on official borrowing and a drawdown of foreign
exchange reserves to less than one month's worth of
imports. A major loan was arranged from a group of
banks in March 1982 on only slightly stiffer terms
than obtained in previous years, but bankers have
since become even more cautious in their medium-
term lending. Indeed, Greece's chief foreign loan
negotiator stated privately to a US official that the
country is entering a "foreign exchange crisis." He
indicated that Athens is hoping to cover its needs over
the next few months by relying on short-term, bank-
to-bank credits, but soon it probably will have to seek
a sizable new official loan of longer maturity. Total
foreign debt is now over $10 billion. Although
Greece's debt service ratio-about 15 percent taking
into account receipts from both exports and invisi-
bles-is not particularly alarming when compared to
ratios of other countries, it has doubled over the last
four years and is still rising rapidly.
The Current Policy Situation
Although Papandreou can claim with some justifica-
tion that Greece's current economic bind is due in
large measure to the policies of his predecessor and to
external factors, we believe that his actions have
aggravated the country's problems. His programs
have reduced profits and undercut business confi-
dence, major factors, we believe, in the decline in both
foreign and domestic private investment. And in the
face of the continuing huge budget deficit-financed
largely by monetary expansion-his price controls are
bound to reduce profits further and impede the effi-
cient allocation of resources. Even on the unemploy-
ment front, where direct steps have been taken to
create or preserve jobs, it is likely that, on balance,
government actions have worsened the outlook. Meas-
ures such as higher minimum wages and benefits,
recent prolabor legislation, and restrictions on layoffs
impede new hiring and tend to discourage job-creat-
ing investment
3 While capital flight is difficult to quantify, the drop in net capital
transfers into Greece and Athens's actions to tighten exchange
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Table 2
Greece: Economic Indicators
Real GDP growth
6.7
3.7
1.6
-0.7
-0.5
Fixed investment growth
6.0
7.9
-8.7
-12.1
-10.0
Inflation rate
12.5
19.0
24.9
24.5
21.0
Foreign debt service b
7.6
8.4
9.4
13.1
15.0
Ratio of public-sector
borrowing to GDP
8.0
9.0
12.0
17.0
15.0
Current account
balance (billion US $)
-1.0
-1.9
-2.2
-2.4
-2.2
more workers.
candidates for socialization include insurance and
energy. Furthermore, financially troubled firms in
any sector are subject to takeover, either directly or
by state-controlled banks, because Athens fears the
political backlash of plant closings and the layoff of
Papandreou appears to be increasingly concerned
about the economic situation, and we believe he
realizes that an all-out effort to implement PASOK's
socialist program over a short period would be disrup-
tive for the fragile Greek economy. Apparently recog-
nizing that postponing austerity measures would
merely force a politically more expensive retrench-
ment later, Papandreou has begun talking less about
a Estimated. "socializing" Greece and more about the need for
b Debt service as a percent of earnings from exports and invisibles.
Papandreou has labeled his 1982 policies a transition
to the five-year plan to be launched in 1983. The plan
was to have been unveiled late last year but now is
expected in March of this year. The plan should
provide further indications of whether Papandreou is
still clinging to the socialist ideals outlined in his
campaign or has accepted the need for more pragmat-
ic, restrained policies. We expect the plan to contain
some obligatory socialist rhetoric and optimistic goals
for economic progress. It will probably include pro-
posals for reform of the inefficient health and welfare
system, sharply increased public investment, measures
to encourage the development of advanced technology
industries, development of export-oriented and
import-substitution industry, and the "socialization"
of some sectors of the economy.
Papandreou's latest vision of socialization appears to
include the creation of councils made up of represen-
tatives from labor and government to exercise "social
control" over key industries. This system would, in
our view, involve more regulation and red tape for the
already overregulated private sector. Recent legisla-
tion affecting the pharmaceutical industry could re-
sult in a virtual government monopoly of the manu-
facture and distribution of pharmaceuticals. Many of
the multinational firms involved-20 are US owned-
have threatened to pull out of Greece if government
control becomes too great. Other key sectors that are
years originally envisioned.
take much longer to implement than the four or five
patience and sacrifice. Mlmster of Nattonal Economy
Arsenis now says that PASOK's plan for Greece may
This gradual shift toward pragmatism is evident in
the 9 January devaluation of the drachma and in the
recently announced incomes policy for 1983. The 15-
percent devaluation, however was belated and lacked
a commitment to maintain a realistic exchange rate
through more rapid depreciation. Moreover, the de-
valuation was accompanied by protectionist measures
to restrict imports-particularly from EC partners-
to the 1980 level. The new incomes policy provides for
significant delays in cost-of-living adjustments that
should hold wage increases in 1983 well below the
inflation rate. Although Papandreou has promised
publicly that any real wage shortfall will be made up
in 1984 and that there will be bonuses to match real
GNP growth, the policy represents a major change in
course. If carried out, it would actually erase-at
least temporarily-most of the real wage gains made
by labor in 1982. 25X1
The recently announced government budget for 1983,
on the other hand, offers little evidence of any other
policy shift. It projects increases of 29 percent for
expenditures, 32 percent for revenues, and 20 percent
for the total public-sector deficit. Social services
spending is to rise 36 percent and public investment is
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projected to jump 48 percent, while spending on
agriculture and defense will grow more slowly than in
1982. Increased revenue is expected from sharp hikes
in automobile and fuel taxes, greater net transfers
from the European Community, and anticipated high-
er charges for public utilities. In our view Athens has
overestimated the gains from increased economic
activity and a crackdown on tax evasion. Even with
the optimistic revenue projections, the budget deficit
is projected to remain over 15 percent of GDP.F_
It is increasingly unlikely that Papandreou will pursue
his earlier threats to withdraw from the European
Community or submit the issue to a referendum. He
is acutely aware of the growing importance of agricul-
tural support funds and regional development assist-
ance in reducing deficits in both the current account
and the government budget. Athens has complained
about a flood of imports from EC partners following
Greece's lowering of trade barriers, but the recent
deterioration in the balance of trade with the Commu-
nity is due more to falling Greek exports. One un-
pleasant surprise: the Greek balance on food trade
with the Nine has gone from surplus to deficit since
Greece joined the Community.
Papandreou apparently is satisfied by the Communi-
ty's willingness to consider Athens's request for pref-
erential treatment and a "special relationship." Ac-
cording to the US Embassy in Athens, he believes he
has considerable leverage because his EC partners
fear that economic problems could generate a threat
to Greek democracy. Papandreou believes the Com-
munity will not press Greece on its obligations;
Athens already has delayed implementation of most
EC directives and its takeovers, proposals for reducing
competition in the drug industry, and talk of delay in
introducing a value-added tax have raised eyebrows in
Brussels. Highlighting Greece's less developed status
and its current inability to meet the Community
obligations imposed on it, Papandreou probably will
settle for arrangements easing Greece's transition to
full participation rather than press for renegotiation
of the terms of its accession
Outlook
We believe the state of the economy will continue to
be the single most important standard against which
the Greeks measure Papandreou's performance. This
will put the Prime Minister in an increasingly difficult
position. On the one hand, inflation and balance-of-
payments problems will push him toward more re-
strictive policies. On the other, he will face mounting
labor unrest and pressure from within his own party to
implement his socialist program.
Given these conflicting pressures, we expect that
Papandreou will chart a middle course that will
neither satisfy any of his constituencies nor restore
economic health. Recent announcements, including
the recent devaluation and the restrictive 1983 in-
comes policy, signal some movement away from
Papandreou's sharply expansionary policies but no
serious turn toward needed austerity measures. To
deal effectively with Greece's economic problems we
believe Athens would need to adopt more restrictive
fiscal and monetary policies, reduce the budget defi-
cit, ease government controls (particularly on prices),
and adopt a more favorable attitude toward private
investment.
We believe Athens's claims for the new budget and
the incomes policy as anti-inflationary are exaggerat-
ed. The deficit will keep pressure on money supply
growth and crowd out productive private investment.
As for the more restrictive incomes policy full imple-
mentation this year is questionable, given strenuous
objections and strike threats from labor, and Papan-
dreou has promised to reverse the policy in 1984.
We think it unlikely that investment will pick up
significantly in 1983, even with the new investment
law in place. Continued low profits and excess capaci-
ty alone argue against recovery. Moreover, most
businessmen probably will remain cautious until the
government takes a more positive position on the role
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of the private sector. Arsenis has said that there is
"room" for the private sector in a mixed economy, but
he goes on to argue that private firms must be subject
to "social control" designed to assure that "the tradi-
tional private sector will promote the more general
national interest."
The most critical problem over the next year or two
probably will be the balance of payments. Athens
concealed the deterioration in 1982 with stopgap
measures. However, neither oil stocks nor foreign
exchange reserves can be drawn down much further,
and foreign loans probably will be more difficult to
obtain as international bankers become increasingly
troubled by trends in the Greek balance of payments
(and perhaps in Athens's policies) and by world debt
problems. With the volume of oil imports returning to
normal, the current account deficit could set a record
in 1983. The import restrictions may mask the prob-
lem temporarily, but if Athens does not continue its
depreciation of the drachma to offset the high infla-
tion rate, the deficit could continue to widen in 1984
as well, perhaps even forcing Papandreou to turn to
EC or IMF emergency loan facilities.
In short, we believe that during the next few years
Greece will continue to be plagued by a very sluggish
economy, continued high inflation, and a serious
payments deficit. Papandreou will, with some justifi-
cation, blame the world recession for Greece's diffi-
culties; but public dissatisfaction will grow if other
West European countries begin to make significantly
greater progress in their own battles against stag-
flation.
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