The lesson of the Greek crisis: Every government cheats and no one wants to know

03/09/2010 8:30 am EST


Jim Jubak

Founder and Editor,

Greece cheated on its national accounts in 2009. And that led to a budget crisis in 2010.

But that’s not the important part of the story.

What makes this a crisis not just for Greece, and the euro and the European Union is that everyone—from the Greek government and its accountants to the financial officials of the European Union to the experts at international watch dog agencies such as the Organization for Economic Cooperation and Development--knew it.

And knew it for at least a decade.

Makes you wonder what other countries are cheating on their accounts. Or maybe better phrase the question as “Is anyone not cheating?” We all know that the United States does. But so does China that much admired model—at the moment anyway—of economic management. Even the Canadians—yes, the Canadians!—cheat.

The consensus view is that the world’s books are in pretty bad shape. But the consensus view has a long history of ignoring problems until they bite it. Hard.

We’re anywhere from a few years to two decades (closer to the former I think) from feeling those teeth close in on our posterior. (Especially if the economic recovery is going to be as profitless as I now expect  If we want to save anything from those chompers, it’s time to face a bit of reality.

Building a house to with stand a 50-mile-an-hour Nor’easter doesn’t make much sense if you live in tornado alley.

If everyone cheats, it’s more than time to look at some of the lies.

You’ve probably had the details of the current Greek budget crisis drilled into you until your head feels like you’ve had too much retsina. You know how the Greek government was projecting a 2009 budget deficit of 3.75% in June and then 6% in the fall and then finally admitted that the real deficit for the year was going to be 12.7%.

What you may not know is that as early as June economists and number crunchers at think tank such as the Organization for Economic Cooperation and Development (OECD) were blowing the whistle on the Greek budget figures. On June 24, for example, the OECD issued a report saying that the official target, at that point 3.75%, was spoiled feta and that a 6% deficit was way more likely.

I really had to dig to find that report too. An obscure little news organization called the Dow Jones Newswire carried the news globally that day.

But creative Greek accounting has a much longer history than that. In 1999 when Greece first applied for membership in the euro it got turned down. Its budget deficit was way too large and the country didn’t have a chance in Hades of getting it down to the 3% maximum allowed under the rules of the European Monetary Union.

It was a totally different story when Greece applied again in 2001 and sailed into membership. What led to the amazing turnaround? Simple. Greece cheated.

The Greek government admitted it publicly in 2004. (One of the advantages of the constant rotation of governments in Greece is that each party makes a practice of revealing all the dirty laundry of the previous opposition government when it takes office.)

In November 2004 Finance Minister George Alogoskoufis admitted that the budget figures the country had used to gain admission to the euro club were fudged. “It has been proven that the deficit had not fallen below 3% in every year since 1999,” he told reporters. The Greek financial daily Naftemboriki even reported the exact size of the lie. In the years from 1997 to 1999, the years that the European Union examined to determine if Greece had met the 3% deficit maximum, the Greek budget deficit was 6.44%, 4.13%, and 3.38%. (Given what we know now, you’re entitled to take even those figures with a grain of salt.)

At that time in 2004 Greece was looking at a 5% budget deficit—and rising as the country added cost after cost for the Athens summer Olympics. Data filed with the European Union showed that the country had broken the 3% budget deficit maximum every year since 2000.

And the reaction from the European Union? As best as I can judge a collective shrug. It was a done deal with no do-overs even for cheaters. European Commission spokesperson Gerassimos Thomas said, “Greece’s admission to the euro zone was done on the basis of the convergence report which was established at the time and on the basis of figures and the statistical methodology applied at that time. It wasn’t in question at that time.”

  At this time, I’ll bet there are more than a few officials and politicians in Brussels, Berlin, and Paris who wish that decision hadn’t been allowed to stand at that time.

 It was available on the Dow Jones Newswire globally

There isn’t something in the air or water in Athens that makes Greek governments especially prone to cheating on its accounting. The Greek governments might have had a little more motivation than most to cheat—Exactly what was the alternative economic plan if the country couldn’t get into the euro zone?—but the rewards from cheating on the national accounts far outweigh the benefits of telling the truth for any politician.

Let’s see on the one hand, by cheating a politician gets to deliver the goodies (jobs, subsidies, loans, rising real estate prices) without paying for them, and on the other hand, a politician gets to sleep soundly at night knowing the country is on a sound financial footing.

That’s not even a vaguely hard choice for most politicians most of the time.

Think I’m exaggerating? Then take a look at the finances of Canada, the extremely prudent U.S. neighbor.

Or at least that’s how the country is normally portrayed. (The comparison to the United States helps any country’s reputation for financial rectitude, of course.)

Canada is in the midst of its own budget squabble.

The Conservative government has forecast that after going into the red in fiscal 2008-2009 by CDN $56 billion, the budget will move back into balance by 2014. The Parliamentary Budget Office (PBO), the equivalent to the Congressional Budget Office in the United States, has begged to differ, however. The PBO has issued a report saying that the country faces a structural budget deficit that will result in annual deficits of CDN $12.5 billion to $18.9 billion in each of the next five years.

The difference comes down to an argument about how fast the Canadian economy will grow once the global economy has recovered from the Great Recession in the United States. The government says growth will rebound to the pace before the global slowdown. (Canada’s economy grew by 2.7% in 2006.) The PBO, on the other hand, says that economic growth in Canada will decline, averaging just 1.9% in 2009-2014 as a result of an aging population driving down the speed limit for growth in Canada’s economy. In the next decade, the PBO says, the percentage of Canadians compared to those working will rise to 27% from 20% now.

Granted a $56 billion deficit doesn’t seem like that big a deficit even when say that it would be equivalent to a $600 billion deficit in the much bigger U.S. economy. The U.S. budget deficit for fiscal 2009 was $1.4 trillion. But Canada spent a decade reducing its debt—which peaked in fiscal 1997-98 at $563 billion--to $458 billion in 2007. So even a small move back into the red seems a big step backward.

And many Canadian financial experts, even those that criticize the government’s projections, remind Canadians that while the budget deficit is important, Canadian finances in general are just fine. Especially if you compare them to those of other countries. According to IMF (International Monetary Fund) estimates Canada’s net debt will be just 31.3% of GDP in 2010. That compares to 117% for Italy, 72.9% for France, and 76.2% for Germany. Half the debt load of Germany, the poster-child for fiscal conservatism in Europe? Why worry?

But remember the thesis of this post? Everybody cheats.

Canadian politicians would like Canadians to focus on net debt because given the structure of Canadian national and provincial finances the measure understates the debt problem in Canada.

The problem is that net debt understates the financial problems in a government system where the different parts—say the national and provincial governments hold a lot of each other’s debt. And that’s a problem in Canada: while the finances of Canada’s national government in Ottawa are in decent shape, the finances of the provinces are a horror.

The province of Ontario is the national basket case. In fiscal 2009–10 the Conference Board of Canada projects the provincial budget deficit will hit $14.1 billion. That would be the largest provincial deficit ever. The Conference Board projects that over the next three years the provincial debt will grow by $56 billion.

The IMF has a measure—gross national debt as opposed to net national debt—that captures some of this problem for countries such as Canada which delegate a big percentage of governmental spending to the states. (The difference between gross and net debt is very simple in theory. Take the gross debt of the government subtract its assets and you get net debt. In practice, though, the issue of what is an asset gets very complicated. So for example, if the state of California (or the province of Ontario) holds a lot of Treasury debt in its pension fund does that count as an asset? Neither gross nor net debt is a perfect measure. That’s why the IMF uses both numbers.)

 For a country such as France with a heavily centralized system of government finance (When Louis XIV said “I am the state” he could have been talking about Paris’s dominance of government spending) net and gross debt loads aren’t very different: Net debt in 2010 for France will be 72.9% of GDP, according to the IMF) and gross debt will be 82.6%. Same for Italy where net debt will be 117% of GDP in 2010 and gross debt will be 120%.

But in Canada, because of the way that government spending is divided between Ottawa and the provinces, the difference is stunning. Remember that net debt was projected as just 31.3% of GDP in 2010. Well, the IMF projects gross debt at 79.3% of GDP in 2010.

Ottawa, you’ve got a problem. And one of a magnitude that isn’t captured by the current debate between Liberal and Conservative politicians.

Now I live in the United States so I’m in no position to throw stones. Remember everyone cheats?

The IMF projects that U.S. net debt as a percentage of GDP will be 66.8% in 2010, more than twice that for Canada, and gross debt will be 93.6% of GDP, still almost 14 percentage points above Canada’s.

And even the IMF gross debt numbers don’t capture the full extent of the fiscal lie in the United States. A recent study pegs un-funded pension liabilities for the 50 states are somewhere between $1 trillion and $3 trillion, depending on the rate of return states will get on their pension investments over the next decade. And then there are all those off-budget liabilities such as Social Security and Medicare. These promises of future spending aren’t included in budget calculations since they’re “covered” by special trust funds with a source of revenue that is, supposedly independent of general government revenues.

No politician in Washington wants to come up with a realistic estimate of the problem because that number would make it immediately clear that the dimension of the problem makes all the proposed “fixes” laughably inadequate.

And to be honest we don’t want to hear that message either. We’d salute the politician that told us the true extent of the problem briefly on the editorial pages of the New York Times and the Wall Street Journal, and then promptly vote him or her into retirement.

All this should make you wonder what games the Chinese government is playing with its budget and debt numbers. Remember it’s in the self-interest of politicians everywhere—and the officials of the Chinese Communist Party are politicians too—to promise everything and pay for as little as possible.

Everyone cheats—but everyone cheats in their own way. Next Friday, March 12, a look at the lies on China’s books.

Full disclosure: I don’t own shares of any company mentioned in this post.
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