Greek tragedy: lessons learned for Timor-Leste

*Cosme da Costa Araujo & Simen Bjornerud

The financial crisis of 2007-2008 led to a global economic recession, which the world has
yet to recover from, and a European sovereign debt crisis, which is not yet resolved.
Many consider the last five years as being the most economically challenging the world
has faced since the Great Depression of the 1930s. Unemployment rates are high and
rising, especially in South-European countries like Greece, and it will be a long and
painful journey for these economies to get back on track.

The news of this drama does not claim headlines in remote Timor-Leste. Interestingly,
the last five years of dismal development in main economies of the world has coincided
with double-digit annual economic growth in Timor-Leste. Since our undeveloped
economy still does not have strong trade links with the world markets, we are
somewhat shielded from the downturn in global economic activity.

We need to recognize, however, that our strong economic growth in recent years is
driven by a significant increase in the spending of petroleum income. Being nonrenewable, petroleum income may look high today, but this inflow will stop in the not
too distant future. Public expenditures, on the other hand, are difficult to curb, let alone
reduce. These prospects set the stage for an evolving financing gap that needs to be
filled by domestic revenues. Otherwise, we are just living beyond our means and will
before long run into serious economic and social problems.

The core of the Governments Strategic Development Plan is to create a robust and
diversified economy with viable jobs that will alleviate poverty and also help provide
the Government with sustained incomes to finance its programs. The development plan
is bold and necessary, although not risk-free. The outcome may become different. This

article looks at how things went wrong in Greece and discusses if there are lessons that
Timor-Leste can learn from to avoid unnecessarily falling into known pitfalls.

What caused Greeces debt crisis?

Important factors behind the Greece debt crisis include; (1) lack of fiscal discipline, (2)
ineffective public spending, (3) structural challenges and macroeconomic imbalances,
and (4) borrowing.

Lack of fiscal discipline is the most important factor behind the Greece debt crisis.

Spending more than she could afford, Greece lived beyond her means for decades.
According to IMF data, government expenditures were significantly higher than
government incomes in all the years since 1980, when the recording started. The
financing gap, as measured by the government net borrowing, peaked at EUR 36 billion
in 2009, equal to almost 16% of GDP.

Ineffective public spending. A large part of the governments budgets has been

allocated to subsidies, wages, pensions and other entitlements. While a natural part of
any modern welfare state, recurrent expenditures such as these needs to develop in
tandem with the governments income side, which again depends on economic growth
and private sector employment. Instead of facilitating the latter, the government
embarked on a dramatic increase in public sector employees, both in central
government (ministries) and in municipalities, as well as a significant rise in the relative
wage compared with the private sector. This did nothing to improve private sector
entrepreneurship

and

competitiveness.

Moreover,

productivity-enhancing

real

investments were lacking. Many argue that the 2004 Olympics price tag of some EUR 7
billion actually triggered Greeces demise.

Structural challenges and macroeconomic imbalances. The oversized public sectors

lead to trade imbalances. On average, industrial production fell by 1.6% every year
between 2000 and 2012. Without a competitive currency generating export sector to
finance the countrys excessive demand for goods and services, the current account
deficit ballooned at some EUR 50 billion in 2008, according to IMF figures. Widespread
corruption and a business structure run by elites groups lobbying for government
projects, cemented the economic malaise.

Borrowing for consumption. Not surprisingly, to be able to finance the excess, the

government needed to borrow lots of money. Initially intended to finance productive

investments, the loans soon became a central financing vehicle of the budget, increasing
substantially between 2005 and 2011 from EUR 195 billion (100% of GDP) to EUR 356
billion (170% of GDP). The unsustainability became apparent and the possibility of
defaulting approaching.

Greeces experience shows how fiscal slippage and ineffective spending lead to
structural challenges and macroeconomic imbalances, which paved the way to illadvised borrowing and misuse of those funds. Eventually, Greece found itself on the
edge of the abyss with an agonizing journey ahead.

What price does Greece pay for its mistakes?

Tough austerity measures, meaning strict measures to align expenditures with

revenues, are the high price Greece now needs to pay. The government has to
significantly tighten its belt by cutting spending, raising taxes or both. Some has argued
for Greece leaving the EU to assume more flexibility in its policy tools, but this outcome
seems less likely, as it would represent a serious blow to this prestigious political
agreement. The EU has provided rescue packages in terms of cheap loans to struggling
European countries, including Greece, to prevent them from defaulting. These rescue
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packages have come with tough conditions, however, to get public finances back on a
sustainable footing. Measures in Greece include wage cuts and other unpopular labor
market reforms, increased taxes, increasing the retirement age and tightening loopholes
in the tax system.

It is difficult, to say the least, to strike the right balance between necessary fiscal
tightening in the face of default, on the one hand, and to offer some kind of stimuli to an
economy on the slide, on the other. The Greek economy has declined since 2008 and is
operating far below its potential with unemployment rates reaching 25% in 2012. This is
not a time you prefer to slash public spending, but then again Greece has no choice.
Unemployment rates at these levels are not merely an economic issue it is a serious
challenge for the society. People have repeatedly taken to the streets to show their
disapproval with government policies. This kind of social unrest reminds us that at the
end of the day it is ordinary citizens that have to pay the price for the governments
irresponsible behavior.
What can Timor-Leste learn from the Greece debt crisis?

Every country is different and has to find its own way. Every country will also make
mistakes along this way, including Timor-Leste. Still, some mistakes are graver than
others and some may be unnecessary, giving a true ring to the Chinese proverb telling
us that it is wise to learn from your own mistakes, but it is wiser to learn from those of
others. We are fortunate in the sense that experiences of others, either they are good or
bad, like the Greece debt crisis, are readily available for us to study. Below are some
yardsticks that will benefit Timor-Leste when it is navigating towards its overall goal of
being a prosperous and strong nation. The point of departure is that we are currently a
poor nation with temporary high income from the petroleum extraction. History has
clearly shown that to be a significant challenge in terms of transforming the temporary
windfall into persistently improved lives for all citizens.
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Avoid the resource curse. This should be Timor-Lestes top priority. Timor-Leste takes
seriously the fact that developing countries with abundant natural resources often
experience relatively weak economic development compared with countries without
natural resources. The most important decision for Timor-Leste to avoid the resource
curse is to separate the inflow of petroleum income from its spending. We have already
done this by establishing the Petroleum Fund (PF). All petroleum incomes first go in to
the PF before a suitable amount is being transferred to the state budget. The Parliament
decides how much to spend and how much to save every year, taking into account the
welfare of both the current and the future generations. The Estimated Sustainable
Income (ESI), described below, is meant to help Parliament make that decision.

Maintain fiscal discipline. Timor-Leste is the second most oil dependent country in the
world, after South Sudan. Petroleum revenue finances more than 90% of government's
budget. Without a fiscal rule, it is likely that government spending will be too high.
Appreciating that fiscal discipline is a precondition for a stable economic development,
as Greece now painfully experiences, our PF framework involves the so-called
Estimated Sustainable Income (ESI). In short, the ESI is how much oil money we can
spend every year without depleting our wealth. One way to look at the ESI is as the
zero-line in the budget. If we spend more than the ESI, we are running a budget
deficit. That may be ok for a while, while important projects are undertaken (like the
governments Strategic Development Plan), but not for long. Greece ran a budget deficit
for decades and that did not go well. Accordingly, Timor-Leste quite soon needs to
align spending with ESI.

Be careful with borrowing. Timor-Leste has over $13 billion in the PF, so it is no obvious
economic reason why the Government should borrow. Usually it is more expensive to
borrow than to use your own savings. Sometimes, though, a poor country like TimorLeste may benefit from concessional terms as well as technical assistance on the project
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level that makes pursuing the loans worthwhile. We need to remember that the loans
have to be paid back, not by us, but by our children. Hopefully we invest the money
wisely so that our children are better off than we are now and therefore are better
enabled to pay off the debt. The experience from Greece and many other countries
warns us that we should go about this very carefully.

Ensure a lean and efficient public sector. The number of people employed in our public
sector has increased significantly since 2005. The increase in staff and their salaries is
reflected in the upward trending government recurrent expenditures. There are limits
to how many civil servants we need and, importantly, can afford. We need competent
people in our administration, but the public sector should not be the generator of jobs.
That is the private sectors task. The paradox is that if we make it overly attractive to
work in the public sector with relatively generous wages and other entitlements, why
pursuing a job in the private sector? A key principle to be adhered to in the public
sector is putting the right person in the right place. This involves a strict merit based
hiring policy and following up by rewarding those who perform well.

Boost the private sector and create viable jobs. As laid out in the governments Strategic
Development Plan (SDP), our prospects are dependent on a strong and competitive
private sector that generates viable jobs. It is important to facilitate this development by
ensuring that basic infrastructure is in place. Equally important, however, is to ensure
that the business environment is attractive for foreign and domestic firms. Currently we
have a long way to go, as documented in the World Banks Doing Business reports. One
important avenue forward in pursuing the goals in the SDP is to provide the agriculture
sector with readily available technology to increase the yields from its current low
levels. This will also improve food security and reduce the drag on economic growth by
replacing imports. Increased revenues in the agriculture sector will spread out in the
economy and it is important to have Timorese ready to grab the opportunities that is

most likely to occur in the service sector. We need to educate our people to make them
skilled and ready and have a business environment that encourages firms to engage.

Ensure government programs are affordable over time. Pension schemes, for example, tend
to appear cheap in the beginning, but become costly later. Being non-renewable, we
know that our petroleum income eventually will diminish and cease. We should not put
ourselves in a position where our public expenditures start accelerating when the
petroleum incomes abate and peter off. Rather, we need to be responsible and consider
long-term sustainability when designing government programs.

Make sure every dollar spent counts. We are unlikely to achieve this if we try spending too
much too fast. It is like pouring water into a small glass; it will soon spill over. Another
way of understanding this is that if we spend more than the economy can absorb, the
result will only be higher prices and not more economic activity that would create jobs.
Effective spending is not only constrained by the absorptive capacity in the economy,
another bottleneck is the capacity of our administration. Let us assume our public
administration is able to efficiently process a budget of $1 billion. If we then double the
budget over just a few years, it is likely that this will result in more waste. We need to
be very thorough in selecting and prioritizing our projects. Our current high petroleum
income may be perceived as a soft budget constraint, which makes it easier to
approve projects with questionable long-term social and economic return.

What is the key take aways?

The main lesson the Greece debt crisis taught us is that we need to keep order in our
own house. If we spend more than we can afford, we eventually run into serious
problems that affect ordinary people. This is not just a lesson from Greece and the other
troubled European countries nowadays, it is an easy-to-grasp key lesson from history;
Fiscal discipline is a necessary condition for a sound and stable economic development.
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Few, if any, will contest that it is important with budgetary discipline. The challenge in
Timor-Leste is that the current big inflow of petroleum income may obscure our fiscal
reality. We look wealthier than we in reality are. It is human capital and not petroleum
that determines a countrys wealth. That is why Timor-Leste is still a poor country. The
SDP is aiming to change that, but we need to sequence correctly. When SDP starts
giving results in terms of more viable jobs and more sustainable income for the
government, then we can start develop our welfare system accordingly. Anticipating
success and in advance reaping the benefits of an assumed outcome is risky. It could
cloud the most important condition for us to prosper as a nation hard work.