Greece needs institutional reform, starting with the public sector
Nikos Miserlis // 20 March 2017
The challenge for Greece is how to reduce taxes without lowering government revenue in a stagnant economy that is under tight fiscal monitoring by its lenders.
Global experience has shown that one of the most effective ways to increase economic activity, and eventually increase tax revenue, is to reduce corporate taxes. There is a wide range of success stories from Ireland to Cyprus and Malta in Europe, to Singapore and Hong Kong in Asia, and the list goes on. Even the UK after Brexit, and the US after the election of Donald Trump, are openly alluding to a reduction of corporate taxes as a means to achieve growth during a period of significant change.
Corporate taxes in Greece account for €3.1bn out of total general government revenues of €56.1bn, i.e. a mere 5.5%. A small share of government revenue coming from corporate taxes makes corporate tax cuts a relatively safe bet. It is widely accepted that Greece needs Foreign Direct Investment (FDI), as well as investment in R&D, technology and manufacturing, and these are particularly responsive to corporate taxation.
The Importance of Competitiveness and Institutions for Long-Term Growth
The Greek banking sector is currently awash with bad loans and thus it has a limited ability to induce economic growth through corporate and consumer lending. At the same time, the government does not have room in its balance sheet to launch a sizeable public investment programme. As a result, the return to sustainable GDP growth can only realistically come from a new wave of private investment (foreign and domestic) and private consumption.
Nevertheless, globalisation has diminished national borders, bringing into play dozens of countries that are currently competing for capital flows and investment. So, for Greece to compete credibly for a larger share of investment capital it needs to provide better incentives for prospective investors.
Tax incentives can give an immediate boost to the economy, but the economy will not reach its full potential in the long run if in parallel Greece does not build a set of solid institutions. The most important institutions to focus on are institutions related to economic activity, namely the tax office, national security and the legal framework (e.g. regulations on setting up and running private companies, legal authorisation of land use or production, resolve of disputes, regulations on employment, etc). Therefore, in summary Greece needs to create incentives for investments but at the same time commit to the creation of effective institutions that allow private investment to materialise quickly and be run efficiently without bureaucratic rigidities.
General Government Spending and Modernization of the State and Institutions
Having analysed what the Greek government can do to induce economic activity and growth while running a tight budget, we should not ignore the other side of the income statement which is state expenses. Improving the quality of public spending will increase efficiency, release resources and allow the state to come back to the markets quicker. Improving the efficiency of the state will enable Greece to break free from the supervision of its lenders and allow for more expansionary policies that will support growth.
Discussion has been going on in Greece for years over the size of the public sector and the need to reduce the number of public servants that are the largest part of public expenses. This discussion tends to always become politically polarised and in the end, politicians avoid making any meaningful changes to avoid the political cost.
In fact, the latest political narrative adopted by almost all parties in Greece is that the number of public servants is not especially high compared to other European countries. However, a closer look at OECD data that ranks countries on government spending as a percentage of GDP shows that Greece has still one of the highest level (49.8%) in the OECD countries. It is true that there are a number of countries where government spending is higher than in Greece but those are mainly Northern European countries that have much stronger institutions and economic models. These countries can afford a large public sector. Greece cannot. France and Portugal, meanwhile, also have higher public spending levels than Greece, and they have been facing challenges throughout the economic crises. They need to reform quickly in this area as well.
Clearly, Greece does not have room for a sizeable public sector given its other economic hurdles, never mind the fact that the public sector acts as a burden to growth due to its malfunctioning institutions and associated bureaucracy.
However, a big paradigm shift has occurred over the past years which can be used as a game changer in reforming the public sector and its legacy institutions. This is the advancement of technology and its potential use in the public sector. So, the Greek state does not have to reduce expenses by directly reducing the number of public servants in state organisations (which will most probably make them operate even worse) but use technology to fully redesign the structure of those organisations from the ground up. A radical redesign of the public sector using technologies like digitalisation and standardisation, as well as modern flat organisational structures offer today the potential to reduce costs and modernise the state significantly.
Such reforms require political will and consensus to go through, but for Greece this is an inevitable path to take. The public is so frustrated with public services, and years of distrust in government institutions cannot be undone by marginal changes in the current organisations. A radical message of change needs to be conveyed in society. In fact, rebuilding of trust requires not just a message of change but also a radical improvement in public services that will be felt in peoples’ everyday lives. Technology gives the potential to do exactly that.
It would be a great positive surprise for Greeks to move from the current state, where they are used to queueing for hours in the tax office, submitting all kinds of documents and taking ages to get anything done, to a state where they can do most of that online. Such changes would go a long way towards restoring public trust in the government. Along with trust, efficiency will be also installed in the system and the cost of the public sector will be reduced significantly.
There are many countries that have digitalised their public services which Greece can use best practices from. Israel, South Korea, New Zealand and Estonia are just a few examples. Their digital government efforts have been received very positively by citizens. Estonian politicians, for example, have realised that citizens don’t want to bother with the government – they just want to get things done.
The Example of Estonia’s Digital Society
Estonia is at the forefront of digital technologies used in government and one of the first countries where politicians committed to digitalising public services, as early as in 1996. There was a reason for that. Estonia was then still a poor peripheral country with few natural resources, and its economic success was by no means guaranteed. So for Estonia to succeed, they needed to embrace innovation and technology to push the country forward.
Similarly to Estonia, Greece has a reason to change radically. It is a small country with a relatively small ageing population, high unemployment, a strict memorandum of understanding with its lenders and an ailing economy. So, there is a clear incentive to modernise. Handily, the Estonian government is offering to share their knowledge and experience with countries that want to introduce e-government initiatives with more than 40 countries currently using Estonian e-solutions.
Looking into the Estonian digital government model in more detail, they started creating an e-society in 1996 by launching project Target Leap as a cooperative initiative involving government, business and citizens. Target Leap is still active today and has expanded into a wide range of digital public services varying from e-ID, e-signature, e-tax filings, i-elections, e-Police, e-health/prescriptions etc.
The automation that those services enable removes bureaucracy completely and is a huge benefit to citizens. So, for example an Estonian can renew their driving license online in a few minutes, they can register their new baby’s name online, they can file a tax return in 5 minutes because the government has the largest part of the form pre-filled or they can digitally sign a legally binding agreement over the internet.
The technological push from the government, apart from helping citizens in their everyday interaction with the government, has another positive side effect. The private sector grew a passion for innovation and high tech solutions as well. Estonian banks have introduced full end-to-end online banking and new tech entrepreneurs developed clever innovations like M-parking and location-based services. This also attracted investment from big technology companies like Skype, Transferwise etc in the country. So, beyond an open and transparent democracy, the Estonian e-government initiatives have induced innovation and growth in the private sector.
To further attract talent and induce investment, the Estonian government has also launched a pioneering e-residency scheme where anyone can become a digital resident in the country and then register a company, open a bank account online and start trading.
The vision for e-residency is to reach a state where taxes and financial reporting are fully automated for companies. Also, the Estonian tax office intends to be linked with the tax offices of other countries to allow taxes for Estonian e-residents that live for example in the UK to be paid automatically in the UK without requiring any action from the tax payer.
Estonians believe e-residency can be a huge growth driver for them in the future but more importantly revolutionise public services around the world. They envisage e-residency to allow people and companies to move between “linked” countries without doing any paperwork or people living in one country and working in another while their activities are fully recorded and shared between countries automatically.
Clearly disruptive innovation does not come without risks and Estonians will face challenges related to data privacy or anti-money laundering compliance along the way. However, their commitment to innovation in the public services brings huge benefits to its citizens and the overall economy.
Greece needs to reform the public sector and rebuilt its institutions. The Estonian model can prove to be an invaluable example to this endeavour.
 Greek Ministry of Finance, State Budget 2015
 OECD (2017), General government spending (indicator). doi: 10.1787/a31cbf4d-en (Accessed on 22 January 2017)
MORE FROM THE BLOG