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Elena Panaritis

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Institutional Reforms Can Lead Greece Out of the Crisis

Posted: 12/13/11 01:04 PM ET

Resolving the deep and prolonged economic crisis in Greece -- an economic and financial storm of historic proportions and the worst since WWII -- requires a lot more than rescue funds. It requires more than short-term macroeconomic reforms and austerity measures.

Unsustainable debt was diagnosed as the underlying malady of our economic crisis. But after two years of trying to find the right cure, it appears we are actually suffering from a deficit of trust. There seems to be a lack of trust between the citizens and the public sector (the state). Greeks have yet to be convinced that any new set of austerity or macroeconomic reforms will end the crisis soon.

In a similar vein, there seems to be an absence of confidence and a lack of trust from the international financial markets. They have started to doubt whether the crisis is a short-term one and are even questioning the role of Greece in the Eurozone.

Fixing the problem requires bold, even controversial, measures. It requires deep reforms that will change the structure and behavior of our economy and will successfully transform informality. Informality is market behavior outside the formal structures and the bureaucracy of the formal economy. And because it does not get counted, it ultimately serves to shrink our formal growth!

Fixing the problem, therefore, will mean addressing the crisis through the lens of sustainable solutions. It means deep structural changes or what we economists usually call institutional reforms.

For a sustainable reversal of the crisis, we need to focus our attention on transforming informality so as to provide tangible results among constituents and re-establish trust among the citizens and the state.

This approach is based on my years of experience as an institutional economist working to put economic theory into practice in order to: (i) correctly identify and evaluate the impact of informality and (ii) apply the institutional reforms to successfully transform the informal economy and property rights into tradeable assets (establishing the foundations for any economic development).

Drawing from my experience, the recommendation to kick start stalled economies facing a crisis similar to the one gripping Greece is to focus on institutions, institutions, institutions!

And do not confuse institutions with organizations. Institutions are agreements among people in an economy or in the market. They are made of formal rules, norms, regulations that define and enforce agreements so that they are securely applied (examples of such institutions are the institutions of purchasing property, receiving a proper education, upholding justice and security). Organizations are tools used to apply the norms, rules and regulations needed to create and enforce transactions.

What does this mean? It basically means that instead of changing the organizations when something goes wrong, we should reform the institutions -- the norms.

When institutions break down, we are faced with a broken system that basically translates into malfunctioning norms, rules and regulations. This looks like overlapping and conflicting regulations or laws, too much regulation that creates bureaucracy and generates confusion. As a result, organizations also malfunction and the state becomes ineffective.

It is very similar to what is happening in Greece and, to a lesser extent, across the European Union.

Ultimately, this environment is a breeding ground for informal behavior. This is when people start maneuvring around the rules instead of within them.

Why does it happen?

The most plausible theory is that there is a divorce between decision-makers and those who bear the cost of the decisions - the people, the country.

It is when decision-makers draft new laws, rules and regulations that overlap and conflict with existing laws, rules and regulations.

By creating new laws and not improving or replacing existing legislation, there can only be one result: A moribund process. A system that suffocates the formal growth of the economy and forces people to work around it.

So, is there a way forward?

Drawing from my recent in-depth assessment of informality in Greece in as regards the country's property and labor markets, I can definitively say that there is a relatively high level of mistrust with the State formal rules and bureaucracy is much to blame. It's suffocating!

In the property market, the result is a mushrooming of informal and even illegal construction and a torrent of informal or unfulfilled transactions.

The shocking scale of the problem is exposed in the World Bank's latest Doing Business survey of 183 economies. Greece ranks 150 -- one of the lowest in Europe -- when it comes to registering property.

Buyers in Greece need to navigate a convoluted maze with up to 27 steps that involve meeting with more than a dozen professionals and agencies -- from lawyers and notaries to officials at the national cadastre, their local municipality and the tax office.

As for the labor market, the latest official data show more than 188,000 workers were not insured by their employers last year from a total of about 4 Million. More than 200,000 others were also working outside the social security system.

The issue with labor in Greece, is not that much no-reported labor, but semi-reported one. In other words the labor force that gets insured only for part of its salary is not so much an issue of unreported -- or uninsured -- labor. This is growing lately as of all newly-hired workers, only 55 percent of the men and 45 percent of the women are insured by their employers.

This could be the result of one of two things (or both): an influx in illegal immigrant workers without any social security insurance or low incentives among Greeks to demand social security insurance.

In recent years, we have also noticed high turnover rates and an increase in contractual employment.

As for joining the ranks of the self-employed, it's tougher -- more requirements and higher costs -- to do in Greece compared to most other European countries. According to the World Bank's report, Greece ranks 135. While the situation here is a tiny bit better than in fellow European Union members Spain (134) and Austria (133), it's nowhere near as easy to set up a business as it is in Belgium (36) and France (25). Germany ranks 98.

However in the ease of registering property Greece may rank as badly as 150 but France ranks 149 and Belgium 174

This is not without an element of irony, considering how heavily we borrowed from the Franco-German model of doing business when Greece became an independent state back in 1821. In fact, much of Greece's legislative framework (civil, commercial and land codes) was imported from France and Germany. These laws formed the backbone of Greece's formal economy.

Now fast-forward some 200 years to the present. Greece's economy is broken -- but not irreparably. The country's economic future hinges on a reliable property rights system, low transaction costs and strong enforcement mechanisms.

Here's what needs to be done.

Follow a set of principles that have proven important ingredients to successful reform efforts.

First and foremost, we need to demonstrate an appetite for reform. We also need to start asking the right questions in order to correctly diagnose informality.

Another important ingredient is to establish a strategy that will help to build up trust with the people. Decision makers cannot afford any U-turning and politicians should stop back-pedaling on their decisions -- no matter what the political costs entail.

We should also focus on the policy changes needed to produce measurable results both for the short and long term. Also its imperative to prioritize institutional reforms across key policy areas that will create results and rebuild confidence, such as tax administration, civil service, property registries, and the judiciary system.

Bottom line: we need to fend off any old-guard resistance to institutional reforms so that we can finally lead Greece out of the crisis.