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Can Greece invest its way out of the crisis?

Greece could surely use some economic growth - badly. But how? An evaluation of more than a hundred studies has revealed that public investment, even on credit, may just hold the key to long-term success.

First of all, no one doubts that Greece is in need of fundamental reforms. It requires better administration, less corruption and more competition. It is also understandable that creditors attach certain conditions to their loans.

The question, however, is why the Eurogroup put so much emphasis on austerity during its negotiations with Athens when it could have been focusing more on investment. This is a point at which Germans will reflexively recall the image of the "Swabian housewife." She has her family's finances in perfect order and never spends more than she can afford.

That mantra also happens to be German Finance Minister Wolfgang Schäuble's justification for not being more lenient with the Greeks. "My grandmother, who came from the Swabian Alb, used to say, 'Good nature comes right before debauchery,'" Schäuble said in a recent interview with the German newsmagazine Der Spiegel. "There is a certain type of generosity that can quickly have the opposite effect of what was intended."

Evaluation of 104 international studies

Fact is, ailing economies cannot be compared with Swabian households. Economists agree that Greece will only be able to overcome the crisis when its economy returns to growth and starts creating new jobs again. But to get there, it needs investments.

There have been numerous studies in which economists have investigated how countries can best give their economies a boost. One such expert, Sebastian Gechert from the Macroeconomic Policy Institute (IMK) in Düsseldorf, an independent academic body within the non-profit Hans-Böckler-Foundation, analyzed the results of 104 studies that were published between 1992 and 2012 in international scientific journals.

All of them dealt with so-called fiscal multipliers. These are simulations that predict how government spending affects growth.

The result? Public investments were by far the best way to stimulate growth. For every euro invested by the state, gross domestic product, or GDP, grows by 1.30 to 1.80 euros.

The effect is significantly weaker when the state uses its money to hire more public servants or when a government simply increases spending on education, sports, culture, social safety nets, public order or environmental protection. Military expenditures are the least effective economic stimulant. At best, they create one euro in growth for every euro spent. Most of the time, however, they fail to achieve even that.

Greece, along with Spain, Portugal and Ireland lost a great deal of economic strength during the financial crisis. Unemployment also took off, as the graph below shows. The austerity policies had "a negative impact on growth and employment," Gechert wrote in his meta-study for the IMK. "By contrast, publicly financed investments would have resulted in relatively large momentum for growth."

New debt?

The only question is how does one go about financing public investments when the state doesn't have any money of its own? One way could be tax increases. Cuts to public spending could be another. That's how they did it in Greece, Spain and elsewhere. The only problem is that such measures have a negative effect on growth, thus offsetting the positives that come with more investment.

That's why Gechert looked into the question of whether it would be worth it to finance investments entirely through new debt. His conclusion? "A growing deficit or a smaller surplus as a result of more investment spending does not necessarily increase the debt ratio," he said.

This is because when the investments have the desired effect and trigger growth, the expenses practically finance themselves. The costs for the state would be "comparatively low," wrote Gechert - it would only feel an additional burden of between 10 and 40 percent. This would require a functional tax system, however.

Renewed failure?

In the talks about a new aid program for Greece, there has been very little mention of new investments. Granted, European Commission President Jean-Claude Juncker has pointed to up to 35 billion euros from regular EU coffers, but this would require Greece to use its own money as co-financing - money that the government in Athens doesn't have.

The EU has now lowered its requirements for co-financing. The chief economist and director of the IMK, Gustav Horn, recommends taking things a step further.

"Our suggestion would be to permit Greece a year of access without any co-financing. The government would then be able to get an investment plan underway immediately - and they would have to due to the time pressure," Horn said.

Economically, based on the agreement that Greece has reached with the Eurogroup until now, Horn perceives there's "at least a slight chance that the Greek economy could recover." However, this will only be possible if there are investments.

"If the rescue strategy is restricted to a continuation of intensified cuts to the state budget, then this program will fail just as its predecessors did."