The Levy Institute released a very interesting report on the Greek economy, authored by its president Dimitri Papadimitriou. It looks at various aspects of the Greek economy since the early 1990’s from a sectoral balance approach which points to the fact that the simple profligate nation thinking is not that close to reality.

Based on the sectoral balances, a nation’s external balance is basically the result of investment minus saving. As long as government saving (surplus/deficit) is roughly steady, a large change in the external balance can only come from a corresponding change of the domestic private sector balance. This seems to have happened in the case of Greece:

It is evident that since the mid 90’s, the government deficit was lowered significantly while the private sector balance moved from a surplus of roughly 10% GDP (reflected in corresponding government deficits) to a deficit which reached 8% at various points after the Euro introduction, a change of more than 15% of GDP. This was the driver of the large external deficits rather than the government deficit which did not change much until the 2008 crisis.

Since the private sector balance is defined as S – I, one has to examine both components. Starting with investment we can reach some important conclusions:

  1. There’s no construction boom evident. Rather, ever since the mid-90’s construction investment has been lower and remained quite steady between 13-15% of GDP.
  2. The increase in investment is driven by an increase in equipment purchases which almost doubled after 1995 from 4% GDP to 7.5% and even 9-9.5% in 2007/2008.

The increase in equipment investment can only be regarded as a positive development since the construction sector falls in the non-tradable category, while new equipment will allow higher production and productivity growth in the industrial, tradable sector.

A scatter plot of the real change in imports of goods and transport and equipment investment tells the same story:

Actually if one takes a look at the goods deficit minus equipment investment he ‘ll find that the balance was declining after 2000 and only increased after the oil shocks of 2006 and later:

The clear conclusion is that unsustainable investment did not seem to be the driver of the goods deficit after the Euro introduction. Nevertheless, the strong deterioration between 1995 and 2000 of roughly 4% GDP which is evident in the diagram requires an explanation. If one looks at the trade balance components and private sector saving the driving force is clear:

Household saving went from +8% GDP in 1995 to -4% in 2000 (a change of 12%) with the manufacturing deficit increasing by 4% GDP in the same period. This negative balance persisted up until 2005. So it seems that the actual deterioration in the trade balance happened before Greece entered the Euro with the latter helping the private sector to persist its negative balances without consequences.

One can wonder at this point if, despite low domestic savings, Greece could have taken advantage of the strong international economic growth in order to increase its exports and thus improve the trade balance. In this context the evidence is rather mixed. It seems that Greece REER actually followed the Euro rate, while Germany embarked on a ‘devaluation’ path through steady ULCs:

The  following diagram shows that Greece kept its market share since 2001 and more or less took full advantage of world trade growth:

An excellent IMF study of Euro Area Imbalances provides some useful thoughts on the periphery trade balances:

  1. The lion share of the appreciation between 2000 and 2009 was accounted for by the nominal appreciation of the euro vis-à-vis other currencies, even for the countries such as Greece and Portugal that entered the euro at a potentially overvalued real exchange rate.
  2. The rise of China generated strong demand for machinery and equipment goods exported by Germany while exports from euro area debtor countries were displaced from their foreign markets by Chinese exports.
  3. The term of trade shock associated with higher oil prices contributed to rising trade deficits but higher income in oil producing countries also generated strong demand for machinery and equipment exported by Germany.

In the case of Greece High and Medium-High technology manufacturers account for 20% of manufacturing while in the case of Germany these account for 55%. Manufacturing accounts for 55-60% of goods exports while food still accounts for 20%. So it seems that Greek production was just not in high demand, while China and the oil shocks, helped by the REER appreciation, pushed imports higher without a corresponding increase for exports (in contrast with the German case). Lower ULCs would have probably helped in the import side but not much in the export side, except if they made Greece an FDI target.

Turning away from the goods balance, one has to remember that the balance of payments also includes other important components:

Net transfers and property income seem to have contributed as much as the goods balance since they went from a combined 10% surplus in 1995 to a deficit of more than 5%, especially after 2005, a change of 15% GDP.

A significant part of net transfers balance change is probably attributed to the large inflow of immigrants to Greece after the mid-1990’s, moving the corresponding balance to deficit:

In the case of property income, large external deficits did not adjust through the exchange rate (as during the drachma era) but were accumulated as claims of the external sector leading to large interest payments:

These claims were held by the Euro debtor countries while the rest of the world held claims on the latter and not the periphery. Both movements should be considered ‘structural’, since they are inherent features of a monetary union and of a country rather open to large (legal and illegal) immigration flows.


  1. Greece saw a structural negative change in net transfers and property income balances which will probably persist in the future.
  2. Investment seems to have been a positive contributor since it was targeted towards equipment and not to non-tradable sectors such as construction.
  3. The features of a monetary union allowed its Net International Investment Position to deteriorate with the external sector accumulating claims on Greek residents (government and private sector).
  4. Production was targeted on food and low technology manufacturing sectors and lost ground to China, other Asian EMEs and Eastern Europe countries.

As the IMF acknowledged in its latest WEO, internal devaluation projects utilizing fiscal consolidation are self-defeating in the current environment due to very large fiscal multipliers. Eurobank Research also published a similar research note which found a government spending multiplier of 1.32 and a wage multiplier of 2.35.  2013-2014 measures are projected to lead to further output loss of €15-20bn (7.5-10% GDP). Any positive developments on the trade balance mainly come from demand destruction, while low internal demand, large long-term unemployment and negative bank credit conditions make investment actually the most negative component in real GDP growth. An impressive statistic is the fact that the Total Factor Productivity index for Greece will drop to 100.4 in 2012, down 11.1% from 113 in 2007, back to the 2000 levels. That will limit potential growth and require much more intense usage of other factors (labour and capital) in order for the country to achieve positive growth.

The strong deterioration in the NIIP has been spread throughout the economy, with no sector having a high positive net balance with the rest of the world:

As a result, Greece cannot lower its external debts by moving net financial assets from the private to the government sector (most of the positive ‘other sectors’ balance is due to low Greek equity prices held by foreign investors). Unless a strong policy of economic growth is adopted (through financing by the rest of Europe), the only way out for Greece, as long as it keeps with the current fiscal consolidation policy, is to literally move real resources to the external sector. Since the NIIP is now close to 105% of GDP and property prices in Greece are in considerable fall, even that alternative requires very large transfers.