Continuing on the subject of the external sector I ‘d like to elaborate a bit on a simple fact: Imports are usually a function of domestic demand, not of relative prices. Greek imports did not increase during the Euro era because Greece lost competitiveness but simply because its internal demand grew faster than its trading partners. As a result, exports grew slower than imports and the latter became a much larger percentage of GDP.
The point of this observation is significant. As long as domestic demand is strongly correlated with credit growth (and credit flows were above 15% of GDP during the peak of the credit expansion and dropped to negative territory after 2009), imports (and the trade balance) will follow domestic demand with relative prices playing a secondary and limited role. Trying to adjust through wages will further reduce domestic demand, something which might improve the trade balance but at the expense of employment, debt servicing costs and long-term growth potential (due to hysterisis effects and negative net investment).
As a starting point I ‘ve calculated the ratio of imports of goods and services to domestic demand (excluding inventories) at constant prices for the 1995 – 2013 period (the last observation is based on projections from Ameco). A unit root test indicates that the process is stationary (although the test is not highly significant):
If one tests for a simple AR(1) process the results are quite significant, with a good fit (R² = 0.52) and no problems in basic diagnostic tests. The computed long-run mean value is equal to 30.2%.
Looking into the corresponding graph (of fitted, actual and residual values), it is clear that the fit is good apart from two periods. The Euro introduction of 1999 – 2001 and the pre-crisis period of 2006 – 2008. Both can be considered special cases: In the first case, the Euro introduction came just after a large stock market bubble while during the second, net imports of fuel and ships increased by more than 3% of GDP, from 3.8% in 2005 to 7.2% in 2008. Obviously just adding a dummy variable for these years increases the fit to R²=0.80 with a relevant coefficient of 3.1.
Right now, the relevant ratio is close to 27.5% which points to either a permanent regime change (with import substitution) or significant credit and income constraints (something also evident from the negative residuals for the last few years). A return of the ratio closer to 30% would subtract roughly the same amount from GDP, constraining growth (if the long-run variable is still around 30%).
One can argue about if the relevant long-run mean is high or not, but the reality is that any positive residuals (which might be indicators of relative price effects) have clear and plausible explanations related to outside factors and imports more or less followed the evolution of domestic demand. A relative price policy (targeting wages) seems to be just a wrong diagnosis of the problem.
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28 Αυγούστου, 2013 στις 18:03
Jimbo
Why doesn’t local production also grow along with demand growth (houses not taken into account)? I suppose the answer is simple; Greece doesn’t produce, say, smartphones. Well, this is a very serious problem with demand growth, especially if you’re a member of a problematic monetary union.
29 Αυγούστου, 2013 στις 19:44
kkalev
I ‘m not sure I understand your first question. Per Ameco, domestic demand actually stands for ‘domestic production’ since it is the sum of C + I (minus inventories in my case). So it tracks all production excluding exports.
Or are you referring to the share of imports falling as production increases? That’s an interesting question and one that requires quite a bit of research (probably with input-output tables). So long as services are the bulk of value added, it is not unreasonable to suggest that their ‘demand; for imports will be roughly steady.
The problem is that as long as the imports share is stationary and domestic demand increases faster than foreign demand, the trade balance will worsen ‘by construction’. In a monetary union where accumulated claims through the financial account are not considered risk-free (at least if we are referring to portfolio investment in – mostly government – securities), countries will sooner or later hit a ‘current account constraint’.
Although the Eurozone seems to have found the answer to the latter, by transforming member external liabilities (which had the form of government securities or inter-bank loans) to Eurosystem liabilities (which can be considered stable as long as each country’s membership is not questioned). In a sense, Eurosystem liabilities always clear at par, something not necessary for other claims (although they impose pressures on the domestic banking sector to find collateral to cover its liabilities with the NCB).