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In this post I will do a simple enough exercise: Look into the evolution of the Greek government primary current balance. This is just the balance of current income minus current expenditure excluding interest. Thus it excludes both the investment budget as well as interest payments on government debt.

Although public investment does impact national income (and is added in GDP in the first place), the current primary balance can act as a crude estimate of the «weight» of government on the economic process. Especially its change from one year to the other indicates the expansionary or contractionary stance of fiscal policy.

Greek Government Primary Current Balance 1995 - 2019 %GDP

The general pattern is quite clear. The primary current balance was in surplus in the late 1990s and reached a peak of 7.5% GDP during 2000. Afterwards, the fiscal stance relaxed substantially with a drop of 6.5% GDP in the 2001 – 2007 period to reach only 1% in the final year. The Great Recession took its toll with the balance dropping almost 6% of GDP during 2008-9 to a negative close to 5% GDP.

Then came austerity: The balance grew 8.6% of GDP in the 2010-13 period while it relaxed substantially during 2014 with a drop of 1.1% compared to an increase of 3% in 2013. This can most clearly explain the return to growth in 2014 since the economy experienced a change in the fiscal impulse of 4% GDP.

The effects of the 3rd economic adjustment program are also quite visible with the balance increasing 4.2% in the 2015-18 period which explains why these years had a sense of strong austerity despite a return to economic growth.

The 2019 current primary balance is expected to reach 7% of GDP, roughly similar to the 1999 balance. Yet 1999 registered 6% GDP private credit flow with a further increase to 10% during 2000 (which increased and persisted until 2008) while 2017 closed with a 1% fall in that flow. It is thus clear that the underlying dynamics are quite different and such a large surplus will definitely act as a serious drag on growth.

It is also interesting to take a closer look on the evolution of current revenue and primary expenditure during this time:

Greek Government Primary Revenue & Expenditure excluding interest 1995 - 2019 %GDP

Current revenue starts with a steady increase during 1996 – 2000 (close to 5% GDP total increase), remains stable for a couple of years and then makes a step drop of 1.5% GDP in 2003 to 37.5% around which it hovers until 2009. Since then it starts an uphill march to around 45% in 2013, a change of 7.5% GDP. Although it grew more than 3% GDP in 2014 to 48.4%, this level appears quite unstable since current revenue is projected to return to 45.5% during 2019. Assuming that 45% is the «new equilibrium», future current primary balance will depend heavily on the primary current expenditure trajectory.

The latter appears to grow steadily from 30% in 1998 to 39% a decade later. Even the large austerity package from 2010 onward was not able to break that limit, mostly because of the large fall in GDP which made the denominator fall substantially along with nominal expenditures. The 2013-17 average was 41.7% which dropped significantly during 2018 to 40% GDP and is projected to reach 38.5% in 2019, a cumulative fall of 3% GDP in two years. Whether such a fall can be sustained in the long-run is a question that will be difficult to answer.

If primary current expenditure returns to the 41.5% average, the primary current balance will drop to half its 2019 projection to 3.5% GDP. Since that is the current primary balance target until 2022 this implies that the investment budget will need to be balanced. Given that is close to impossible, the stability of the 3.5% primary surplus target will depend on the Greek government achieving a primary current expenditure level of close to 38.5% GDP.

Actually (Gross Fixed Capital Formation – Capital Transfers Received) has a mean value of -2.4% GDP and a standard deviation of 1.42% for the period 1995 – 2017. If the values were drawn from a normal distribution the probability of a non-negative balance would be around 4%.

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Since my last post was mainly focused on the issue of inequality I would like to continue on this road and introduce a concept which I will call «Economic Reproduction Frontier» (ERF).

The main idea is rather simple: Take the threshold of the major brackets of income distribution as a share of average per capita income and examine their course across time. I will be using data from the World Inequality Database on a per adult (equal split) unit for this exercise.

One can think of average per capita income as a crude pointer for both the consumption basket (or frontier) in a given country at a given time as well as the cost of human capital development for an individual. An income say 20% of average per capita income will correspond to a significantly different (and highly constrained) consumption basket and place large obstacles on the opportunities and capabilities of an individual increasing and expanding his human capital. Since most economic output is mass consumed and production is highly connected to human capital, the income available to a large proportion of the population will ultimately act as a constraint on economic growth. Especially if individual income as a percentage of average per capita income falls on a permanent basis.

To do this I calculate the share of threshold income for various income brackets in the US during the period 1966 – 2014 (due to data availability). Below are two graphs, one for P20/P30 percentiles and one for P40/P50. Linear trendlines along with the exact equation and R² for each percentile are also presented.

P20 P30 Percentile threshold % GDP 1966 - 2014P40 P50 Percentile threshold % GDP 1966 - 2014

It is striking how all threshold shares are on a permanent downward trajectory, as well as the very strong R² for all lines (over 0.93 in all cases with stronger results in the P40 and P50 cases). The relative stability of the threshold shares up until the turning point of 1980 is also evident. The regression coefficient points to a fall of roughly 50bp annually for the P40 and P50 brackets which means that each bracket losses almost 5% share of per capita GDP every decade.

P20 and P30 brackets start below 50% and fall to 20% and 30% by 2014. What is striking is that the P40 brackets falls to roughly 40% by 2014 starting from 63% (the P50 bracket falls to 56% of average income starting from 77%). This suggests that at least 40% of the population  cannot maintain a middle-class consumption basket and human capital without going into debt since it is severely income constrained. Even P60 and P70 brackets show a clear drop in the given period (from 90% to 73% for P60 and from 106% to 94% for P70) suggesting an extremely strong middle class hollowing out in recent decades, at least for the p30p70 bracket. Only the top-10% threshold share shows an increase in the given period from 170% to 184% while even the P80 threshold share lost 2.5%:

Change in threshold share of average income 1966 - 2014

Although I am sure this simple exercise will have methodological issues it still suggests a strong loss of income resources for a major part of the general population with serious consequences on long-term growth. If 40% of the population are not able to finance their human capital development through their income nor afford a basic middle-class consumption basket without going into debt, this suggests that long-term growth will be affected in one way or another.

Modern capitalist economies are based on large scale production of mass consumption goods and on using a highly educated workforce in a large part of the production process and sectors.  Linear extrapolation suggests that the P50 bracket will fall to 50% of per capita income by 2026 (while P40 will be 35% and P30 24%) making the above process highly constrained. We might be nearing an inflection point for economic growth due to growing inequality.

Jordan Peterson is a clinical psychologist who’s earned his fair of publicity in recent years, especially through videos of his lectures and speeches on Youtube. Personally, I have found the views expressed on his videos quite helpful and inspiring while his lectures contain a ton of useful information and methodology on how to address life (I especially recommend the Biblical Series).

On the political front, it is clear the Dr. Peterson leans to the right and has been highly critical of far-left and Marxist views. Nevertheless, he makes a solid exposition for the necessity for both broad political parties with the right focusing on personal effort and values, order (which allows people to cooperate and plan for the future) and hierarchy of competence (implying equality of opportunity but not of outcomes). The left on the other hand tends to focus on classes instead of individuals, inequality (which is ultimately a destabilizing force) and change which attempts to balance out the fact that the economic games tends to work like «Monopoly» with most people stacking up at zero and a significant few acquiring almost all the wealth.

In a recent video he analyzes a film by «Future Majority», a team of Democrats trying to bring about change in the political landscape in favor of the working class. Dr. Peterson is especially critical of the main part of  the video which describes the surge in inequality during the last decades. In his own words, he considers this to be the weakest part of the film and that the inclusion was an error.

In my view, this is actually the stronger and most important part of the film and what distinguishes the creators politically. The part in question describes how incomes (for the lower and middle class) have stagnated for decades, how CEO compensation has skyrocketed when compared to worker wages and how almost all of the recovery since the Great Recession went to the top-0.1%.

What I especially like about this part is that it mainly analyzes the inequality problem in relative (rather than in absolute) terms and across time. CEO compensation is compared to their own workers wages and working class income to where it was decades ago. The important part is that the data are absolutely real.

The ratio of CEO to worker compensation has actually increased ten-fold in recent decades:

CEO to worker compensation ratio 1965 - 2014

while the bottom-90% has not seen any actual increase in real income since 1980!

US Bottom-90% real average income (base 1950)

Dr. Peterson basically states (and assumes) that income is mostly earned honestly through hard work with only a small minority being the result of exploitation or counter-productive endeavors. So it seems that CEOs earning 300 times average compensation (instead 30 times during 1980) is the result of exceptionally high productivity and work while the bottom-90% is just not being any more productive for almost 40 years now.

What is missing from the analysis is the fact that work/income outcomes are not only the result of personal choices and work but also of class negotiation power. Worker power will depend on the state of the business cycle (and the level of unemployment), union density and power, outsourcing threats, import penetration (which embody foreign labor acting competitively to domestic labor), the level of sectoral competition (which determines to what point a company will actually act as a monopsony) and a host of other factors.

Since 1980 unemployment has mostly been above the «natural level of unemployment» with only the second half of the 90s accounting for an actual high-pressure economy:

fredgraph

union density fell from 27% in 1973 to 19% in 1986 and 11% in 2011 while the real minimum wage (which mostly determines the floor for the bottom-20% income) has never increased above 85% of its 1980 level:

fredgraph(1)

Even increasing educational attainment has not really helped workers since only post-bachelor degree college education has posted steady increases in weekly earnings. Apart from an increase during the second half of the 90’s (when the economy was allowed to run hot) the rest of the college level education earnings have been flat all the while student loans outstanding have climbed to a total of 1.5tr $.

Real Weekly Earnings by Educational Attainment, 1963 = 100, 1963–2012

In my personal view, Dr. Peterson has allowed his own political views to cloud his analysis of income inequality. It seems that he clings to a stereotype where any actual exposition using hard data of the problem is a manifestation of resentment towards the hard-working wealthy instead of the first step of trying to determine and solve the problem. In so doing and especially by insisting that the film should not have included a section on inequality in the first place he appears to make the case that thinking and analyzing inequality has no value and wealth and income are only the result of personal choices, competence and hard work. Given that the Democrats voter base is within the bottom-90% working class it seems quite strange to insist on not really focusing on income inequality at a time when the working class has not been able to see its real income rise above 1980 levels.

Recently, the IMF published its long-awaited Article IV consultation on Greece which includes an assessment of the latest developments of the Greek economy as well as its own DSA on Greek debt (which rests on significantly different assumptions than the ESM DSA).

The IMF starts with a stark chart showing how the Greek tragedy compares to the US Great Depression, the 1997 Asian crisis as well as the Eurozone crisis:

IMF Greece Crisis US Great Depression Asian Crisis

The depth of the Depression is quite similar to the US case while Greece has managed to «maintain» a 25% lower GDP for a period of 5 years.In contrast, even the US managed to return to its pre-crisis GDP level 7 years after the start of the Great Depression. This is a clear indication of the way the Greek case was tragically mismanaged by the European countries and the IMF whose priority was avoiding a principal haircut of official loans rather than a quick return of Greece to growth.

The IMF projects that Greece will grow moderately during the 2018-2022 5-year period which also coincides with the period during which the country will have to register primary surpluses of at least 3.5% GDP. Most of the growth is projected to come from fixed investment with private consumption contributing 0.5% annually and a neutral contribution from the foreign balance:

IMF - Greece 2018 - 2022 main macroeconomic projections

As I have outlined in the past, such a growth path rests on the assumption that Greek households will continue dis-saving at the order of €9bn annually even while they have already depleted their financial assets by €34bn in the 2011-2017 period. This is based on the fact that, given a neutral external balance and a 3.5% primary government surplus, sectoral balances indicate that the private sector will need to maintain a negative net asset position in order for the other sectors to achieve these balances.

Projecting nearly 1% annual increase in private consumption during the 2020 – 2023 period without any countervailing factor (such as a positive external balance or a significant relaxation in the fiscal stance) seems quite optimistic. An annual negative balance of just €8bn means that households will have to consume another €40bn of their financial assets in the 2018-2022 period. Only employment growth (which will increase disposable income of the household sector) will act as a countervailing force. It’s a pity that the IMF does not use sectoral balances to check whether assumptions for private consumption and government surpluses can be realistic in the long-run.

The other important part of the IMF document is obviously the Greek debt DSA as well as its assessment of the possibility of maintaining large primary surpluses for many decades.

In its baseline scenario the IMF staff agrees with the ESM that debt-to-GDP trends down and Gross Financing Needs (GFN) remain below 15% of GDP in the medium term.

Nevertheless, the IMF argues that Greece will be unable to maintain a primary surplus larger than 1.5% of GDP after 2022 while its long-run economic growth will hover around 1% in start difference with the ESM which is projecting a primary surplus of 2.2%. As a result, the IMF is much more pessimistic for the long-run, projecting that Greek debt will become unsustainable after 2040:

IMF - Article IV 2018 DSA

What is also quite interesting is how even medium-term sustainability rests on assumptions of large primary surpluses and growth during the 2018 – 2022. A small 2 year recession during 2019-22 (with a total of -3% GDP growth) coupled with a small primary deficit for just one year will immediately push debt-to-GDP close to 200% and GFN to 20%.

IMF - Adverse Scenario 2019 - 2022 Greek Debt

Lastly, the IMF staff try to justify analytically why Greece will be unable to maintain high primary surpluses and economic growth in the following years. While the specific arguments have been put forth many times in the past, it is interesting to repeat them here once more (in IMF exact wording):

  • Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades.
  • Total factor productivity (TFP) growth over the last 47 years averaged just ¼ percent annually, by far the lowest in the Euro Area. Assuming this historical average TFP growth rate going forward, labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output).
  • Combining the historical growth in output per worker of 0.4 percent with expected growth in the number of workers of -1.1 percent would imply long-term annual growth of -0.7 percent.
  • While studies have documented an impact on output levels of 3 to 13 percent over the initial decade, the impact of reforms on growth tends to fizzle out afterwards.
  • Lifting long-term growth from its baseline of –0.7 percent to 1 percent requires reforms to add 1.7 percentage points to growth per year for the next decades. The OECD (2016) estimates that full implementation of a broad menu of structural reforms could raise Greece’s output by about 7.8 percent over a 10-year horizon, which translates into an increase in annual growth of some 0.8 percentage points for about a decade. Bourles et al. (2013) estimate this gain to be slightly higher, at about 0.9 percentage points per year, while Daude (2016) finds that reforms focused on product markets and improving the business environment in Greece could boost growth by about 1.3 percentage points per year for a decade.
  • Implicitly, the 1 percent growth projection presumes that Greece would manage to increase labor force participation to levels that exceed the Euro Area average (to offset the significant projected decline in Greece’s working age population) and that would generate TFP growth rates permanently far above Greece’s historical average.
  • Historically, Greece has been unable to sustain primary surpluses for prolonged periods. During 1945–2015, the average primary balance in Greece is a deficit of about 3 percent of GDP, although a brief period of near-zero primary balance took place at the time of Greece’s EU accession. The high water-mark for Greece was a primary surplus exceeding 1 percent of GDP during eight consecutive years (1994–2001).
  • In a sample covering 90 countries during the period 1945–2015, there have been only 13 cases where a primary fiscal surplus above 1.5 percent of GDP could be reached and maintained for a period of ten or more consecutive years.
  • Economic conditions matter. Among EU countries, before entering a period of high average primary balances, countries tend to have strong real GDP growth (2.7 percent) and modestly high inflation (4 percent). They also have moderate unemployment (10 percent) and low net foreign debt (24 percent of GDP), conditions that do not conform to those now applying in Greece. Moreover, during the high primary balance periods, growth has been rapid (about 3.4 percent), inflation slightly elevated (3 percent), and unemployment contained (at about 7.2 percent). This suggests that sustained periods of high primary surpluses are driven by strong economic growth rather than by sizeable fiscal consolidation.
  • Unemployment weighs on the budget through higher social expenditures—such as for unemployment benefits and social safety nets—as well as lower income-related revenue. Greece’s unemployment rate is exceptionally high—only 10 countries have had unemployment higher than 20 percent in the postwar period.Within the above sample, the average primary balance corresponding to countries suffering double-digit unemployment rates is about zero percent of GDP (i.e. balance). For double digit unemployment lasting for 10 years or longer, the average primary balance is about -½ percent of GDP. With long-term unemployment likely to remain high for some time, pressures on social assistance spending in Greece—such as the guaranteed minimum income—are likely to mount.

Overall, the IMF tries its best to provide Europeans with political cover for the medium-term outlook on the Greek front while still presenting a scientific case for why the targets set in the Greek program are highly unrealistic and will not be achieved. In my view it should pay closer attention to sectoral balances which would make it even easier to argue why large primary surpluses cannot be maintained in a country with a structurally negative external balance.

So ELSTAT announced the Greek GDP figures for 2018Q1. The main taking point was that GDP increased 2.3% on an annual basis compared with 2017Q1. Yet if one takes a closer look I feel that there are a few worrying signs, specifically in the sectoral breakdown:

Greece 2018Q1 GDP

It is clear that consumption, especially private consumption continued registering negative growth for a third consecutive quarter. As I have outlined recently I find it quite difficult for Greek households to continue running down their financial assets at a pace of €9bn per year in order to maintain (or even increase) their consumption levels. This is destined to have its toll on investment activity which actually registered a 10% fall during 2018Q1.

As a result, Greek internal demand contributed negatively to GDP growth with only net exports being a driver of the positive 2.3% growth figure. Unless these internal demand dynamics take a positive turn during the next quarters I fear that GDP growth for 2018 will prove to be disappointing, at least compared to projections (the Commission projects that 2018 growth will be driven almost completely by internal demand and not by net exports). Obviously running a primary surplus close to 4% of GDP for the third year in a row will only make matters more difficult.

 

The latest data on Greek national accounts indicate a steady deterioration in private consumption throughout 2017 which registered negative growth during 2017H2 and only contributed 0.1% in annual GDP growth. Overall, only investment was the main driver of the small growth in the Greek economy during 2017:

Greece GDP components increase 2015 - 2017

Since investment is usually described by an accelerator effect (with domestic and external demand driving capacity utilization upwards and increasing the need for investment in new productive capacity) the only way for Greece to achieve significant growth in the coming years will be through an increase in private consumption (which is still close to 70% of GDP).

Yet as was described in a recent Eurobank 7-days economy bulletin, private household saving registered its 6th consecutive year in negative territory. According to AMECO data household gross saving was -€9.4bn in 2017, a new negative record and significantly lower than the €7.7bn during 2016. During the 2011 – 2017 period total saving was an impressive -€33.6bn (or almost 20% of the 2017 GDP figure).

Greece household gross saving 2000 - 2017

It is quite obvious that households can maintain consumption by running down assets only temporary yet the EUprojects the same dis-saving to continue throughout 2018 and 2019 with an additional €16bn reduction in household assets.

On a cumulative basis (starting at 2000 with the introduction of the Euro) total gross (negative) saving by the end of 2019 will have reached back to 2004 levels at close to €44bn (from a peak of €93bn).

Greece - Cumulative Household Gross Saving 2000 - 2019

Given the fact that a large part of household saving is not directed towards liquid deposits but is invested in other assets such as housing, it is evident that a total negative saving flow of €50bn by 2019 will place a significant challenge on household balance sheets. This is even more difficult given the large pool of outstanding NPLs, private debts towards the state/social security funds and the difficulty of securing new loans from the Greek banking system.

Since Greece is targeting large primary surpluses for the public sector at least until 2022 (in the order of 3.5% of GDP) and taking into account its structural external deficit, sectoral balances indicate that the household negative net balance is most likely to continue. Given these balance sheet dynamics it seems quite unlikely that private consumption will register large increases in the coming years and support a strong cyclical recovery for the Greek economy.

There’s a (greek) article circulating on the internet during the last few days based on an older Mises post from May 2015 which analyses how 67% of the Greek population depends on public funding which is obviously provided by taxing the remaining 1/3.

The essence of the above article can be summarized in the graph below which is supposed to show the percentage of population reliant on public funding for various countries:

population reliant on public funding by country

Although the article does not really bother to describe in detail how the graph is created or which year it refers to I will assume that it is based on 2014 data (since it first appeared on the Internet in 2015) and try to roughly recreate the relevant metric for Greece but explore it in historical terms.

The main argument of the Mises post is that public employment and pensions are reliant on private sector taxes and pension contributions and should thus be considered «a burden». Since I want to keep the data simple and easily accessible I will assume that pensioners are those over 65 years old and public employment the sum of «public administration and defence», «health services» and «education» from the Employment Survey. According to the latter, the sum was roughly 800 thousand persons at the end of 2014 which I will regard as constant due to data availability at FRED.

Based on the above a rough estimate of the percentage reliant on the private sector will be «1 – (employment – 800,000) / population over 15 years old» which is shown in the graph below (FRED only has data starting at 1998):

Greece population dependant on private employment.png

What is evident is that this percentage was over 50% already before the introduction of the Euro and started decreasing after 1999 reaching 48% in 2008 (from 54% in 1999) mainly driven from the increase in private employment. It shot through the roof during the Greek Great Depression to the level of 62% in 2013 because of the increase in unemployment. This is the point in time when Mises took «a picture» of this percentage to make its argument.

It is almost a tautology that in a country with more than 25% unemployment and another 20% of the population being over 65 years old a large part of the population will be reliant on those left working for its income and basic needs. Mises (circular) argument is more or less that the large unemployment in Greece is due to… people being massively unemployed. The fact that Greece has a structural primary balance of over 6% obviously seems to not play any role.

 

The latest ESM compliance report on the Greek adjustment program also contains an updated Debt Sustainability Analysis (DSA) which reaches some fairly important results.

Its main assumptions are:

  • Real GDP growth close to 1.5% after 2022 and 1.25% from 2030 onwards. Coupled with inflation equal to 2% after 2024 the Greek long-term growth outlook is equal to 3.25% in nominal terms (the IMF on the other hand expects a nominal GDP growth rate of 2.8%).
  • Total privatisation revenues of €17bn with no need for further bank recapitalisations (the IMF projects €10bn revenue and a need for an additional €10bn buffer for bank capital needs).
  • A 3.5% primary surplus until 2022 after which the primary surplus starts to decrease 0.5 p.p. per year levelling off at 2.2 % as of 2025 (the IMF does not consider these long-term surplus targets sustainable).

Event under these assumptions the baseline scenario expects the debt-to-GDP ratio to reach 165% in 2020 and 127% in 2030 while the Gross Financing Needs (GFN) are projected to increase from 2020 onwards reaching 23% in 2055.  As the report itself states:

Given the high debt-to-GDP and GFN-to-GDP levels, concerns remain regarding Greece’s debt sustainability under this scenario.

 Under more unfavourable scenarios the debt-to-GDP and GFN ratios are quite explosive and do not allow Greece to reach any measure of debt sustainability.

DSA - results* Scenarios B & C are the adverse scenarios.

Even the ESM is not able to paint a rosy picture of Greek debt dynamics despite making some very favourable assumptions regarding long-term growth and government primary surpluses. A small deviation from these (optimistic) assumptions puts the Greek debt to an unsustainable path.

Although the above make it clear that further rounds of debt restructuring will be needed, the fact that GFNs fall significantly during the 2018-20 period means that Europeans can narrowly focus on short-term targets regarding Greek primary surpluses while postponing debt reduction measures for the more distant future. As a result, Greece might be caught in a situation where short-term measures are demanded (such as bringing the income tax threshold reduction forward) while debt restructuring is only offered as a promise for .. the next decade and contingent on fiscal measures being passed immediately.

Most people believe that the significant deterioration in the Greek balance of payments after the introduction of the Euro is a clear sign of the fall in Greek competitiveness and of unsustainable private debt expansion dynamics. It is assumed that the Greek economy was not able to provide the global market with goods and services of a sufficient quality and competitive price while the large expansion of domestic demand (due to significant private credit flows) expanded imports with a rate that led to a large increase in the goods deficit.

Although there is some truth in the above statement, a closer look at the detailed balance of payments data (from BoG) reveals some very interesting facts. The actual balance of payments figure deteriorated significantly from a deficit of €11bn in 2002 to €36.5bn in 2008 all while nominal GDP expanded by 50% in the corresponding time period.

Yet imports and exports of goods excluding oil & ships expanded with the same rate (although at a rate higher than nominal GDP which suggests that private credit flows did play a role). What made the corresponding deficit increase by around €10bn was the fact that exports are only 34-36% of imports although that ratio remained relatively steady throughout that period:

Greek Balance of Payments Imports Exports of other goods 2002 - 2008The actual increase in the balance of payments deficit can be attributed to 3 factors:

  1. An increase in the oil balance deficit which more than doubled by 2008.
  2. The ship balance moving from a surplus of €400mn to a deficit of more than €4.6bn in 2008 and
  3. A significant increase in the balance of investment income (mostly interest payments) from €2.3bn in 2002 to €10.6bn during 2008

Greek Balance of Payments - Oil Ship and Investment Income Balance 2002 - 2008

The first factor can mostly by attributed to a large increase in global oil prices during that period, especially denominated in Euros.  By 2008, global Euro oil price had increased 150% compared to 2002 while the Greek oil balance deficit had expanded by a comparable 170%.

The swing of the ship balance to a large deficit is most probably accounted by a corresponding increase in ship building/purchases investment by Greek ship companies. This was a period of large global trade growth with the Baltic Dry Index reaching new highs. The reasonable assumption was that these large investments would quickly translate into increased shipping payments that would be used to finance the initial outflows and (also) lower the current account deficit through a higher services surplus.

As for the investment income deficit this is mostly the outcome of stock-flow adjustment and monetary policy. Each year’s current account deficit added to an increase of Greek foreign net liabilities and to larger net interest payments in a semi-automatic way. Moreover, the increase in short-term interest rates by the ECB after 2005 made servicing the same amount of net liabilities even more expensive which is one of the reasons why the investment income deficit expanded more rapidly during 2006 – 2008.

If we assume that the sum of the Balance of Goods excluding oil & ships and the balance of services can be regarded as the most representative metric for the Greek external sector and competitiveness we observe that this deficit expanded by only €4.5bn during 2002 – 2008. The bulk of the balance of payments deficit expansion can be accounted by oil, ships and investment income. In other words, global factors (oil prices, expansion of trade and the shipping industry, ECB monetary policy) as well as the automatic effect of flows on stocks were the main drivers of the Greek external deficit.

Greek Balance of Payments changes since 2002 up to 2008

As I ‘ve highlighted many times in the past, the level of future long-run primary surpluses for Greece plays a major role in the debt sustainability scenarios. The major difference between the IMF and Euro institutions projections is identified in the primary surplus assumptions. The IMF projection for a 1.5% surplus makes debt restructuring necessary while the European institutions assume much higher primary balances which make debt sustainability more favourable.

IMF vs Euro Institutions Greek DSA

A recent ESM paper on Greek debt reveals the importance of these projections. If Greece achieves 3.5% primary surplus until 2032 and 3% until 2038 no debt restructuring is required as long as economic growth is 1.3%. On the other hand, the IMF scenario of 1% economic growth and a primary surplus of 1.5% after 2022 makes Greek debt explosive.

European institutions try to make the case that episodes of large and sustained primary surpluses are not uncommon in European modern history. The ECB especially highlights the cases of Finland and Denmark as well as other countries:

The European Central Bank says such long periods of high surplus are not unprecedented: Finland, for example, had a primary surplus of 5.7 percent over 11 years in 1998-2008 and Denmark 5.3 percent over 26 years in 1983-2008.

and

ECB - Selected Episodes of large and sustained primary surpluses in Europe

My comments are twofold. First, the average primary surplus figure is not always equal to the year-by-year primary balance. Denmark achieved a primary surplus equal or higher than 5.3% in only 5 years during the 1983 – 2008 period. Actually, the primary surplus was at least 3.5% during 9 of the total of 26 years.

Yet the most important element that is not highlighted in the above cases is the fact that large primary surpluses were achieved in the context of equal or (mostly) higher current account surpluses. This is highly important since it allows the domestic private sector to achieve a positive net asset position even when the public sector is in surplus. As a result, economic growth is not threatened by the public sector and the private sector maintains a healthy balance sheet.

To illustrate the above I ‘ve «corrected» the primary surplus by subtracting the current account surplus. I ‘ve also deliberately set the vertical axis maximum to 3.5% which is the surplus requested from Greece to illustrate the fact that it is almost never achieved.

corrected primary balance for current account - selected high surplus episodes.jpg

On the contrary, of the total of 60 years in the above episodes, 26 had a negative corrected primary surplus while it was lower than 1.5% in 40 years illustrating the fact that the IMF assumption of a 1.5% surplus is not unreasonable.

Since the Greek cyclically adjusted current account is highly negative it is clear that the assumption of high primary surpluses which will be maintained for decades is almost without precedence in the context of the private sector balance. Assuming a 3% nominal growth rate (based on the IMF assumption of 1% growth), a 10 year 3.5% primary surplus is equal to a 30% GDP transfer from the domestic private sector while a 20 year 3.5% surplus is equal to 52% GDP transfer which will not be counterweighted by a current account surplus.

In my view, the European institutions continue to make assumptions consistent with avoiding explicit costs for Greece’s creditors but inconsistent with economic reality and sectoral balances.

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Kostas Kalevras

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