You are currently browsing the tag archive for the ‘Greece’ tag.

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

Advertisements

Recently I have been going through the excellent blog of Dietz Vollrath (which is mainly focused on long-term economic growth and its drivers) and have found a number of points on long-term growth which are highly related to the Greek case. As the IMF debt sustainability analysis made clear, Greek long-term growth expectations of 2% annually were based on Greece achieving a steady TFP growth rate equal to the best Euro performer (Ireland). These expectations have already proven way too optimistic and economic growth projections have been lowered to 1.5% yearly. Yet, as the DSA states, if Greece were to achieve a labor force participation rate close to the highest of the Euro area, unemployment fell to German levels and TFP growth reached the average in the euro area since 1980, real GDP growth would average 0.8 percent of GDP. As a result, any long-term growth projection higher than 1% per year seems highly optimistic and conditional on extremely favorable TFP growth rates. In this blog post I would like to explore a few of the headwinds that are likely to put a serious break on Greek long-term growth and how the structural reforms blue pill will not be able to help.

Structural Reforms long-term impacts

Before looking into specific issues let me remind people that the IMF’s own research indicates that most of the proposed reforms in the Greek case (labor and product markets) have low impact on long-term TFP growth rates. The reforms that do impact technical change and productivity in a positive and permanent manner are those that involve actually investing large sums of funds on R&D, ICT capital and infrastructure. Labor market reforms on the other hand have negative effects in the short-term and no impact on long-terms horizons yet they remain high on the reform agenda, even after Greece has already implemented a whole set of measures that have reduced labor bargaining power, minimum wages and allowed for much more flexible working conditions (something which is evident in the very large share of non-permanent work contracts in new hires):

Short and medium term impact of structural reforms on total factor productivity

Sectoral Composition and Growth

Dietz Vollrath also makes a very valid point when analyzing the services sector. He highlights the fact that when someone buys a service what he is ultimately purchasing is time, not a thing. When you buy a massage you are buying 60 minutes of a professional’s time. Increasing productivity in services is not even very difficult, it is also not desirable. We could increase productivity in schools by enlarging the number of children in each class but no parent would be overly fond of such an idea. Ultimately, what the services sector can achieve is either to increase its mark-ups by offering higher quality services (ie in restaurants and tourism) or provide massive, high productivity services (think large retail stores like Zara or large super-markets) which require closing down most SMEs and lowering labor inputs (since much less labor will be required to provide these services). In any case, both avenues require real investment and restructuring of the economy and not just having the state ‘reform and get out of the way’. Obviously taking the second route can increase productivity but at the expense of employment, markups, competition and most probably quality.

In any case, what the above highlights is that one cannot expect that economies with very different sectoral composition between services and industry can achieve comparable TFP/productivity gains without a long and painful process of economic restructuring. This is especially true in the case of Greece when compared to Ireland and Germany:

Sectoral Value Added Shares Germany Ireland Greece

* Source: OECD STAN archives

Economic Restructuring and the financial sector

Closely related to the argument above is the fact that economic restructuring (which means moving resources from low-productivity firms and sectors to high-productivity ones) requires a working financial sector. As long as banks carry a large pool of NPLs on their balance sheets they will mainly attempt to ‘postpone the day of reckoning’ and not help in moving capital towards high-growth/efficient sectors. This phenomenon is highlighted in recent research by BoE on the impaired capital reallocation mechanism in the UK. The high increase in the standard deviation of firm rates of return since the crisis is a significant indicator of such ‘distortions’:

figure 4 - SD of firm rates of return relative to change in capital stock

Obviously Japan is also another example of how NPLs can become a long-term bottleneck for economic restructuring and a drag on new bank lending and economic growth. As long as Greek banks are not properly recapitalized and cleared of their NPLs (which will probably reach €100bn) they will remain a barrier for restructuring the Greek economy and increasing long-term growth.

This is even more important for Greece because of the relative dominance of SMEs in the economy since SMEs are much more reliant on bank financing for their continued operation and growth:

Source of SME financing

Poverty and risk-aversion

Another point emphasized by Dietz Vollrath is the fact that there is a close (and probably non-linear) relationship between poverty and risk-aversion. High growth is usually closely related to high risk and opening an enterprise in a high growth/export oriented sector requires, apart from capital, risk taking individuals. As long as people face the risk of poverty and social exclusion (over 37% of Greek nationals aged 18-64 faced that risk during 2014) and are in trouble of securing their most basic needs such as food and shelter they are bound to be extremely risk averse and not willing to take business risks. You cannot have almost 40% of the population risk poverty and still expect strong productivity growth based on implementing risky and cutting-edge entrepreneurial ideas.

Sectoral Balances

Furthermore, whatever our projections about economic growth, the economy should be able to achieve it without creating (or worse, increasing) economic imbalances. One of the most basic tools to guarantee consistency on this front is to use the sectoral balances which involves the basic macroeconomic accounting identity that the sum of savings in an economy should balance to zero. In the Greek case this revolves around the fact that ‘debt sustainability’ requires a long-term fiscal primary balance of 3.5% from 2018 onwards. This large fiscal surplus requires a corresponding balance for the private domestic and external sector. Either the current account surplus will have to reach and remain at close to 3.5% of GDP or the private domestic sector will face a constant deficit of its net accumulation of financial assets.

Given the fact that Greece has achieved a current account surplus of less than 1.5% GDP and an output gap that is probably close to 10% its cyclically adjusted external position is still close to deficit. A quick way to determine that is to assume an import-to-GDP ratio of 25% and a low correlation between the output gap and exports (since the latter depend on external demand). As a result, closing the output gap and bringing the Greek economy back to potential will mean a deterioration of the current account balance by 2-2.5% of GDP which will bring it back to deficit. Consequently, achieving the 3.5% long-term fiscal primary surplus target implies a domestic private sector deficit of close to 4% GDP. Basing long-term growth on the accumulation of large imbalances is obviously not the way to make credible projections.

Fiscal financing of growth

One last thing that is related with the long-run target of a 3.5% primary surplus has to do with the simple fact that achieving high growth cannot be decoupled from the availability of public financing. An economy cannot grow without a strong and high quality public capital stock, nor without heavy investment in public education and R&D (especially since Greek growth will depend mainly on moving resources between non-tradable/tradable and low/high growth sectors). Nor can a country achieve high employment in the context of an aging population without finding ways to increase participation rates of women and people close to retirement which require financing of things such as (re-)educational initiatives and childcare (see the IMF on the related German case).

Conclusion

Overall, the point of this post is not to make any long-term projections for TFP/economic growth (a task which is clearly very hard) but rather to highlight the fact that achieving the IMF ambitious targets does not (mainly) rely on structural reforms but rather on actual investment (which requires large fund injections), financial sector restructuring, NPL clearance and reduction of poverty all while respecting sectoral balances which most probably requires an upfront debt restructuring and much more realistic fiscal surplus targets.