Prospects for the Greek Economy

The Greek economy is rarely a few weeks or months away from another economic, financial or political crisis. Does Greece have a long-term future inside the Euro Zone?

It is clear that, having enjoyed strong economic growth in the years following her accession to the European Union, Greece has struggled to emerge from deep economic problems in the aftermath of the Global Financial Crisis.

Greece is a small open economy, her GDP accounts for less than 0.25% of world output and Greece is a relatively small country within the Euro Zone. But her difficulties pose systemic risks for the currency union.

Greece in 2017

• Real output (GDP) has fallen by 25% since 2008
• Per capita incomes were Euro 18.6K in 2011, now 16K
• Real consumption is 40% lower than pre-crisis
• Unemployment has been above 20% for six years
• Economy remains on the edge of price deflation
• Private sector wages have fallen by more than 40%
• Investment fell to 10% of GDP in 2014 v 27% in 2007
• Tourism is recovering strongly – having the Euro helps!
• But economy has number of supply-side weaknesses
• Interest rate on 10 year government debt = 7.4%

In the years following Greece’s accession to the euro zone, economic growth relied mainly on credit-driven private consumption and debt-financed public expenditure rather than on saving and investment. All of this came to a halt in 2008 and by 2009, Greece was at the start of what was to prove a persistent and deep depression in real output.

During the period 2008-13, the Greek economy went through a dramatic contraction. Output fell by approximately one-quarter during this period, and unemployment rose to more than 25 per cent of the labour force.

The fall in capital investment spending dwarfs the contraction in real GDP – strong evidence of a negative accelerator effect. Real investment has declined by more than 60 per cent since 2007 and capital investment is only 10-11% of GDP, easily the lowest investment rate of any country inside the EU. Greece’s capital stock is shrinking and ageing, a major factor hindering progress in lifting productivity and improving competitiveness.

IMF Report on Greece, February 2017

Greece has not managed to return to sustainable growth, with output having contracted by more than 25 percent since 2008, investment down by more than 60 percent, and unemployment at the highest level in the euro-zone.

Social costs of the Greek depression

• Steep rise in relative poverty – more than a 3rd of households now fall below the poverty line of <50% of median income
• NEETs - 30 per cent of young people in Greece are not in employment, education or training, this is one of the highest rates in Europe. Graduate employment rates are only 49%.
• Sharp decline in measured life satisfaction / happiness
• A third of marriages in Greece are ending in divorce compared to 2 in 10 before the recession
• The informal economy of Greece is one of the largest in Europe, exceeding 20 per cent of the country’s GDP
• Greece ranked 29th on HDI outcomes – below the average score for high income advanced countries

“Thirty-six per cent of the population are at risk of poverty or social exclusion and almost 30 per cent of young people not in employment, education or training, one of the highest rates in Europe.” (Source: EBRD)

Weak manufacturing

Greece’s economy is dominated by services. The share of industry in GDP is the third lowest in the EU. Presently, manufacturing in Greece is mainly related to labour-intensive food processing. Real estate and tourism are key sectors for the Greek economy. Shipping does well but it is capital intensive and is often said to take advantage of tax-holidays (avoidance).

Essentials on the Greek Debt Crisis

• Over the last 6 years, Greece has had 7 governments
• Public debt has continued to rise, reaching 180% of GDP by end-2015 (65% higher than its pre- crisis level.
• Greek pension system is in crisis – deficit of 11% of GDP
• Greece has a very narrow tax base - taxpayers in the highest income decile pay about 60 percent of personal income tax revenue, while 53 percent of wage earners and 85 percent of farmers are exempt from tax
• Rates for all major taxes in Greece are higher than the euro-area average (e.g. VAT is 24%) this encourages tax evasion and also reduces labour market participation.

Imposed Fiscal Austerity

• The TROIKA has imposed fiscal austerity on Greece
• TROIKA comprises the European Commission, ECB and IMF
• Fiscal austerity has included:

1. Cuts in public sector pay and pensions
2. Rise in the retirement age
3. Large scale privatizations
4. Increases in VAT (to 24%)
5. Deep cuts in public sector employment

Does fiscal austerity work in a country in semi-permanent recession and with a shrinking ability to raise the tax revenues needed to pay off the debt and provide basic public services?

Greece’s Internal Devaluation

“In Greece economic policies of austerity, in conjunction with internal devaluation, have been adopted in an attempt to improve competitiveness, correct external deficits and promote export-led growth.”

Source: https://dspace.lib.cranfield.ac.uk/bitstream/1826/11158/1/A_post-mortem_of_austerity-2016.pdf

Internal devaluation is when a country attempts to improve competitiveness through lower wage costs and prices

This is an alternative to a currency depreciation / devaluation

In Greece there has been a significant reduction in labour costs – with private sector wages falling by 40%

A key evaluation point is that prices have not fallen much – because of sheltered oligopolistic sectors and high VAT

And Greece does not have a sufficiently large export sector that sells price-sensitive products to other countries.

Potential benefits to Greece from Grexit

• Chance of export-led growth from a devaluation
• Higher import prices will help domestic producers
• Greece able to inflate away some of their debts
• Greece able to run an independent monetary policy
• Negative real interest rates can provide a monetary stimulus to help Greece out of a deflationary trap
• End to imposed fiscal austerity allowing the Greek government to increase their spending
• Some countries such as Iceland have recovered well since their own financial crisis / currency devaluation

Risks to Greece from Grexit

• Spike in inflation – affecting the poorest most
• Risk that Greece will turn printing presses on – hyper-inflation?
• Higher inflation will bring about increased interest rates
• Risk of huge capital flight from banks – big risks for depositors
• Likely to be another deep short term slump in real output
• Devaluation comes with debt default - creditors are unlikely to lend to Greece again at an affordable interest rate
• Greek export capacity is limited – modest gains from devaluation
• Tourism has boomed with Euros - no guarantee this will continue
• May involve leaving the EU and loss of key EU structural funds