Understanding what ails the Greek economy

A decade after the financial crisis of 2008, which saw the Greek economy nosedive, Greece is still a long way from normalcy. To understand why Greece has been in a recession longer than any other country in modern history, one must look closely at the structural problems in the Greek economy and its evolution for the past 30 years.

Before the Covid lockdown, Greece’s GDP was still 25% below its pre-crisis peak, with unemployment above 20% for most of the last decade. Greece’s no-grow recovery is unparalleled in modern history, even among the most severe depressions. For context, 5 years after the great depression, US GDP per capita had risen by 35%. Likewise, after Argentina’s 2002 crisis, per capita GDP was up by 45% within 5 years. But in Greece, GDP per capita rose by less than 6%. This appalling figure begs the question ‘Why?’

To answer why Greece was doomed to fail, one has to dive deeper into the history of its economy. Greece’s failure to recover stems from its failure to qualify for the Euro. During the 80s and 90s Greece was racked with high inflation along with twin deficits in government spending and trade account. Its get out of jail card was its exchange rate. In order to make the economy more competitive, the Greek government artificially weakened the country’s currency, the Drachma. The problem with this strategy was that it failed to address the structural flaws tin the Greek economy and as a result the Greek was subject to higher interest rates on its debt.  This was the invisible hands method of keeping excessive borrowing in check.

So, when the EU decided to rollout a new currency, the Euro, Greece was highly interested in adopting it, as the new currency would eliminate Greece’s high inflation, unstable exchange rate and provide Greece with a source of cheap capital.

Ideally, to play in the same economic sandpit as Germany and France, Greece needed to reform its economy to one with sound finances, competitive international trade practices and economic sustainability. However, Greece chose to do exactly the opposite. As its government admitted in 2004, Greece was printing false GDP figures, giving an illusion of a prospering economy. For instance, counterfeit items and smuggled cigarettes, which are a part of the black economy and must not show up in official GDP figures, were being presented as legitimate economic activity. The structural problems in the Greek economy were not addressed and wouldn’t’ve been an issue till the world economy kept growing.

The ball dropped in the financial crisis of 2008. By this point, Greece had built up an unstainable debt, its economy was overinflated on cheap credit, it has one of the most non-competitive labour supply for a country with similar income and had very little high value trade.

Greece was the furthest from being a fit in Solow’s model of economic growth. The Solow model of growth outlines few fundamental factors an economy needs to grow. These include labour, capital accumulation and population growth; all the factors Greece lacked.

In aspect of labour, Greece had become uncompetitive by European standards. This was something that historically Greece had dealt with by devaluing its currency in the international market. But being tied to the euro dictated that these external devaluations would now become painful internal devaluations. In practice, this meant that average wages and pensions went down by 25%. This decimated demand; in a country dependent on domestic consumption.

To put the labour market situation of Greece into perspective, from 1995 to 2010, Greece recorded the highest increase in hourly wages of any European country at 97%, with a productivity increase of 18% in the same period. In comparison, the average European productivity growth in the same period was almost 60%. This meant that the per unit labour cost in Greece was rising sharply, becoming highly uncompetitive.

After the financial crisis and subsequent bailouts given to Greece, Greece still remained the most uncompetitive economies in the Eurozone. one statistic showed that between 2010 and 2016, Greece was the only country in the OECD to display negative productivity growth. This can be attributed to another Solow factor- Fixed Capital formation, or investment.

Since 2008, FCF has nearly halved, as businesses have invested less, further hampering their competitiveness. Until 2018, Greece’s FDI had been under the EU average, being below 2% of GDP until 2019. Greece has seen negligible growth in FDI since 2008. This is in part due to high corporate taxes, which were until recently, among the highest in the EU. These high taxes combined with a lengthy bureaucracy has disincentivised the setting up of business. Also, the instability of the Greek economy, whether it be due to protests, referendums on bailouts or being the first developed country to default on its IMF debt, acts as a catalyst to deter businesses from investing and has done so for the best part of the decade.

Another factor complementing investments, is savings. Savings are vital for economic activity as they help in increasing the capital stock. Savings can also be a proxy for investment, that is, one person’s savings can be used as capital for another person’s business. However, Greece is plagued with the lowest savings rate in the EU. It was the only country in the EU to record a negative savings rate for the whole of the 2010s. however, this was not to fuel a lavish lifestyle, as some may think, but to compensate for the brutal wage cuts and high taxes Greeks were facing. all this has had a severe impact on Greece’s population. This brings us to the final factor in the Solow model- population growth.

Population growth is important for economic growth. However, Greece has been facing a decline, rather than growth in its population numbers. This is partly due to Greece having the second oldest population in Europe and partly due to the vast number of Greeks who emigrate to other countries. Greece has lost 5% of its population to emigration, many among which were highly qualified, educated, and most importantly- productive. This brain drain has been so bad, that Greece’s population has never recovered to its peak of 2010 and has had a great impact on Greece’s export industries.

When we think about Greece, tourism is the first thing that comes to mind. This is an industry Greece seems to excel at, welcoming record numbers of tourists every year since 2011. Greece has now become the 7^th most visited country in the EU and 16^th in the world. The GDP share of tourism industry has grown to 25%. But even the increase in tourist numbers cannot help the Greek economy that much. Tourism is a low value-add industry with stagnant wages. So, when this low productivity industry accounts for a quarter of the country’s GDP, stagnant wages become a wider economic reality. Also, as a seasonal industry, the unemployment rates are volatile as compared to job security provided by industrialisation. An economy based on tourism also loses out on the other benefits that come along with proper industrialisation, like improvements in infrastructure, institutions and governance and work culture.

So, while tourism is a growing sector in the Greek economy, its high numbers cannot compensate for the structural issues that fester as a by-product.

Though Greece exports little, it facilitates international trade in a significant way. Greece has the largest merchant navy in the world, making up over 25% of the global fleet and over 50% of the EU fleet, owing to its strategic location and seafaring history. The shipping industry is so important to Greece that tax breaks for this sector are enshrined in its constitution. However, the contribution of shipping to the economy is a topic of contention, with many experts claiming that its real contribution to the economy is negligible at 1% to GDP instead of the 6% claimed by the Greek state. This is due to different measures of accounting used by the 2 parties. Realistically, most of the shipping activity does not happen in the country, with ships rarely docking on Greek ports, and most of the repairs, maintenance and crew coming from foreign countries. Hence, the real impact of a sizable industry and a key export market may be lower than some may believe.

The structural issues in the Greek economy are not the only reason for its failure to rebound from the recession. Another significant factor at play is the way the Greek economy was bailed out by the EU.

After the 2008 crisis, Greece received the largest bailout package in history. There were 3 separate bailout packages totalling $352 Billion. In order to avail these bailouts, Greece had to agree to some policy changes. These policy changes entailed higher taxes and cuts in wages and pensions. This resulted in a further fall in demand, deepening the recession.

Another controversial condition for this bailout was the high government surplus Greece was supposed to run. Greece was directed by the EU to run a government surplus of 3.5% of GDP till 2022 and 2.2% of GDP until 2060. This makes sense on paper. It essentially meant that Greece would be bailed out if it does not pile up more debt. However, the sustainability of running this big a government surplus has been called into question. This is because, to maintain such high surpluses, governments need to drastically decrease expenditure on a wide variety of government programs and increase taxes.

To put this surplus into perspective, an IMF study of 90 countries from 1945 to 2015 found only 13 instances where a government surplus of 1.5% could be maintained for 10 years. At the EU’s proposed rate of 3.5% for Greece, the study found only 3 instances of success (and only 1 success if natural resource rich countries are excluded). This essentially means that the proposed surplus is near impossible to sustain.

Another problem of Greece’s huge debt is that it is mostly foreign. When debt is foreign held, it is less likely to be recycled as investment to fuel economic growth. In contrast, high sovereign debt countries like Japan and China can function only because their debt is largely held by domestic institutions and investors.

The grassroot recovery though, is coming to Greece. Before the Covid-19 pandemic, 2020 was predicted to be a very good year for Greece. Investor confidence was returning, a number of economic indicators were showing positive growth and Greece’s national stock exchange, the Athens stock exchange had been the best performing stock exchange in the world in 2019. Even Greece’s banking sector- long plagued by NPAs and NPLs had seen strong growth. These changes can, in part be credited to the new government; one set to make Greece economically more competitive through a series of policy measures.

The financial market’s rapid recovery has some economists worried, as they believe that a significant portion of investment coming in is ‘Hot Money’. This means that investors are looking to profit from assets undervalued for a long time due to the economic depression, and now being traded at potentially overinflated prices. Even though recovery is around the corner, the structural problems persist. Greece still has a large trade account deficit, unemployment is high and there is a large investment gap.

Ultimately, Greece is still far from recovering to the same level of prosperity it had before the financial crisis. Over the decade, its economy had played out like a quintessential Greek odyssey. The sacrifices the average Greeks have made to ensure economic revival is testament to their resilience, and as soon as the pandemic gloom lifts, Greece can expect growth stronger than ever before.