The Greek Crisis – Pt. 1

Part I

A Slow Descent to Economic Hell

By Odysseus Katsaitis, Ph.D.*

Contrary to popular economic folklore, the collapse of the Greek economy did not come as a surprise: the crisis was an accident waiting to happen. What should come as a surprise was that the party lasted for so long.

This crisis is not about economics. It is about a society, or, at least a significant part of a society, including most of its politicians, that decided to live its myth. Like the song, Greece “put on the pink glasses and life was like the movies.” Except that with this movie the ticket had to be paid at the end. Unfortunately, it turned out that the ticket was so expensive that this society and the next generation and, most probably, the generation after the next will have to keep paying for the ticket.

Starting our analysis from the sixties, the period 1960 -1973 can be described as the “golden era” of Greek development. Consumption, as a share of GDP, was actually dropping (!) during the period, while savings and investment were rising. As Figure 1 indicates, consumption dropped to about 55% of GDP while investment rose to, approximately, 40%. Thus, it was not surprising that GDP grew at an impressive 7.1% per year. The contribution of each component of GDP is presented in Table 1 and it is obvious that consumption and investment were equally important. The negative contribution of net exports (exports minus imports) was not especially worrisome because most imports were machinery and equipment for industry.

The period 1974 -1994 can be described as the period of “missed opportunities.” By the late seventies / early eighties things change radically. Society, unilaterally, declares itself wealthy, consumption as a share of GDP increases, savings and investment decline dramatically. It is hardly surprising, that the economy grows at a pathetic 1.4% per year. Moreover, this growth comes from consumption while investment has a negative impact.

From today’s perspective poor economic growth was the least of Greece’s problems of that period. The actual problem was that society entered into a self-destructive path that ended with the 2009 crisis. By 1980, politicians began discovering the joys of government deficits. Rather than fighting tax evasion or trying to attract new investments and, therefore, increase tax revenue, they just borrow money. Public debt, which was only 20% of GDP in 1980, doubles to 40% in just five years (see Figure 2). Consequently, demand in the economy increases, putting pressure on prices. At the same time, Greece receives substantial amounts of EU money[1] which was supposed to be spent on projects improving the competitiveness of the Greek economy, but, unfortunately, was spent on consumption[2]. Thus, besides government deficits, demand was also increasing because of EU subsidies. Bottom line, inflation went out of control (see figure 3). As prices were rising, wages had to follow. But, as the cost of production was rising, exports declined and imports increased (see figure 4). Given the foreign exchange constraint that the country was facing in those days, the easy solution was devaluation of the national currency, the drachma. Devaluations, eventually, increase the level of prices (because the cost of imported goods increases). So Greece entered a vicious cycle of devaluations: price increases, wage increases and, consequently, more devaluations. Just note that in the mid-seventies the exchange rate was 30 drachmas to the dollar and by the mid-nineties it was 300 drachmas to the dollar.

These problems could have been addressed by increasing the productive capacity of the economy, i.e. by attracting investments, especially, foreign investments. In principle, Greece, like Portugal or Spain, should have been able to attract foreign investment. However, Greece attracted a minute fraction of the funds invested in those countries. The reasons are well known: an institutional framework unfavorable, to put it mildly, to business, a corrupt bureaucracy, an unpredictable tax system, an ill-defined framework for obtaining the necessary operating licenses for a business, highly regulated markets, archaic labor legislation, a dysfunctional judicial system.

The last period, 1995 – 2008, can be described as the “party time” period. Investment increases a little bit, but growth (3.4% per year) is driven primarily by consumption (see Figure 1 and Table 1). The government is forced to reduce the budget deficit (net lending of the government) in order to satisfy the Maastricht criteria (budget deficit less than 3% of GDP). So, the deficit drops from 9% to almost 3% (possibly with a little bit of help from “creative accounting”). As soon as we enter the Eurozone the deficit increases and by 2004 reaches an impressive 7% (see Figure 5).

During the 2001 – 2008 period consumer and housing loans increase at a rate of 30% per year. By 2008 private consumption reaches an astonishing 73% of GDP compared to less than 60% for the rest of EU. Imports increase accordingly (see Figure 4). In 2008 net lending of the economy equals 16% of GDP. To put it differently, we were spending 16% more of what we were producing while the sum of public and household debt was over 220% of GDP. It was just a matter of time for our lenders to realize that Greek bonds might be a risky investment.

* Dr. Katsaitis is Professor of Economics and head of the Economics department at DEREE. He is a graduate of the University of Athens and holds a Ph.D. from the University of British Columbia.

Figure 1

Evolution of Greek GDP: 1960 – 2008

Source: AMECO