Is the Greek Crisis One of Supply or Demand?

Yannis M. Ioannides, Tufts University

Christopher A. Pissarides, London School of Economics and University of Cyprus.

The Greek crisis is more difficult than just fixing debt; Deeper reforms needed. 
Greece’s low productivity and competitiveness will hamper growth. Even if Greece’s debt were eliminated tomorrow, the Greek economy will still not grow substantially enough to catch up with the rest of Europe.

While the Greek debt is too high to allow the government flexibility in its budgetary policies, Greece also suffers from serious structural problems such as low productivity and lack of competitiveness. Since joining the Eurozone, the Greek government collected less in taxes than it spent, the country consumed more than it produced, and had to import well above its exports. For implementation to succeed, market reforms need to be “owned” by the Greek government and public and eased in gradually to give affected workers alternative means of support in the transition.

Despite the availability of ample finance for this purpose and more than five years since the initial agreement with the Troika in May 2010 to free up competition, several professions continue to jealously guard their privileges, by restricting access to licensing and only slowly letting go of gross over-billing practices for services provided through public sector projects.

With sticky prices and barriers to entry the fall in wages and unit labor costs so far have contributed to the recession instead of reversing it. In such circumstances it makes much more sense to target first product market reforms, which would improve price flexibility and the structural competitiveness of the Greek economy. Labor market reforms are also essential but they can come later, when the economy is performing well and they are easier to implement. That said, wages did fall by over 20%, much more than in the other
EZ program countries. The associated fall in unit labor costs was consistent with the improved performance of exports but was slow to translate into a fall in prices. Wage reductions reflected in greater increases in profit margins rather than reductions in prices.

The Economic Adjustment Program has been a major “demand” force in the severe contraction since 2009, but there is also a “supply” force. Greece must further improve its competitiveness vis-a-vis its EZ partners, and debt relief in and of itself cannot address the competitiveness problem. That requires a targeted approach that involves structural reforms, especially ones that improve competitiveness in the market for goods and services and have long lasting effects through total factor productivity growth. Reforms are necessary to make Greece more productive, help it attract investment and develop forward-looking export industries. This will inevitably require deep restructuring of the economy, a process that typically follows crises, and is to some extent already under way in Greece.

Full paper, as presented at the Fall 2015 Brookings Papers on Economic Activity Conference, September 10-11, 2015. PDF  Full Brookings conference site


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Tufts University

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