The competitiveness conundrum

The Greek economy is peculiar in many respects compared to other developed economies, so policymakers should be very careful when applying solutions to Greece that may be appropriate for other countries. The loss of competitiveness and suggestions that it can be tackled effectively by slashing labor costs highlight this issue.

The Greek economy has posted one of the highest average growth rates among the European Union countries in the last five decades though it went against the main economic paradigm that associates high GDP (Gross Domestic Product) growth rates with a healthy export increase and an open economy.

By all accounts, the local economy has been a small, closed one in the sense that the sum of its exports and imports account for a smaller percentage of GDP compared to other small developed countries.

It is true that Greek exports and imports represent more than 50 percent of GDP nowadays compared to about 30 percent on average in the 1960s, however, their share is small compared to its small peers in the EU. As a matter of fact the local economy resembles more some large economies, i.e. the United States, the United Kingdom, France etc., where the external sector is relatively small compared to the GDP, in this respect.

More importantly, the country has been exporting fewer products and services than its EU peers. Greek exports accounted for less than 23 percent of GDP on average in the last decade and even lower in the previous decades. They stood at less than 19 percent of GDP in the 1990s and averaged around 10.5 percent in the 1960s.

So, there is indeed a problem with the country?s low exports and a clear sign of insufficient international competitiveness. Especially if one notices that the exports of Ireland and Portugal, the other two countries of the EU periphery hit by the debt crisis, averaged more than 85 percent of GDP and 28 percent in the first decade of the new century.

But in measuring a country?s international competitiveness, most international organizations, banks and academics use a yardstick called the real effective exchange rate. The latter adjusts the nominal exchange rate for unit labor costs or other appropriate relative price indices. According to the Organization for Economic Cooperation and Development (OECD), unit labor costs measure the average cost of labor per unit of output and they represent a direct link between productivity and the cost of labor used in generating output.

Calculations show that Greece?s real effective exchange rate appreciated significantly since it joined the eurozone and even going back a few years to the 1990s.

All this points to labor cost rising faster than productivity during this period, resulting in the appreciation of the real effective exchange rate and the ensuing loss of competitiveness.

Therefore, it should not surprise that some argue in favor of labor cost cuts in various forms, such as the abolition of Christmas, Easter and vacation bonuses, popularly known as the 13th and 14th salary, to devalue the real effective exchange rate and address the issue of competitiveness.

But what they really have in mind is not a comprehensive indicator of overall competitiveness but a ?reflection of cost competitiveness,? to use OECD?s line.

If the real exchange rate was the true indicator of competitiveness, then the share of Greek exports in global trade should not have risen between 1993 and 2007 because the real exchange rate appreciated during the same period, as Economics Professor Yiannis Stournaras pointed out once.

It is interesting to note that the share of medium-to-high technology goods almost doubled in total Greek non-agricultural exported goods during from 1995 through 2007. The latter points to the importance of technology in boosting Greek exports rather than relative unit labor costs over this period.

Moreover, one should not ignore that goods compete in international markets on the basis of price, quality and marketing, and not wages or profit margins.

So, we may end up producing more problems than we are trying to solve by focusing on the real effective exchange rate and labor costs as a means of tackling Greece?s competitiveness problem.

Of course, some politicians and labor leaders use this argument as a pretext to hide their main intention, which is to safeguard the interests of their constituencies and hopefully see no reforms in the labor market.

Still, a right policy prescription which aims at boosting the country?s competitiveness in foreign trade should focus foremost on other issues such as exploiting its comparative advantage in areas such as tourism, shipping and transport, and addressing the technology deficit in boosting exports rather than follow the dictates of the real effective exchange rate model and its emphasis on relative labor cost growth rates, with little attention paid to productivity gains as well.