The Greek current account deficit remains quite high and has to close. This requires a national action plan to boost exports and highlight the benefits of a change in the composition of consumption in favor of domestic goods and services. If this is not done, the alternative will be the restrictive policies suggested by textbook economics which may perpetuate the current vicious cycle.
The Greek current account deficit narrowed to 21.1 billion euros at the end of 2011 from 22.9 billion a year earlier despite a double-digit rise in the cost of fuel imports. Assuming that GDP (gross domestic product) was 215 billion euros in 2011, the deficit ended up at around 9.8 percent of GDP.
This figure is lower than the record-high ratio of 2008 when the current account deficit reached 14.7 percent of GDP, but it is still higher than the average between 1980 and 2010, estimated around 5.3 percent of GDP. One has to go back to 1994 when the deficit came down to 0.1 percent of GDP to spot the lowest figure during this 30-year period.
If Greece were not a member of the eurozone, the large current account deficit — which is the result of total imports of goods, services and transfers being greater than the country?s total export of goods, services and transfers — would have certainly caused a foreign exchange crisis a long time ago.
Like some other countries, Greece experienced a chronic current account deficit over the decades as the relatively high GDP growth rates for most of the period and the change in consumer behavior resulted in higher imports.
A strong domestic demand fuelled by consumption spending on the back of rising disposable incomes and low interest rates following Greece?s adoption of the euro combined with healthy investment spending until 2007 to produce high GDP growth rates.
The economy underwent some important changes during this period as well with the significance of agriculture diminishing and the importance of services increasing. In particular, the agricultural sector accounts for less than 6 percent of GDP nowadays compared to about 20 percent in 1960. It accounts for less than 3 percent of GDP in core eurozone countries today.
According to a number of economists, the loss of international competitiveness as demonstrated by the course of the real effective exchange rate explains the large Greek current account deficit. So, policies have to be put in place to make up for the loss of competitiveness. Cutting unit labor costs appears to be among the preferred options by Greece?s international creditors since the country cannot devalue its currency to improve its current account balance.
Others have warned about the pitfalls of using the real effective exchange rate calculated on the basis of unit labor costs to gauge competitiveness and have the desirable change in the current account deficit. The findings of an old OECD report support this view.
In the OECD?s Economic Outlook released in June 2008, there are some figures on the correlation coefficient between the annual change in relative labor costs and the annual changes in the current account balances for some EU countries spanning the period 1990-2007.
It is interesting to see that the correlation coefficient does not have the minus sign one would have expected if he believed in the link between labor costs and the current account balances. Of course, it is hard to guess what the updated figures may show, but the OECD report is clear.
One may also take a look at the Greek current account deficit from a different angle. The deficit can be looked upon as the difference between national investments and national savings. In this regard, the targeted reduction in the budget deficit should have a beneficial impact on the current account balance. Some may even propose more austerity policies aimed at drastically cutting private consumption and even investment spending to slash the current account deficit.
The rise in deposit interest rates to stop the hemorrhage in private bank savings could also help to that end but they will have some negative side-effects on the economy by driving up lending rates as we explained last week.
So, the question is: Are there any other less painful solutions to improve the country?s current account balance? We think there are two solutions — a medium-term and a short-term — but both require political leadership along with political and social consensus.
First, there should be a national growth strategy based on boosting exports. This ought to become Greece?s national goal and obsession, and it is more important than discussing fiscal retrenchment.
Political, business and union leaders should sit together and form a medium-term action plan to boost exports, involving perhaps all tradeable sectors and not just the usual, such as tourism. This may require setting up a task force reporting directly to the president of the republic, which will propose ways to do away with current disincentives and provide fresh incentives to corporations and individuals.
Second, there should be a national campaign to inform the Greek public of the benefits of preferring domestic products and services over imports. If successful, this campaign should have an immediate impact on the current account balance, mainly by reducing the imports of consumer goods, and could cut the deficit by 2 to 5 percentage points of GDP in two years.
Of course, underpinning this consensus should be the recognition by most political, business and trade union leaders that domestic demand, meaning consumption and investment spending, should grow slower than the country?s nominal GDP for a number of years to bring the current account closer to balance.
Some may say this is wishful thinking and they may be right given the tendency of the Greek political and business elite to put their own interests before those of the nation. However, we think this time it may be different. Greece is 22 billion euros away from becoming a fast-growing extrovert economy, we were once told by Harvard?s Riccardo Haussman. This is equal to South Korea?s memory chip exports. Greece does not need even this. Just 10 billion euros in more exports may do it.