ECONOMY

Investment subsidies are no substitute for effective demand

The declining share in Greece’s gross domestic product by industry, especially that of manufacturing, and this potential threat to the country’s economy has been the subject of much discussion. The reason for this is that manufacturing, unlike other sectors, has multiple positive repercussions (known as the «multiplier effect») on agriculture and several types of service industries. The smaller the share of manufacturing in GDP, the smaller the multiplier effect and the lower the growth rate in any economy. Greece has never had a particularly strong manufacturing base. Its largest share in GDP was in the mid-1970s, when it just exceeded 20 percent, while the GDP rate of manufacturing in other developed economies was twice that. By 2000, it had fallen to around 10 percent. To be sure, the share of manufacturing in GDP fell in other developed economies too. To some degree, the fall was considered natural, given the contemporary trend away from vertical integration and toward outsourcing of the many necessary auxiliary services to manufacturing. However, the rate at which Greek manufacturing has shrunk has exceeded that of any other developed economy and was not necessarily accompanied by outsourcing. The picture of deindustrialization is clear and painful. It is interesting to note that since the mid-1970s, Greece has had an active industrial policy. The pertinent question then arises as to whether this policy was not appropriate to stem the decline, and if so, what would have been appropriate policy. Empirical studies have shown that the long recession in the 1980s, combined with rising unemployment, slender disposable income and adverse terms of trade, played a key role and that microeconomic variables were much less important. It can thus be explained why the costly policy of support to specific sectors and investment did not succeed in arresting the decline in manufacturing. It follows, therefore, that it is expedient for industrial policy to be based on a sound macroeconomic base before arriving at microeconomic options. Reducing unemployment by increasing flexibility in the labor market, increasing disposable income, reducing taxation and implementing institutional measures designed to improve competitiveness will have a much greater impact in boosting industrial production than offering selective help to certain branches or enterprises. Such selective support is perhaps expected from the new law on investment incentives, which will essentially be the new blueprint for the country’s industrial policy. If the overall economic base is shallow, without basic structural changes, the likelihood is that no matter how generously resources are devoted to specific branches or enterprises, their effectiveness will be insignificant to small and the waste of resources unavoidable. In the final analysis, investment is made in anticipation of demand and not because capital is cheap. In economic terms, the elasticity of investment in relation to the cost of capital, which is only one factor of production, is much smaller than the elasticity of investment in relation to expected demand. Cheap capital, via subsidies and other support, helps investment to take place more quickly, but in the knowledge that profits are there to be had because of anticipated demand. The new industrial policy will again fail to be effective without the appropriate structural changes. (1) Eleni Louri-Dendrinou is a professor at the Athens University of Business and Economics.