Investment collapse bodes ill
Greece may have made substantial progress in cutting its twin deficits, mainly thanks to the sharp drop in domestic demand, but has little to show on another front: the rebalancing of its economy from a consumption-based to an export-oriented, investment-driven model. This cannot be done overnight but the results to date are far from satisfactory, raising concerns about the effect of the collapse of investment spending on capital stock and the capacity of the economy to generate growth in the future.
Many economists and others have blamed a huge, inefficient and corrupt public sector for Greece’s economic malaise. They have also singled out the need for a fundamental change in the composition of domestic demand with a lesser role for consumption, and a bigger role for investment spending and exports of goods and services.
So far, the rebalancing of the economy has been the result of the collapse in domestic demand that is driving mass unemployment to the tune of 27 percent of the labor force. This, along with lower interest payments after the restructuring of the public debt, has contributed to the narrowing of the current account deficit to about 3 percent in 2012 and an estimated 1 percent or lower this year.
Fiscal consolidation has also been a bright spot in the adjustment process with revenues seen surpassing expenditures without interest for the first time since 2002. The country is projected to register a small primary surplus compared to a primary deficit in excess of 10 percent of GDP, or more than 23 billion euros, in 2009. Optimists also like to mention the closing gap in international competitiveness between Greece and its eurozone partners by pointing to the sharp reduction in unit labor costs over the last few years.
However, a closer look at the numbers shows that little progress has been made toward a more desirable economic model, relying more on exports and investment spending than on private and public consumption to sustain GDP (Gross Domestic Product) in the medium-to-long term. It is noted that total consumption spending is estimated to fall to 163.5 billion this year compared to a record high of 214.6 billion in 2009. This is a decrease of 51 billion euros, of which 35.3 billion account for private consumption and the rest for government consumption.
Nevertheless, the weight of total consumption in the economy has not fallen much because the economy has shrunk as well during the same period. The consumption-to-GDP ratio is seen falling to about 89 percent this year compared to about 90.5 percent in 2008 and an all-time high of 93 percent in 2009. This is well above the ratio of about 85 percent averaged in the 1960s, 77 percent in the 1970s and 84 percent in the 1980s, but similar to the average ratio of 89.5 percent recorded in the 1990s.
The drop in consumption spending has been accompanied by an increase in exports of goods and services to an estimated 53.6 billion euros this year compared to 44.5 billion in 2009. Still, it is below the exports of 56.3 billion registered in 2008. The importance of exports to the economy has increased since they account for an estimated 29 percent of GDP this year compared to 19.3 percent in 2009 and 24 percent in 2008. But the share of exports to GDP is still relatively small and is not in line with the extroverted economic model envisaged by some economists, bankers and policymakers. Of course, exports have never been the strong point of the Greek economy, ranging from an average 10.5 percent of GDP in the 1960s to a high of about 22 percent between 2000 and 2008.
The performance of exports may have not lived up to expectations and the demands of the extroverted economic model but investment spending has done much worse, clearly disappointing and becoming a drag instead of a booster to GDP so far. Investment spending is seen falling further to about 13 percent of GDP this year from 18.6 percent in 2009, 24 percent in 2008 and a high of 26.7 percent in 2007. Investment spending averaged 24 percent of GDP in the 2000-2008 period. It reached a high of 26 percent in the 70s and ranged between 19 and 22 percent in the 80s and 90s. The lack of investment spending can be attributed to a number of factors, ranging from the country’s cloudy prospects on the debt overhang to the credit squeeze, among others.
Since consumption spending has fallen but exports have not managed to post a big increase, and investment spending has collapsed over the same period, the resulting recession comes as no surprise. More worrisome is that the anticipated shift of spending from consumption to exports and investment has not been realized so far, casting doubts on the success of the outward-looking economic model.
Some economists warn that some large-scale fiscal adjustments may leave an economy with a weaker capacity to generate growth in the future. This is because such adjustments deter investments without providing a big boost to exports to offset weakness elsewhere.
With gross fixed capital formation declining continuously since 2007, there are questions regarding whether this process has undermined Greece’s growth prospects for years to come. So, it is imperative that investment spending is revived via various initiatives to help exports in pulling the economy out of recession and facilitate the shift to a more extroverted economic model.