ECONOMY

Domestic demand and high debt hobble Greece’s economy

Greece’s high economic growth rates (4.7 percent in 2003) are based on rising domestic demand that is fed by European Union investment subsidy inflows and lax monetary and fiscal policies. This overwhelming reliance on domestic demand is not right, not only because growth cannot go on expanding indefinitely but also because it is bound to further weaken already dim macroeconomic stability conditions. Moreover, overall economic progress has not been satisfactory, as, despite the high growth rates, employment is not rising and the two most important structural problems – the imbalance in public finances and the economy’s low international competitiveness – are not being tackled. Besides, these two weaknesses are largely due to shortcomings in the real economy. Fiscal concerns The need to bring the fiscal situation under effective control is urgent, as, due to the high deficit and the State’s various obligations, public debt is not being reduced, despite significant revenue from privatizations and strong economic activity. Half of the revenues from privatizations went toward reducing public debt and the other half covered consumption expenses. It must be understood that privatization revenues and a sizable part of EU inflows are extraordinary receipts that will come to an end at some point. If public debt is not reduced under the current favorable circumstances, it will be difficult, if not impossible, to do it when these sources of extra revenue dry up. The current account deficit, about 6 percent of gross national product for a number of years, is the result of the accumulated negative impact of low competitiveness. This also becomes evident in the fact that, despite favorable conditions in international markets, the country’s export performance has declined in recent years. Moreover, reduced competitiveness, in combination with oligopolistic situations – particularly in public sector procurements – discourages foreign direct investment that could contribute to the introduction of new technologies and the production of new goods to meet further developments in demand. The narrowing of the degree of openness of the Greek economy, from 55.9 in 2000 to 47.1 in 2002, denotes that Greek enterprises are turning inward and becoming less exposed to international competition. The Greek economy, in fact, is one of the most inward-looking in the EU and its shares in international markets are falling. Deficit The deficit in the country’s external balance shows we are consuming and investing more than our income allows, living above our means. A second interpretation is that total savings are less than investment. Which interpretation one chooses to believe depends on the economy’s prospects over time. When the deficit is due to falling savings (higher consumption), the first interpretation describes reality, while when the investment climate is favorable and investment is increasing, we use the second interpretation. In the first case, we borrow to consume and in the second we borrow to invest. A rise in investment boosts the country’s productive potential, production, employment and exports. The resulting higher income helps pay off the debts. If macroeconomic data is reliable, the country’s current account deficit is due more to a rise in investment and less to a fall in savings. However, this point is subject to some controversy. Specifically, while borrowing to finance investment increases the debt of the economy, production and exports are stagnating. Similarly, employment in the international sector of the economy is not rising. Further, while investment in industrial equipment is rising, the degree of capacity utilization is falling: Unused capital is accumulating. Some claim that the widening of the country’s current account deficit is a result of the single market, of the integration of money markets and the adoption of the euro common currency. The fall in interest rates causes savings to drop and a rise in investment, which are the two fundamental causes of the current account deficit. The same people argue that the deficit is no cause for concern and does not pose the need for measures to deal with it, as its financing presents no difficulties. However, we believe that basing growth on borrowing cannot provide a solution to the country’s economic problem. Short-term dangers The continuous burdening of the economy with debt will inevitably lead to falling investment and lower growth rates in the long run. Undoubtedly, risks are under control in the short term and this has allowed certain delays in the introduction of the necessary changes. In the long term, however, the dangers emanating from a persistent fiscal and external account imbalance undermine the economy’s potential to keep growing. To avoid such dangers, we need a policy that will secure macroeconomic stability. Such a policy would consolidate a climate of confidence and boost investment as well as the economic growth rate. Increases in labor costs should be consistent with securing jobs and reducing unemployment. Greece has trained workers and a broad margin for increasing its employable work force. Greeks have also shown skills in the services sector (tourism, shipping), which give the country an advantage in the post-industrial age. The services sector is not dependent on the State and, therefore, freeing these resources through a reduction in government would allow its further growth. However, such measures do not suffice to create the domestic productive forces that can ensure sustainable development in the long run. This requires reforms and creating the prerequisites for markets to operate under competitive conditions, bolstering market incentives and encouraging the inflow of capital. It also requires reforms to support an increase in productivity and employment and encourage the use of technological and scientific developments to assist in stemming the consequences of an aging population. The country’s development must be based more on qualitative than quantitative factors. It is such conditions that bolster competitiveness and open up the economy to international markets. (1) Georgios Economou is a professor of economics and an adviser to the Bank of Greece.