High growth rate in 2002, inflation a snag

There are good reasons to believe that the Greek economy will post one of the two highest growth rates in the eurozone next year. There are, however, equally strong reasons to believe it will rank among the worst inflation performers in the eurozone next year, undermining the economy’s international competitiveness and long-term economic growth potential. However, more than anything else, this combination of high gross domestic product (GDP) growth and inflation rates highlights once again the need for structural reforms and calls into question some of the tax relief measures included in the 2002 budget. According to the Organization for Economic Cooperation and Development (OECD), the Greek GDP is expected to grow by 4 percent next year, which is lower than its previous forecast of 4.4 percent but still much higher than the eurozone’s revised 1.4 percent average growth prediction. OECD’s earlier forecast put the eurozone’s economic growth at 2.7 percent in 2002. The government has also revised downwards its economic growth forecast for next year to 3.8 percent from 4 percent previously, and an expected growth rate of about 4 percent in 2001. All these projections rely on a relatively safe assumption. That is, that domestic spending will continue to be robust next year, more than compensating for the expected negative effects from the world economic slowdown. Investment spending is expected to rise as many projects linked to the 2004 Olympic Games and the implementation of the third Community Support Framework are finally implemented. The expected low interest rate environment and some business tax incentives will also encourage some additional investment spending. Private consumption, another component of aggregate demand, is also expected to increase in 2002, largely thanks to an increase in disposable income boosted by tax cuts, modestly higher wages and lower oil prices. On the other hand, slow economic growth abroad is expected to dent part of this stimulus, although the exact impact is difficult to calculate due to uncertainty about the negative effect on tourism and exports. Economic growth prospects may be Greece’s strongest point heading into 2002, nevertheless inflation is still its weak point. National headline consumer price inflation is expected to average 3.3 percent this year versus 3.2 percent in 2002, and is widely projected to fall to about 2.6 percent and 2.9 percent next year. Although the drop in inflation should please at first glance, it does not do so when viewed against the projected average eurozone inflation in 2002. For example, the Dutch ABN-AMRO bank forecasts Greek inflation at 2.9 percent in 2002 against an average 1.5 percent for the eurozone, that is a difference of 1.4 percentage points. The same bank sees the inflation gap between Greece and the eurozone standing at 1.0 percentage point in 2001 as opposed to 0.5 percentage points in 2000, which points to a clear deterioration in the trend. Undoubtedly, the projected drop in average Greek headline inflation is welcome and quite credible, since it is based on a number of easily identifiable factors such as the phasing out of second round effects from the sharp rise in the price of oil in 2000 and the expected slowdown in imported inflation as the unfolding economic slowdown puts downward pressure on product prices. An unknown factor is the outcome of the new collective wage agreement, although few analysts believe it will call for more than a 3- to 4-percent wage increase in total. The relationship between GDP growth and inflation is not unique to Greece. As a matter of fact, the fast-growing Irish economy has been registering high rates of inflation along with high rates of growth over the last few years. The Irish economy grew by 10.6 percent in 2000 and is expected to grow at a 5 to 6 percent clip in 2001 before settling for a sub-4-percent performance in 2002. At the same time, Irish inflation stood at 5.6 percent in 2000 and is expected to slow down to around 4.2 percent this year before falling to 3.2 percent in 2002. International experience shows that the best way to achieve a better economic growth-inflation relationship is to make a comprehensive set of policy measures aimed at boosting aggregate supply rather than fine-tuning aggregate demand. The Greek government seems to understand that but has not been bold enough in pursuing this objective. The liberalization of key markets, such as energy and transport, has been slow, while progress on the privatization front has been limited to a number of state-controlled companies, some of which have been on the privatization list since the drachma’s entry into the EU’s ERM (Exchange Rate Mechanism) in March 1998. Moreover, some tax cuts, such as the reduction in the corporate tax rate to 32.5 percent from 35 percent included in the 2002 budget, have lagged behind similar drives in other EU countries. Also, much needed reform in personal taxation seems to be boosting aggregate demand via consumption, more than aggregate supply, at the same time inflation that remains a thorny issue. Greece’s being an economic growth star in the eurozone is a welcome development. It has, however, to be supplemented with a set of coherent economic measures aimed at boosting the supply side to ensure a lasting, sustainable high growth-low inflation combination in the years to come. How can the violence stop without negotiations? How can peace prevail when every day Israeli tanks invade the areas that belong to the Authority; when Israeli blockades prevent Palestinians from getting about; when Israeli soldiers insult the dignity of my people, when Jewish settlers and act violently toward my people? How can the Palestinian Authority impose order when Israel bombs the buildings of the Palestinian police and security service and destroys the Palestinian infrastructure? It’s crazy. I repeat, I speak the language of peace and Sharon speaks the language of war.