Private consumption hinders an improvement in productivity
Most economists agree that the Greek economy needs to bring down inflation to improve its competitiveness and keep the economy growing at above average EU rates in the next few years in order to converge with its rich EU partners. With business activity decelerating, exports performing poorly and private consumption projected to be the main driver of growth, this may turn out to be more wishful thinking than reality. Moreover, data suggests that satisfactory GDP (gross domestic product) growth rates will depend more than before on strong private consumption growth, something difficult to achieve without generous wage increases, widely considered a major hurdle to beating inflation. So, unless the country experiences a boom in exports and productivity, it has no choice but to endure high inflation in its quest for strong GDP growth rates the next couple of years. It is well known that the Greek economy has managed to outgrow most of its EU partners since the mid-1990s, banking on strong gross fixed capital investment aided by huge EU inflows, the sharp drop in interest rates and the ensuing boom in residential construction as well as investment spending related to the 2004 Olympic Games. Healthy growth rates in private consumption also played a major role, helping Greece overcome the economic recession and significant slowdown afflicting some of its major trade and investment partners this decade. The end of the Olympic Games and the need to address the huge budget deficit, expected to exceed 5.0 percent of GDP this year, imply that an economic slowdown should be in the cards next year. Nevertheless, no forecast puts GDP growth rate below 3.0 percent in 2005, with most estimates placing it between 3.0 and 3.5 percent, well below the government’s 3.9 percent projection. Signs of economic deceleration are already evident in the business sector, especially in construction, and the most recent GDP growth estimate. According to recent data, GDP growth slowed to 3.8 percent year-on-year in the third quarter compared to 3.9 percent in the second quarter and 4.6 percent the same period a year earlier. Consumption, investment As expected, the experienced slowdown is accompanied by a deceleration in investment spending to 3.2 percent in the third quarter, versus 5.0 percent in the second quarter and 13 percent in the third quarter of 2003. At the same time, private household consumption remained strong, rising by more than 4.0 percent in the third quarter, underlining its importance to the country’s quest for economic growth. This has become more evident since the second half of the year, when private consumption overtook investment spending as the primary contributor to GDP growth for the first time since the last quarter of 2002, as pointed out by a National Bank of Greece research report published last week. In line with conventional thinking, National Bank’s economists pointed out that strong household consumption can be explained by solid wage growth over the last few years, a boom in the real estate market and a significant pick up in consumer credit linked to low interest rates and the complete liberalization of consumer lending. Obstinate core inflation At the same time the economy is slowing down, and with private consumption becoming the main driver of growth, inflation shows no signs of abating. It rose to 3.2 percent year-on-year in October from 2.8 percent in September. Even more worrisome is the fact that core inflation, which excludes volatile energy and fresh produce, is hovering at even higher levels and is projected to rise to 3.6 percent this year from 3.1 percent in 2003 by the central bank. It is generally acknowledged that strong wage growth in excess of productivity gains, especially in the civil service and state-controlled organizations have played a significant role in keeping Greek inflation at above average EU-15 levels. This in turn has not helped the performance of Greek exports, depriving the economy of another growth lever. Although consumer credit is still growing at double digits and mortgage lending remains strong despite showing signs of fatigue, the real estate market has stabilized. This means that unless stocks and bonds appreciate considerably to make up for the anticipated small contribution of real estate, the largest component of Greek household wealth, to private consumption growth, the burden of keeping the latter growing falls squarely on disposable income, that is, what is left of your income after you pay taxes. How can one reconcile the need for solid wage growth to boost the economy at the same time it wants it gone to bring inflation down? The answer is to undertake a major effort to enhance productivity in the public and the private sector and make the Greek economy more outward-looking. Providing tax breaks and other incentives via the soon-to-be-released development law by the government is a step in the right direction but hardly any answer to the problem. Assuming away plans to get rid of redundancies, not a wise choice in a country like Greece, the next best solution to boost productivity is to recruit competent managers at state-controlled companies with clear mandates and specific timetables to turn things around. National Bank’s duo, Arapoglou-Pehlivanides, may be considered such an example, although the bank had a competent management team even before they took over. Privatizing some state-controlled companies should also contribute to the same effect. In addition, turning up the heat on private sector companies by removing barriers of entry and doing away with other disincentives to ensure fair competition should help keep things moving forward. It would be welcome to see more Greek companies export more goods and services or go abroad but this cannot be dictated by anyone but competition in the marketplace. All in all, it becomes more and more clear that Greece will have to take steps to resolve the paradox of depending too much on wage growth to boost its economy via private consumption, while wage growth helps fan inflation and erodes competitiveness. This paradox can be reconciled only if further gains in productivity are realized by increasing competition in the product and input market and in restructuring the public sector.
