Public sector is a drag

Greece’s medium-term policy goal of converging with EU living standards will be in danger if it fails to sustain high labor productivity growth rates in the years to come. The significance of reforms and higher investments in achieving this outcome should be highlighted in view of the expect- ed drop in EU inflows after 2008. Therefore, the government’s emphasis on structural reforms is well-placed although Greek history is not on its side, since it shows that a series of governments failed to deliver on promised reforms. Greece was successful in meeting the so-called nominal convergence criteria a few years ago, earning the right to enter the eurozone in 2001. Everybody knew at the time that the gap in living standards between Greece and most of its partners, with the exception of Portugal, was still big and had to close. However, the so-called real economic convergence was not quantifiable and carried no binding deadline, contributing to a less activist policy approach. Nevertheless, in the following years, Greece took advantage of most of the other EU countries’ poor economic performance to further close the gap in living standards, a process dating back to the mid-1990s, reversing the previous trend. According to EU statistics, the gap between Greece’s per capita income and the 15 members of the European Union (EU) widened from the late 1970s to the mid-1990s before starting to narrow again. Most of the analysts believe the existing income gap between Greece and most of its EU partners should be mainly attributed to lower labor productivity. Eurostat figures appear to support this thesis, since the level of Greek productivity is less than the average level in the eurozone, the EU-15 and even the EU-25, that is, all 25 European Union countries. The level of Greek productivity has been rising steadily since 1997, reaching 94.9 in 2004 versus 100 for all EU-25 and 107.4 in the eurozone and EU-15. The index of Greek productivity is forecast to rise to 97.8 this year against 100 in the EU-25, 107.1 in EU-15 and 107 in the eurozone. Strong labor productivity gains in the order of 2.0 to 4.0 percent annually, recorded most of the period since 1997, meant Greek wages could rise by a similar margin above inflation without hurting competitiveness. However, it appears that unit labor costs, which encompass both wage growth and productivity, increased faster in Greece than in many other of its EU partners, partially explaining the persistence of inflation differentials. Still, the loss in international competitiveness registered by a number of surveys, for example, World Economic Forum, and other reports has not yet translated into slower economic growth. Many economists say the relatively strong labor productivity growth rates are the offspring of a number of factors. The fact that Greek productivity started from a very low base partly explains the strong growth in labor productivity of the last few years. Undoubtedly, strong investment spending has also played a significant role in lifting the output produced by each employee. Greek investment spending for fixed assets has been hovering around 26-27 percent of GDP in the last few years and is one of the highest in the EU. Public investment spending accounts for some 5.0 percent of GDP with the rest attributed to the private sector. Contrary to the general impression, private investment spending represents some 21.4 percent of GDP in Greece, compared to 17 percent in the EU-25. Total investment spending rose 13 percent year-on-year in 2003 and 6.0 percent in 2004 but eased 2.7 percent year-on-year in the first half of 2005. Lower investment spending in the first six months of 2005 should be mainly attributed to a drop in public investment expenditures and soft spending by the private sector. The decrease in public investment spending is mainly due to a base effect, since it was exceptionally high in 2004 due to the Olympics. In addition, the government’s efforts to bring the budget deficit to below the 4.0 percent of GDP level would also have played a role. Nevertheless, there are concrete signs of a pick up in private investment spending in the second half of this year as the new development law is adopted along with the Competitiveness Program from the Third Community Support Framework. Assuming some foreign direct investments finally take off as expected, the prospects for higher total investment spending in 2006 and 2007 look good, especially if one takes into account that projects worth more than 20 billion euros funded by EU money will have to be implemented by the end of 2008. So, the investment side of the labor productivity equation looks promising for the next two to three years, although there is increased uncertainty after 2008, given Greece’s smaller expected intake of funds from the EU. However, the low levels of labor productivity in the greater public sector coupled with the low use of IT technology and poor management provides great scope for improvement in a sizable segment of the Greek economy. This, coupled with the pressure on private companies in various industries to become more efficient in an increasingly more competitive business environment, makes a strong case for healthy labor productivity gains in the years head. This is even more probable if fiscal consolidation is attained and more structural reforms are instituted in the public sector as promised by Prime Minister Costas Karamanlis and Finance Minister Giorgos Alogoskoufis. Assuming the reforms are accompanied by an increase in employment in the modest order of 0.7 percent per year as forecast by the OECD, deemed feasible if more women are brought into the labor force and the time between education and initial vocation for young people shortens, Greece is bound to make important strides in raising its living standards and closing the income gap that separates it from its rich eurozone partners. All the chips are in place but history teaches that Greek governments have always had problems delivering on promised structural reforms.