The Greek economy surprised even the pessimists by putting on a strong performance in the first quarter supported by a mix of consumption, investment and export growth. This runs contrary to the popular belief that the economy is slowing down under the burden of higher oil prices, interest rates, limited gains in disposable incomes and increasing job insecurity. It also highlights the role of the real estate market which may partially help solve the country’s consumption paradox, that is, strong consumption spending in the face of widespread complaints by consumers and businesses. The economy grew by 4.0 percent on an annual basis in the first quarter thanks to a 3.5 percent rise in consumption which continued to defy pessimists, a 5.3 percent in investment spending and a 3.5 percent increase in exports. By all accounts the strong rise in residential investment played a significant role in propping up total investment spending, according to government officials. The rush to get building permits last year before changes in the tax system affecting the housing market came into effect at the start of 2006 accounts for this. It is reminded that demand for houses strengthened considerably in the last three quarters of 2005 as buyers snapped up apartments and sites in a bid to avoid paying more in taxes as the state announced an increase in «objective values» widely used for the calculation of taxes and the imposition of value-added tax (VAT) on new dwellings whose permits were to be issued from the beginning of this year. The VAT was not imposed on purchases of a first house. The tax changes also included the imposition of a capital gains tax in case the house was resold under certain conditions, lowered the transfer taxes and raised tax allowances for parental donations and inheritances. Under these circumstances, it does not surprise that house and other property prices rose by as much as 30 percent in some cases-the average increase is estimated between 10 and 15 percent. The house price increase boosted the profits of construction companies, engineers and others working in the residential construction business, paving the way for strong residential investment this year. We should keep in mind that local contractors are usually cash rich therefore less leveraged than their peers in other EU countries. This makes them less vulnerable to the ups and downs of the real estate cycle since they are less prone to lower prices to sell their stock, helping insert downward rigidity on house prices. The importance of last year’s developments on the Greek economy should not be underestimated as private residential investment is estimated at about 20 percent of gross fixed capital formation. The increased contribution of residential investment spending to the strong rise in total investment spending in the first quarter of 2006 confirms it. Moreover, the house price inflation helped support consumption spending through the wealth effect. Residential property accounts for some 80 to 90 percent of total household wealth in a country where home ownership exceeds 80 percent of the population. The latter may partially explain the buoyant consumption expenditure at a time of rising complaints. Individual complaints Individual consumers, craftsmen, businessmen and others have been vocal in expressing their complaints although data on retail sales, VAT (value-added tax) for the first few months of the year had been very encouraging about the pace of economic activity and consumption spending in particular. The results of business surveys also showed increased business confidence in retail and other sectors, which also pointed to a healthy increase in consumption spending in line with the reported first quarter aggregate data. In the past, we tried to explain the so-called consumption paradox by pointing to some peculiarities of the Greek economy. First, there is the tendency of Greeks – consumers, businessmen and others – to underestimate their profits, play down their rising standard of living and overstate their problems even when times are good. This, of course, does not mean, as we pointed out, that certain social strata were not hurt by the ongoing transformation of the economy. Many small companies and shops in different sectors closed down as large firms displaced from the market. Some small firms even took their production to neighboring countries with much lower labor costs. Second, the double digit growth in credit cards and personal, consumer and mortgage loans over the last few years. All of them have contributed to this increase in consumption spending, a case supported by a study commissioned by the Bank of Greece which showed that some 47 percent of Greek households had taken out a loan at the end of 2005 with the average loan per person increasing to more than 19,000 euro compared to some 14,500 euro in 2002. Now, we can add a third reason. The vibrant real estate market. The latter has been behind the pick up in investment spending, which bolsters economic activity and therefore disposable incomes underpinning consumption. In addition, it has also boosted household wealth and indirectly support consumption. Mortgage equity But real estate property appears to help consumption via another route which is not that evident: Mortgage equity withdrawals. Mortgage loans expanded by 33.4 percent year-on-year in 2005 and continue to be strong, rising by more than 30 percent in the first two months of the year. Although last year’s fast growth rate is supported by the heavy volume of real estate transactions that took place, brokers and other say transactions in the house market are quite subdued this year. The latter does not bode well with a double digit growth in mortgage loans, implying the money may be heading elsewhere and this is likely consumption. If true, this is going another route through which the real estate market props up consumption and the economy.