Current account deficit link to saving-spending trends

The large current account deficit is widely seen as one of the Greek economy’s soft spots, reflecting the lack of international competitiveness. Although this may be partly true, it is not the whole story. Indeed, it may be misleading. The further widening of Greece’s current account deficit in the first six months of the year to 16.9 billion euros compared to 14.4 billion a year earlier was greeted by the vast majority of economists with skepticism. This stems from the belief that the ever-widening deficit reflects a deterioration in the economy’s international competitiveness which portends a sharp increase in unemployment in the years ahead and the transfer of more Greek assets into foreign hands. Although it is expected to widen in absolute numbers, the current account deficit may end up below last year’s figure as a percentage of GDP. The current account deficit, which includes the balance of trade, net factor income such as interest and dividends and net transfer payments such as inflows from the EU, stood at 12.2 percent of GDP in 2007. The critics say the lack of discipline on the foreign exchange side puts less pressure on the government to take unpopular restrictive economic measures to reduce it. Prior to Greece’s entry to the European Monetary Union, a wider current account deficit usually resulted in the drachma’s slide against the dollar and other major currencies. However, this is no longer the case since the country joined the eurozone. This interpretation indeed has some relevance, since Greek inflation and unit labor cost growth, a yardstick for measuring international competitiveness, has far exceeded the average inflation and unit labor cost increase in its eurozone partners for many years. However, this adverse price effect is partly diluted by the growing importance of neighboring countries as a destination for Greek exports and the improving composition of Greek exports with a greater share of less price sensitive goods. Moreover, after observing the widening of the current account deficit for many years, one would expect the loss of international competitiveness to hit home, in the sense of dampening economic growth and resulting in an increase in unemployment. However, this does not seem to be the case. The Greek economy has been growing strongly for the last 12 years and unemployment is declining, while employment continues to climb at a modest pace. So, we have not yet seen the main symptoms associated with loss of international competitiveness. Consequently, if the loss of competitiveness does not suffice to explain the widening of the Greek current account deficit, then what, one may ask, does? According to a handful of economists, the answer is the imbalance between savings and investment in the Greek economy. Arguing that the increase in the current account deficit is not due to the loss of competitiveness, they point to Greek merchandise exports which grew by 15.5 percent in the first six months of the year compared to the same period one year earlier, and the 16.7 percent increase in exports of services year-on-year. «We cannot blame the increase in orders for new ships by Greek residents, which contributes to a larger trade deficit, and by extension, current account deficit for the loss of competitiveness of the Greek economy,» says Dimitris Maroulis, head of the economic research division at Alpha Bank. Maroulis and a few others believe that the larger current account deficit reflects an imbalance between domestic savings and investment more than anything else. Greek savings have fallen to about 10-11 percent of GDP from 15 percent a few years ago, while investment spending has remained strong, he points out. «The deficit is more a function of savings and spending than anything else,» says Maroulis. According to this rationale, the purchases of domestic government bonds, stocks and even companies by foreign investors would not have been made if they thought they were not attractively priced and the Greek economy was going down the drain. Instead, capital inflows help release Greek purchasing power for goods and services, resulting in a wider current account deficit. The explanation of the current account deficit as a function of savings and spending seems convincing but does not rule out the loss of competitiveness as a potential source of the deficit. For policymakers, the trick is to find the right mix of policies which can help address both sources of instability of the current account balance without hurting investment spending.