Greece and Portugal are the two European Union countries with the lowest gross domestic product (GDP) per capita. Both managed to close the income gap with the other EU countries quite significantly in the 1990s. They both benefited greatly from an acceleration in structural reforms that deregulated several important economic sectors and from the decline in interest rates that preceded their entry into the eurozone – Portugal’s in January 1999, Greece’s in January 2001. However, their paths to convergence were quite different. A study published by the International Monetary Fund last Friday, titled «The Determinants of Growth: The Experience in the Southern European Economies of Greece and Portugal» and prepared by Athanasios Vamvakidis and Luisa Zanforlin, investigates the factors that contributed to the two countries’ different paths to economic growth. In the early 1980s Portugal was clearly lagging; however, it began opening up its economy even before it joined the EU – then the EC – in 1986 and was able to overtake Greece. Greece did not speed up its reforms until the mid-1990s, when it became apparent that the country was in danger of missing out on monetary integration. Overall, Portugal’s performance over the past 20 years has been much better than Greece’s. This, according to the IMF study, can partly be attributed to the fact that «the Greek economy was less integrated with the world economy than Portugal, which has historically been more open than the average EU economy.» The IMF study remarks that «for Greece, further progress in structural reforms – privatization and domestic market liberalization – and in integration with the world economy, as well as a stable macroeconomic outlook are necessary to maintain its recent relatively fast growth performance… For most growth determinants, Greece is still lagging behind the rest of the euro area, despite progress in the second half of the 1990s.» On the contrary, the report says, «in Portugal, many indicators are close to euro-area averages.» Openness helps The IMF emphasizes the fact that the Portuguese economy has been more open to the outside world than the Greek economy. This is reflected in the importance of trade for both countries. In Greece’s case, trade, as a percentage of the country’s GDP, averaged 41.9 percent in 1980-84, rose to 47.1 percent in 1985-89, but has been declining since, to 44.7 percent in 1990-94 and 43.2 percent in 1995-99. By contrast, Portugal’s figures for those periods are 65 percent, 68.2 percent, 65.5 percent and 68 percent, respectively, all significantly higher than EU averages. Greece’s figures have deteriorated due mostly to a precipitous decline in exports, which last year put Greece dead last among EU countries, including Luxembourg, in the value of its exports. And we’re talking absolute value here, not per capita figures. The study’s findings confirm what is widely known in economic literature, namely that higher investment and higher integration into the world economy are positively correlated with economic growth. Moreover, a more open economy also benefits from the higher growth of its trading partners. The IMF study estimates that if the Greek economy was as open as the rest of the EU – i.e. if its trade as a percentage of GDP had been about 10 to 12 percentage points higher – the economy would have grown by an extra 0.7 percent per year. If it had followed Ireland’s example and completely opened its economy, it would have grown by an extra 3.1 percent. Despite Greece’s relatively limited international integration, it did benefit from its trade partners’ higher growth rates in the second half of 1980s and also in the second half of the 1990s. Conversely, it was hurt by the sluggish global economy of the early 1990s. In Portugal’s case, growth was helped less by trade, since it has long been an open economy, and more by the opening up of domestic markets to competition. While Greece was asleep Portugal’s greater success within the EU was the result of the policies followed in the years prior to its joining. The same period, the early 1980s, was when Greece lost its footing. Having enjoyed average annual growth rates of 7 percent during the 1960s and 5.1 percent in the early 1970s, its pace fell to 3.9 percent in the late 1970s and to just 1 percent during the 1980s and early 1990s. This was also a period of high inflation, which made matters even worse. Almost all countries had known double-digit inflation during the 1970s, with the two oil crises in 1973 and 1979, but by the early 1980s, most countries returned to single-digit inflation after implementing economic austerity programs. Greece, under its new Socialist government, wasted too much time before implementing, in 1985, a severe austerity program, before abandoning it in 1987, as then-Prime Minister Andreas Papandreou was thinking about calling an early election in the fall of 1988. The 1980s stagnation caused Greece to lose considerable ground in terms of income. Its per capita GDP, adjusted for purchasing power parity, was 53 percent that of the United States in 1980 but just 47 percent in 1995. Portugal’s, by contrast, rose from 45 to 49 percent during the same period. Ireland’s income compared to the US rose from 45 to 63 percent, while Italy’s remained at about 74 percent throughout the period. Things started improving for Greece only in 1995. Not surprisingly, it was in June 1994 that it agreed on its first convergence program with the European Commission, setting specific inflation, growth and spending targets. From 1995 to 1999, Greece averaged 2.7-percent growth against 1.9 percent for the 12 countries that eventually joined the eurozone. It was the first time since it joined the EC in 1981 that this was happening. Greece was, and is, trying to compensate for all the lost years. By contrast, Portugal’s growth was interrupted only for a brief period following the restoration of democracy in 1974, when many enterprises were nationalized. In the early and mid-1980s the government of the period took the necessary measures to keep deficits and inflation under control, and began privatizations, thus enabling the country to adapt better to its EU entry than did Greece and to withstand the global slowdown of the early 1990s. In the period 1985-1990, especially, it made significant progress in raising its national income. Its only weak spot, according to the IMF analysts, is productivity. What the study aims to achieve is not merely a recapitulation of the countries’ recent economic performance but also a prediction of their future growth, or as the authors term it, their potential output. Using a variety of statistical methods, the authors conclude that the Greek economy has a potential for annual growth between 2.5 and 3.7 percent, depending on how much productivity will increase. Even the latter figure, based on a high estimate of 2-percent annual productivity growth, is less than the 3.8 percent the economy is forecast to grow in 2002, or the 4.1 percent it actually grew in 2001. This is because growth has been boosted by temporary factors: In 2001, for example, without the beneficial effects from interest rate convergence, Greek growth would have been just 2.6 percent. In Portugal’s case, potential growth is estimated at between 2.7 and 3.1 percent. This narrower differential is due to the fact that productivity has grown less in Portugal than in Greece but at a much more even pace. In Portugal’s case, too, falling interest rates played a large part in boosting economic growth. Also, both countries were, and continue to be, great beneficiaries of EU aid through the Community Suport Framework programs. Whether both countries succeed in pursuing convergence – i.e. further reduce the gap between their per capita incomes and the EU average – will depend on a number of factors. Greece requires a further opening of its economy and more reforms; Portugal mainly needs to improve its productivity, since the other factors appear to have exhausted their potential.