Quite obviously, Greece’s commitment to structural reforms has reached a breaking point, both on the economic and political fronts.
As far as economics are concerned, Greece has some good reasons to be wary. Largely intended to improve the country’s competitiveness (and in turn its fiscal position), the program has clearly missed its target. As can be seen on Figure 1, the GDP per capita has been plummeting since 2008; unemployment shows no sign of decline; public debt is now at a staggering 175% of GDP against roughly 100% in 2007, and the current account deficit just recovered to its (already quite bad) 2004 level.
Politically, Syriza knows that maintaining the reform program as it is will wreck the public support it gathered in the run-up to the elections. Backed by a mere 32% of voters, partisan disaffection could be fatal to the new government lead by Alexis Tsipras. Already, Greek finance minister Yanis Varoufakis’s pledge to extend the troika’s bailout (to which the reforms are tied) has sparked a first round of protests in Athens and within Tsipras’s own party.
Point being, if we hope to restore Greece’s long-lost competitiveness, it is high time to look for a plan B. But before we do so in an upcoming post, it is crucial we have a look at how Greece got there in the first place.
To understand the competitiveness crisis that hit Greece starting, roughly, in the mid-2000s, it is crucial to grasp the role that the euro had on the Hellenic economy. Figure 2, extracted from the OECD database, shows that the introduction of the Euro in 2001 went hand in hand with a domestic credit boom. Thanks to the new currency, Greek banks were able to find extremely cheap financing and long-term interests in the country went down sharply.
This credit influx was directed to non-productive sectors of the economy and, in the end, mostly fueled inflation, as can be seen on Figure 3 (source: Eurostat). This graph explicitly shows that, from the introduction of the euro to the financial crisis, Greece had unsustainably high inflation levels.
This inflation is the key to understanding Greece’s loss of competitiveness. As can be noticed on figure 4, the credit boom did fuel steady growth and kept unemployment low, but the inflation also increased Unit Labor Costs. Prices rose and so did wages. When the financial crisis struck in 2008, Greece had already accumulated huge external imbalances and had lost most of its competitiveness, despite tentative labor market reforms in 2005-2006 (Figure 5).
Keeping this story in mind is important when looking for solutions to the Greek competitiveness crisis. After all, it puts into perspective the claim that Greece has to abide by inversors if it wishes to regain its competitiveness. Truth be told, unsustainable investments and unrealistic market expectations were precisely what created this competitiveness crisis in the first place by pumping funds into an overheated economy up to 2008. Surely, poor economic management did not help.