Looking Beyond the Greek Crisis

Transcript of presentation delivered at the conference

Growth and Employment in Europe Session. Panel I

By Yannis M. Ioannides Megaron, Athens, May 12, 2014

Organized by Lucas Papademos

Slides

Introduction

I want to start by comparing the evolution of Greek GDP, after the onset of the crisis, first with Portugal and Ireland, the other two Eurozone countries that also received assistance from the Troika. I don’t need to belabor the severity of the crisis to this audience, but “a picture is worth a thousand words!” It is comparably severe to the US Great Depression, 1929–1938, and much more severe to the Finnish Great Depression of 1990–1997. I will explain why these comparisons are important. But crises do end, with help from policy, and we know from past and recent experience that when they end the economy looks quite different.

Here is an outline of my talk. I start with a brief description of the Greek Crisis. Then I will discuss ways to improve Greece’s competitiveness. They include, the need for structural reforms, investment in infrastructure and investment in physical and human capital, the importance of the quality of institutions, quality of education, rule of law, the importance of aiming at world markets, with a brief but important remark on the role of expectations, and will end with an argument in favor of “reinventions.” You will have to wait and see what I mean by that. The fiscal contraction along with the cutoff of bank credit, persistent uncertainties related to public debt, the extraordinary fall by one third of the real wage, the collapse in the expectations by the public and the business sector, collapse of investment, together caused a severe contraction of aggregate demand, in turn led to a huge rise in unemployment, its severity accentuated by longstanding and pervasive frictions and rigidities in the Greek economy. Yes, Greece has accomplished a huge reduction in unit labor costs. Unfortunately, those persistent frictions and rigidities mean that lower wages (unit labor costs) have not been adequately reflected in lower prices for consumers or for buyers abroad. So, price rigidities and non-competitive practices have contributed to the collapse of purchasing power. Although we know that eventually Greek prices do partially adjust to costs they do so with a lag: of 5-quarters, by an estimate by a National Bank of Greece study.

Structural reforms do take time but they are indispensable. Only with such reforms can we accelerate price adjustment, reallocate resources to most productive sectors and improve the competitive of Greek exports. Modernization is essential to increasing trust in institutions, increasing tax compliance, strengthening the rule of law. It is also a pre-requisite to encouraging foreign investment that is essential to recovery. I like to be specific about what is feasible. I like comparing Greece with Finland and Ireland, similar countries in many ways. In terms of Income per person, Greece was at about the same level as Ireland, when Ireland entered the EEC in 1973. Finland was a little richer. Then, Ireland overtook Finland and Greece, but Finland was not left much behind. Why? Ireland was considered a “problem economy” in the 1980s. Ireland made massive investments in human capital that improved the quality of a young labor force. At the same time a very welcoming attitude to foreign investment attracted masses of foreign capital. Finland industrialized after World War II, using renewable natural resources plus massive investments in human capital and industry. Its educational system has become the envy of the world! And it is not because of some superior geographical or natural advantage. Nowadays, Finland’s forests contribute 5% of GDP. Our natural resources are our climate, coasts and mountains. Tourism contributes 15.8% of Greek GDP.

Finland’s Great Depression, 1990–1997 came about because of the Collapse of the Soviet Union, Finland’s biggest trading partner. That, combined with a banking crisis to produce the most severe contraction for Finland since 1929. From its great depression the Finnish economy emerged restructured, with information technology industries leading the way, with greater specialization and growth in services. The ICT industries contributed 0.9% to Finland’s annual output growth rate of 4.1% (1995–2004). Finland’s success is best demonstrated by Nokia, the mobile phone maker. An old low-tech firm, Nokia grew enormously after the Finnish depression to end up contributing 2.8% to GDP, 2% of government revenue, and 1.6 percentage points to Finnish annual growth. Now a giant international company, with 90,000 across 120 countries, it owes its success to spending on R&D domestically and internationally, in close relationships with universities, really a model firm. And, it does not matter that Nokia just sold its phone business to Microsoft. The Finnish economy’s sophistication means that sooner or later they will come up with another product. So what are the lessons from Finland and Ireland: Aim at world markets, where a little bit of a cost or product advantage makes a big difference — Nokia’s clam shell mobile phone smartly designed and in bright colors, is just one example. This is an old lesson, from Britain’s economic success in the 19th century. Competitiveness Forecasts suggest that the Greek economy will recover slowly, unfortunately. The recovery can be accelerated by investment. In this connection, it is important to bear in mind that the Great Depression has produced a double tsunami of an income shock plus a wealth shock that have shrunk national savings. Thus, we need massive foreign savings and foreign investment. To compare, Ireland and Portugal have done very well with respect to Foreign Direct Investment: While for Greece, it is down to 9.95% (GDP) 2012 (13.12%, 2009); Ireland, up 161.62% (111.64%,$, 2009); Portugal, up 55.2% (49.01% ). Investment, down 58%, in Greece, which is at the heart of the crisis.

And this is what we need to focus on. For the recovery, we need new ideas, big and small ones. Can we mobilize entrepreneurial and artistic talent along with ICT expertise and capital? I like Corallia Clusters Initiative, as an example. I am also a fan of Upstream, a high-tech firm, that has just been sold successfully, with its proprietors moving on with new ideas. Many of the government assets to be privatized are in the form of land. Why don’t think of industrial parks with enterprise zones, ones that offer facilities as well as special tax treatment, especially for technology startups? They might not be compatible with EU law, I don’t know.

Some key large privatizations must be complemented with massive public investments. Together, they can work as the Big Push. We know from large public interventions elsewhere that they complement and increase the returns to private investments, generating jobs throughout Greece. It is unfortunate that public investments have stopped in order to meet fiscal targets. They are critical for the recovery and the future.

The Greek press has talked of a feasibility study for new industries by McKinsey; they are estimated to generated 70,000 jobs, adding GDP Euro 7 billion. Here is their list: The “Stars”: 1. Generic drugs.  2. Acquaculture. 3. Medical tourism, long term elderly care (big, with portable pensions in EU). 4. Regional cargo/logistics hubs. 5. Waste management. And “secondary stars”: 6. “Classical” tourism, niche tourism. 7. Specialty foods. Some may seem like small ideas, but small ideas can be valuable if they generate jobs and growth. Medical tourism can generate important spinoffs, especially if it is by facilities near medical schools, or other biomed/biotech establishments. Many people come to Greece to hike, and not to sit on a beach. Some come to track the travels of Lord Byron, with fabulous fall foliage. I know this from the NY Times travel section. Let’s make it easy for them. Municipalities can — and a few already do — take initiatives in mapping trekking trails. Let’s make it possible to for people to find out about such niche tourism options and plan their trips. Often this is in the shoulder tourism season. It is a management/marketing problem.

Greece’s ability to survive depends improving competitiveness, domestically and internationally, which in turn depends on productivity gains throughout the economy. These in turn depend on firms’ grabbing new opportunities. Removing restrictions in product and labor markets increase income by increasing economic activity, by an estimated 5–15% GDP over 10 years for Greece. This I call a static effect; it will end when markets have been liberalized. There is, in addition, the powerful effect of Total Factor Productivity (TFP) Growth. This is over and above the increase in the productivity of each worker that comes from using more capital and input materials per worker. Several studies of TFP growth measure it in terms of a country’s distance from the best performer among the OECD countries. Deregulation in product and labor markets work better when combined; together with the gap from best performers account for 60% of TFP Growth in OECD countries, 1983–2003. This is a large number. The studies do imply that the effect vanishes when the gap is closed. As good new ideas are implemented, new gaps between countries’ productivity regularly appear. We need to learn quickly and catch up with best international practices. Flexibility allows the relatively most productive firms to attract greatest increase in sectoral employment. Greece is doing poorly within the EU. With Sweden and Finland the leaders in the EU, Greece does better than Poland only. Deregulation of product and labor markets produces a net benefit to society, but also winners and losers. We need a modern social safety net that will compensate those who lose with transfers from the winners, in ways that provide the right incentives to all. We need to engage energetically in retraining older workers as well as providing relevant training and education for our youth. Such retraining is an economic activity that will be essential in Greece and that is subsidized by the EU. You might say: I am talking about small numbers here, and Greece needs to grow by leaps and bounds to cover the awful losses that incomes and careers have suffered. Still, small differences grow to big ones thanks to the power of compound interest. Here are some examples of growth rates of real income per person. India, 1884–2010: grew 6.1 times, or 1.43% per year; the US 1865–2010, or 12.9 times, 1.72% per year. A difference of 0.29% and of an extra 19 years! For Greece, 1864–2009, real income per person grew 12.3 times, at 1.69% per year. Greece, 1950–2009: 6.97 times, 3.24% per year.

There has been progress with market reforms in Greece, but much remains to be done. Still, World Bank’s 2014 Doing Business Report shows that Greece jumped from the embarrassing 147th to 36th spot in “ease of starting business.” Reforming the educational system is not just a buzzword; it is not about grabbing political power. Education is indispensable for competitiveness, employment, growth, for our lives. On May 8th, the latest Pearson–Economist rankings were reported by the Greek press. They aggregate cognitive skills scores, based on such tests as PISA, TIMSS and PIRLS for reading, mathematics and science and on educational attainment. They place Greece about a standard deviation below the mean of OECD countries. Sparing you the actual rankings, let me say what this translates to in terms of growth. Mathematics and science education is crucial for growth: relative to the mean OECD, raising higher mathematics and science scores (PISA) by 1/2 standard deviation adds 0.93 percentage points to growth rate GDP/person, once those people have entered the labor force. This is causal, not a correlation.

We need to reorient our educational system to more technical and scientific subjects. Our universities must work more closely with the industry. Non-cognitive skills are also important for employment. They are produced at an early age. Consider trust.  We know from international studies that total factor productivity is correlated with trust. In the context of the European debt crisis, Germany has been a bit too self-righteous touting their success in improving their competitiveness. They point at the Hartz reforms of the 2000s of the German labor markets. But recent research shows that Germany’s improved competitiveness came before those reforms and are mainly due to a cooperative environment in German labor relations: trade unions, employer associations, works council, and firm-level bargaining all cooperate. Skills at cooperating on the job (and elsewhere) are an example of non-cognitive skills that are essential in modern workplaces. International research shows that a large gap between vertical learning (a teacher lecturing to a passive class) and horizontal learning (where students actively work in groups to learn) correlates with low trust. The Greek educational system is almost a singularity in that regard: lowest in tolerance and respect, high in distrust. We must do better in producing trust. We cannot, and might not want to, become Germans and Finns overnight, but we can learn from scientific findings. The Evolution of Employment in the Medium Run will depend on New Opportunities.

We know from the international experience of many countries’ recovering from the Great Recession of 2007, and from Finland’s recovery from its Great Depression, that the new restructured economy will be more specialized and will likely favor services. In Greece, the enormous increase in unemployment has hit severely the lower and middle classes, especially the young. We need measures to help prevent loss of skills during unemployment. In the transition to recovery, we need a smart, vigorous safety net, to protect especially households with no members employed, the most tragic aspect of the incidence of unemployment. OECD countries with rich vocational education and training have better unemployment record, esp. for young. Among workers without tertiary education, those with vocational training have better employment prospects than those with academic upper secondary education. In the new economy, computer skills will be even more critical. In assessing computer skills of the Greek public, the evidence shows that use of internet, and computer skills, generally, are below the EU average. However, the high skilled are near EU average. And firms report little difficulty in filling high-skilled jobs. Web-related knowledge curiosity is high, but Greek society needs a way to direct it to productive uses.

I am moved when I read about high school students who win competitions that allow them to visit great foreign universities. We are amidst geopolitical changes: political instability in eastern Europe, the rapprochement with Israel (a small country but an ICT giant), new opportunities in energy networks and trade. Our geographic position can mean markets for business services. We can learn from Cyprus there, and we also need a labor force with the appropriate skills. Competitiveness has a European dimension, affecting all of the European Periphery. It is a big issue that underlies discussion among specialists; it is not so well known among the broader public. An interesting study by an IMF team, Chen et al., hat appeared in Econ. Pol. (2013) last year, shows that loss of competitiveness of European periphery since 2000 is mostly due to the exchange rate appreciation of the euro and to asymmetric trade interactions with Eastern Europe, China, oil exporters. It less due  to cost increases because of high labor costs. This is shown in this bar chart, from that study. The high value of the euro affects all of the European periphery. As Commissioner Ollie Rehn argued (on his blog in November 2013), Germany needs to boost domestic demand, investment, thus reducing pressure on the euro. Europe also needs massive infrastructure and ICT investment in the periphery to boost productivity. This is along the lines of the EU Agenda 2020. That investment will generate spillovers throughout EU. The EU economy, as an economic entity, is neither too closed not too open; spillovers of investment spending will likely stay within. For Germany to accept a bit more inflation has been an issue all along.

Another problem affecting competitiveness is the aging of the populations in the European South, where total fertility rates are falling. Greek population fell by 1.3%, 2001–2011. Out-migration selectively deprives Greece of very skilled workers. A given amount of debt is easier for more people to pay off. This link from demography to indebtedness has not been widely recognized. Expectations

The recent macroeconomic literature sees a crucial Role for Expectations in recoveries from deep recessions.  The OECD (2013) “Going for Growth” study identifies a small role for expectations, but I think it takes very narrow view, and certainly ignores expectations of about new policies. Instead, I look at the US. Studying how the US Great Depression, 1929–1938, ended, Eggertsson (2008) credits shift in expectations by the US public about Roosevelt’s credibility when he eliminated several policy dogmas from the past. In Roosevelt’s case, they were the gold standard, a balanced budget, and small government. Eggertsson argues that the shift in expectations were responsible for 70–80% for the recovery, 1933 to 1937. National income would have been 30 percent lower in 1937 than in 1933, instead of increasing 39 percent in this period

Critical for speedy recovery is credibility and confidence that: Greece is conducting business differently, policies are delivering, and the political environment is conducive to investment and to new ideas. On May 9th, the international financial press, following the ECB press conference in Brussels on May 8th, drew attention to fears of deflation in the eurozone. This macroeconomic policy matter makes it even more pressing for Greece to focus on structural reforms to maintain competitive advantage.

Reinventions

Boston, where I live, is now wealthy and prosperous. It was not always like that in its four hundred year history. It reinvented itself three times during the last two hundred years. During 1920–1900, its population fell by 26%. It was losing out from competition with other US cities. As Glaeser (2005) states, Boston real estate values in 1980 implied that three fourths of its homes were worth less than the bricks and mortar cost of construction. The city was riddled with crime and its center was ruled by gangs. My university’s medical school, which is located in downtown Boston, had acquired unique expertise in murders from knife wounds. But more generally, Massachusetts (the state whose capital is Boston) had lost its industries to other US states, and had become an unattractive place to live. How did Boston reinvent itself? Early 19th century, it developed seafaring human capital for a far flung trading and fishing empire. Late 19th century: it evolved into a city whose economy rested on factories using immigrant labor from rural areas and abroad. Late 20th century: prosperity returned due to region’s human capital, via new industries, education, information technology, biomedical technology.

What are the secrets of success? Human capital and the right institutions, both man-made.

Reinvent Greece!

Thank You!

About Y_Ioannides

Tufts University

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