Towards a theory on the causes of the Greek depression and its implications for understanding the Eurozone crisis

Paul-Adrien Hyppolite

Paul-Adrien Hyppolite ( is a graduate student in economics and a student-engineer of the Corps des Mines. His research focuses on international macroeconomics and finance. @PaulAdrienHypp (

October 10, 2016

The following text serves as introduction to the attached presentation summarizing the main findings of a research project on the root causes of the ongoing Greek crisis. Throughout the text,  there are references to the slides of a more detailed presentation.


Drawing on a new dataset [slides 7 to 21], I explore the sectoral dynamics of national wealth accumulation in Greece since 1997. I show that the Greek crisis can be best viewed as a balance of payments (or external debt) crisis driven by a real estate bubble and unsustainable foreign capital flows, rather than as a pure sovereign debt crisis. Thus, I depart from the conventional explanation of the crisis that focuses only on fiscal indiscipline. It is not a question of denying the fiscal slippage or even the role of fiscal issues in the run up to the crisis, but rather of highlighting the broader and endogenous macroeconomic dynamics that ultimately plunged the country into crisis.

The decomposition of the real growth rate of national wealth over the pre-crisis period [slides 22 to 30] teaches us that (i) real capital gains on the domestic capital stock explained the bulk of the increase in national wealth and (ii) the investment in overvalued domestic capital goods was sustained by net borrowings from the rest of the world. Then, the crisis has involved the bursting of the real estate bubble and destroyed the entire wealth accumulated through new investments before the crisis. The last two decades therefore appear as “lost decades” for Greece with respect to wealth creation. So the dynamics that led to the crisis reflects striking similarities with the one of other periphery countries: a domestic real estate bubble inflated by foreign capital flows which suddenly stopped when foreign creditors realized that debts would never be paid off because the assets they financed were overvalued [slide 32].

The main difference between periphery countries now relates to the magnitude to which the various sectors of the economy (i.e. the government, financial corporations, non-financial corporations and households) borrowed from the rest of the world in order to invest in the domestic economy during the boom phase. Compared with Spain and Ireland for instance, the Greek government was far more involved in this very process – relative to domestic firms [slide 33].[1] As a consequence, the crisis turned out to be in the first place an external public debt crisis, instead of an external private debt crisis like in Spain or Ireland. Two specific structural features of the Greek economy could help to account for this fact: the smaller size of firms and the greater size of the public sector [slide 34].[2] Indeed, the indirect consequence of the entry into the euro area for Greece was an asymmetric shock on funding costs between firms and the government. With the national saving rate gradually declining,[3] Greek firms had to secure foreign sources of funding to continue investing. Unable to tap international financial markets as a result of their small size, they had no choice but to rely on credits by domestic banks.[4] Yet, amid a housing bubble, credit demand by households was already high. Thus, domestic firms suffered from credit constraints and/or higher borrowing costs than the government, which had now access to a deeper bond market thanks to the EMU. In the end, the government had strong incentives to “step in” i.e. to invest in domestic capital goods in the place of firms.

So are fiscal issues not important? Let me make it clear: of course, they are. The question is to what extent. Only one third of the pre-crisis increase in the Greek government’s external debt can be attributed to public investments in infrastructure. Roughly speaking, the rise in government final consumption expenditure – i.e. fiscal indiscipline in the most direct and immediate sense – accounts for another third, while the last third is due to the roll-over of public debt previously held by domestic creditors. Moreover, it is difficult to validate the “stepping-in theory” on empirical grounds [slide 35]. If one cannot prove that (i) domestic firms were credit constrained and (ii) the investments undertaken by the public sector could have been carried out by the private sector i.e. they were not public or quasi-public goods, these investments could be associated with fiscal indiscipline. Leaving aside the fact that we do not observe the counterfactual, the distinction between quasi-public goods and classic capital goods can be especially fuzzy when it comes to public infrastructure (e.g. think about roads, railways, telecommunications, power lines etc.). However, even if we do not have the detailed breakdown by asset classes of public investments made over the pre-crisis period, the most famous and important ones suggest that more partnerships involving the private sector could well have been contemplated – to say the least.[5] Also, on the question of the government final consumption expenditure, what is really specific to Greece compared to other periphery countries is not its increase per se, but rather the government’s inability to raise revenues at the same pace.[6] So against the extreme view pretending that the Greek crisis is all about fiscal indiscipline in its root cause, I oppose a more balanced approach in which the fiscal slippage has an important role, but against the background of a broader and more fundamental pernicious macroeconomic dynamics [slide 36]. This is not about minimizing the importance of fiscal issues, but rather about putting them into the right context.[7]

This study has several policy implications [slides 39-40]. First, on the fiscal front, securing a strong tax base in order to avoid future fiscal slippages is urgent. This necessarily implies fighting offshore tax evasion at the EU or international level and tax fraud at the domestic level, implementing a modern tax system and a proper land register to tax capital and improving the management of public assets to generate more revenues. Then, on the macroeconomic front, I have identified several flaws at the euro area and domestic levels that need to be addressed in a timely fashion. In short, policymakers should (i) implement macro-prudential policies at the euro area level to better monitor capital flows and to avoid the emergence of regional asset bubbles, (ii) seek to eliminate credit constraints of firms[8] and (iii) scale down the government balance sheet (both liability and asset bases). As the external imbalance of the government has kept deteriorating during the crisis, the priority in the short term remains to reach an agreement between Greece and its European partners involving public debt relief. In the long term, the privatization of assets resulting from the aforementioned pre-crisis investments might be contemplated. Importantly, that course of action would only make sense if it is a continuation of the policies seeking to eliminate the credit constraints of firms.[9]

To conclude, the view that unsustainable or unproductive capital flows from core to periphery countries were the fundamental source of the euro area crisis did not seem to “fit” with what we knew about the Greek crisis. Yet, this first sectoral analysis of capital accumulation in Greece reveals precisely the role of capital flows in the run up to the crisis. So Greece is not such an exception after all!



Hyppolite P-A (2016), “Towards a theory on the causes of the Greek depression: an investigation of national balance sheet data (1997-2014),” mimeo, Paris School of Economics (earlier versions published by the Center for European Studies at Harvard University and the Crisis Observatory ELIAMEP).


Paul-Adrien Hyppolite ( is a graduate student in economics and a student-engineer of the Corps des mines. His research focuses on international macroeconomics and finance. Contact:  @PaulAdrienHypp (

The accompanying presentation was made at the Conference for Research in Economic Theory and Econometrics, Tinos, July 2016.

[1] The contribution to the net capital formation of the government relative to firms is markedly higher in Greece than in other periphery countries. Besides, about one third of the pre-crisis increase in the Greek government’s external debt can be attributed to public investments in infrastructure.

[2] I refer to the size of the government balance sheet (asset and liability bases).

[3] A sectoral breakdown of the national saving rate shows that the pre-crisis decline is due to households. The most likely explanation for this decline is a positive wealth effect tied to the housing bubble.

[4] Note that, contrary to firms, banks were able to directly borrow from the rest of the world, notably through the interbank market.

[5] E.g. investments directly related to the 2004 Olympics (stadiums, swimming-pools etc.) or early 2000s large-scale investments in transportation infrastructure around Athens (expansion and modernization of the metro system, the Athens tram, Venizelos international airport and the railway linking the airport and the suburban towns of Athens, the motorway encircling Athens etc.).

[6] I show that, over 1997-2009, the value of private assets increased by 35% (from 347% to 469% of national income), the value of government assets by 39% (from 151% to 210% of national income), while government revenue increased only by 12% (from 42% to 47% of national income).

[7] Note that the fiscal and macroeconomic aspects are closely interrelated: for instance, if there had not been severe flaws in the Greek tax system (e.g. no proper land registry) or serious dysfunctions in the tax administration (e.g. endemic tax fraud), government revenues would have increased with the real estate bubble. Similarly, if there had not been a mismanagement of the government asset portfolio, public assets resulting from recent investments would have generated additional revenues.

[8] On the “real” side, it includes removing the regulations that distort the size of firms as well as introducing size-based fiscal incentives to encourage partnerships and economies of scale. On the “financial” side, it involves improving the deepness of the European and domestic financial (bond and capital) markets to enable firms to diversify their sources of funding.

[9] Note that since we have, as things stand at present, euro-area-wide restructuring or resolution mechanisms for banks (with the new bail-in rules and the Single Resolution Mechanism/Board) and not for the sovereigns, the reduction of the government balance sheet could also be contemplated in a risk management perspective.


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Tufts University

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