Since I made a series of articles on the Greek external (im)balances I think it’s a nice idea to write a shorter summary on my main observations.
The basic method used is to examine fundamental macro identities:
- The external trade (goods and services) balance will be the outcome of two forces, relative prices and relative incomes. Relative prices can be represented by the Real Effective Exchange Rate (calculated using ULC or inflation indexes) and the relevant Nominal EER, while relative incomes reflect major differences on the growth paths of domestic demand between the country in question and its trade partners. In the case of Greece, since it is part of a monetary union (with nominal exchange rates not existent between union members) both the intra and extra-Euro trade must be examined (which can be proxied by intra and extra-EU trade for which detailed information is available).
- The external balance is the balancing factor of the difference between domestic saving and investment so one has to examine both variables in order to determine which was the driving factor.
- The annual current account deficit is reflected in the net international investment position. It is important to determine how the external sector “invests” its accumulated claims since that will determine both the stability of the external balance, as well as the annual income outflows that will be produced from this (negative) position.
- The structure of the current account with each factor playing a significant role on the long-term path and shifts of the external balance.
The main observations are as follows:
- Greece saw a relatively stable intra-EU trade balance with the extra-EU balance deteriorating significantly (from 4% GDP deficit up to 1999 to close to 10% in 2008). The trade balance excluding ships and fuel on the other hand shows a much milder increase of only 2% GDP and only for a shorter period.
- Both the REER towards EU and 35 industrial countries (based on ULC) appreciated significantly. In the case of extra-EU REER this was driven almost exclusively by the corresponding appreciation of the NEER. If Greece had maintained its own currency, such a large appreciation (+20%) would most probably not have happened (since it was followed by very large current account deficits).
- Structural reasons meant that Greek products had to compete with low-cost EMEs and East-Europe manufacturers, in contrast with German producers. High and Medium-High technology manufacturers account for 20% of manufacturing while in the case of Germany these reflect 55% of manufacturing. Manufacturing accounts for 55-60% of goods exports and food still accounts for 20%.
- Greek gross fixed capital formation was very stable during the Euro era, with construction dropping significantly from the drachma period highs. What did increase by almost 5% GDP was equipment investment which shows a very strong correlation with imports of goods. An increased production capacity investment cannot easily be regarded as an “unsustainable path”.
- Since mid-1990’s there was a large structural shift in household saving which went from 8% GDP to almost -4% GDP until 2004 and moved to 0% afterwards. This was reflected in total private sector saving which went from 24% GDP to 13% GDP (a shift of 11%). Annual private credit flows show a very strong correlation with current account deficits.
- Remittances and compensation of employees slowly moved to a negative position, shifting almost 1.5% GDP during the Euro area, most probably due to the large flow of immigrants in Greece.
- Since Greece adopted the Euro, the exchange rate would not adapt in order to maintain a roughly steady net international position (in dollar terms) but instead the external sector increased its outright claims and the NIIP moved from -25% to close to -100% GDP. As a result, property income shifted 3% GDP from -1% to -4% with most of the change accounted by interest payments.
- The increase in the negative investment position (in historical costs) was mainly accounted by accumulation of government securities by the external sector, mainly other Euro countries. As long as confidence in the bond market was maintained, Greece was in a position to increase its net debtor position in the same way that the United States were able to maintain large ca deficits. Government deficits could be considered a stabilizing factor since they allowed the external sector to acquire government bonds instead of claims on the domestic private sector (private securities and debts). If the latter had happened then a negative domestic macro shock (a recession) would have probably resulted in an external balance crisis, which could not have been averted by the ECB. Nevertheless, the ECB was not determined to keep Euro countries sovereign bonds as close substitutes to one another, thus actually allowing the external balance crisis to happen.