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Mounting imbalances.

I. Mounting imbalances

Reflecting unsound policies in the 1980s Greece has entered the 1990s facing what are probably the largest imbalances of all OECD countries (Diagram 1). Macroeconomic performance, highlighted by a general government deficit of nearly 20 per cent of GDP, inflation at around 20 per cent and a current external deficit of 5 1/2 per cent of GDP ($ 3.6 billion), is practically the worst in the OECD area. The scale of these imbalances reflects a situation of excess domestic demand which, in nominal terms, grew by an average of more than 20 per cent per year during the 1980s. This, combined with a sluggish supply response resulted in the slowest rate of GDP growth in the OECD area, apart from New Zealand and Denmark. In the circumstances, the unemployment rate (slightly less than 8 per cent) might be thought relatively low. However, this does not reflect output-related employment creation, but rather overmanning in the public sector and labour hoarding in ailing enterprises.

Yet Greece had enjoyed a favourable external environment, due to the integration effects following EC membership in 1981 and the upturn in the world economy during the second half of the 1980s. The comparison with Spain and Portugal, members of the EC since 1986, is worth noting. During the first half of the 1980s, growth was comparable in the three countries, even though the two Iberian economies could not benefit from the positive effects of trade creation and confidence (notably of foreign investors) that normally arise from the participation in an economic union such as the EC. After 1984-85, these two countries showed remarkable dynamism while the Greek economy continued to stagnate.

The destabilising role of the public sector

Main features of macroeconomic policy during the 1980s

The cause of the poor performance of the Greek economy lies in the excessively expansionary stance of macroeconomic policy and the inadequate functioning of markets. The main focus in this chapter is on the macroeconomic aspects, in particular fiscal policy, government measures with respect to income formation and the economic policy mix [1]. The most spectacular and probably the most damaging feature of macroeconomic management during the last decade was the steep increase (nearly 15 percentage points of GDP) in the public sector deficit (Table 1). The public deficit fluctuated sharply, the peaks coinciding with election years. Beyond the political cycle, it was mainly structural factors which were responsible for the worsening of the deficit. On the expenditure side:

i) General government current spending rose significantly, led by an

unprecedented increase in employment (of 30 per cent in 10 years);

ii) Pension expenditure and the deficits of the pension funds rose substantially,

pushed up by the generosity of the system, including a

rather flexible application of the rules governing disability pensions,

coupled with inadequate funding;

iii) Subsidies and other forms of financial assistance increased sharply

as a result of the deteriorating financial situation of the so-called

"problematic" enterprises, mainly due to poor management. These

comprise some forty of the country's biggest companies, presently

managed by a public holding (the IRO), which ran up substantial

debts in the 1980s.

Table : Table 1. Public-sector imbalances Per cent of GDP

1980 1990 Difference

General government
  Current primary expenditure               27.0   38.5     +11.5
  Interest payments                          2.3   11.2      +8.9
  Investment                                 2.8    3.8      +1.0
  Total expenditure                         32.1   53.5     +21.4
  Total receipts                            29.2   34.3      +5.1
  Gross dissavings                          -0.1   15.0     +15.1
  Net borrowing                              2.9   19.2     +16.3
Public enterprises borrowing                 1.0    1.7      +0.7
PSBR (public sector borrowing requirement)   3.9   20.9     +17.0


Memorandum item:

Public sector debt 39.4 109.2 +69.8

Source: Direct submission by the national authorities.

Since the early 1980s, general government revenue has remained stable as a proportion of GDP, at a relatively low level, despite the increases in tax rates, partial indexation of tax brackets and the introduction of the VAT. Tax fraud and evasion, more or less tolerated by the authorities (particularly during electoral periods) and also facilitated by the lack of motivation of the tax administration, gained ground. Tax avoidance is practised above all by farmers, who can in practice be said to be exempt from income tax. Fraud mainly benefits the liberal professions and unincorporated employers who take advantage of the ineffectiveness of tax audits. Wage-earners, on the other hand, are taxed at source and so find it difficult to escape income tax.

The public sector had also played a decisive role in the wage formation process, but without much account being taken of market forces or underlying economic trends. In 1982 the government introduced a new system of wagesetting, the ATA (automatic indexation adjustment). Basic wages in the public and quasi-public sectors (including banks) were raised every four months, on the basis of past inflation up to 1986 and according to officially projected inflation ever since. Indexation was total for low wages and partial for higher wage brackets. During most of the 1980s, ATA was virtually compulsory in the private sector and wage-earners usually looked upon ATA increases as a minimum. Conflicts between employees' representatives and employers were dealth with by a special tribunal, whose members were appointed by the government and which usually decided in favour of applying ATA.

The monetary authorities have endeavoured to offset the inflationay impact of expansionary fiscal and incomes policies through the imposition of restrictive monetary conditions. During the first half of the 1980s, a complex credit allocation system (including quantitative limits) restrained credit expansion to the private sector so as to compensate partially for the increasing financing needs of the public sector. Since then, with interest rates being the main instrument of monetary management, the increase in public sector deficits has resulted in an increased cost of credit to the private sector. Also, since 1988 in order to damp inflation pressures the monetary authorities have opted for a non-accommodating exchange rate policy, the depreciation of the drachma only partially offsetting the domestic cost differentials with other countries.

Growing consumption propensity and investment crowding-out

It is consumption, with an average growth rate of 2 1/2 per cent, which sustained the low level of GDP growth. In addition to the increase in public expenditure, government action with regard to income formation gave a major boost to consumer spending: real personal incomes rose briskly under the combined effect of higher wages and the expansionary policy on transfer payments (notably pensions). Also, in contrast with the experience of other highly-indebted OECD countries [2], it appears that Greek households do not take into account future increases in taxation or reductions in transfers that will be necessary in order to mitigate the growing public debt service burden. That budget deficits have relatively little bearing on Greek households' decisions regarding savings and consumption could be attributable to the fact that financing constraints were quite soft in Greece (see below).

Total private savings have been maintained at a relatively high level of about one-fourth of GDP. However, reflecting the deterioration of the public-sector accounts, the national saving ratio has fallen since the late 1970s by more than ten points, down to some 13 per cent of GDP, a very low level by international standards (Diagram 2). By contrast, in countries with comparable levels of income such as Spain and Portugal, the national saving ratio exceeds the OECD average, which is all the more important in that the catch-up process typically requires substantial saving and investment efforts.

While fiscal policy has bolstered household demand, widening public sector deficits have crowded out investment. During the first half of the 1980s, bank claims on the public sector rose to some 70 per cent of GDP, compared with 40 per cent in 1980. At the same time, credit to the private sector declined relative to GDP, in particular for bank lending to industry. Since the onset of interest rate deregulation, interest rates on private-sector loans climbed sharply, reaching historically high levels of around 10 per cent in real terms on average in the last five years. The higher cost of credit has weighed heavily on the profits and investment of non-financial enterprises, the latter having accumulated substantial debts. Partly reflecting the substantial debt of ailing firms, the debt/equity ratio for Greek industry is 3, which is the highest figure for any of the OECD countries for which statistics are available. Although the marginal cost of capital has risen significantly, the public sector, has continued to benefit from relatively low-cost finance, at negative real rates of interest.

Economic policies also affected income distribution, to the detriment of firms' profitability. For instance, in 1982, when wage moderation was the rule in most OECD countries, the government decreed wage increases of the order of 30 per cent. Such shocks are all the more difficult to absorb when wages have been made rigid by the indexation mechanism and inappropriate labour market regulations. The sharp rise in wages was mirrored in the continued decline, during the first half of the 1980s, in the share of profits in value added (excluding agriculture). Profitability improved somewhat in the wake of the 1986-87 Stabilisation Programme. But since 1989 the financial situation of firms has again worsened, especially in industry.

Rapidly falling profits also explain why, despite a relatively strong growth in domestic and foreign demand, investment performance has been so

disappointing (Diagram 3). Thus, the share of investment in value added has fallen by 4 points since the late 1970s, and by 7 points compared with the period of strong growth. In relation to GDP, Greece invested one-fifth less than the OECD average and a third less than Spain or Portugal in the 1980s.

Weak supply responsiveness

With capital accumulation sluggish and structural rigidities affecting income formation in particular, the rate of growth of actual and potential output was of 1 1/2 per cent during the 1980s, one of the lowest rates in Europe. During the same period, output expanded twice as fast in Spain and Portugal as in Greece. As Table 2 shows, these results partly reflect the weak growth of capital stock, one of the lowest in the OECD area, reflecting the insufficient investment effort. Moreover, in contrast with developments in other OECD countries, the efficiency of the productive system has declined in Greece, as illustrated by the negative growth of total factor productivity during the past decade.

Table : Table 2. Potential output growth (business-sector) Annual percentage change (1980-90)
                             Greece   Spain   Portugal
Actual output                  1.5     2.8      3.0
Potential output               1.4     3.0      3.2
  Capital stock                1.9     3.5      2.9
  Labour force                 0.9     1.0      0.9
  Total factor productivity   -0.1     1.3      0.7


Source: OECD estimates.

In addition to the effect of the lack of investment, productivity has suffered from other factors:

i) The inappropriate policy mix (expansionary fiscal and wage policies

coupled with a restrictive monetary policy) has entailed a real

appreciation of the drachma during the 1980s, thus creating a bias

against the tradeable goods sectors, which usually record high productivity

growth; ii) The imposition of investment ratios on banks has impeded an efficient

allocation of resources. Moreover, for the majority of banks,

which in Greece are under State control, banking or economic

criteria were not always given priority; iii) The compression of wage differentials resulting from the introduction

of the ATA wage indexation scheme may also have adversely

affected employees' motivation and productivity. Given that the

degree of indexation differed according to the wage level, and that

non-wage emoluments traditionally account for a small proportion

of total earnings earnings' differentials have narrowed considerably

since the early 1980s. In the public sector, for example, after-tax

income of the highest wage-earners was only a little over twice the

lowest wage in 1990, compared with six times in the late 1970s.

Rigid recruitment and dismissal procedures may also have

depressed productivity; iv) The poor state of economic infrastructures has hindered private

investment, both domestic and from abroad. Table 3 suggests that

the size of the infrastructure network lags behind that of the average

OECD country. Moreover, it appears that the quality of certain

public services, already low, has worsened;

v) Public enterprises have in general, been badly managed and most

of them are heavily subsidised, thus distorting competition and an

efficient allocation of resources. The largest banks, transportation

and telecommunication belong almost entirely to the public sector.

Moreover, the government has encouraged most banks to finance

and take control of ailing enterprises, so as to avoid liquidations and

lay-offs. This also explains the relatively large proportion of bad

loans in banks' portfolios. [Tabular Data Omitted]

External deficit and inflation

Despite the decline in investment, domestic demand grew in volume terms by more than 1 3/4 per cent on average during the 1980s, which is faster than GDP. Hence, the drain on real national product represented by net imports increased by some 5 percentage points of GDP during the decade. However, the 1986 oil counter-shock and, more recently, the real appreciation of the drachma led to a slight terms-of-trade gain, thereby limiting the deterioration in the external balance on goods and services to some 4 percentage points of GDP in nominal terms (Table 4). The resulting increasing recourse to foreign saving has largely served to finance consumer spending.

Table : Table 4. Net export trends Per cent of GDP
                              1979-80   1988    1989    1990
Non-oil trade                  -10.8   -11.9   -13.6   -14.9
Services, net                    8.8     8.6     7.6     8.9
Investment income, net          -0.5    -2.8    -2.9    -3.0
|Underlying" net-exports        -2.5    -6.1    -8.9    -9.0
Oil balance                     -5.7    -2.6    -3.1    -3.3
Balance on goods and services   -8.2    -8.7   -12.0   -12.3


Source: Bank of Greece, Monthly Statistical Bulletin and OECD estimates.

The size of the public sector deficit largely explains the high inflation rate, not only because of the direct effect of an excessive monetary expansion, but also because of its real supply and demand repercussions. During the second half of the 1980s, the monetary base (or reserve money) grew at an annual rate of 13 per cent. The growth of Bank of Greece lending to the public sector accounts for all of the increase in the monetary base (Diagram 4). Though to a small degree, lending to the banking and private sectors also contributed to the growth of the monetary base. But this was offset by the decline in the net foreign currency assets of the Bank of Greece.

Weak internal and external financial constraints

It may seem surprising that these imbalances should have reached the levels they have without triggering a domestic or external financial crisis. In fact the funding, both of the external deficit on goods and services and the PSBR, with the sole exemption at the end of 1985, did not pose serious problems up to recently. The profusion of EC transfers and loans limited the resort to foreign private credit in the 1980s, whereas the financing of the PSBR was facilitated by strict regulations concerning the allocation of financial resources. As a result of widening deficits, important stock-related constraints emerged: internal and external debts have reached such high levels that debt-dynamics have started to bear heavily on economic performance.

The predominant role of the banks in funding the PSBR was a crucial aspect of the way the Greek economy operated. During the 1980s, the banks financed between two-thirds and three-quarters of the public deficit (Diagram 5). They were required to invest more than half of their assets in Treasury bills or bonds issued by public enterprises. Until 1986, Treasury borrowing from abroad covered between a quarter and a third of the deficit, while "market" borrowing was negligible. Since then, the share of the private, non-bank sector (residents and non-residents) in the financing of the deficit has risen steeply to around 20 per cent, while that of foreign borrowing has diminished. The rate of interest on bank financing being lower than both inflation and, a fortiori, market interest rates (which would prevail in the absence of regulations), the average cost of the public debt, though rising, was very low (Diagram 5, Panel B).

The "financing" of the foreign deficit on goods and services (i.e. the current account excluding transfers) is also somewhat distinctive. Structurally, Greece enjoys substantial flows of funds from Greeks living abroad (more than one-tenth of the resident population). These consist of current transfers, representing on average 3 per cent of GDP, and of financial and real-estate capital inflows representing about the same amount, which do not generate debt in the sense that the income is usually reinvested in Greece. Overall, these inflows have remained broadly stable at around 6 per cent of GDP, insufficient, therefore, to offset the deterioration of the foreign balance on goods and services.

EC transfers, on the other hand, have risen gradually to 4 per cent of GDP, thus largely offsetting the worsening of the goods and services balance. Receipts from the EC amounted in 1990 to some $3 billion, two-thirds of which were for farm support and the rest mainly structural funds. Not all the available EC funds have been used because of shortcomings in the Greek authorities' management of the structural programmes. There has, nevertheless, continued to be a substantial current account deficit and, despite the "autonomous" capital inflows, Greece has borrowed heavily abroad. The EC has also provided Greece with financial assistance, notably with a ECU 1.7 billion ($2 billion) loan in 1985 when the current deficit stood at almost 10 per cent of GDP, and this undoubtedly boosted confidence among foreign lenders. Total EC loans outstanding represent some 8 per cent of GDP, or one-quarter of Greece's foreign debt. In all, EC transfers and loans have averted a balance-of-payments crisis in Greece. On the other hand, they may have served indirectly to postpone the shift in fiscal policy and the introduction of supply-side reforms by giving the impression that the imbalances were sustainable. As shown in Diagram 6, Panel B, national disposable income which, excluding EC transfers, increased by only 10 per cent during the last decade, rose by more than 15 per cent thanks to such transfers, thereby giving wrong signals as to the true situation of the Greek economy.

In the early 1990s Greece will have to face a heavy domestic and external debt burden. Public debt is now in excess of annual GDP and the debt service (amortization and interest payments) comes close to 30 per cent of GDP. Total foreign debt represents almost two-fifths of GDP, that is four times more than in the late 1970s, and somewhat less than one-quarter of export earnings have to be devoted each year to debt servicing. Interest payments to foreign lenders absorb the equivalent of 3 per cent of national income. During the first half of 1991, external borrowing requirements are likely to be sizeable, reflecting the deficit in the basic balance of payments together with amortization payments worth some $ 2 1/2 billion. Given the cautious attitude of foreign creditors and the low level of foreign exchange reserves with respect to borrowing requirements, the recent EC loan of ECU 2.2 billion ($3 billion), of which half was made available in 1991, provided a timely relief to the balance of payments.

The considerable debt servicing costs also reflect the worsening in competitiveness of the Greek economy, as witnessed by the considerable losses in export market shares during the 1980s (Diagram 7). The disappointing performance is all the more serious as it occurred in a context of relatively weak domestic demand growth, which could have helped to shift the focus of activity towards foreign markets. This evolution partly reflects the relative deterioration in unit labour costs (15 per cent since end-1985). But the persistent sluggishness of investment has also contributed, to the extent that Greek producers have been unable to adjust productive structures in response to the new requirements of world demand. Empirical estimates (3) show that the elasticity of Greek exports to world trade is probably below unity, suggesting that further losses in export market shares will be recorded, unless cost-competitiveness improves and/or domestic demand grows significantly less than in the main trading-partner countries.

PHOTO : Diagram 1. MACROECONOMIC PERFORMANCE IN 1985-1990: AN INTERNATIONAL COMPARISON

PHOTO : Diagram 2. SAVING AND INVESTMENT TRENDS Per cent of GDP

PHOTO : Diagram 3. PROFITABILITY AND INVESTMENT IN MANUFACTURING

PHOTO : Diagram 4. PSBR AND MONEY SUPPLY Average annual percentage change (1984-89)

PHOTO : Diagram 5. PUBLIC DEFICIT FINANCING AND COST OF DEBT

PHOTO : Diagram 6. FINANCING OF THE EXTERNAL DEFICIT

PHOTO : Diagram 7. COMPETITIVENESS AND EXPORT PERFORMANCE
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Title Annotation:Greece; economic
Publication:OECD Economic Surveys - Greece
Date:Jun 1, 1991
Words:3456
Previous Article:Basic statistics of Greece.
Next Article:Lax economic policies in 1989 and 1990.
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