The Most Important Question Facing Greece

February 2, 2015

The victory of the left-wing, anti-austerity Syriza party in the recent Greek election has sparked widespread speculation about one question:  Will the new government persuade its primary creditors (the European Central Bank, the International Monetary Fund, and the European Commission) to renegotiate a portion of the country’s massive debt?

We agree that this is an important question, given the stakes, which include the possibility of a Greek default and exit from the eurozone or, at the other extreme, an attempt by other heavily indebted eurozone countries to secure an equivalent write-down of their debts.

But the default/renegotiation question is not the most important question facing Greece today.  Rather, that honor goes to a different question: Will the new government be able to foster growth in Greece’s labor force, capital investment, and productivity?

For any country on the planet, long-run economic growth requires an ability to accumulate some combination of labor, capital, and productivity. Yes, policy to support aggregate demand through efforts like ECB quantitative easing is important to employ currently idle people and capital. And, yes, the outcome of the debt-renegotiation game of chicken will influence companies’ investments and innovativeness in Greece. But what will ultimately create sustainable economic recovery and hope in Greece is growth in its economic potential thanks to growth in some combination of these three factors. Without policies to spur their growth, no amount of debt renegotiation or forgiveness will matter.

It is useful to remember precisely how and why the Greek economy plummeted. There were years and years of economic mismanagement, which was never reflected in the country’s official statistics (statistics that were later revealed to be highly compromised). A handmaiden of the mismanagement was widespread corruption and highly-restrictive regulation that protected well-connected groups and stifled entrepreneurship. Example: in 2013, the government acknowledged 343 professions had been effectively closed to outsiders.

In 2010, with the country teetering on the brink of default and running a budget deficit that was 12 percent of the country’s GDP (four times the legal limit), the EU, IMF, and ECB provided a bailout package. In exchange, Greece was required to overhaul its economy. That overhaul, which featured a strong dose of tax increases and spending cuts, has been a shock to the system, contributing to a 23 percent contraction in Greece’s GDP since 2007 and a commensurate spike in joblessness. Today, overall Greek unemployment stands at 25.7 percent, and at a sobering nearly 50 percent among people under 25.

Syriza tapped into a wellspring of resentment over the country’s economic woes; the new prime minister, Alexis Tsipras, has pledged to “bring an end to the vicious circle of austerity.” But the reforms announced since the election are not obviously policies aimed at long-run growth: raising the minimum wage by 10 percent, reversing public-sector layoffs, and halting privatization. There is also discussion of raising taxes on hotels—one of the few sectors that remains healthy—and even restricting their ability to offer all-inclusive packages. Adding to the bluster is Syriza’s pro-Russian posture. In light of these initial moves of the new government, it is not surprising that the market valuation of the country’s publicly-traded banks was down as much as 40 percent last week.

Regardless of how Greece and its creditors resolve their differences, the country will still face long-term growth challenges that must somehow be addressed. For example, its total population declined by about 200,000 people between 2001 and 2012 (and has surely declined even more since then)—a function of low birthrates, low immigration, and high out-migration. The median age is also projected to be 43.5 this year (an increase of 10 years since 1970), which is one of highest in the world. Demographically, Greece has quickly become like already-shrinking Japan.

Greece is also saddled with low levels of innovation and very low spending on research and development. Increasing that spending—e.g. by continued deregulation of the economy to incentivize private R&D spending and investment—could deliver a number of benefits: spurring domestic innovation, keeping Greek companies in Greece, attracting immigrants and foreign direct investment, and perhaps even persuade some of the millions of Greeks living abroad to return to their ancestral home.

Greece has made some growth progress; for example, it has improved its position in the World Bank’s Doing Business rankings from 109 in 2011 to 61 today. No other country has come close to achieving this improvement over the past four years. One encouraging sign: Uber, which is in the crosshairs of regulators throughout the world, has been operating freely in the country since December.

But so much work remains if Greece is to raise its potential for long-term growth in output, jobs, and incomes. One place to start would be working through the 555 regulatory restrictions that the OECD, working in partnership with Greek authorities, identified as undermining competition and handicapping the Greek economy.

Greece’s experience over the past few years is a potent reminder to countless other countries that poorly designed public policies today have consequences that can persist far into tomorrow. And those consequences are intensified when capital and labor can move around the world to where it is welcomed and rewarded.

Greece has a glorious past. If it can use the ongoing crisis as an opportunity to transform its economy, and unlock economic opportunity, it could have a glorious future as well. Debt discussions of today must not obscure the deeper reforms that are needed for attaining that future.

Articles © 2014 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2014 Trustees of Dartmouth College. All rights reserved.