Well, as was widely predicted Costas Karamanlis has now been re-elected prime minister of Greece. He was helped in this, some say, by the recent strong performance of the Greek economy.
According to an impressive array of economic data assembled by the Economist he deserves the applause:
During his first term, George Alogoskoufis, the canny finance minister, got public finances back in order and removed bureaucratic obstacles that were preventing Greece from receiving its full share of EU funding. The economy is growing by more than 4% a year. Tourism is headed for a record year, with more than 16m visitors expected. Unemployment fell at the start of the tourist season to 7.7%, the lowest rate in memory.
But does he? Is the Greek economy really so sound as some pretend. And will there be enough meat in the traditional diet of institutional reforms to really get to grips with the underlying issues which confront the Greek economy. It is fashionable in economic circles to talk about imbalances and twin deficits. Well if ever there was a text book example of such problems it is certainly the case of Greece, as we will see.
So the purpose of this post is to dig a little below the surface and take a detailed look at that "other" Greek economy, the one lurking out there just behind all the recent glowing headlines. Let's see if we can try and discern some of the longer run tendencies which may be at work in Greece, tendencies which, if we can identify them accurately, may actually help us to determine the general outline of Greece's economic future in the medium and longer term.
Since I want to put this post up today, and given that time is at the moment is a really precious commodity, since, among other things, the growing emerging market credit crunch seems now to be steadily closing in on the Romanian Leu (as predicted here in this post)and it now seems to be in danger of entering into some kind of free-fall, I will, just for a change, try to be a man of few words. Lets see if, in this case, the charts don't largely speak for themselves.
Lets start with a look at recent performance of Greek GDP. As we can see this has been growing pretty strongly in recent years. Although one thing that can be seen immediately from the charts is that Greek GDP certainly is extremely volatile.
and here what it all looks like when you iron out some of that volatility. The quaterly year on year growth rates:
This volatility in Greek GDP growth can be observed stretching all the way back across the years:
However this examination of Greece's GDP growth since the late 60s, also reveals another highly characteristic feature, very high levels of growth with then slowly and steadily begin to drop. Thus we can see that despite the relatively strong growth rates of recent years things have slowed a lot since the heady days of the 60s and 70s. This evolution is of course reasonably normal, and for two reasons. Firstly developing economies tend to experience quite rapid rates of "catch up growth" (you can see this process at work now in Turkey or China) as they converge on the more developed economies. This catch up growth is largely technologically and efficiency driven. But there is another component at work here, a demographic one. As societies develop they move through a series of age structure changes. Initially these changes are almost all favourable - this is the so called demographic dividend period, which as we can see was more or less to be found in Greece in the 1960s and 1970s. Then comes the mature - peak performance - stage, when participation rates are high, dependency ratios are low, and a high proportion of the workforce are in the prime age 30 to 50 group. This has been the Greek case since the early 1990s.
But then comes the mature demographic phase, with life expectancy at birth over 80, and median ages moving up through the 40 to 50 range. This is the stage that Greece is now entering, and this stage presents particular features and problems as we will now see.
Components of GDP Growth
One of the areas in which this changing age structure of a population can be monitored and studied at the economic level is in the evolution of the relative shares of the different components of GDP.
And, as could be expected, if we take a closer look at the composition of Greek GDP in recent years we can see some interesting lines of development. In the first place if we look at private domestic consumption we can see that this has been growing quite steadily over the years.
But if we dig a little bit deeper and take a look at private domestic consumption as a share of GDP we will notice something very interesting and potentially significant, since we we will see that in recent years this has been falling, slowly but steadily:
Now those of you who are regular readers of this blog should not in fact be surprised by this discovery, since Greece, like many other European societies is in the process of ageing, and one of the characteristics that Claus Vistesen and I have been trying to draw attention to in those societies who have moved up through the 40 year median age frontier is that the consumption share steadily starts to drop off as a component in GDP growth. This process seems to be constant, relentless and irreversible. It is, at the end of the day, one of the principal drivers of the growing problem of global imbalances.
So if we now take a quick look at Greece's median age, we will see, not surprisingly, that this has now started slowly but steadily to nudge up over the 40 frontier:
So Greeece is now, it would seem, like other ageing societies - and most notably in this context Germany and Japan - destined to have to live increasingly from increasing exports as a share of GDP, and getting growth from leveraging its export potential. But this is just where the problem arises. Let's look at the chart for export share:
Now as we can see, Greece is a long way from being where Germany and Japan are. Indeed it looks like a much worse case - on the surface at least - of where Italy is. Exports are if anything also trending down very slightly in terms of GDP share, and they are certainly not picking up the slack left by the gap in domestic consumption.
So if exports and private consumption are trending down, and if government spending given the huge debt which has been accumulated (more on this later) is now being tightly reined in, just where exactly has Greece been getting all that GDP growth from in recent years. Well that question isn't too difficult to answer, it comes from fixed capital formation, that's where it comes from.
And what exactly does fixed capital formation mean in the Greek context? Well that can be summed up in just one word - yes you guessed it - cement. Tha is the economy has been increasingly driven by construction activity.
(A curious detail here, the Greek statistical office, in constructing its construction activity index, actually uses the cement volume as a key proxy measure for activity).
So now lets take a look at the evolution of Greek construction activity in recent years:
As we can see, the high point in recent construction activity was in 2002 (not too surprising really, what with the Olympics and all that). Since 2004 the level of activity has clearly been well below the level attained in 2002 and 2003. This becomes even clearer if we look at the chart for the year on year changes in the activity level:
What we can see is that since the end of 2006 there has been some recovery in the civil engineering sector, but housebuilding has not recovered dramatically, despite a generally favourable environment in 2006.
Now lets look at house prices. Firstly if we look at the recent annual data we will see that prices rose significantly in 2001 and 2002, and then subsequently slowed.
So obviously Greece has been living from some sort of construction boom or other. But just how much of a boom has Greece "enjoyed" in recent years. Well, one measure of this would be the rate of change in house prices, so lets take a look. Looking at the quarterly data for 2003 to 2005 what we can see is that the rate of price growth dropped to a low in 2003/04 and then subsequently recovered to some extent in 2005.
If we now look (see below)at the more recent data for urban areas ex-Athens (which is the only data we have for this period at this point. All of this comes from the Bank of Greece, Bulletin of Conjunctural Indicators) we can see that the rate of price increase seems to have peaked in the last quarter of 2005, and since that time it has been steadily slowing, and of course this evolution is consistent with the steady tightening of interest rates from the ECB. So what we can discern here is that while - post 2000 - Greek house prices have not been exactly stationary - they have averaged increases of what, something in the 10% range - these rates of increase are well below the levels attained in the main EU housing boom economies - Ireland, the UK, Spain - and this should not surprise us if we take demography seriously, and compare Greece's median age with that of the other countries involved. Greece may now have touched base just on the other side of the "partage des Eaux" in the median age sense, and housing booms may be effectively "done" as a future driver of growth.
Indeed if we look at the latest data on the national construction index which is posted on the Greek Statistical Institute website we will find that construction posted an annual drop year on year in June 2007 of 7.9%. Given what we know about the global market for credit for construction activity, and given the constraints on the Greek government debt, it is extremely unlikely that this situation is going to improve greatly in the coming months, and to this whole topic we will return at the end of this post.
Now one of the points I am highlighting here is just how the economic activity of a society changes as the age structure changes. As median ages of societies pass the critical 40 mark, as we are seeing in the Greek case two things happen. The domestic consumption share starts to decline, and the role of private construction activity (ie housing) as a driver of economic growth starts to decline. Thus the society starts to depend increasingly on exports to be able to achieve economic growth. And if there are weaknesses in the export capacity, then there are weaknesses in the whole structural profile of the economy, and this, of course, is the Greek case.
But before we go on to look at this, let's stop for a moment and examine the drivers of the upward movement in median ages. Essentially there are three key parameters here: fertility, life expectancy, and immigration.
Lets take fertility first. As can be seen from the following chart, Greek fertility (in terms of TFR) dropped below replacement in the early 1980s, and has subsequently fallen to the lowest-low level (the 1.2 - 1.3 range) where it has stubbornly remained.
Basically sustained low level fertility impacts on the economic system via its influence on the labour suppply and via the demand related influence on population age structure (ie the relations between savers and borrowers). With less people being born, and increasing numbers of people in the older age groups, the ration between births and deaths steadily changes until a point is reached where more people die are being born (ie the natural rate of increase in population turns negative). Greece reached this stage in the mid ninetees, as can be seen from the next chart.
As I say though, fertility is only one of the factors which influences age structure and median ages, life expectancy is also important, and, as we all know, life expectancy has been increasing steadily in recent decades across the developed world. In this Greece is no exception to the general picture, as can be seen from the next graph.
The third factor is immigration. Really due to the extensive operation of the informal sector in the Greek economy it is very difficult to get accurate information on the scale of immigration in Greece in recent years. The information we do have is provided by the Greek Statistical institute, and such as it is I present in the chart below:
As can be seen, there has been a steady rise in the level of immigration into Greece in recent years, pulled essentially by the relatively strong level of economic growth. As can also be seen the vast majority of the migrants come from Albania (and a good chunk of the rest come from the Balkans I could add) and I mention this as significant since in the main inward migration into Greece has been of ethnic relatives. This detail is significant, since it gives us a cultural measure of societal flexibility, a measure which may be important when we come to think about the issues of reform and change which inevitably face Greece as a rapidly ageing society. In this sense the Greek migration model seems to follow a pattern which is to be observed in Japan, Germany and Russia, where the temporary availability of culturally close "diaspora" groups may serve to postpone the longer term opening towards a more culturally diverse environment. This could be regarded as a rather key institutional structural indicator.
Eurostat also provide information on annual migration into Greece, and I have made an additional chart based on this information. As I say, migrant data need to be handled with care, and it isn't really clear why, if the Greek statistical agency can provide such systematic and accurate information to Eurostat they have such shabby data on their own site, but still, such is the nature of things, and it is not for us mere mortals to ask why. Anyway, here is the chart:
What is quite revealing about this graph is the fact that there seems to have been far more migration into Greece in the early ninetees than there was in the first years of this century. As I say, I wouldn't want to make too much of this data, since I am not sure of its level of reliability, but if it is at all accurate then it is very consistent with the story Claus and I are trying to tell, since it would seem that Greece did not have the kind of housing-driven pull, migrant-arrival push between 2001-2006 that say the UK, Ireland and Spain did, and the general situation begins to look increasingly more like the Italian profile, but this really awaits further investigation and confirmation before I personally would want to jump to any hard and fast conclusion.
Coming back to the general issue of inward migration into Greece in recent years, really there is no big mystery as to why Greece should be receiving migrants. Basically, and as can be seen below, the rate of increase in Greece's working age population has started to slow dramatically in recent years. It is too early at this point to say when this number will turn negative, since essentially it depends on the rate of inward migration, and since the rate of inward migration depends essentially on the rate of economic growth we are in danger of going round and round in circles here.
Obviously there is another key factor to be taken into account at this point, and that is the age structure of the workforce. Essentially in the Greek case this has been largely positive in recent years (and hence the reasonably good productivity statistics) as the share of the population in the 35 to 50 age group has risen steadily.
This situation, however, is not set to continue. If we look at the down trend shown in the following chart in each of the key younger groups, then it is obviously only a matter of time before the share of the 35 to 50 group starts to fall, and with it Greek collective productivity.
Now going back to the stagnating working age data, as we can see below the Greek economy has been steadily generating employment in recent years:
So, with the total population in the relevant age group stagnating, and new jobs being created, three things tend to happen: unemployment goes down, immigration goes up, and participation rates go up. The second of these we have already looked at. Here is the unemployment data:
Basically It is pretty much what we would expect. It is important to remember though that this drop in unemployment has two components, an economic growth "feelgood" one, and a demographic, ageing society, one. The impact of each of these components is quite distinct.
As might have been expected participation rates in Greece have also increased over the years, but it is important to continually bear in mind that in the context of an ageing society this process has limits, since there must both be an upper ceiling to the aggregate level of labour market participation, and the human capital (or value added) component of those who enter in the higher age ranges (or re-enter, as in Japan, after an initial retirement) is well below that of workers in the prime age categories.
Finally, going back to the 35 to 50 age group for a minute we can see from the floowing chart that this group has been steadily growing as a proportion of the working population in recent years, but that recently the rate of increase has slowed, and must be now near its peak:
This very favourable demographic situation is, of course, reflected in the Greek productivity figures, which have been pretty good:
The point of all the demogrphics, however, is that, in productivity terms, Greece is now near its peak potential, and this is why the longer term outlook has to be preoccupying, since if you reach such as structurally distorted position, and accumulate so much public debt during your "heyday", then it is hard to see how you can easily correct and "sweat off all those extra kilos" of debt later.
Returning to our main topic which is perhaps where we might expect growth to come from in the Greek economy in the coming future - given that domestic consumption is now unlikely to be a driver, and for the same reason construction activity is now unlikely to be the engine that pulls the train, we are left with two possibilities, government consumption, and exports.
Well, if we look at the government angle, we will rapidly see that the goose is already pretty much cooked, in the sense that a massive debt has been run up during what were the rather favourable years, and that now, as the going gets tougher the room to maneuver will be much less (as is also the case in, for example, Italy and Japan). If we look at the evolution of the Greek government deficit over the years, we will see that it has been substantial:
As a result of this, the Greek government debt has climbed steadily as a % of GDP.
It might be worthwhile addressing at this point a standard argument that arises in these cases that societies like Greece and Italy are much richer than actually appears due to the existence of a large informal sector. I have to reply to this in advance by saying that in terms of government debt dynamics this is essentially irrelevant, since this sector, by definition, does not pay taxes. The only road to go down is to formalise the sector. But formalising involves adding non-direct wage costs to output, and is thus likely to reduce total activity, and, of course, that activity which is formalised also brings new contributors into the social security system, who at some stage also have a claim on government outgoings, so two points are clear. Firstly the situation is much more complicated than some imagine, and secondly, the informal economy is unlikely to be able to rescue the formal economy in its ability to maintain government solvency.
Lastly, let's take a look at exports and the trade balance. The first chart shows the evolution (in value trems) of Greek exports and imports in recent years.
As is obvious, there has been a significant trade deficit. This is not the point for an in-depth analysis of the Greek current account situation, but let us say that, in the short term at least, the export sector is unlikely to rescue Greece from a looming growth slowdown.
Greek Inflation and Monetary Policy
One of the points which has not received any attention so far in this review is the impact on Greece of participation in the eurozone system. A brief examination of some of the imbalances - in trade, in the government deficit etc - we have identified here should be sufficient to illustrate the superficiality of those approaches which focus on eurozone wide aggregate data, and lose all the little devils (of which there are many) lying around just waiting to be uncovered in the details.
Now as of the turn of the century the Bank of Greece effectively lost control over monetary policy, as a zone-wide rate of interest was applied from the ECB. One of the impacts of this policy has been - as we can see in the chart below - that Greece has not for a single year since the introduction of the common currency had an inflation rate which falls within the ECBs much vaunted 2% target.
Actually if we now come to look at recent inflation, we will see that, as the ECB has tightened, so the rate of inflation has gradually started to come down, although it is still however stubbornly stuck around 50bps above the 2% target:
This situation seems to suggest that the Greek economy has for some years now been growing at somewhat over domestic capacity. This process is also reflected in the steady ongoing wage cost push pressure, since wages as can be seen in the chart below, have been consistently rising at well above the rate of productivity increase:
This situation, however, does seem to be rather inbuilt into a one size fits all monetary policy. I reproduce below, courtesy of the kind data collection efforts of the bank of Greece, a chart comparing the overnight Eonia loans rate offered by the bank (which is effectively the ECB refi rate plus a few BPs) with the Greek CPI on a monthly basis since January 2001. As will be seen the rate dropped below the Greek CPI in early 2002(hardly an advisable state of affairs for a country with an inflation problem and a twin deficits one) and effectively remained there till the late summer of 2006. The big question is, what is the long term consequence of such a long period of above capacity growth?
Obviously capital inflows, and inward movements of migrants can help offset the limitations of the domestic economy, and the inward movement of migrants can help slow down the upward march of the Greek median age (as might a substantial pro-natality policy Scandinavian or French style, if Greece only had one). It is hard to say at this point, but it would seem the monocultural characteristics of the inward flows into Greece and the relatively lower levels than those achieved in say Spain or the UK or Ireland may well mean that migration is not slowing ageing sufficiently in Greece, and that the danger of an "italian" evolution is now a real one. We basically need more data and more analysis on this process, and more detail on the connection between excess economic growth fuelled by ultra-low eurozone interest rates and inward migration rates (a work in progress).
Short Term Prospects
Well, as we have already noted Greek GDP growth in the second quarter of 2007 slowed down considerably, and indeed turned negative. It is difficult, as has been said above, to draw any hard and fast conclusions from this given the long term volatility of Greek GDP output. However the June and July building index data point should already serve as an initial warning. Other data tend which we do have to hand only serve to confirm this slightly uncertain and mildly preoccupying outlook.
First off, let's look at retail sales. Here's the most up to date version we have of the short term index:
if we now look at the year on year changes since Jan 2006, then I think it is clear that there are definite signs of a slowdown since the middle of 2006.
If we come to industrial output it is clear that Greek industry was ramping up production again quite nicely in the first six months of this year after the slowdown in the second half of 2006, although since April the rate of growth seems to have slowed considerably:
But if we come to examine year-on-year rates of change, then we can see that the real expansion took place in the first six months of 2006, and since then things have obviously been slowing considerably:
So, to return to where we started, and Mr Karamanlis, and his recent election victory, can we agree with the verdict of Economist that the handling of the economy has been more or less what Greece needed? I'm afraid we can't. Severe problems seem to be lying out there just waiting to be addressed, and unfortunately, whether we like it or not, these problems are going to make their presence felt. Worse, people don't even seem to be thinking about the right sort of problems. Certainly pension reform is urgently needed, but so too are other reforms to felxibilise migration and to try and encourage an increase in fertility, topics not normally found on the hitlist of the institutional reformers whether these be staff journalists of the Economist, or economists at the world bank. Meantime the global headwinds are turning. Next year is already looking to be a difficult and complicated one. The Greeks - who to some extent still live from shipping - have long been renowned mariners, so lets just hope they can learn some of the key lessons, and sail these choppy seas with out taking on-board too much water. Unlike the Presige, they will be well advised to deck themselves out a double and well re-inforced hull to try to get themselves through the coming storm.