Saturday, 10 April 2010

A Greek myth: the inflexible Euro-economy

Paul Krugman (via Niklas Blanchard) is among many people asserting that:
...when the music stopped, Greece found itself with costs and prices way out of line with Europe’s big economies.
(Niklas says this violates the law of one price - but the law of one price applies only when there is one good. In fact, hardly any goods are the same between Germany and Greece - labour is not as productive in Greece, the local tastes are for different products, and many services are non-tradable and not subject to the law of one price. An important example of this is that retailing is a service. Both the cost of retailing and the demand for it (which in Greece is strongly derived from tourism) affect the price of goods sold in shops. So the existence of the euro doesn't by itself imply that wages and prices should equalise quickly.)

But that is an aside. In fact, I am unconvinced that Krugman's statement is true at all. According to this report, Greek unit labour costs last year were the lowest in the EU-15, and have increased by less than productivity over the last decade. So is the problem instead that prices have been pushed above their competitive cost base by consumer and government borrowing? Well, inflation was 3% from 2004-07, which is only 1% higher than the EU as a whole - and entirely appropriate for a low-cost economy converging with the average.

What's more, Greek people work an average of 42.6 hours per week - one of the highest rates in the EU, directly attributed to "the low level of workers’ wages, who then try to work longer hours in an effort to meet their needs". This is consistent with other information in the same report, suggesting that growth has been driven by an increase in wealth among the richest 20% of Greeks, and that taxes on company profits are among the lowest in the EU at 15%.

It is possible that consumer borrowing has outpaced income growth, and that Greeks have imported their standard of living by building up external private debts (this paper [PDF] supports that idea, though points out that Greek household debt started from a very low base, and is still low relative to the rest of Europe). And we know that the public deficit is very high. So is this, in fact, not a crisis of productivity, inflation, prices or an inflexible economy - but a simple matter of borrowing up to their credit limit?

In other words, is the consensus interpretation of the Greek crisis based on pure mythology? Economists, like everyone, have been attracted to the poetic ideal: Greeks, like Prometheus, have been inflated with false pride, foolishly believing they can live like the gods (that is, the Germans). Surely such hubris must bring about its nemesis?

Well, the real story seems less dramatic. Maybe the right analogy is neither Prometheus nor Icarus but Daedalus, who also flew near the sun but managed to stop in time - chastened and saddened by his loss, living more modestly but able to end his days without further disaster.

1 comment:

PunditusMaximus said...

Two things:

1) You're implicitly assuming equal productivity between Greece and Germany when comparing their wages straight out.

2) Krugman's argument isn't that Greece was at the time out of balance; it's that Greece became out of balance because of its enormous investment in the housing bubble. To put it another way, if the US were part of the Eurozone, we'd have the exact same problem.