Greece: From Icarus to Phoenix?

David Skilling

13 September 2019

Greece has been the worst performing advanced economy over the past decade.  But after being a prominent part of the international economic debate for all the wrong reasons, recent developments suggest that Greece has the potential to become one of the better-performing small advanced economies over the next decade. 

The Greek economy is growing again, at 1.9% in the year to Q2 (+0.8% qoq).  Export growth has also picked up, at 5.4% in the year to Q2.  The July election of a new government with a reforming agenda has provided additional confidence.  Greek sovereign 10-year bond yields have reduced to just 1.6%; and Greek equity markets are up a remarkable 42% through 2019 (the best-performing advanced economy market in 2019).

But there is a long way to go.  Greek GDP remains over 20% smaller in real terms than its pre-crisis peak in 2008; Greece is the only crisis-hit European economy not to have returned to its pre-crisis level of GDP.  And Greece still faces a range of serious challenges: gross government debt is 180% of GDP, the fiscal policy commitments require a suffocating 3.5% of GDP primary surplus, and unemployment remains at 17% (despite large outflows of Greeks to countries with stronger labour markets).

Greece now needs a small economy growth strategy that responds to its context, and which understands the dynamics of economic growth in a small economy.

In 2015 I argued that the fundamental issue with the Greek economy was that it had not been run as a small advanced economy.  Greece was markedly different from other small advanced economies.  It had a low export share (20% of GDP compared to shares of 50-80% common among small European countries), low investment in innovation (about 0.8% of GDP compared to a small economy average of around 2.5% of GDP), and was reliant on a domestic sector supported by loose fiscal policy and private debt.  Larger economies can get away with this in some circumstances, but not small economies where productivity growth needs to come from competitive external sectors.

The dominant focus of the Greek economic policy debate over the past several years, shaped by creditor countries and institutions, has been on fiscal sustainability as well as aspects of structural reform, such as labour market flexibility, product market competition, and privatisations.  This was understandable given Greece’s fiscal situation and its distorted economy, and many of these actions were important and necessary for Greece.  But these measures did not amount to a small economy growth strategy that could place the Greek economy on a sharply different economic trajectory, with a focus on how the Greek economy was going to compete in global markets.  Competitive strengths in external sectors are the productivity engines of small advanced economies, and are required to drive convergence towards the income frontier.

Greece is now moving in the right direction, with stronger export growth rates – and an export share around 37% of GDP (partly due to the denominator effect of lower GDP).  This stronger export performance has been supported by improved cost competitiveness as wages have come under sustained downward pressure, as well as by recent weakness in the euro.   Unit labour costs are down by around 10% since 2010.  This process has caused deep pain for many households but it has provided the basis for rebalancing the Greek economy. 

Inward investment is beginning to flow into some of these externally-facing sectors, such as Chinese investment into the port at Piraeus.  There are a range of opportunities for Greece, from its port infrastructure to the tourism sector and other services sectors.

These developments suggest that Greece’s economic fundamentals are in better shape and provide some momentum for the prospective reform efforts to build on.  But a sustainable growth strategy can’t simply rely on being a low-cost platform.  To develop a sharp economic growth strategy, Greece should learn from the international small advanced economy experience.

Greece comes close to the bottom of Landfall Strategy Group’s ‘Economic Strength Index’, which measures the policies, structure, and institutions, that are associated with strong performance by small advanced economies.  There are marked differences between Greece and other small advanced economies on a range of dimensions: capital investment is very low, R&D spending is low with weak innovation outcomes, international economic engagement remains below small economy benchmarks, there are significant issues around institutional quality, and so on. 

A coherent economic strategy is required to strengthen the growth potential of the Greek economy.  The experience of high-performing small advanced economies provides clear lessons in terms of the priorities for action in addressing these issues, and particularly the role of the external sectors.  And a central part of this will need to be improving political institutions: without high-quality institutions and governance, the Greece’s economic outlook will be constrained.

But there is clear catch-up growth potential if Greece can put in place policies appropriate for high-performing small advanced economies.  The strong income convergence process seen elsewhere in central and eastern Europe (economies that are at a similar level of per capita income as Greece) give a sense of the potential if Greece can make the necessary domestic reforms and develop competitive strengths in its external sectors. 

It is an increasingly challenging and complex global environment for all small advanced economies.  But there is a significant opportunity for Greece to out-perform if it can develop and implement a growth strategy appropriate for its small economy context.