Greece Is the Crisis Club’s Odd Man Out

Stunted export sector makes eurozone’s weakest link less responsive to bailout medicine

 The Wall Street Journal

By GREG IP

Updated June 10, 2015 2:06 p.m. ET

53 COMMENTS

Odds are Greece and its international creditors will strike some sort of deal to avoid default before a deadline looming at the end of June.

The bigger question is whether Greece will emerge from a new bailout any better able to grow, and thus support its debts, than it did from prior deals.

Alone among the countries at the center of the eurozone’s sovereign-debt crisis, Greece saw its economy shrink in the first quarter this year. While the bailout negotiations are the latest stumbling block, Greece has lagged behind its peers throughout the crisis.

Blame that not just on the burden of managing its debt, now nearly 180% of gross domestic product, but on a fundamentally different economy: its export sector is small, undiversified and deeply uncompetitive.

Spain, Greece, Portugal and Ireland all entered the crisis with huge current account deficits—the balance on all exports, imports and income between a country and its partners.

Such deficits are typically corrected via currency devaluation, which boosts exports and curbs imports. But membership in the euro makes devaluation impossible. Instead, prices and wages must decline, a painful process called “internal devaluation.”

This has worked to boost other crisis countries’ exports for more than Greece’s, which, adjusted for inflation, are still lower than in 2008.

Most economies of comparable wealth, such as Israel and Hong Kong, boast diverse and sophisticated export sectors reflecting their broad economic capabilities, according to Ricardo Hausmann of Harvard University. Greece is an outlier: its income is relatively high, but its export sector is not diverse or sophisticated, more closely resembling Brazil’s or Tunisia’s.

Research by a group of scholars led by Daniel Gros at the Centre for European Policy Studies notes that Greek goods exports are dominated by refined petroleum products, and its service exports by maritime shipping. Very little of the value of either is actually added in Greece; crude oil is imported, and most of its ships’ crews are foreign.

The weak link between Greek exports and what Greek workers and businesses actually contribute is why internal devaluation hasn’t helped as much as in other crisis countries. In 2008, just before the crisis, Greece’s exports equaled 23% of GDP. But Mr. Gros’s team reckons that exports equal to just 12% of Greek GDP would actually benefit from internal devaluation, compared to about 25% in Portugal, or 70% in Belgium and the Netherlands.

Greece’s competitiveness has long been a problem, but joining the euro made it worse. No longer fearing devaluation, foreigners poured money into Greek debt, driving down interest rates that were once among Europe’s highest. That fueled a borrowing and spending boom, drove up wages, and rendered what manufacturing Greece had even less competitive. Between 2000 and 2008, its per capita output soared 29% and its current account deficit ballooned to more than 14% of GDP.

A day of reckoning was inevitable. But the International Monetary Fund, the European Central Bank and the European Commission (collectively known as the troika) made the subsequent crisis far worse. Greece’s debts were plainly unsustainable in 2010 (as the IMF, in effect, later admitted) and should have been restructured then. But that would have required French and German banks to write down their loans. Fearful of contagion, the troika claimed Greece’s debt could be repaid and prescribed steep austerity to make it happen.

Instead, the Greek economy imploded. Lenders had to write down Greece’s debts anyway. Investors assumed Italy and Spain were next and fled. To end the contagion, the ECB in 2012 effectively promised that no eurozone government would default.

The ECB’s actions, together with bank recapitalization and an end to new austerity, have enabled the other crisis countries to start growing, albeit from very deep holes. For a while, so did Greece: GDP grew last year, the current account was in balance, and the government ran a budget surplus, excluding interest payments.

The election of the leftist Syriza party and the threat of euro exit have caused political uncertainty to spike. Deposits are fleeing the banking system. That has not only dented near term economic growth, but it has also deterred the sorts of innovation and investment that exporters require.

A new bailout deal isn’t enough for Greece to follow in its peers’ footsteps to recovery. Though Greek exports are growing thanks in great part to tourism, the Paris-based Organization for Economic Cooperation and Development says the performance has been disappointing, given how much Greek wages have fallen.

Leaving the euro would not cure Greece’s competitiveness problem. To expand its export base, Greece needs not just lower costs but also more firms willing to innovate and invest in products other countries want to buy. That will take lots of small, microeconomic steps that reduce the costs and barriers of starting new businesses, and more efficient public services. Greece had made progress but it has been slow, and the current government shows little interest in moving faster. Until that changes, Greece will remain Europe’s odd man out—whether or not it stays in the euro.

Write to Greg Ip at greg.ip@wsj.com