The Reason Austerity In Greece Didn't Work

2/26/2015 @ 4:13AM 71 views

Tim Worstall

Forbes

One of the little puzzles of the past few years has been why was the reaction of the Greek economy to austerity so much worse than that of other countries? For it is true that other countries (I think particularly of Spain and Portugal) had the same sort of shrinkage of the government budget, had the same (entirely wrong and inappropriate) monetary and currency policies but they did much better. Or at least not as badly. So what was the secret to that Greek economy that made the out turn so awful? And awful it is, Greece has had a fall in GDP akin to what the US had in the Great Depression of the 1930s. The answer, it appears, is that the underlying structure of the Greek economy is such that it just couldn’t take advantage of the meagre benefits that austerity did provide.

The point is made in this NYT piece:

Greece has fared much worse than other eurozone countries that faced a sudden drop in foreign financing, and then enacted similar austerity programs. It lost 26 percent of its G.D.P. from the pre-crisis peak, while Portugal, Ireland and Spain lost no more than 7 percent each. Much of this difference is due to foreign trade.

Yes, of course, there’s more to it than only foreign trade. But this is also a large part of the difference:

Finally, the size of companies in Greece is a fundamental structural issue. Industrial capitalism was never strong in Greece, which is a society of small owners and of microbusinesses. Land and homes belong mostly to their occupants, free of mortgage, more so than in any Western country. Self-employment and companies of fewer than 10 employees are much more prevalent than in any other European nation. Only 5 percent of employment in the whole economy occurs in companies with more than 250 employees. Even the main export industry, tourism, consists mostly of medium and small businesses.

Think it through as a macroeconomic story for a moment. So, austerity might not be the best policy in the first place. And being tied into a currency and monetary policy entirely inappropriate also doesn’t help, to put things mildly. However, when there’s vast unemployment, as has happened, then wages are going to fall, as has also happened. At which point exports should pick up: it’s now cheaper for foreigners to purchase the products of Greek labour. At which point some of that lost GDP should start to come back.

However, that macroeconomic solution does depend upon the microeconomic structure of the economy itself. And a vast morass of small firms with very few large ones is just not going to be conducive to increasing exports. Simply because small firms tend not to export nor have the ability to start doing so. So while the wage and productivity issue might have been dealt with the country simply cannot take advantage of that fact. Thus Greece is stuck.

There’s one other thing we can say about this too. Which is that if this is the reason for the ongoing problems then being out of the euro won’t in fact help all that much. For the point of being out of the euro is that one could have devalued the drachma to achieve that same reduction in export wage rates. But if the economy simply isn’t able to increase exports, just because it doesn’t have companies capable of exporting, then that’s not going to help much. Thus the end answer is that Greece really does need structural reforms in or out of the euro. And those, sadly, take time.

My latest book is “23 Things We Are Telling You About Capitalism” At Amazon or Amazon UK. A critical (highly critical) re-appraisal of Ha Joon Chang’s “23 Things They Don’t Tell You About Capitalism”.

http://www.forbes.com/sites/timworstall/2015/02/26/the-reason-austerity-in-greece-didnt-work/