A slightly edited version of this article was published in the New York Times, on 26th February 2015.
Everyone frames the depression in Greece as an issue of macroeconomics: fiscal policy was tightened too quickly; government debt is too high; the tools of currency devaluation and monetary expansion are not available inside the euro zone. No doubt these are important factors, but they tell less than half the story. Local politics and microeconomic factors are at least as important in explaining the depth of the crisis.
Greece has fared much worse than other euro zone countries, which also faced a ‘sudden stop’ of foreign financing, and then enacted similar austerity programs. It lost 26% of GDP from the pre-crisis peak, while Portugal, Ireland and Spain lost no more than 7% each. Much of this difference is due to foreign trade.
In all four countries, when capital from abroad stopped flowing in, increasing exports became a primary goal, to offset the drop in domestic demand. The other three achieved this quickly, as projected in their adjustment programs. Greece did not. If it had, its recession would have been much shallower; by one estimate, a 25% rise in exports could have limited the drop of GDP to just 3%. Fiscal contraction would have caused much less damage.
This failure of trade adjustment is a puzzle to those economists who tend to view competitiveness in terms of labor cost. Wages did in fact drop by much more in Greece since 2010 than in any other country, and labor cost is no longer a barrier to exports. Firms have not taken advantage of this for three reasons: regulations, fear, and size.
Regulatory barriers to starting or expanding a business used to be far worse than in any other European country. Since 2010 there has been some reform, demanded by the ‘troika’ of institutions (European Commission, European Central Bank, and the IMF), but progress is slow. Hundreds of thousands of pages of small print need to be cancelled, thousands of officials must lose their authority to block business decisions, and protected professions must be opened to competition from new business models. Politicians did not spend much political capital to push through these changes.
Fear is the result of Greece’s particular brand of populist and divisive politics. In other countries most parties reached a broad consensus over structural change. In Greece no party had the courage to take ownership of any reforms, any cuts in expenditure or any new taxes, even though it was very clear that some such combination was inevitable. When in government, politicians blamed all measures on the troika; when in opposition, they declared all measures unnecessary and wrong, and they labelled those in government as traitors.
Polarization brought violence and threats. Tourism was hit for three years by pictures of arson and beatings in Athens, as well as by port blockades and taxi strikes. Foreign investors were put off by threats from the surging Syriza opposition that they would reverse all sales of state assets, and would restore a centralized system of wage determination that enforces pay rises every year, regardless of productivity. Deposits flowed out of banks due to fear of Grexit or on rumors of nationalization, leaving no funds to lend to export oriented businesses.
Size of firms is a fundamental structural issue. Industrial capitalism was never strong in Greece, which is a society of small owners and of micro-businesses. Land and homes belong mostly to their occupants, free of mortgage, more so than in any western country. Self-employment and firms of fewer than ten employees are much more prevalent than in any other member of the EU. Only 5% of employment in the whole economy is in companies of more than 250 employees. Even the main export industry, tourism, consists mostly of medium and small units.
Over many decades, institutional factors have been blocking growth of firms and consolidation of industries. These factors range from uneven enforcement of tax and labor regulations in favor of the smallest, to a bankruptcy regime in which the state has first claim on all assets of insolvent companies. Most entrepreneurs used to make a profit in retail shops protected from international competition, and most middle class careers were in professions such as lawyers and doctors, rather than as managers in corporations.
Such a weak business sector found it hard to adapt to the negative shock of reduced domestic demand, and to the positive stimulus of lower labor costs. Firms can only adapt quickly if they have managers with some experience of exports, and factories in good shape where they can hire more workers. Small firms had neither. Bigger firms that became overindebted could not get a quick resolution to start exporting. Only a handful of big and healthy firms grasped the opportunity.
Greece now has a new party in government, radical left Syriza. How likely is it that their policies will help export-led growth? Not very. In opposition, they were denouncing all reforms that could boost competitiveness. In government, they say they will focus on tax collection from the rich, on better social services for the poor, and on taking on the ‘oligarchs’, who dominate the media and public works. These are laudable aims, but they will do little for trade.
Contrary to populist stereotype, ‘oligarchs’ have a very limited grip on the tradable economy. They do not control mineral resources as in Russia; they do not move huge amounts of capital as in Wall Street; there are no large sweatshops as in China; they do not own great tracts of farmland as in earlier Latin America. They had some sway over the banks, but this has diminished greatly in the bailout. They are not the key obstacle to growth.
What Greece needs is bigger businesses, more foreign investment, more experiments with new business models, more innovation coming out of its universities. Syriza appears to be against all of that. If so, it matters little what they can negotiate on debt and fiscal deficits. Unless it can export more, Greece will fail in the anti-austerity phase of the crisis, just as it failed in austerity.