Geographies in Depth

Why austerity is not the cause of Greece’s economic woes

Edmund S. Phelps
Director, The Center on Capitalism and Society, Columbia University
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Too many politicians and economists blame austerity – urged by Greece’s creditors – for the collapse of the Greek economy. But the data show neither marked austerity by historical standards nor government cutbacks severe enough to explain the huge job losses. What the data do show are economic ills rooted in the values and beliefs of Greek society.

Greece’s public sector is rife with clientelism (to gain votes) and cronyism (to gain favors) – far more so than in other parts of Europe. Maximum pensions for public employees relative to wages are nearly twice as high as in Spain; the government favors business elites with tax-free status; and some state employees draw their salaries without actually turning up for work.

There are serious ills in the private sector, too – notably, the pervasive influence of vested interests and the country’s business and political elites. Profits as a share of business income in Greece are a whopping 46%, according to the latest available data. Italy came in second at 42%, with France third, at 41%. (Germany’s share is 39%; the United States’, 35%; and the United Kingdom’s, 32%.) Insiders receive subsidies and contracts, and outsiders find it hard to break in. Astoundingly, young Greek entrepreneurs reportedly fear to incorporate their firms in Greece, lest others use false documents to take away their companies. According to the World Bank, Greece is one of the hardest places in Europe to start a business. The result is that competition for market share is weak and there are few firms with new ideas.

This stunted system springs from Greece’s corporatist values, which emphasize social protection, solidarity instead of competition, and discomfort with uncontrolled change. These values may well be beneficial for family life; but, even with the best of intentions, they are a recipe for a static economy and stultified careers.

Indeed, Greece’s labor productivity (GDP per worker) is only 72% of the level in the UK and Italy, and a mere 57.7% of that in Germany. And surveys indicate that mean life satisfaction in Greece is far below that found in the wealthiest EU countries (the EU15). Contrary to claims by the Greek government, corporatism impoverishes the less advantaged. EU data on poverty rates in 2010 put Greece at 21.4% – far higher than the mean EU15 rate of 16.7%.

To be sure, Greece saw productivity gains after World War II – but mostly from increases in education and capital per worker, which can go only so far. Two important sources of broad prosperity are blocked by Greece’s system. One is an abundance of entrepreneurs engaged in detecting and exploiting new economic opportunities. Without them, Greece does a poor job of adjusting to changing circumstances (an imperative emphasized by Friedrich Hayek). Greece’s much-lauded shipowners, for example, were too slow to adapt to containerization, and thus lost their market share.

The other source of broad prosperity is an abundance of business people engaged in conceiving and creating new products and processes – often termed “indigenous innovation.” Here, Greece lacks the necessary dynamism: venture capital investment flows are smaller, relative to GDP, in Greece than in any other EU country. So Greece’s economy has scant ability to create sustained productivity growth and high human satisfaction.

Some economists believe that these structural considerations have nothing to do with Greece’s current crisis. In fact, a structuralist perspective illuminates what went wrong – and why.

For several years, Greece drew on the EU’s aptly named “structural funds” and on loans from German and French banks to finance a wide array of highly labor-intensive projects. Employment and incomes soared, and savings piled up. When that capital inflow stopped, asset prices in Greece fell, and so did demand for labor in the capital-goods sector. Moreover, with household wealth having far outstripped wage rates, the supply of labor diminished. Thus, Greece went from boom to outright slump.

The structuralist perspective also explains why recovery has been slow. With competition weak, entrepreneurs did not rush to hire the unemployed. When recovery began, political unrest last fall nipped confidence in the bud.

The truth is that Greece needs more than just debt restructuring or even debt relief. If young Greeks are to have a future in their own country, they and their elders need to develop the attitudes and institutions that constitute an inclusive modern economy – which means shedding their corporatist values.

Europe, for its part, must think beyond the necessary reforms of Greece’s pension system, tax regime, and collective-bargaining arrangements. While Greece has reached the heights of corporatism, Italy and France are not far behind – and not far behind them is Germany. All of Europe, not just Greece, must rethink its economic philosophy.

This article is published in collaboration with Project Syndicate. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Edmund S. Phelps, the 2006 Nobel laureate in economics, is Director of the Center on Capitalism and Society at Columbia University and author of Mass Flourishing.

Image: A boy holds a Greek flag March 25, 2015. REUTERS/Yannis Behrakis 

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