8/2/2017
By Matthew C Klein
Some people didn’t appreciate Alphaville’s recent comparison of Greece’s economic performance since 2007 with that of the United States during the Great Depression, which implied the Greek government missed a trick by committing to remain a member of the euro area no matter the costs.
Their argument went something like this (our paraphrase):
''America in the 1930s was a large diversified economy with strong institutions. It was also in the midst of the one of the greatest periods of technological innovation in human history. Of course reflation would work well there.
Greece, by contrast, is a small economy that depends on a handful of industries (mostly tourism, shipping, and oil refining) to earn hard currency. The country is notorious for the corruption of its officials and the weakness of its tax collection, legal system, and property registry. Low asset prices, collapsing wages, and catastrophically high unemployment wouldn’t be fixed by spending printed money. Instead you’d just end up with (hyper?)inflation and even more misery. Greece grew too much after the euro was introduced and now it’s simply gone back to where it should have been all along.''
Baloney.
Leave aside the unwarranted confidence in the technocratic capacity and commitment to the rule of law among American officials in the 1930s. And forget, for now, the tame Greek inflation figures in the pre-crisis period, which suggest there wasn’t much growth in nominal spending power above what could be supported by the underlying productive capacity of the economy.
Instead, for this post, let’s compare the recent Greek experience with what happened to a few countries with even weaker institutions when faced with the same problems of capital flight: Argentina, Brazil, Indonesia, Thailand, and Turkey. All data come from the International Monetary Fund’s World Economic Outlook database.
Like Greece (and Spain and Ireland et al) these countries received massive capital inflows from abroad, which helped sustain overvalued exchange rates and boosted domestic spending at the cost of export competitiveness and productivity growth. For various reasons at various times, these inflows rapidly went into reverse. That tightened financial conditions, caused asset prices to collapse, and thwacked consumer purchasing power.
Policymakers responded in lots of ways, but all let their currencies float so that the burden of adjustment would be split between foreigners and net importers rather than imposed squarely on the local population. Depreciation lets the central bank bring real interest rates down to a level sufficient to restore investment and consumption spending, while also giving a boost to exporters to pick up some of the slack from reduced domestic demand.
This worked well. Argentina, Brazil, Indonesia, Thailand, and Turkey all performed far better in the aftermath of their crises than Greece, by any measure. That’s particularly impressive considering they also grew more than Greece before their crises.
There are two basic ways to look at this question. The first is to use the IMF’s estimates of real output per person for each country and the second is to use the IMF’s estimates of output per person for each country in dollars at market exchange rates. While the average performance of the EM crisis sample looks a bit different under the two measures, Greece’s relative performance is comparable under both sets of estimates.
Start by comparing the “booms” each country experienced. Greek GDP per person grew about 34 per cent between 1999 and the peak in 2007 in real terms. In the eight years before their crises began, the equivalent figure in our EM sample grew about 42 per cent on average. That number is dragged down by Brazil, which didn’t grow at all in the years leading up to its crisis. Take it out and the average pre-crisis boom was about 52 per cent.
If one instead compares GDP per person in dollars at market exchange rates, Greece’s boom looks far more impressive: GDP per person grew by 132 per cent. Most of that can be attributed to the euro roughly doubling in value against the dollar during this period. Greece imports relatively little from America compared to its European neighbours, however, so it overstates the change in actual living standards.
Besides, Greece’s pre-crisis boom, in dollars, is still less impressive than what occurred in the other countries in our sample. On average, dollar GDP per person grew by 153 per cent in the nine years before their crises. Intriguingly, including Brazil makes no difference, which suggests that country lost nearly a decade of growth in the 1990s by trying to prop up its exchange rate. (The difference between using eight years versus nine years can be explained by the impact of exchange rates on the exact timing of Greece’s pre-crisis peak.)
Greece may have had frothier growth than, say, Italy, but it wasn’t outside the norm of what happens when a small country is deluged with foreign money. In fact, it got somewhat less of a growth boost, on average, than countries one might think of as peers. Argentina grew about a full percentage point faster than Greece each year during its boom (in the 1990s) despite weak commodity prices, for example.
Greece’s bust was significantly worse than the average, however. The peak-to-trough decline in real output per person was 26 per cent between 2007 and 2013. That compares with an average drop of about 12 per cent during other crises, which were also much shorter. Only Argentina’s depression comes close. Between 1998 and 2002 real GDP per person fell there by 22 per cent. In Indonesia, where the crisis led to the collapse of the Suharto regime and the independence of East Timor, real GDP per person fell by “only” 14 per cent.
Intriguingly, this seems to be entirely due to the absence of monetary sovereignty. When looked at in dollar terms, the peak-to-trough decline in Greek GDP per person is comparable to the average of emerging market crisis countries, and significantly less severe than what happened in Argentina or Indonesia.
But unlike those countries, Greece lacked the ability to use the exchange rate as a shock absorber. So while Brazil and Greece faced the same type of downturn in dollar terms — about 45 per cent in GDP per person — Brazilian living standards only deteriorated about 2 per cent, compared to 26 per cent in Greece. The net effect is that Greece had a relatively typical crisis in dollars but an unprecedently painful one in the terms that matter most:
More importantly, Greece had a very different post-crisis experience: it never recovered. By contrast, all the other countries were well past their pre-crisis peak after this much time had elapsed. On average, Argentina, Brazil, Indonesia, Thailand, and Turkey have outperformed Greece by more than 40 percentage points after nine years.
The performance gap is slightly bigger whether you compare the performance of GDP per person in dollars, although the specific performance of each country looks a bit different. For example, Argentina was still 34 per cent below its peak in dollar terms even though it was up by 14 per cent in real terms, while Turkey was up much more in dollar terms (76 per cent) than in real terms (21 per cent). Either way, the case for monetary sovereignty remains strong:
Putting it all together, the chart below compares Greece’s experience since 1999 with the average equivalent experience of Argentina, Brazil, Indonesia, Thailand, and Turkey, in real terms. Notice anything?
The gap between the average performance of Argentina, Brazil, Indonesia, Thailand, and Turkey on the one side and Greece on the other is even wider when looking at GDP per person in dollars:
It’s entirely possible Greece would have much less to gain from restoring monetary sovereignty now than it did six or seven years ago. But any honest comparison makes it clear a great opportunity was missed back then, for which the Greek people continue to pay the price.
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