The impact of regulations and institutions on competitiveness and productivity: the case of Greece.

• Author: Nicolitsas, Daphne

1. Introduction

   Most of the discussions on the causes of the Greek crisis have focused on the features that made the country vulnerable when the global financial crisis hit in 2007-8. The twin deficits: the fiscal and current-account deficit are identified as such (Kouretas and Vlamis, 2010, Manessiotis, 2011; Noyer, 2015; Santacreu, 2015). How did the twin deficits come about? Antzoulatos (2012) and Feld et al. (2016), interalia, argue that these developments suggest state failure in regulation and supervision. Others (Rebooting Consensus Authors, 2015) point the finger to unfettered markets. A third group, however, suggests that the Greek crisis was an accident waiting to happen as market signals for adjusting wages, prices and productivity were ignored (Belke and Gros, 2017; Ioannides and Pissarides; 2015; Taylor, 2015).

   This paper falls in the third strand of the literature identified above and presents characteristics of the Greek economy which contributed to the loss in its competitiveness. The aim is to identify labor and product market institutions that seem to have contributed to the formation of the economic imbalances. These institutions are not a recent feature of the Greek economy. In the past, however, they had not created visible obstacles as Greece was not part of a monetary union and the option of currency devaluation was available. The focus of the discussion is on the interaction between labor and product market institutions. More specifically, the paper elaborates on features associated with the low productivity of the Greek economy (composition of economic activity, high share of self-employed, small size of firms, limited product market competition, lack of appropriate workforce skills) and on the wage- setting mechanisms (multi-layer bargaining, extension mechanisms) behind the limited responsiveness of wages to unemployment (as pointed out by amongst others Belke and Gros, 2017).

   The mechanisms through which institutions affect the economy have been investigated theoretically by inter alia Blanchard and Giavazzi (2003) and Joskow and Rose (1989). The main idea is that product market institutions impact on the intensity of economic activity while labor market regulation influences the distribution of rents between employers and employees. Furthermore, as stressed by Aiginger and Rodrik (2020) and Rodrik (2016), institutional quality can also affect the composition of economic activity which in turn affects the dynamism of a country's economy. Finally, social partnerships and the industrial relations climate also impact on the size and composition of economic activity (Mueller and Philippon, 2011).

   The reference time is the period between 1996 and 2007. The starting point is the year in which Greece began preparing for entry into the euro area. The end point is the year in which the global financial crisis hit.

   During the period 1996 to 2007, Greece grew at a rate considerably above the euro area average. This growth was accompanied, however, by a considerable loss in competitiveness as manifested by the large fiscal and current account deficits at the time the global financial crisis hit. Between 1996 and 2007 nominal and real interest rates in Greece decreased significantly and the working-age population increased as immigrants flowed into the country at high and accelerating rates. The above two factors contributed to the surge in activity; the average annual growth rate stood at 3.9%. But this was an expansion based on sectors sheltered from international competition: the construction sector and wholesale and retail trade sectors expanded at rates higher than average (5.0% and 7.2% respectively). Private sector investment expenditure was significant (around 19% of GDP) although a large share, especially in the first half of the 2000s, was concentrated in housing.

   Nominal unit labor cost increased by 4.2% per year in Greece. In Germany, Greece's third largest export destination, nominal unit labor cost decreased between the two years. In a monetary union and given intense world-wide competition, regular divergences in nominal unit labor cost developments are difficult to sustain. The combined current and capital account deficit ballooned from around 4% of GDP in 1996 to 12.6% in 2007.

   These imbalances were also reflected in the unemployment rate which despite having decreased, did not fall anywhere as much as expected given the expansion in activity. The unemployment rate stood at 8.3% in 2007 from 10.3% in 1996.

   The sequel is by now well known: a severe sovereign crisis compounded by a deep recession resulted in Greece producing around 24% less output in 2018 compared to 2007. The unemployment rate peaked at 27.5% in 2013 (26.5% in 2014, 24.9% in 2015). In the absence of an effective safety net, poverty also increased (Koutsogeorgopoulou et al, 2014).

   The above developments reflect the lack of an industrial strategy for the country's future.

   The paper is organized as follows: Section 2 documents the low and deteriorating level of competitiveness of the Greek economy. Section 3 outlines the thread of the argument used in the paper. Section 4 focuses on labor market rigidities that could dampen the responsiveness of wages to changes in economic performance. Section 5 then discusses potential reasons for which productivity in the Greek economy has been lagging that of other developed countries. Section 6 next outlines the elements a strategy for the future could include to address Greece's competitiveness and productivity issues. Finally, Section 7 summarizes and concludes.

   The analysis in the paper is based on aggregate macro and sectoral-level data and on information on the institutional framework. Data on the latter are derived from a firm-level survey on wage and price setting practices conducted by the Bank of Greece (BoG) in 2007/8, as part of an ESCB/Eurosystem research initiative on wage and price setting procedures (the Wage Dynamics Network, WDN). and from the OECD Product Market Regulation (PMR) database.

2. Developments in price, cost and structural competitiveness of the Greek economy

   Fagerberg (1988) defines international competitiveness as the ability to compete in price (price and cost competitiveness), in technology and in delivery (capacity). Price and cost competitiveness are usually measured in terms of the effective exchange rate while several indices are used to proxy capacity.

   From the mid-1990s and until 2000, Greece followed stability-oriented economic policies which set the stage for Euro Area (EA) entry (IMF, 2001). Policies were effective in reducing the rate of inflation and this is mirrored in the improvement of competitiveness as measured by the ECB harmonised competitiveness indicator (real effective exchange rate) deflated by the consumer price index (Figure 1). Competitiveness indicators deflated by either the unit labor cost or the GDP deflator did not improve as much (Figure 1) but nevertheless these also picked up for part of this period. For a number of reasons--including the nature of the products exported by Greece, the sunk costs firms incur before starting to export, the uncertainty around the exchange rate--Greek exports do not respond swiftly to changes in the real exchange rate (Belke and Kronen, 2016). As a result, and given that during this period domestic demand for imports (for both consumer durables and capital goods) increased while exports did not rise to the same extent, the current account deficit deteriorated. Early in the 2000s analysts (see, inter alia, IMF, 2001) expressed concerns that the widening of the current account deficit, despite it being only a proximate gauge of domestic imbalances in a monetary union, suggested a trend of deteriorating competitiveness. As it turned out, following entry into the euro area, Greek international competitiveness weakened (Figure 1) both because of the appreciation of the euro (between 2000 and 2007 the euro appreciated by over 48% against the US dollar) as well as due to insufficient adjustment in the domestic economy. The strength of the euro should have led to internal devaluation--that is a decline of domestic prices and wages. Instead wage costs continued rising at rates higher than productivity.

   If we delve a little deeper on ULC we find that between 1996 and 2007 the annual rate of increase of the nominal ULC in Greece was 4.2% compared to 1.3% for the EA19. The gap between Greece and the EA-19 in the ULC was much wider than the corresponding gap in the rates of inflation (annual inflation rate of 3.5% in Greece vs 2% in the EA-19).

   Looking at developments in wages and productivity separately, the picture becomes more complete. The annual rate of increase of real hourly wages in Greece was 3.2% compared to 0.5% in the EA while the corresponding figures for hourly productivity were 2.9% in Greece and 1.4% in the EA. The gap between the change in wages and the change in productivity explain the growth rate in ULC.

   Even though productivity in Greece increased at a rate double that in the EA, productivity per hour worked in Greece was at most 60% of the respective EA-19 value. The gap reflects amongst other factors a disadvantage in what Fagerberg calls technology and capacity competitiveness, or what is more often termed structural competitiveness. Greece appears to be lagging and not catching up fast with countries at the frontier as institutional factors (Belke and Kronen, 2016). Indicators such as the World Bank's Ease of Doing Business indicator published as part of the Doing Business report, illustrate the difference in achievement.

   The above provide a succinct picture of the competitiveness position of the country prior to 2007. What we turn to next a presentation of the mechanisms through which institutions can affect economic performance and competitiveness.

3. From institutions to economic performance and competitiveness: a framework for analysis

   Before turning to...