Germany Greece and the Dutch Disease Euro version (feb)



Robin Matthews


Greek debt isn’t just a problem of Greek debt or even mainly so. It’s a joint problem, shared between Greece and the surplus countries in the euro area, but primarily a balance sheet problem between Greece and Germany. German surplus Greek deficit; one the reciprocal of the other. The euro area balance sheet recession mirrors the global balance sheet recession from which some of the world has apparently recovered. A euro induced version of the Dutch disease exists in Greece because the Greek and German economies are out of sync.   

Germany’s productivity has been on average, the highest and productivity growth the fastest before and since the euro area was founded (as book money in 1999 and currency change-over in 2002). The reasons why are another story. The story of Greece, Germany and the Dutch Disease is in three parts. 

Part 1 of the story is this. A single currency and a fixed exchange rate between the 19 euro members means that the productivity gap between Germany and elsewhere inevitably increases. Greece (and Italy, Spain and Portugal) become increasingly uncompetitive and Germany becomes reciprocally more competitive and experiences export led growth. Apart from an interruption between 2007 and 2009, Germany’s trade surplus has increased since the euro was launched.

Since German relative competitiveness increases, a balance sheet problem emerges as a Greek current account deficit and a German surplus; German capital account deficit, Greek surplus. Greek unemployment increases. German industry becomes super competitive.

But who can buy German goods? Greek customers (among others) if German banks (among others) lend to plug Greece’s current account. They lend short term, so Greek debt must be refinanced short term. If much of its industry is uncompetitive, Greek faces unemployment.

To prevent a catastrophic rise in unemployment, the Greek government must create jobs. But where? In the short term it can only be in the non-tradable (primarily the public) sector. The short term matters to electorates. And Greek employment and income generated by loans to Greece sustains demand for German goods.

The story, part 2 is familiar, a euro induced balance sheet recession. As long as financial markets are euphoric, as they were until 2007/8, Greek bond yields are low. Post euphoria, Greek debt is perceived to be more risky; yields rise. Refinancing Greek debt becomes increasingly costly up to the point of default. The troika (IMF, European Commission and Central Bank) steps in, supports Greek bonds, in return for a promise of austerity; that is reducing demand by generating a budget surplus, when there is lack of demand.

The intention behind austerity, if it’s not just that Greek governments, indeed all Greeks are judged to be profligate as compared to industrious Germans, is an intention to shock the Greek and other economies into higher productivity and greater competitiveness.

If convergence as a result of joining the Eurozone didn’t happen, why austerity should make it happen now?     

Unemployment in Greece is 25% and 50% for the over 25’s. Catastrophic. So Greece voted for a government pledged to renegotiate austerity.

A euro version of the Dutch disease underlies both parts of the story. The Dutch disease originally described the situation that arose in Holland in the 1970’s, when the discovery of oil off the coast led to a Dutch export surplus and an appreciation of the guilder, making the non-oil sector of Dutch industry uncompetitive.

The real value of a currency depends on the exchange rate and the average the country’s costs. Average costs are roughly unit labour costs, a weighted average of wages, divided by average productivity. So the real value of a flexible currency increases as the exchange rate appreciates relative to other currencies and as relative labour costs increase and average productivity falls relatively.

Now the story part 3. The origin of the euro Dutch disease is different, but it amounts to the same thing. Greece has become uncompetitive because Greek productivity growth is lower than the corresponding German productivity, whilst they share a common currency. Bank lending has counterbalanced the Greek current account deficit, created demand for euro area manufactures which has stimulated German export led growth. The problem of Greek debt is variation of the Dutch disease, not founded currency over valuation as a result of oil exports, but overvaluation of the euro in Greek terms, because the value of the euro is determined by German costs and productivity. 

Since around 1870 Germany has been pre-eminent in Europe, industrially, financially and otherwise. Evidence of its industrial, financial and recently political pre-eminence is clear. Greece amounts to a small percentage of the euro area (2%), but if the Greek crisis were to percolate to Spain and Italy (12% and 17% respectively), then the EU as a political and social project, which it always has been, will fail. The USA took responsibility for post war Europe because it recognized a joint interest between the USA and Europe; political, economic and empathetic.  

The solution to the joint debt problem, German surplus, Greek deficit on current account, is a bail in by the euro zone which amounts to a bail out by Germany, accompanied by some arrangement that enables the Greek government to run a substantial budget deficit, first, to reduce unemployment and second, in the medium to long term, to restructure, gain competitiveness and converge its economy with the German economy.  

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