Greece MUST continue to have current account deficits for quite some time!!!

This article by Daniel Gros stands out for two reasons: (a) it is brilliant in the sense that it points out something which is obvious but which has been essentially ignored by EU/domestic politicians so far - namely, the ultimate importance of current account balances in the Eurozone's crisis; and (b) it is totally insensitive in as much as it ignores the impact of current account balances on domestic employment (particularly the devastating impact which Greece's now more or less balanced current account has on Greek employment).

I have written ad nauseum about current accounts being at the root of the Eurozone's debt problems. Those who want to read more about it should browse through the Position on Current Accounts in my blog inventory. Let me, once again, summarize the essentials.

While a government/state works totally differently from a family (refer to Prof. Krugman), a country as a whole works exactly like a family in its cross-border transactions: if it spends more abroad than it earns abroad, it needs to find capital abroad to finance that. These are the two simple but extremely critical formulas to understand:

current account surplus = exporter of capital (i. e. Germany)
current account deficit = importer of capital (i. e. Greece)

Mathematics (not economics!) require a country's Balance of Payments to balance. That balance is the result of two sub-balances: the current account and the capital account. Any surplus/deficit in the current account must MATHEMATICALLY be offset by an identical deficit/surplus in the capital account.

The current account is something like a country's 'statement of cross-border operational cash flows': it captures the imports, exports, cross-border services, etc. If a country spends operationally more abroad than it earns abroad, it needs to get capital from abroad to finance that. That capital doesn't have to exclusively come in the form of debt; it can also come in the form of EU-grants, foreign investment, remittances by residents working abroad; etc. In the case of Greece, it came mostly in the form of debt.

The principal issue is NOT the sovereign debt of a country like Greece. Instead, the principal issue is its FOREIGN debt (that is foreign debt of the entire country and not only that of the state). If all of Greece's sovereign debt had been held by Greek residents, there would have been a lot less excitement between Paris/Brussels/Berlin in the last 3 years. One party's debt represents the savings of another party. If all of Greece's sovereign debt had represented the savings of Greek residents, Paris/Brussels/Berlin might have casually advised Greece 'to work that problem out with your own residents'.

Greece's principal problem (as a country, that is, and not as a state) was/is that its debt represents the savings of other countries, and that was/is only possible because Greece had current account deficits. And it can become very difficult for a country 'to work that problem out with the residents of other countries'.

Consider this: from 2001-10, Greece accumulated current account deficits of 197 BEUR. By definition, Greece had to import at least 197 BEUR in foreign capital during that period (in actual fact, Greece imported as much as 283 BEUR foreign debt during this period, not even counting other forms of imported foreign capital). Had Greece imported all that capital in the form of foreign investment, EU-grants, remittances by residents working abroad, etc., Greece would not have an external payments crisis today (perhaps still a domestic economic crisis but definitely not an external payments crisis).

Is a current account deficit bad per se? Definitely not per se! It all depends which form the resulting capital imports take and what that imported capital is used for. Let's return to the family.

A family which spends more than it earns needs to borrow. If it borrows to finance the next vacation, the pleasure is gone when the vacation is over but the debt is still there. If it borrows to invest in a, say, hotel and that hotel operates successfully, the family can service its debt out of operational earnings and it increases its wealth in the process of running the hotel.

Greece didn't spend all that debt on vacations abroad. Neither did Greece spend all that debt on building hotels. Instead, Greece spent all that debt on imports and, to a large extent, on consumption imports. So the pleasure of consuming the proceeds of that debt is gone but the debt is still there.

I maintain that, contrary to what the memorandum stipulates, the Greek economy MUST have a current account deficit for quite some time; i. e. Greece MUST continue to import capital. Why?

This is where Daniel Gros fails by not pointing out the terrible impact of a balanced current account on Greek employment. Modern Greece has a history of almost 200 years where it was proven time and again that the Greek economy cannot employ its people at satisfactory levels if there are no financial stimuli from abroad. By now, Greece's current account is rather close to being balanced (certainly before interest). The results of that can be visited in the unemployment figures.

An economy can only employ its people satisfactorily if there is sustained domestic economic activity (i. e. domestic value creation). If such domestic economic activity is a direct function of current account deficits, it collapses as soon as the current account is brought into balance. It works the same way in the opposite direction: Germany's current account surpluses are primarily a function of its exports. If something happened to Germany's customers in the rest of the world, Germany's unemployment would explode.

Greece MUST continue to import capital for the simple reason that the Greek economy does not generate enough domestic savings to finance the growth required for better employment. If Greece continues with a balanced current account (or even drives it into surplus as the memorandum stipulates), unemployment will continue to remain sky-high. It is simply not envisageable that Greece can increase its export activity so much as to bring enough foreign capital into the country to finance the necessary domestic growth.

If the only objective were to stabilize the external payments situation of Greece, a balanced current account (or even a surplus) would be enough. If the objective is to also create employment, Greece must continue to import capital.

Thus, the principal question should not be whether or not Greece should continue to import capital. It must! The principal questions are: what form should that imported capital take and what should it be used for? If it takes the form of loans and is used to import consumption products, we will see the 2000s all over. The employment situation would improve but only as long as the loans keep coming.

Greece's capital imports must be shifted to the form of non-interest bearing and non-repayable capital. The classic forms are foreign investment, EU-grants and, possibly, remittances of residents working abroad. From 1950-74, remittances by Greeks working abroad represented by far the largest portion of capital imports (and those capital imports were spent reasonably well by the families of the guestworkers). Going forward, Greece must secure the maximum of EU-grants available but that alone won't carry the day. In short: there are only 3 solutions for the capital needs of the Greek economy - foreign investment, foreign investment and, again, foreign investment. Mind you, foreign investment not only brings capital; it also brings the badly needed foreign know-how in all areas!

Daniel Gros argues that 'as soon as the current account swings to surplus, the pressure from financial markets abates. This is likely to happen soon. At this point, peripheral countries will regain their fiscal sovereignty'. True! As I have explained, there can be no need for net foreign debt if current accounts are in balance. But what good does fiscal sovereignty do when the sovereign is looking at unemployment of more than 25%?

Daniel Gros' most cynical comment is 'the larger the fall in domestic demand in response to a cut in government expenditure, the more imports will fall and the stronger the improvement in the current account – and thus ultimately the reduction in the risk premium – will be'. That is academically totally correct but it also totally ignores what should be the real issue for the Eurozone - namely, to have real national economies which can employ their people on a sustained basis out of their own value creation!

In summary: Greece can continue on the road towards achieving surpluses in its external accounts. The government may even qualify for the next Nobel Prize for Responsible Governance. I do suggest, however, that there will be more than a million Greeks who won't applaud the Nobel Prize!

This is what I suggest Greece MUST do: attract foreign capital to invest in the creation of domestic value generation (a combination of import substitution and export expansion). To attract foreign capital, a current account deficit is required. The current account deficit is, primarily, the result of importing more than exporting. If Greece justifies a current account deficit by importing machinery and equipment for investment in domestic value creation (instead of consumption products), domestic economic activity (and employment!) will improve.

What is required of Greece? Very simple! Create the economic framework to attract foreign investment and, for God's sake, don't scare foreign investors away!!!