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Friday, August 17, 2018

Long-Run GDP Growth Prospects Are Poor

Last month, the IMF pubslished its 2018 Article IV Report on Greece and it was widely commented in the media. I have now read the full 80+ pages and can only recommend others to read the full report. It can be found under this link (under the caption Electronic Access, click on Free Full Text).

I focus here on Annex VI about Greece’s Long-Term Growth Potential and I reproduce it below. A summery statement would be: "Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades. Labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output). Long-run GDP growth prospects are thus poor, absent a major change in policies. Structural reforms to raise TFP growth and employment are therefore the only option to achieve higher long-term output growth."

Below is the Annex VI about Greece's Long-Term Growth Potential.


1. Greece is set to experience dramatic population aging over the next several decades. In its 2018 Aging Report, the EC projects Greece’s working age population to fall by about 35 percent between 2020 and 2060 due to a shrinking and rapidly aging population. This is among the largest such declines in the Euro Area, and three times the average fall for the Euro Area. Ceteris paribus, aging would imply an average yearly decline of 1.1 percentage points in Greece’s labor force during the next four decades.

2. Greece’s productivity growth has historically been poor. Greece’s underperformance relative to peers is often associated with relatively low openness of the economy and a high share of labor allocated to non-tradable sectors. Total factor productivity (TFP) growth over the last 47 years averaged just ¼ percent annually, by far the lowest in the Euro Area. Assuming this historical average TFP growth rate going forward, labor productivity (output per worker) would grow only at about 0.4 percent in the steady state (the rate of TFP growth adjusted for the labor share in output).

3. A pickup in investment could provide a short-run boost to growth, but productivity and demographics will dominate in the longer run. Investment is bound to recover from its highly depressed level once Greece emerges from the crisis, but the growth effect of this will wane once the capital stock returns to its long-run level. Staff’s medium-term projections already assume a temporary boost to GDP growth from higher investment (with real GDP growth rates averaging close to 2 percent during the investment recovery). Once the transition to the new, higher capital ratio is completed, however, the impact of increased investment will fade and growth dynamics will be determined by the evolution of output per worker and of the number of workers.

4. Long-run GDP growth prospects are thus poor, absent a major change in policies. As a starting point, combining the historical growth in output per worker of 0.4 percent with expected growth in the number of workers of -1.1 percent would imply long-term annual growth of -0.7 percent. This simple result is broadly similar to other recent findings in the literature, which estimate Greece’s baseline growth rate (before the effect of reforms) at -0.4 percent during 2024–2043.

5. Structural reforms to raise TFP growth and employment are therefore the only option to achieve higher long-term output growth. Estimating the gains from structural reforms is technically difficult, and results are necessarily imprecise. The empirical evidence suggests that the GDP growth gains from reforms are somewhat modest and transitory: while studies have documented an impact on output levels of 3 to 13 percent over the initial decade, the impact of reforms on growth tends to fizzle out afterwards.

7.
 • The 2016 WEO estimates the GDP level gain from past episodes of product market deregulation in 26 advanced economies over 1970–2013 at about 3 percent on average, with gains accruing over a period of eight years, suggesting a GDP growth gain of about 0.4 percentage points per year during the eight-year period.
• Adhikari et al. (2016) looks at case studies of major past reformers in both labor and product markets—Australia, Denmark, Ireland, Netherlands, and New Zealand in the 1990s, Germany in the 2000s—and finds that the GDP effect of reforms ranged between 0 and 34 percent over a period of 5 years. Excluding Ireland, which is a clear outlier, the average impact was 0.6 percentage points per year over the five-year period, and in two out of six cases, there were no significant gains. Permanently raising growth would require a period of reform implementation that exceeds in both ambition and duration what Greece has achieved so far. While Greece has initiated numerous structural reforms in the context of its adjustment programs—from labor markets to energy, judicial reforms, closed professions, and others—implementation has sometimes lagged. The country’s key accomplishment has been a cornerstone labor market reform adopted in 2011, but this is set to be partially reversed after the current program. Other legislated reforms have faltered at the implementation stage. For example, numerous attempts at privatizing state monopolies in the energy sector are yet to reduce significantly the state’s share in this sector; judicial reforms have been slow moving, with continued high court backlogs; reforms to liberalize close professions have fall short from expectations in terms of both pace and scope; and; the investment licensing reform, which started in 2011, is still not fully completed. Given demographics, the impact of structural reforms will need to be substantial to achieve an overall long-term GDP growth rate of 1 percent over the next half century. Lifting long-term growth from its baseline of –0.7 percent to 1 percent requires reforms to add 1.7 percentage points to growth per year for the next decades. The OECD (2016) estimates that full implementation of a broad menu of structural reforms could raise Greece’s output by about 7.8 percent over a 10-year horizon, which translates into an increase in annual growth of some 0.8 percentage points for about a decade. Bourles et al. (2013) estimate this gain to be slightly higher, at about 0.9 percentage points per year, while Daude (2016) finds that reforms focused on product markets and improving the business environment in Greece could boost growth by about 1.3 percentage points per year for a decade.

9. In conclusion, achieving staff’s assumption of 1 percent growth in the face of adverse demographics and historically weak productivity growth will require that the Greek authorities and people commit to an extended period of profound structural reform. Implicitly, the 1 percent growth projection presumes that Greece would manage to increase labor force participation to levels that exceed the Euro Area average (to offset the significant projected decline in Greece’s working age population) and that would generate TFP growth rates permanently far above Greece’s historical average. This underscores the importance of rapid and decisive action on the part of the authorities to tackle the many bottlenecks that constrain growth and limit the country’s ability to prosper in the Euro Area. 

1 comment:

  1. I first turned to Annex II. The Greek Authorities Growth Strategy, in order to look at the very elusive "Plan". Unfortunately it only contained IMF's opinions of the "Plan", not high. Once again Greece goes for elections with the two main parties both having a plan and none of them revealing it. Strange country.
    Yes the report was well worth reading, bleak but more realistic than the wishful thinking they emit from Brussels.
    It does not matter what the next government look like, Greece will not be on the straight and narrow for another two years. The promises and lies we will hear at the next Thessaloniki Bazaar will be of epic dimensions, even for Greece.
    Lennard.

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