Sunday, May 12, 2013

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!!!


  1. So basically you're saying the greeks need tom remain slaves of foreign markets to get the money necessary for their investments.

    If it was really just a matter of having money to finance investment, well, Greece could actually print it, if only it had a sovereign money system (and, i concede, some reliable public institutions to deal with it).

    1. Even if Greece had the Drachma, it could not just print money for investment. You generally need a lot of foreign machinery & equipment for investment and you can't pay for those with Drachma.

      Think of the following: you are a person of modest means and can't to offer your family much of a living standard. Then you have a great idea; a plan for a new hotel in a unique place with unique features. Sadly, you lack the money. You succeed in persuading a bank to finance your hotel. The hotel develops very nicely; you employ quite a few people who, in turn, support their families with the wages you pay them; you have no problem servicing the loan from the bank; and --- your new income from the hotel allows to to offer your family a very nice standard of living.

      Why would you consider yourself a slave of the bank???

  2. Off-topic, yet it might interest you. In Avgi newspaper -traditionally Syriza-leaning- it is written that A. Tsipras will be present at the SEV cnference (Hellenic Federation of Enterprises). I translate the last paragraph of the article:

    Point of reference in all speeches will be the McKinsey study regarding the adoption of a new development model that our contry needs, whereas Dimitris Daskalopoulos (SEV president) will describe all measures needed in order to pull the economy out of the swamp.

    1. Well, that will be a day to remember when I see that, of all Greek politicans, it is Alexis Tsipras who discovers that many, many answers to Greece's problems are in the McKinsey report 'Greece Ten Years Ahead'. If Tsipras were indeed to become a honest champion of the GTYA-report, then he would deserve to be elected!

  3. Apologies, apparently, my comment was misleading. Besides A. Tsipras, PM Samaras will be present at the conference. So, I guess that his speech will have McKinsey report as a point of reference, as well.

    Btw, I checked SEV'S website and here's what they say about the McKinsey report:

    ''Greece 10 Years Ahead'' is a study that aims to define a new growth model and strategy for economic development in Greece in the next 5 to 10 years, founded on the principles of competitiveness, productivity, extroversion, investment stimulation, and employment opportunities.

    The ''Greece 10 Years Ahead'' study was jointly sponsored by the Hellenic Federation of Enterprises (SEV), the Hellenic Bank Association (HBA) and McKinsey & Company.

  4. While I agree with the general logic of the article, I remain unconvinced that Greece must be a perpetual importer of capital in order for Greeks to be employed. I don't think it happened in the past (pre 90's), and I don't think it needs to happen in the future either. It only needs to happen if Greece remains in the euro. If Greece reverted to a national currency, the government could invest in domestic value creation/ employment (i.e. anything denominated in drachmas) without problems. Whether the Greek government is competent enough to do it, is another matter. Also, let's not forget that domestic value creation is not only the job of the government, but also of the private sector. Once the economy gets going, or once it is profitable to get involved in the domestic market again, the private sector is gonna acquire his own liabilities. So, arguably, the actual problem isn't that Greece needs to attract foreign capital, but that globalization and the euro force Greece to compete internationally for value creation.

    1. Well, I hope you noticed that I was not talking about perpetual capital imports. That would be an illusion. I was talking about capital imports 'for quite some time'. To use my above example, for that time which it takes for the hotel to be up and running, and to generate revenues.

      As of now, Greece has a primary surplus and the current account is also in surplus before interest. So one could say that internal and external accounts are in balance. With that new equilibrium (which every technocrat in the world applauds of late), unemployment is well over 25%. At some point, Greece will hopefully have restructured its economy so that a lot less food products are imported and a lot more exported; a lot less other products imported and a lot more other products exported. But there has to be a jump start from somewhere and I don't see it coming from within. Maybe I'm wrong but I simply can't see it coming from within.

      Mind you, foreign investment isn't necessarily a German company investing in Greece. It is also foreign money which Greeks hold in offshore accounts and which they bring back to Greece. I think the latter could become the quickest source of 'foreign investment' if only Greece put into place some structures which would incentivate those Greeks to bring some of their money back.

  5. To remind, Greece in 2012 had almost the same amount of exports with Slovenia.
    Foreign investments and import substitution are the keys as you say.
    During 1990-2008 in Gr were created more than 300.000 -uneeded -employment oppurtunities with meritocracy in public sector and not in productive industries with ability to produce and export value added products.
    If you remember before months the issue today is not current account deficit, but to create strategic competitive advantages in a region with dynamic and potential.

    An example

    Y = national income
    C = total consumption (both private and state, eg petrol for schools or staples for offices)
    S = total savings
    T = total amount of taxes (indirect, direct, special, etc.)
    G = government spending
    I = total investment (both private and state)
    X = exports (in EUR)
    M = imports (EUR)

    In an economy as a whole, the national income (Y) is the sum of total consumption (C), savings (S), and taxes (T).

    Y = C+ S +T

    We have to stabilise C so with reduced taxes in gas and energy, which are the basics of an economy, to increase revenues from taxes and stabilise savings -as long as- foreign capital and investments are not sufficient.

    At the same time, the national income (Y) must be equal to the sum of total consumption (C), investment (I), government spending (G) and the difference exports-imports (X-M) - which is, of course , when we have (always)a negative trade deficit.

    Y = C +I +G +(X-M)

    Reducing the recession,by mildinging a bit taxes its much easier for all people to find motives and for government to implement a better planning for attracting foreign investments.


  6. Klaus, I would not deny that attracting foreign investments to create more jobs would dramatically improve the current situation.

    But I believe that for some time it's wishful thinking because all boundary conditions are against it.

    H. Trickler