Wednesday, June 3, 2015

Greece and its Grim Economic Future

The debt crisis in Greece will continue to have a long-term impact on the country's economy, particularly since domestic investment activity, particularly in capital goods, has plunged since 2007.

In a report by Eurobank Research, the author, Olga Kosma, notes that real capital stock in Greece has declined for the first time in 50 consecutive years.  As shown on this graph, real gross fixed capital formation (otherwise known as "investment") reported its largest cumulative decline as a percentage of GDP since 2007:

Real fixed capital stock includes the following:

1.) dwellings.

2.) other buildings and structures.

3.) transportation equipment.

4.) cultivated assets.

5.) intangible fixed assets.

Here is a graph that looks at what happened to investment in each of the five capital stock sectors since 1995:

The drop in investment in dwellings is particularly noticeable, declining from 50.7 percent in 1995 to 18.3 percent in 2013, a drop of 85.5 percent over the years between 2007 and 2013 alone.

For the first time in the years between 2011 and 2013, the value of real fixed capital stock dropped after rising between 1960 and 2010.  The total investment-to-GDP ratio dropped from 26.6 percent in 2007 to 12.1 percent in 2013.  This has pushed the net capital stock of the entire Greek economy (in 2010 prices) into negative territory as shown on this graph:

This will have long-term ramifications for the Greek economy.  A decline in capital stock means that the nation's ability to produce will be compromised since investment is required to create new capital goods.  If both the public and private sector are unwilling to increase their investment in the Greek economy, the future looks very grim.

It is interesting to look at the history of the investment-to-GDP ratio in Greece and compare it to that in both Spain and Portugal.  The author has divided the history into five phases as follows:

1.) In the first phase of investment during the 1960s and 1970s, investment-to-GDP rose from 19 percent in the early 1960s to 31.4 percent in the late 1970s and was accompanied by a strong economic expansion with average annual output growth of 6.6 percent between the years 1961 and 1980.  Similar investment patterns were noted in both Ireland and Portugal, however, Greece reported the strongest investment ratio increase, largely because of the massive public infrastructure programs that were implemented by the nation's military dictatorship between 1967 and 1974.

2.) In the second phase of investment between 1980 and 1995, the investment-to-GDP ratio fell from a peak of 31.4 percent in 1979 to 17.7 percent in 1995.  This led to much slower real GDP growth with rates falling to 0.9 percent annually.  As well, the Greek government started to run high fiscal deficits with public debt rising from 27 percent of GDP in 1979 to 111.6 percent in 1993.  Inflation also rose from an average of 8.9 percent over the years from 1961 to 1980 to an average of 17.8 percent over the period from 1981 to 1995.  Along with the spate of economic bad news, Greece's productivity growth actually shrank by an annual rate of -2.2 percent over the period from 1980 to 1994.

3.) In the third phase of investment between 1996 and 2007, the investment-to-GDP ratio rose from a low of 17.7 percent in 1995 to 26.6 percent of GDP in 2007, a rate that was well above the EU average.  This was largely because Greece's leadership needed to achieve economic convergence with the rest of the European Community so that it could participate in the European Common Currency which became known as the Euro.  As a result, monetary policy was tightened and there was a downward trend in government debt and deficit as well as inflation.

4.) In the fourth phase of investment between 2008 and 2013, the investment-to-GDP ratio hit 29 percent in the first quarter of 2007 but then fell to a low of 10.4 percent in the third quarter of 2013 in the aftermath of the global financial crisis.  Other European nations have had similar drops in capital investment with Ireland seeing theirs drop by 16.5 percentage points and Spain seeing theirs drop by 13.0 percentage points.   The difference with Greece is that the nation lacked the structural reforms in the fiscal, business and public sectors that were necessary since the nation suffered from high wage and price inflation, making Greek industries much less competitive than their European counterparts.

5.) In the fifth phase of investment which started in the first quarter of 2013,  the investment ratio rose  to 12.4 percent in the fourth quarter of 2013.  While that is a significant improvement, we can see that the current rate of investment is still well below historical levels, a harbinger of what could be a long-term low growth economic picture.

Investment activity by both the private and public sectors is a prerequisite for economic growth.  Without a reasonable investment-to-GDP ratio, Greece's economy is destined for even further trouble in the future.  At its current level of around 12 percent, investment is insufficient to create  a robust economy.  Unless the current central government makes meaningful structural changes, it is unlikely that Greece will experience the robust economic growth that it needs to pull itself out of its debt crisis. 


  1. By this weekend we should know more about a possible Greek default. If they do default obviously there will be a huge pull pack of investment. What your graphs are showing is that the Greek people already think its going to happen so have already cut way back. For most Greeks it probably seems like its taken longer then they thought it would.

  2. The phenomenon described above is the result of Globalization. Investment has gone elsewhere, where it can reap better returns for the top 1%. Under Globalization, the Greek people should all become economic migrants and follow the money. When will people wake up to this huge lie that Globalization leads to anything but ruin for developed countries?