Wednesday, 27 April 2011

The Greek (un)competitiveness saga - part 2

I want to come back to the competitiveness issue or more correctly to the non-competitiveness issue for Greece.  In an older post I was talking about the unit labour cost of Greece and that since wages appeared to be lower than in other EU countries that their unit labour costs were roughly equal, so I assumed that this had to mean that labour productivity for Greece had to be lower than these of our EU peers.

As it turns that was indeed the case, labour productivity for Greece is lower than that of other core-European countries and lower than that of most PIIGS countries, the sole exception being Portugal.

source: OECD

Of course since this metric is just GDP per hour worked, it’s a little bit generic, at least I would prefer to see separate data for each sector.

Boileau Loko and Mame Astou Diouf of the IMF (“Revisiting the Determinants of Productivity Growth: What’s new?”, IMF Working Paper, Middle East and Central Asia Department, October 2009) identify a number of factors that influence productivity growth.

The paper is talking about Total Factor Productivity (TFP) and its determinants. Since the relevant academic literature and common sense suggest that TFP is one of the determinants of labour productivity I’m going to look into the factors believed to affect TFP as if they affect labour productivity as well, which is the case anyway. I’m sticking to labour productivity because I could not find TFP data for Greece.  

Before looking into as many factors as I was able to find data for Greece, here’s the trajectory of labour productivity growth for the total economy for Greece and Ireland.

source: OECD

I think that the chart makes it obvious that Irish labour productivity growth was by far superior to the one displayed by Greece.

To cut to the chase, the first factor that the paper identifies that it is bound to have an effect on productivity is inflation. My take on why this could be happening is the following. A high inflation rate could prove to be negative for productivity growth, since it affects decisions at the firms’ level.  It makes budgeting, planning and other corporate decisions less certain and more difficult and it tends to affect investment negatively. 

source: OECD

I think that during the second half of the 80s and the first half of the 90s, when inflation for Greece was significantly higher than for Ireland, the differential between their respective productivity growth is significantly larger (of course in favour of Ireland). I'm not saying that this was the sole reason for that, but it surely played its role.

The next factor that the paper cites is government size. The net effect of that factor appears not to be that clear in literature. I think that the Greek and Irish evidence reinforce this. Since for the pre 90s when government in Ireland appeared to be larger productivity growth was higher. I think that higher productivity growth during that period in Ireland can be attributed to other factors which I will discuss later on. Of course, a large bureaucracy does have adverse effects on productivity but I think that a factor mentioned later on incorporates these effects. A large government sector in my view is detrimental for productivity due to the crowding out of the private sector and the fact that resources are not allocated optimally. If this sounds a bit generic, I mean that a large public sector needs higher taxes in order to be financed and this is directly subtracted from funds available for private investment.

source: OECD

Another factor that tends to push productivity upwards is foreign direct investment (FDI) inflows. The channel for this is the transmission of know-how. I suspect that having increased competition from more technologically advanced players (as is the case usually) can induce local players to try and ramp up productivity as well. FDI inflows for Greece were negligible while for Ireland they were simply exorbitant.

source: OECD

Trade openness seems to have a positive effect on TFP as well. It increases the potential market for local producers, while at the same time it increases the competition they face, something that may work as a good incentive for raising efficiency, hence productivity as well.

Trade openness is measured by the total trade to GDP ratio. Ireland here is some kind of outlier since the relevant ratio is outlandish, while Greece’s reading of that particular indicator is the second lowest among EU countries after Italy. 

source: OECD

Strong and efficient institutions tend to have a positive effect on productivity. The efficiency of Greek public sector and the other relevant institutions has become some kind of a myth. I think that using World Bank’s Ease of Doing Business Index is a adequate proxy for that factor. Greece is by far the worst performer out of all the PIIGS countries and as it was natural it lost 12 places in the rankings table during 2010 due to all the unrest and supply chain disruptions. On the other hand, Ireland is in the top ten.

source: World Bank

The paper authors list labour quality and female participation in the labour force as additional factors that influence TFP. I couldn’t find any indicators time series to represent them satisfactorily for my taste.

The post is already rather long so I will put the rest of it into part three so that you won’t get bored reading this. So, part three is coming soon...

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