Friday, 2 September 2011

Internal devaluation and the continuing plight of the Greek industrial sector

Internal devaluation (i.e. the slashing of labour costs) is supposed to work like a currency devaluation, meaning that its ulterior motive is to make a country’s products more competitive overseas. 

Greece has embarked on such a mission since last year in an effort to make its tradable sector’s output more competitive.

Thus I want to take a look at how Greek industrial production is faring from 2010 and on.

I’ve plotted the performance of the industrial production index for the main aggregations of industrial produce for Greece and Ireland since they have also pursued a similar policy.

source: Eurostat

Greek production of intermediate goods is plummeting and the same goes for Ireland.

source: Eurostat

Greek production of energy which is heralded as the great hope for Greece is in a downward path too.

source: Eurostat

Production of capital goods which seemed to have stopped falling incessantly in the fashion of the aftermath of the 2008 crisis, this year appears to have resumed its move downwards.

source: Eurostat

The same goes for consumer goods, which in the cards is supposed to be the most “defensive” sector of all.

I used the industrial production index and not the industrial turnover index which is affected by price fluctuations and does not reflect actual production dynamics.

The most worrying inference from the charts above is the fact that while average industrial production for EU16 has rebounded after the crush, the one for Greece has not. With the exception of intermediate goods, Irish production has rebounded as well. 

What I can infer from the trajectory of Greek industrial production is that an overwhelmingly large part of it is still channeled inwardly and not overseas. Of course, to be fair, with domestic private demand so weak in the vast majority of EU countries it is not exactly easy to gain exports share. 

To get back on the internal devaluation front, the problem is not that labour costs are not going down, the exact opposite rather. Here’s the relevant chart.

source: Eurtostat

Of course, benefits such as those generated by an internal devaluation-like adjustment are not recorded overnight but in the fashion of the j-curve effect they might take some time to appear on data. Truth is though, that by now we should have seen some signs of them. Could this mean that the size of the downward adjustment is not enough?

Despite the falling real labour costs, Greek producer prices for industry are not following suite. Of course this is easier said than done, since for the most part of the 1st half of 2011 and a large part of 2010 commodities prices were on an upward tear and also let’s not forget that the credit crunch in Greece is here to stay.

source: Eurostat

And here are producer prices for the non-domestic market.

source: Eurostat

As we can see, as far as the non-domestic market is concerned, the PPI for the Irish industry has been declining, the same cannot be said for Greece of course.

A good question that I cannot help asking is the following: isn’t industrial sector in its most part capital-intensive? In my book this means that most part of its cost is dictated by its material inputs and not by its labour inputs (a look at balance sheets of industrial firms could verify that). Hence, what we could achieve by an internal devaluation (if material inputs prices were constant) is to make Greek industrial produce cheaper, provided that material prices in all the countries that we compete with behave in the same way. This is a pretty big if and a quite unrealistic one in my view, since the Greek market is a rather small one and a rather inefficient one. Besides, prices of imports in a country that is flirting with bankruptcy can be rather difficult to forecast and are not bound to be lower than those for other countries. The exact opposite seems more possible. 

Here’s the chart for import prices for industry, which shows just what mentioned above.

source: Eurostat

Apart from that, Greece is dominated by SMEs which in most cases are not as cost-efficient as larger entities (of course there are exceptions to this rule).

I have to say that the current conjuncture where commodities prices were rising were not the most favourable for such ventures. Of course the structure and size of the Greek market are not favourable either.

In my humble opinion the one sector that internal devaluation could help the most (at least in the current environment) in the way of being more competitive, is services, were labour costs comprise the largest part of the overall costs. True to that, tourism according to anecdoatal evidence seems to have had a good year despite all the other reasons that could have served to hold it back. For Greek industry to become more competitive the size of the internal devaluation should be larger (of course this is a rather painful path which bring about rather unpredictable social effects). Besides, most currency devaluations are larger than the decline in Greek real unit labour costs.

All these are my personal views and could very well be totally wrong. A good question is what’s the way forward for Greece? I wish I could answer that. What I can say is that high unit labour costs is indeed a boon for Greece’s competitiveness but not the only one. Low productivity springs to mind immediately and along with it all the other factors that could drive it upwards…

Of course, it sure is easier to tap your keyboard than make policy decisions, since this whole situation requires striking  a fine balance between economic policy choices and political ones...


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