Thursday, 9 February 2017

Is Greece's underperformance compared to sudden stop episodes in other EMs really due to the Euro ?

Yesterday a post from Matthew C Klein under the title "Greece has done much worse with the euro than EM basket cases did with their own currencies" was published in FT Alphaville and caused quite a stir. I will try to pen a response piece since I believe that the said post overlooks some pretty essential points that, in a large part, explain the reason why Greece underperformed the EMs mentioned above. (hint: that reason is not each country's currency of choise)

A sudden stop episode is an abrupt halt/slowdown in private capital inflows into an economy that causes an abrupt current account reversal. Hence, I find it peculiar that there was no mention of the magnitute of the current account deficits involved in the episodes used by Mr. Klein in his analysis in order to draw any conclusions.
The magnitude of the pre-crisis imbalances involved defines the adjustment needed to be undertaken so that the economy in question acquires a more sustainable footing and also pinpoints the liquidity that will be taken out of each one of these economies because of the sudden stop.   

In the current post I only look at the respective sudden stop episodes of Argentina, Indonesia and Thailand because the size of the adjustment appears to be larger and as a result more easily comparable to that of Greece. In the charts posted later on in the post I define the pre-crisis year as the one before the current account balance exploded into positive territory. As far as the Asian crisis is concerned, this is not consistent with normal crisis timelines who define the pre-crisis year to be 1996.
First of all, the level of the current account deficit with which Greece came into the crisis makes the ones of the other three countries appear miniscule. 
source: IMF
The difference between the three EMs and Greece is that the sudden stop episode in their cases was really abrupt and within one year their current account balances swung from varying levels of deficit into hefty surpluses. Since Greece's current account deficit was humongous back in the pre-crisis year, if Greece chose to withdraw from the Eurozone, the amount of liquidity withdrawn from the economy would be monumental and so would be the ensuing depression. If Argentina's swing from a ~ 1,3% deficit to an 8% surplus meant a ~11% drop in GDP what would the resultant drop in Greek GDP be if the curent account swung from a 15% deficit to an unknown, but undoubtely large, surplus?  

One further point overlooked in Mr. Klein's post is the countries' fiscal imbalances, which played a really important role in their respective performance.
source: IMF
source: World Bank, own calculations

Here too, Greece's imbalances were huge. It's more than sufficient to say that if one summed up the respective deficits of Argentina, Indonesia and Thailand in the pre-crisis year, the resulting deficit would still be smaller than that of Greece. What's more, Greece's fiscal deficit grew about 50% larger the following year, magnifying further the level of the fiscal adjustment needed as well as the negative drag on the country's GDP.

Moreover, due to the composition of its economy Greece was not as good positioned as the three other EMs to substitute internal growth with external growth. During the 1960 - 2015 period, Greece posted a balanced trade account only once and that was in 2015. Calculating the cumulative trade balances for all four countries for the 1960 - 2015 period makes obvious that, in this respect too, Greece is an outlier. 
source: World Bank, own calculations

If one wants more evidence that an actual currency devaluation didn't induce Greek exports to perform she/he need look no further than the 80s. During that particular decade the Drachma depreciated by about 66%. According to plain vanilla economic arguments, Greek exports should have posted some stellar performance. Reality though was a bit different. Greek exports during the 80s performed worse than they did during the 00s (until 2008 that is, before the Great Trade Collapse) under the "hard" Euro. And this goes some way to show how simplistic arguments that equate currency devaluations with exports' overperformance are.

source: AMECO, own calculations
source: AMECO, own calculations

To wrap this up, I think that all the arguments outlined above prove that Greece was not only an outlier as far as its performance after the sudden stop episode is concerned but also and more importantly, in its fundamentals. Greece's imbalances were significantly larger than those of the other three EMs examined in this post and these imbalances would also take significant more economic pain in order to be ironed out. So even if Greece had reverted back to the Drachma in 2010, the ensuing contraction would still be much larger than that observed in other sudden stop episodes.


  1. I don't disagree, but..

    1) I find the trade balance analysis misleading. Considering Greece's economy is dominated by the tourism sector (i.e. a service), it would be more useful to view the current-account balance of Greece in a long-term framework instead of just trade. Then we could assess the effectiveness of drachma depreciation better. The author only examines the current-account balance of Greece in a short-term framework (a few years before the crisis and a few years after the crisis).

    2) The point remains that after three stabilization programs Greece has failed to recover.

    1. Thank you for the comment. I have included the services balance into the trade balance figures, maybe I should have named it Goods & Services Balance so that there's no misunderstanding.

      Greece has failed to recover but who knows how things would be if the anemic 2014 recovery wasn't interrupted but was instead allowed to run its course. Maybe it would have perished but maybe, just maybe, we wouldn't be talking about Greece failing to recover after 3 adjustment programs.