One alternate view of why recent IMF-induced adjustments have been that painful

Last month I had written a post about sectoral balances, with the aim to discern what lies behind the current account balance. I now want to come back to sectoral balances but approach the whole issue from a slightly different angle this time.

That is the angle of the current process of deleveraging (or the effort to deleverage). In some countries the sector doing (or trying) to deleverage is the general government, in others the private sector, in others both. This approach can help us explain the current situation that numerous “developed” or “emerging” economies find themselves in.

You can have a look at how OECD defines sectoral balances here.

I will mostly focus on countries that have (or used to have until recently) an IMF program in place or have undertaken a similar process on their own accord.

First one up is my native Greece. Here is the sectoral balances chart again.

source: AMECO, own calculations

A look at the chart tells us that the general government is trying to deleverage but is not able to do so yet, as is the household sector. 

Before analyzing the current situation further I‘d like to take a look at the last time when the Greek general government tried to reduce its deficits, in the 90s. There was no recession involved back then. One thing is that the whole effort then was countercyclical but even as a result of it no recession ensued. One further point that can be made is that this was a program undertaken in order the country to become a member of the EMU and as a result people morale was high. That may well be true but we should not overlook one other fact. The very fact that the household sector was a net lender back then, hence was not stretched, while at the same time no other sector besides the general government tried to save more. As a result of the general government's effort to reduce the deficit, surpluses of households and corporations fell.

Let’s look at what happened in Latvia.

source: AMECO, own calculations

Latvia entered an agreement with the IMF in late 2008, so the internal devaluation process was essentially initiated in 2009. As we can see besides general government, all other sectors (corporations and households) embarked on an effort to save more since 2008 and became net lenders in 2009. The general government started an effort to slash the deficit in 2009 and as a result all other sectors saw their surpluses contract. This serves as evidence that it’s difficult for all sectors to increase their saving at the same time.

Next one is Estonia, that decided to undertake the internal devaluation approach on its own accord, without entering a financing agreement with the IMF (internal devaluation was chosen due to, among others, the fact that there was a large household debt load in foreign currency that would skyrocket if currency devaluation was pursued).

source: AMECO, own calculations

Admittedly, the general government deficit was meager, when compared with Greece and Latvia, but all the same the deleveraging attempted by households and corporations was rather sizeable. Households and corporations swung into surplus during 2009 and remained there in 2010, when general government did so too. Of course, as I mentioned before, the general government deficit was not structural, since the said balance was in positive territory for the span of the 00s and was also rather small. One could say that the effort for Estonia, was relatively easy, but this is not the case when all domestic sectors try to save more at once (and recorded such large deficits in the run-up to the crisis). The exact opposite is more like it. A look at real GDP growth for the years needed so that the private sector became a net lender will convince you.  

Our last stop is Ireland. 

source: AMECO, own calculations

Ireland initiated a program with the IMF in late 2010. Irish public finances were in order during the 00s but were totally derailed due to the bail-out of the monstrously-sized banking sector of the country. The households sector was a net borrower for the span of the 00s but started its efforts to deleverage and save more in 2006-2007 and swung into surplus in 2009. The corporate sector also embarked on an effort to save more. At the same time the general government deficit exploded downwards and was not possible to be contained. 

One takeaway from the charts is that in the wake of the crisis (2008) households and corporations, in all the countries featured in the chart above, started an effort to deleverage (or save more) and by 2009 they were net lenders. In all countries save for Greece, where only corporations managed that. Households only managed to reduce their deficit in 2009. The result was that in all other countries, recessions in these 2 years were significantly deeper than in Greece. When the Greek general government started an effort to deleverage in 2010 (mind you an effort, to actually deleverage means either a budget surplus or high enough GDP growth that ensures it grows faster than debt) Greek households found it much harder to save more and didn’t manage to record a surplus, the exact opposite rather. The result: Greek recession was deeper in 2010 while GDP in said countries either marginally declined or grew. 

source: Eurostat

As I mentioned when talking about Greece earlier, one period when general governments saved more and reduced fiscal deficits was in the run-up to the Euro introduction, in order to meet accession criteria. 

Let’s take a look at Italy.

source: AMECO, own calculations

I think we should start after the 1992 Lira devaluation. When Italian government started its quest for more saving, surpluses for households too fell sharply. The takeaway here is pretty much the same, the effort of the Italian government to save more was made easier by the fact that no other sector did so at the same time, while the households’ surplus fell sharply as a result.

The lesson from the Portuguese experience is pretty much the same. Just look at the chart below.

source: AMECO, own calculations

This is what makes the whole process so painful. In their effort to deleverage, households slash consumption expenditure and/or fixed investment while corporations cut down on fixed investment and/or employees’ compensation. Finally for general government that means cutting down all kinds of expenditures and/or increasing taxation. When all these sectors do so at the same time, it becomes more than apparent that the result is going to be a very deep recession.

It would be preferable then if one sector deleveraged at a time or if all sectors did so at the same time, that the pace of that deleveraging was slower. Currently conversation is revolving around this point. People demanding less austerity, actually ask for the private sector to deleverage on its own and not simultaneously with the general government, or that this deleveraging is slowed down. Other people claim that this is just not realistic. For better or for worse, since entering an IMF agreement means that funding comes (solely or mainly) from the official sector, this is a political process also, so we should not forget that. Either way, as long as deleveraging goes on (and depending on how it is conducted) the developed world could be in for some years of slower growth at the very least. After most parties people usually have to nurse their hangovers and this is very much the case now...

P.S. If you’re wondering why Greek households were that stretched in the run-up to the crisis, then look no further, the reason is twofold, over-consumption and over-investment.

source: AMECO, own calculations

That showcases the extent of over-investment and the next chart displays over-consumption in terms of purchasing power.

source: AMECO

You can see that in terms of purchasing power, private final consumption for Greece, in the early 00s overtook the Euro Area 12 average. This would have been perfectly feasible, bar for the fact that gross disposable income (in terms of purchasing power) was way lower than the Euro Area 12 average.

source: AMECO

Iceland : are things really that good ?

We are constantly getting bombarded with how good things in Iceland are. In an older post I had raved on about how I consider Iceland’s currency devaluation not to be particularly successful (to be fair here, the first year after the Krona devaluation coincided with the first decline in the volume of international trade so this was bound to have had an adverse effect on Icelandic exports).

In this post I'd like to use some indicators that do not get much "airtime". Nonetheless, I think that they are rather interesting.

I stumbled upon figures for enterprise defaults in Iceland. Here’s the chart.

source: Statistics Iceland

 

As you can see there was a massive spike in 2011. Of course this doesn’t mean that the overall number of registered enterprises did decline since enterprise births could have outpaced enterprise deaths. As you can see from the next chart this was indeed the case.

source: Statistics Iceland

What are the implications of that for employment? Unemployment declined slightly. Thing is that at the same time, the activity rate (i.e. the ratio of labour force to total population) took a dive as well (If this trend does not reverse it could have adverse consequences on the saving rate as well as household consumption).

source: Statistics Iceland

The next chart though could explain this phenomenon.

source: Statistics Iceland, own calculations

As you can see the 2011 decline in unemployment is perfectly matched by the number of persons dropping out of the labour force, while employed persons remained unchanged. What's more, employed persons have not increased at all since 2008. If this unprecedented (by Icelandic standards) number of persons had not dropped out of the labour force then unemployment would have been higher. You can draw your own conclusions from that.

Another channel through which unemployment may have been kept in check could be emigration. Maybe part of the decline exhibited by the labour force in 2009 could be explained by the increased emigration. Net migration declined in 2010 and 2011 but remained negative, driven mostly by Icelandic citizens. 

source: Statistics Iceland

Finally, I want to take a look at some indicators which may provide us with a more down to the ground view of how Icelandic households are faring.

source: Statistics Iceland

As the chart makes obvious there is no improvement in households’ financial situation, it just deteriorated with a slowing pace or kind of stabilized. 

It’s getting late so let me wrap this up. Good night and may we all have a nice weekend…

P.S. I want to praise the excellent website of Statistics Iceland which offers a wealth of statistical data on iceland.

The Greek fixed investment saga or how you can get everything wrong...

One chart in my last post was the spark that made me go back and try to make sense of something I’d written in a late 2011 post. Here’s that particular chart that made me stop and scratch my head in confusion.

source: AMECO, own calculations

The Greek corporate sector is a net lender, which can only mean that fixed investment must have been a bit restrained for the whole of the 00s. To put these words into a chart, here’s Greek corporate sector’s Gross Capital Formation (this figure is not exactly the same as Gross Fixed Capital Formation but it’s not that different).

source: AMECO, own calculations

The Greek corporate sector, ranks last among those of all peripheral Euro Area as far as gross capital formation is concerned. It turns out that the corporate sector being a net lender isn’t a such good thing after all...

This is the very point that is in stark contrast with that older post. Here’s that chart about fixed investment in equipment.

source: AMECO, own calculations

Investment in equipment should mostly concern the corporate sector, right? And it seems to rise sharply after 2000, right? Well, wrong on both counts, since investment in transport equipment is included in that figure too.

Just look at that chart, it is an indication of what a sorry excuse for a growth model Greece had these past few years.

source: AMECO, own calculations

Greece tops the peripheral Euro-Area ranks for investment in transport equipment. Probably cheap credit after EMU accession helped too (although cheap is relative).

But what about investment in actual equipment? Well, I think you can guess without even setting eyes on the chart. During the second half of the 90s, Greece was the peripheral countries laggard in that respect too, but during the 00s it was surpassed by Ireland, where property investment crowded out all other kinds. One more excuse for Ireland could be that its corporate sector is dominated by multinational corporations which tend to be mature companies (if that explanation’s lame and someone has a different opinion please enlighten me and say so in the comments section). The picture that the chart paints cannot be too good for the indigenous Irish corporate sector though.  

source: AMECO, own calculations

source: AMECO, own calculations

As you can see, before the 00s set in and abundant and cheap credit gave a push to the property sectors in Spain and Ireland (something that contributed to them reaching bubble-ish proportions) Greece comfortably led the table in investment in dwellings. Even at the height of the Irish and Spanish property bubbles, Greek investment in dwellings wasn’t that far behind.

When added, Investment in dwellings and in transport equipment should be the main ingredients of household fixed investment. Here’s one more chart to make your eyes hurt.

source: AMECO, own calculations

For the span of the 90s Greece topped that table too, with the exception of the years that the Irish property bubble was at its apogee. One could think that it couldn’t be bad that the households invested that much. In my humble opinion, it is. Investment in dwellings generally does not lead to higher labour productivity and in that scale it’s just evidence of distortions being present (or a bubble). It would be more preferable for the households to save more and their savings to be directed to other more productive forms of fixed investment (of course this is more easily said than done and particularly in the case of Greece I wouldn’t bet money that t would happen in the case that households did save more).

Finally, let’s have a look at investment in non-residential construction. I speculate that this could include investment in office buildings, warehouses, industrial structures, logistics hubs, malls, shops, big boxes, etc.

source: AMECO, own calculations

Greece is the laggard in that form of fixed investment as well. It’s not that all of the components of this type of fixed investment are particularly desirable in my humble opinion, but they are certainly more productive that investment in dwellings.

Let me wrap this up since you’re probably dizzy from that swarm of charts above. It wouldn’t be an exaggeration to say that not one of the charts gives away something positive concerning the Greek growth model and the way that resources were allocated. One could say that the least productivity-enhancing categories of gross fixed capital formation got all the juice and it would be spot on. The worst thing about this model is that the growth that was generated was short-lived and not the least bit sustainable. It seems to me that during the 00s Greece experienced a household gross capital formation bubble (but we have to note that level could be pernamently higher than in other countries, so either distirtionary factors are at work or we are just a very special case) and we’re now living through the hangover (among a million other things). The Greek growth model (if one would be that kind and call it that) was had its fair share of distortions and now that it’s past its expiry date a complete overhaul is needed…

Euro Area periphery and core: What lies behind the current account balance

In one of my usual data-trawls I happened to come across sectoral financial balances. That seems like a good thing to do a post on, especially since this is my first post for 2012. I know that at first it seems like an obscure topic but believe me it is pretty relevant to the mess we’re in.

First, a tiny bit of background. When a country runs a current account deficit this quite simplistically means that it consumes more than what it produces. In order to do that it has to borrow from abroad, so a country’s current account balance equals the overall financial balance of the economy. 

There are two ways to calculate this balance for each institutional sector (by that we mean the general government, the corporate sector and the households). This is how the OECD-iLibrary defines it. The simplest one out of the two is the difference between the accumulation-flows of financial assets and financial liabilities for each institutional sector.

I’d mostly like to take a look at peripheral Euro-Area countries that run current account deficits and discern what the sectoral balances are. This could throw some light onto which sector’s behavior was the main catalyst behind each country’s current account balance. So, here we go.

First, let’s start with Greece. It certainly is no secret that Greece has been running a current account deficit ever since AMECO data run. What I haven’t seen explored anywhere is the financial balances of the individual sectors.

source: AMECO, own calculations

As we can see from the chart, post-1999 Greek households become net borrowers (wasn’t that the time that the equities bubble burst?). I hardly need to mention that the General government was a net borrower throughout this period (1995-2010). The corporate sector (comprised by non-financials and financials) was a net lender for the span of the post-1999 period. 

source: AMECO, own calculations

Portugal also runs a current account deficit, hence is a net borrower. Portuguese households were net lenders for the whole 1995-2010 period. The Portuguese corporate sector was a net borrower for the whole period.

source: AMECO, own calculations

Now let’s take a look at Italy. After the 1992 Lira devaluation, the country ran a current account surplus till the end of the decade. The government cut the budget deficit to meet the EMU accession criteria and pretty much kept it into check after that (especially if we take into account the country’s track record). Italian households were net lenders since 1980 when data run, although the sectoral surplus shrank significantly and progressively over the years. Finally, the corporate sector, since the early 90s was a borderline net borrower (maybe the fall in gross fixed capital formation during that period is to blame).

source: AMECO,own calculations

Moving on to Spain, we can see that the country’s current account deficit can be blamed entirely on the fact that the country’s corporate sector became a net borrower progressively after 1995. The Spanish general government after the country EMU accession was rather prudent and even managed to become a net lender until the onset of the crisis when the budget deficit exploded. What is interesting to see is that the general government balance and the household sector one are mirror images of each other. Moreover, it is noteworthy that post-crisis the household sector became a net lender again as did the corporate sector, for the first time since the late 90s. 

I now want us to have a look at a couple of “core” Euro-Area countries. With all the fuss being made about it, Germany has to be the first one. Here is the chart.

source: AMECO, own calculations

The country, moved from being a borderline net borrower throughout the 90s to become a net lender post-2000. The German government wasn’t as prudent as it likes to come across (the Spanish general government was more prudent). The households sector was a net lender during the years featured in the chart and the corporate sector became a net lender post-2000. The consistent drop in gross fixed capital formation may have played a part to that.

Finally, let’s see what the situation in the Netherlands was. Here comes the chart.

source: AMECO, own calculations

The country was a net lender for the span of the period that the data cover. The current account surplus increased further from the late 90s onwards. The trimming of the general government budget deficit may be partly to blame for that. The household sector was oscillating between being a net lender and net borrower during the 00s (the sector’s indebtness became exorbitant during that time) but of course the sector’s balance again appears to be a mirror image of that of the general government. On the other hand the corporate sector became a net lender after the onset of the 00s (plummeting gross fixed capital formation could be partly blamed for that). After the crisis set in, one could say that the corporate sector’s balance became a mirror image of that of the general government’s.

As one could deduct from all my blabbing above, the two core countries are indeed net lenders while the four peripheral countries mentioned above are indeed net borrowers. Differences between them are noteworthy, nonetheless some themes can be outlined. 

Household sectors are in most of the cases net lenders or did become after the crisis set in, a notable exception to that is Greece, where household balance sheets appear to be too battered to swing into being net lenders (of course the current policy of over-taxation doesn’t help the least in that nor does the depletion of deposits to support consumption), as is Holland, where too much debt has been piled onto household balance sheets.

Towards the late 90s - early 00s, households' sectors in most of the countries featured above saw their surpluses fall sharply, Portugal and Germany being the exceptions. One explanation for that is the fact that governments trimmed budget deficits to achieve the EMU accession targets and no matter what way this was brought about (either by raising taxes or by slashing spending) it did have a negative effect on households balance sheets. One further reason could have been the simultaneous bursting of equity bubbles, due to which households’ wealth took a beating. It is no coincidence that the countries where households appear to have been less affected from the equity bubble bursting are Portugal and Germany.

Sectoral balances are of course interconnected. If you observe charts closely you can see (as mentioned before) that in most cases the households’ balance is a mirror image of that of the general government one (as is the one of corporations) and so on. For one sector to run a surplus or reduce its deficit it means that it curtails spending and/or gross fixed capital formation. This process is what actually deleveraging is and most economies were used to debt spending (be it for consumption or fixed investment), whether this originated from the private sector or the general government or both. Of course this is not exactly expansionary for the total economy. This is why deleveraging is a painful process and the years ahead will probably be totally different from what we were used to up until now…

A crucial difference between western Europe and emerging markets

My posts this month were few and far between, but I am working on another post for a long time now (which is admittedly going to be a biiit large). All this scanning of data contributed to me stumbling upon a quite interesting piece of data.

The macro version of the investment rate (=investment/value added at factors cost) is a rather interesting indicator.

If one looks at data for EU countries she/he is bound to notice a quite pronounced divergence. Namely, investment rates for manufacturing firms are much higher in Central and Eastern Europe (CEE) than in western European countries. Here are some charts to help us visualize that.

source: Eurostat

source: Eurostat

Unfortunately, data for some countries are severely limited, but I think that the message they convey gets across anyway.

Here come Central and Eastern European countries (CEE).

source: Eurostat

 

 And here are the Baltics.

source: Eurostat

Why is this particular data point so important? An increased channeling of earnings in investment on behalf of manufacturing firms can signal the existence of potentially profitable investment opportunities. Of course, things are never as simple as that and a number of factors could have contributed to that large differential in investment rates. Different ownership structure between companies of different countries (privately held vs. public companies where shareholders might push for larger dividend payouts), different regulation concerning distribution of profits, different practices in corporate governance could all have played a role. Moreover, the degree of capital intensiveness of each country's manufacturing sector surely plays a part. Furthermore, limited access to bank financing or other forms of financing could force firms to finance investment internally. 

The fact is though that during the years for which data concerning CEE countries are available most of these countries were witnessing credit booms, so the lack of bank financing argument is losing some of its shine.

Moreover, I doubt that CEE manufacturing sectors are more capital intensive than hteones of western EU countries.

This was supposed to be a short post so let me wrap this up. The observed differential in investment rates among western EU countries and CEE countries is first and utmost a differential in dynamism between the manufacturing sectors of the said countries.

P.S. Of course, human nature (I.e. greed) makes sure that along with perceived opportunity comes exaggeration. Could this boom in fixed investment in CEE countries have had some bubble-ish characteristics? Well, how should I know about that… 

P.S.2. Let me take this chance and wish all you brave ones that read this post (and of course those of you that didn’t) a happy new year. Let the new year be a good one…

Gross fixed capital formation: The Greek paradox and its implications for the Greek tradable sector

I want to share with you a couple of charts concerning gross fixed capital formation in Greece. The first one’s about construction.

source: AMECO, own calculations

And the next one’s about equipment.

source: AMECO, own calculations

The charts highlight some facts. The first one is that in Greece, construction accounts for an abnormally high chunk of gross fixed capital formation (especially in the 1960-1990 timespan) while equipment for an abnormally low one. 

It is crystal clear that this consitutes a monstrous distortion in resources allocation, with rather large negative effects on labour productivity, hence on Greek potential and actual GDP growth.

A good question is why did that happen? This wasn’t the case in none of the other Euro Area countries shown in the graphs.

First I want to try to decipher why gross fixed capital formation in construction is that high. I can think of a couple of reasons that could go some way into explaining this.

The time when investment in the said sector was at its highest was during the 1960s – 1980s period.

One factor that must have contributed its fair share in the construction boom is the rampant urbanization happening in Greece during that particular period. I plotted urban population as a % of total.

source: World Bank

Urban population in Greece exploded upwards back then, but the same phenomenon in an even more extreme form occurred in Finland. Of course, gross fixed capital formation for the construction sector was significantly higher in Greece. That can only mean that the on-going urbanization isn’t the whole story here. (I used urban population since its increase implies an instant need for housing, while overall population growth affects housing demand dynamics with a lag).

Another positive catalyst could have been that the housing stock of Greece should have been extremely dated and run-down back then. Of course I can’t back that claim quantitatively. 

One more factor that we cannot overlook is inflation. The 1970s was the decade that the two oil-crises took place. Furthermore, inflation in Greece was more than persistent back then, invigorated by expansionary fiscal policies during the 1980s. The notion that housing is a good hedge against inflation was rather popular in Greece these years. Views by practitioners and academics on that are mixed and not uniform but what really matters is what people believed since that would shape their behaviour, whether that belief was right or wrong is trivial.

source: AMECO

 

To continue the argument above, let’s not forget that given the underdeveloped and deficient Greek financial sector, investment choices for Greeks retail investors were virtually non-existent and for a significant part of them their investment of choice could very well have been real estate/housing. That could have propped up demand a bit more, but I suspect that this effect was more pronounced after the 1980s.

Now, I want to us to take a look at the reasons why fixed investment in equipment, for the whole period shown in the chart, was that low.

As a bit of background I want to say that capital accumulation or capital deepening is a significant positive driver of labour productivity growth. Even though it is in no case the sole positive catalyst for labour productivity and is characterized by diminishing returns, that does not render it trivial. Rather the exact opposite.

I want to point out a couple of things. Even initially, investment in equipment, for Greece, was significantly lower than the other countries in the chart. That is perfectly understandable if someone takes into account that Finland and Austria are two countries that had gone through the first industrialization stage rather early but what about Portugal? One could even say that given the fact that Austria and Finland had gone through early industrialization, then investment in equipment for Greece should have been higher. The next argument reinforces that view (in a way). I also want to remark that (as a % of GDP), for Austria and Finland, investment in equipment was in a downward trend for the whole timespan featured in the graph. For Greece it rose anemically till the early 1970s and then it was constant until the late 1990s when it rose again. As far as Portugal is concerned the upward trend kept for ten more years and then it plummeted too. What does that imply for the situation in Greece and its root causes?

The next chart can explain quite a lot.

source: World Bank

Industrial firms in Greece had very limited access to bank funding which can only mean that they had to finance corporate investments internally (through retained earnings). But why did lending to the private sector decline from the early 80s till the mid-90s? Well, one reason could have been that the Greek banking system was used to finance the huge fiscal deficits that Greece was running at the time, effectively crowding out the private sector, with all these knock–on effects that created the massive distortions highlighted above. Of course it takes two to tango. I have talked about that particular subject before (here, here and here).

Here’s a chart showing the extent of that crowding-out effect.

source: World Bank

After the mid-90s, due to the fiscal-adjustment program (I have talked about that too in an older post) and the up-coming EMU accession, the government’s need for financing was reduced while its ability to finance it externally increased. This gave the banking sector (and along with it the industrial sector) some breathing space and it was able to increase lending to the private sector. After the country became part of the Euro-Area, the sector was able to tap the interbank markets with unprecedented ease and increased lending accordingly. Now if you ask me if there were that many good investment opportunities for the (let’s not forget that, shrinking) industrial sector, I would tell you that I don’t know…

P.S.1. I now want to share with you the scatter plots from a few simple regressions showing the positive relationship between capital deepening and real labour productivity in the industrial sector. The relevant literature goes about the issue using fixed investment in equipment as a % of GDP. I think that this is wrong. In my humble opinion the aggregate that reflects capital deepening (as far as equipment is concerned) is real gross fixed capital formation. What gross fixed capital formation in equipment (as a % of GDP) reflects is the relative importance of that particular type of investment. Besides, let’s not forget that this particular aggregate belongs to the “flows” category, which means that any positive reading will add to the gross capital stock.   

source: AMECO, own calculations

source: AMECO, own calculations

source: AMECO, own calculations

source: AMECO, own claculations

I’ll let you draw your own conclusions about the link between missed opportunities for the Greek tradable sector and the regressions above…

P.S.2. All the above is a result of my own analysis based solely on figures but I could very well be wrong. In any case I don’t mean to imply anything political.

Greek manufacturing : is internal devaluation working...?

I’ve been thinking about the performance of Greek manufacturing in the context of the internal devaluation strategy, again. I want us to take a look at a couple of charts. Here’s the first one.

source: Eurostat

If one focuses at the turnover index for Greek manufacturing he would think that the sector is actually doing rather well. The said index has the drawback that is affected by prices’ fluctuations. I personally prefer volume or quantity indices. The readings of the volume index paint no pretty picture though. The index was in constant decline since late 2008, though it seems to have stabilized during the past few months. It remains to be seen whether this is another head-fake before it resumes its downward path or if this is here to stay. Hence, the rise in turnover comes in its entirety (even to make up for declining volumes) from price increases. 

The Irish manufacturing sector seems to be faring considerably better. Volume didn’t decline much during the dark days of 2009 and the brunt of the adjustment was borne through lower prices. Furthermore, prices have been relatively stagnant for the most part of 2010 and 2011. 

source: Eurostat

For you to have a clearer picture of the evolution of prices in the sector, other than my ramblings, here is producer prices’ evolution over the past 4-5 years.

source: Eurostat

The chart confirms that over the past two years, producer prices for Greek manufacturing have been rising steadily and heavily, while the ones for the respective Irish sector have been at best flat.

A good question is, why?

Is it because of the internal devaluation? Have wages in Ireland declined more than the ones in Greece did? The next chart can answer that. 

source: Eurostat

It seems that wages for the Greek manufacturing sector have declined considerably more than the ones in its Irish counterpart. It would be more correct to compare real unit labour costs (ULC). Irish real ULCs have declined a bit more that the ones for Greece 5,45% compared to 4,43% annualized, probably due to lower inflation in Ireland and the fact that productivity fared better in Ireland than in Greece. But then again this is no significant differential to speak of. Then what can account for the anti-diametrical picture displayed in the producer prices chart?

Manufacturing firms are capital-intensive, aren’t they? That must mean that labour inputs are not the single most important cost-factor for them. The price of their material inputs along with cost of capital should be. A look at an industrial firm’s balance sheet should be enough to verify this (again the degree of capital intensiveness is different for each sector).

But material inputs prices are the same for everyone, right? I have talked about the level of import prices in an older post. Moreover, if you put the credit crunch and the state of each country’s banking sector in the picture, the cost of capital starts to diverge as well (of course a possible credit crunch could affect import prices as well).

In my humble opinion though, the single most important factor is what comes next. Analyses, like the one above assume that the level of sophistication of even the same sectors in each county is the same and more importantly that all countries produce the same basket of goods.

Well, they don’t, hence in most cases they are not directly comparable to each other. They source different inputs, which can only mean that they are affected by different factors or even by the same factors just in a different scale. 

In that older post I had blabbed about how the timing of attempting an internal devaluation on Greece is unfortunate due to the fact that commodities prices are high. I hadn’t put that into numbers but I’ll give it a try now.

Look at how dependent the Greek economy is on oil.

source: Eurostat, ECB, own calculations

The R² of that rather simple regression is shocking really. Look at what the same regression for Ireland, this time, yielded.

source: Eurostat, ECB, own calculations

That, in part, could explain the different behavior of producer prices in the two countries and add weight to the argument that the internal devaluation is unluckily pursued at a time of high oil prices.

Oil prices are exogenous but the fact that the Greek manufacturing sector and the economy in general are overly reliant on oil is not…

By all these I don’t mean that if oil and commodities prices in general were lower, Greek manufacturing would be doing better (this is a function of so many factors that I can’t even dream of writing them down), but would the sector’s products prices be in a downward trend? Moreover, that doesn’t mean that should that be the case, internal devaluation could be characterized as successful, nor would it mean that it would be less painful. The Greek external sector is so small that, in my humble opinion, all kinds of devaluation strategies (currency or internal) would probably need a long time to bear fruits.  

P.S. I want to share one more weird fact with you. Usually there is a lag until oil price spikes are passed through to producer prices. What I was astonished to see is that this lag for Greece is virtually non-existent.

source: Eurostat, ECB

P.S.2. Some more evidence of the higher dependence of Greece on oil.

source: IMF