Greece: victim of excessive austerity or of credit‑induced, turbo‑charged “Dutch disease”?

by ggeorgan

Christos A. Ioannou1 and Dimitrios A. Ioannou2

June 2013

Greek incomes and output have contracted by a cumulative 23% (2013) since 2008 and unemployment has soared to 27%, thus placing Greece in the position of an outlier in the crisis that hit the eurozone.

Αctual GDP performance has been much worse than projected and continues to be critical for the sustainability of Greek public debt, in spite of a sizable haircut. In our view, the key to explaining this collapse of the real economy in Greece is the buildup over time of a large structural imbalance between the tradables and the non-tradables sectors of the Greek economy. In particular, the sudden realisation that what passed as rapid economic growth was, in fact, excessive, credit-financed malinvestment in non-viable non-tradables explains both the rapidity and the depth of the subsequent collapse.

The key factor of “tradables” versus – “non-tradables”.

The distinction of goods (and of some services) into internationally “tradables” versus internationally “non-tradables” is used in the economics literature mainly for two purposes : either to assess the “real exchange rate” of an economy or to calculate the real consuming capacity of its population (“purchasing parity power” theory). There is a less-known and referenced, third case in which that distinction is used ; it focuses on the different effects that the two groupings of goods force upon the long-term growth trend of national economies. Looking through this lens, the distinction of tradables versus non-tradables yields interesting insights into the current -structural- economic crisis of Greece.

Kuznets (1966), Balassa (1964), Samuelson (1964) and Baumol (1967)3 have convincingly argued that the lower the average productivity of a national economy is, the higher, as a percentage of GDP, its sector of “internationally tradable” goods and services should stand. “Internationally tradable” goods can be transported and consumed away from the point where they are produced. Therefore, their price is determined at the global level (“the one-price law”, China-price lately). A local producer that cannot offer her product at an equal or better price than her foreign competitors is inescapably excluded from the market, even of her own country. Internationally tradables, therefore, are produced for a global competitive market according to the real “comparative advantage” of each country. There are two sources of this advantage : either the natural endowment of the country (natural gas for Norway, sun and sea for the Bahamas), or its ability to produce at the “efficient frontier”, that is along the supply curve of the global economy (which could be the “cost-efficient frontier” for the Bangladesh clothing industry or the “technological frontier” for certain US Information Technology (IT) companies.

The sector of “internationally non-tradable” goods and services, instead, comprises a different kind of products. A haircut is the typical example. Although it is quite possible that barbers in Marrakech do a much better job than their colleagues in Manhattan for one-thirtieth of the price, no New Yorker cares to grasp this opportunity. To travel to Marrakesh just for a grooming or to bring the barber to New York for the same reason is not an economically rational act due to the cost of transportation. In this respect, barbers in Marrakech and New York are not competitors at all. Each party has its own market, totally isolated from the other. Internationally non-tradable goods and services can be consumed only in the vicinity of the point of their production and, therefore, their price is determined mainly locally.

Tradables are extremely important for economic development : it is the sector that generates a tangible, observable and measurable surplus and provides it to the rest of the local economy in the form of investible capital, that allows, in its turn, the economy to increase its per capita productive capacity. The “endogenous” growth potential of the entire economy is unavoidably closely related to a, more or less, vibrant sector of tradables. Non-tradables are also important for development, since they, too, are used as productive inputs. Even their quality, however, depends on the quality of the tradables. Tradables, by their nature, incorporate the latest advances of scientific knowledge and technology and therefore predominate over, and exercise the decisive influence on, the whole economic process.

The supply of non-tradables is limited by the current productive capacity of the local economy. Thus, in the case of a sudden surge in demand, the supply of non-tradables cannot increase in the short run because it is not possible to import more of them. Therefore, in the short run, the market has to clear through an upwards price adjustment4. In the medium to long term though, productive resources of the economy can move from the tradables sector to the non-tradables to take advantage of the widening profit margins, generating thus a rise in their produced quantities.

This effect will be stronger in the case of a “small open economy” that functions as a “price taker” (as is Greece) in world markets : the miniscule (on a world scale) fluctuations of demand for tradables in a small economy cannot have any impact, whatsoever, on their globally-formed “one price”. Thus, in the “small open economy”, even an increase in total aggregate demand, that is not particularly directed to the non-tradables, will result in an increase of their relative prices in the short run5 and in the transformation of the structure of production in the medium to long run, with disproportionate growth of the non-tradables sector, provided that excess demand persists.

Indeed, in the particular case in which aggregate demand remains permanently in excess of the productive potential, the disproportionate growth of non-tradables and the corresponding decline of tradables appears to be a perfectly healthy and rational response to economic signals. The producers of tradables, facing continuously declining relative prices for their products, and, therefore, declining profitability, find it more advantageous to move their resources to the non-tradables sector, where the increasing prices of the output allow for more profitability. The state of persistently high demand remains very accommodating to the whole transformation of the structure of production as it seems, for a time, irrelevant whether there is complementarity or substitution between tradables and non-tradables.

When tradables and non-tradables are complements and infinite external credit is available, the increase in consumption of tradables reinforces increases in the consumption of non-tradables. For example, newly-affordable imported printing presses need buildings to be housed in and both allow for increased domestic consumption of newly-cheaper printed materials. Thus, the rate of growth of consumption accelerates beyond the rate that was attainable before credit became available. Moreover, one does not get to notice the slowing of output in the tradables sector when the imported tradables displace the locally-produced tradables. Since credit is available, producers shift their resources to producing non-tradables that they hope (vainly) to be able (at an indeterminate point in time) to sell (at increased prices). Looking at the aggregate figures only and not distinguishing between tradables and non-tradables, one observes faster growth in both consumption and investment.6 Alas, this can only go on as long as ample credit is available.

This process, at least as long as it lasts, is usually perceived by economists, statisticians and policy-makers as a course of “growth” or, even, of “development”. According to some economic theorists of the first decade of the present century, this was a particular kind of economic development : it was classified as “Mediterranean” because it was driven by “consumption” (!), a feature that supposedly made it different from the other kind of “development”, the “Asiatic” that one, on the contrary, driven by “production”. Life finally revealed that there is only one type of development, with no need of geographical prefix, and that this one is solely and closely related to constantly increasing and improving the productive capacities of an economy.

The currency union membership factor.

One may have noticed a logical inconsistency in the “explanation” above of disproportionate growth of the non-tradables sector : the entire process requires extensive recourse to imports, to satisfy the augmented demand for tradables, and to a subsequent widening external deficit (along with creeping inflationary pressures). This deficit would, under normal circumstances, have forced a depreciation/devaluation of the national currency that would have restored, for a period of time, the internal balance between tradables and non-tradables. Even in a Bretton-Woods type system of fixed exchange-rates, this would have been the final outcome of the whole process : readjustment through a formal devaluation.

The answer to that objection would be : yes, that is correct and valid. But, unfortunately, not exactly in all cases. There are two cases at least, where rebalancing tradables and non-tradables, by means of the readjustment of the exchange rate, would not be possible.

The first case of sustained disproportionate growth of non-tradables occurs when a country happens to be a producer of disproportionately large quantities of a particular commodity, a commodity for which there is ready demand in the world market and the price of which increases over time. That commodity helps improve the overall “terms of trade”, the relative prices at which the country conducts its trade with the rest of the world.7 This phenomenon, termed the “Dutch disease” by “The Economist” magazine, in the seventies, to describe the effects that natural gas exports had upon the economy of the Netherlands, in a way runs counter to the conclusions of the Balassa-Samuelson theorem and, especially, to the Baumol-effect hypothesis that, both, attribute the sustainable appreciation of the non-tradable goods, not to the abundance of an exportable commodity but to the continuous betterment of productivity, evidently in the non-commodity-producing, manufacturing sectors of the economy.8

The second case is different. It applies to countries that do not have their own national currency because they are members of a monetary union and, therefore, have not the option to manage exchange rates. Unfortunately, if they are small economies, they have no option either to influence the monetary policy of the monetary union, since this is calibrated and implemented by the Central Bank according to “averages”, in which the big economies -that possibly go through a different phase of the business cycle than the “small economy”- carry much more weight.

The Greek evidence for 2000-2009.

When Greece was connected to the euro system, in the year 2000 (the drachma was abandoned definitively in February 2002) , its output of internationally tradable goods and services, according to our calculations, accounted for 25% of its GDP9. It was a very low ratio, -actually the lowest in the EU 15 at that moment. Nonetheless, instead of high productivity in tradables that could explain the lowest tradables percentage, Greece had the lowest productivity of the manufacturing sector in the EU 15 as well (for instance see Manganelli, 2000). Moreover, the weakness of Greece as regards tradables was evident in its inability to satisfy its consumption with commensurate production of its own. Both the balance of trade and the current account registered significant deficits (in 2000 at -9,5% and -11,2% of GDP respectively). The weakness of the tradables sector of the Greek economy, therefore, was not the corollary of high productivity but of a structural deficiency, well documented and known to all for a long time. In this respect, the “convergence” process at the start of the eurozone project, as regards Greece, was understood not as a path towards less tradables but, on the contrary, as a path towards a stronger sector of tradables and a more balanced overall structure of the entire Greek national economy in general.

What happened since then ? In 2009, when it became evident that the Greek economy was collapsing, the tradable sector had shrunk to 20,5% of GDP. The question, then, arises : was that shrinkage, in one way or another, connected to the failure of the Greek economy ? Or was it totally irrelevant, simply the natural result of the improvement of overall productivity as economic theory postulates, and had nothing to do with the nose-diving of income levels and the severe depression that today runs its sixth year ?

According to a certain narrative, the correct answer is the second : the current crisis is unassociated with the structural transformations that took place in previous years ; it is simply the offspring of bad handling on the part of the “troika” (IMF-ECB-EC) that implemented a wrongly conceived contractionary fiscal policy in recessionary circumstances. Although this narrative does not have time to waste with “structures” (because it believes that only “flows” matter in an economy and not “stocks”), we could hypothesize that the extension of its claim into “structural” territory would be a “Baumol effect” explanation : as the economy of Greece was developing, with a productivity rate of growth that was measured to be higher than the eurozone average, it was perfectly natural that the tradables sector shrank and the non-tradables grew (which is the classic symptom of “Baumol disease”). But is that correct ?

To answer the question and get a better understanding of the variation in the production of tradables in the 2000-2009 period, we can further subdivide tradables into two subcategories. The first one consists of those goods that are produced with technological methods that do not improve dramatically over time and, more or less, belong to the cultural or natural “endowment” of the national economy. Their supply and their price are not determined essentially by the evolution of the technological input but, rather, by global demand. Therefore, the time path of their supply is closely correlated with the trend and cycle of the global economy. We call those goods “Dutch disease” goods. In the case under consideration, we deem that this subdivision of Greek output comprises the sectors of mining, of international maritime transportation- and of tourism -all moving in a pro-cyclical way with the global economy and following its long-run trends.

The second subdivision is the one producing goods that we could call “Baumol goods”. It refers to the industrial sectors in which productivity improvements are of capital importance and where the producer, in order to remain in the market, must always operate on the edge of the “technological frontier”. Those are the manufacturing sectors and the IT sectors of the economy. The “Baumol goods” sector, where “learning-by-doing” is the way to operate, can be considered as that part of the economy where the level and the strength of “endogenous” growth can be properly gauged.

The statistical evidence suggests that the production of “Dutch disease” goods in the year 2000 accounted for 9% of the Greek GDP. In the year 2009, their percentage contribution to the GDP was exactly the same : 9%. On the contrary, the “Baumol goods”, that in the year 2000 accounted for 16%, in 2009 contracted to 11,5% of Greek GDP. Was that outcome the result of a spectacular growth in productivity in this 10-year period, as described by the theory of “Baumol effect”, or, rather, was it the result of a collapse of the productive capacity of the Greek economy due to the fact that entrepreneurs and workers had deserted manufacturing and advanced technology activities in order to pursue higher profits and wages in the sector of non-tradables ?

Intuitively one can understand that this shrinking of the “Baumol goods” sectors could not have been the outcome of enhanced productivity, because, in that case, the real economy would have withstood the shock of the financial crisis better and would have avoided its current sharp downturn and its socially painful major crisis. To get a firmer assessment of the meaning of those structural transformations for the Greek economy, we examine the issue under different angles : a) the external balance and current account variation ; b) the productivity growth in the manufacturing sector, which is indicative of the productivity growth of the entire economy ; c) international comparisons.

The trade balance and the current account, in the first place, not only remained in deficit during the whole 2000-2009 period but, in comparison to the year 2000, had further deteriorated in the last years of that period (the current account, for instance, from -11% of GDP in 2008 to -14,7% in 2009).

As regards productivity in the manufacturing sector, given that accurate data are not available, one needs to look no further that the two co-moving indicators, that is into competitiveness and into the “technical composition” of the products of Greek manufacturing. Competitiveness first : there exists an infinite number of studies and papers (for overviews and indicators see EC, 2012 and ECB, 2012) documenting its plummeting during the first decade of Greek membership of the Eurozone10. Even though competitiveness is not solely a function of productivity but of labour cost as well, no one could seriously claim that productivity in Greek manufacturing was advancing rapidly while its competitiveness was collapsing. Such a claim would not be compatible with the premises of Baumol theory or any other theory that explains the transition from an economy of “goods” to an economy of “services”. Furthermore, the fact that Greek manufacturing during the period 2000-2009 was simply collapsing, and not advancing with big strides of productivity growth, becomes evident, if we consider the knowledge input and the technological content of its products, which during the said period had regressed to the level of other Balkan economies with lower per capita output, income and consumption (Abdon et al, 2010).

International comparisons are also revealing. All the other European “small open economies”, which have a higher level of productivity than Greece, have, nevertheless, “Baumol goods” account for a higher, and not a lower, percentage of their GDP. This is tantamount to proof that the flimsiness of the tradables sector in Greece is not the result of extremely advanced productivity.


Source : OECD-National Accounts.

Note : * With this type of data, the percentage of “Baumol goods” relative to GDP in Greece is slightly different than in the case of NACE tables.

It is, therefore, evident that the low percentage of tradables (and particularly of “Baumol goods”) in the GDP of Greece is not an indication of high productivity but, on the contrary, of a structural deficiency. Moreover, one can interpret the severe crisis that the country is going through as an expression of its weakness in the tradables sector. For a long enough period, i.e. during its first decade of participation in the eurozone, excessive public but, also, rapidly rising private borrowing, at historically very low interest rates, had been overcompensating for the chronic inability of the tradables sector to furnish to the economy the surplus liquidity in the common European currency that was necessary to sustain an hypertrophic consumption pattern. When the borrowing excess became evident, and, at the end of 2009, the mood in the financial markets changed abruptly, aggregate demand in the Greek economy plummeted and the balance between the two sectors shifted. All of a sudden, it became clear that the level of prices of non-tradables was not affordable any more because, in reality, it did not correspond to an analogous level of productivity in the tradables sector, but was simply the effect of artificially high aggregate demand created by the excessive borrowing of the preceding period. The current Greek crisis is nothing more than a violent process by which the relative prices of non-tradables to tradables readjust in line with fundamentals. Sadly, the only way that the forces of the economy know to do that job is through unemployment and “liquidations”.

Unfortunately, moreover, it is not only the non-tradables sector that suffers from the crisis. As a result of the collapse of the banking system, and, therefore, of the “transmission mechanism” of the economy, even companies of the tradables sector, that in normal situations would have been considered totally safe and healthy, are forced to the brink of bankruptcy, since they are being deprived of any credit, whatsoever.11

If one wants to use a metaphor to illustrate the failure of the Greek economy, this could be the metaphor of an economy that was heavily inflicted by the “Dutch disease” during a ten-year period, because of a sudden and mysterious discovery on its soil of a rare and precious commodity that could be exported to the global market generating large profits. But given that the country, believing that the abundance will last eternally, had not taken precautionary measures for the aftermath, it was brought to her knees when, as suddenly and mysteriously as it had appeared, the rare commodity totally disappeared from the soil and evaporated into the air at the end of the ten-year period, leaving the economy with a deformed structure, i.e. with a gigantic non-tradables sector, that the remaining tiny and flimsy tradables sector is unable to support and underpin any longer.

Eurozone membership as a “Dutch disease” factor.

It was clearly “Dutch disease” and not “Baumol disease” that hit Greece. But then, the question that arises is : what was the particular good or commodity, with such a short life, that generated all this turbulence ? Of course, it was not tourism or shipping. Both those sectors, although by their nature contain an element of “Dutch disease”, have remained at a constant ratio of their output to GDP throughout the whole period.12 The commodity that tipped the balance so heavily was something else. Actually it was not a tangible good or commodity at all, but rather a virtual quality or even virtue itself. Namely this “commodity” was the “prerogative” for Greece of being a eurozone member during the first decade of the 21st century.

Claudio Borio’s (2012, 2013) theory on the importance of the financial cycle for macroeconomic fluctuations fits almost perfectly the case of the Greek economy. Due to steadily increasing public and private borrowing from abroad, under the illusion of both lenders and borrowers that a Member-State of the Eurozone cannot go bankrupt or risk insolvency, economic agents in the Greek economy were operating under an entirely erroneous, but at the same time firm, belief that the level of aggregate demand that they were facing represented genuinely and correctly the level of development of the economy. Besides that, there was also an additional element facilitating the whole process of the irrational swelling of the non-tradables sector, while their relative prices were sending all those wrong signals to economic agents : in spite of the claims of neoclassical theory, static “comparative advantage” by itself is not an adequate driver for automatically positioning a country in the international division of labour.

As the Greek experience shows, if a country loses its position in the global market (of “Baumol goods”), even for one instant, it is extremely difficult to regain later its previous market niche or to claim another satisfactory new one at some other step of the ladder. Facing that difficulty, when the alternative of turning their efforts away from tradables for businesses is that much more alluring, no incentive to try to produce “Baumol goods” exists : investors have the opportunity to make the same, or even higher, profit, by engaging in the internal sector of non-tradables, well protected from external competition and roaring. Neither costly and uncertain Research and Development in products and processes is required, nor any Chinese competitor threatens to price one’s business out of the market. In a way, before the triggering of the global crisis, Greek investors in the non-tradables sector were acting under the same false perceptions as their American counterparts, who were dealing with the “securitisation” of the “subprime” market : high returns for almost no risk (supposedly) at all.

There is also another lesson that one can draw from the recent experience of the Greek economy : although the Greek crisis initially appeared as, and is still considered to be, a fiscal crisis, its severe and prolonged repercussions are due to the fact that, beneath its fiscal element, there is a more important structural one generated by the irrevocable and irreparable collapse of its non-tradables sector.

Theoretical economists and policymakers alike should take note that, in this case, the problem with excessive fiscal borrowing is not that much related to a certain theoretical debt “threshold” and the supposed impediment that the burden of servicing it in the future would constitute to the growth path of the economy. Actually, at least as regards a “small open economy” -and, probably, even one that possesses the “safety valve” of a floating exchange rate-, the most important problem is that the process of amassing an excessive (public and/or private) debt inexorably leads a country to build a structurally unbalanced economy with an inherent inability to last longer than the triggering of a “liquidity” at a first stage, and a “solvency” immediately after, crisis. It follows necessarily that excessive borrowing will become excessive demand that will distort the relative prices between tradables and non-tradables at the expense of the former. Hence, the economy will contract an almost mortal “Dutch disease” which -though artificial and unnatural, as it has nothing to do with real commodities- will nonetheless inflict considerable harm as a result of the effects that the specific noxious features of non-tradables can have on development and stability of “small open economies”.

Although it not the central issue of this article, one can hardly resist the temptation to extend the questioning regarding the specific noxious features on non-tradables to other national economies as well, beyond Greece. For instance, if we take two “medium open” European economies, such as France and Germany, and examine them through this particular analytical lens we could probably conclude that the one that boasts a better overall economic performance is the one that has better “tamed” its non-tradables sector.


      – Abdon A. et al, (2010), “Product Complexity and Economic Development”, Working Paper no 616, Levy Economics Institute.

      – Balassa, B. (1964), “The Purchasing Power Parity Doctrine: A Reappraisal, Journal of Political Economy, December.

      – Baumol, W. J. (1967), “Macroeconomics of unbalanced growth: the anatomy of urban crisis”, American Economic Review, 57.

      – Borio, C. (2012) “The financial cycle and macroeconomics: What have we learnt?” Working Papers No 395, Bank for International Settlements.

      – Borio, C, (2013), “Macroeconomics and the financial cycle: Hamlet without the Prince?”, Vox.

      – EC (2012) European Competitiveness Report 2012, Reaping the Benefits of Globalization, Commission Staff Working Document SWD(2012), 299 final.

      – ECB (2012) Competitiveness and External Imbalances within the Euro area, Occasional Paper series, no 139 / December 2012.

      – Kuznets, S. (1966), “Modern Economic Growth: Rate, Structure, and Spread”. New Haven, Conn. Yale University Press.

      – Samuelson, P.A. (1964), “Theoretical Notes on Trade Problems”, Review of Economics and Statistics, 46.

      – Manganelli, G. (2000), “Value added, employment, remuneration and productivity”, Eurostat.

1   Economist (Ph. D.), currently Deputy Ombudsman in Greece. Economist (Ph.D) with research interestsin labour markets, human resources and employment relations. His latest publications include “Recasting Hellenic Industrial Relations for Internal Devaluation in Light of the Economic Crisis and European Integration, IJCLLIR, Vol. 28/2, 2012” and “Greek public service employment relations : A Gordian knot in the era of sovereign default, EJIR, forthcoming”.

2   Economist with research interests in macroeconomic and monetary policy and international trade. His latest publications include “Stories about Defaults” Analysis Bulletin of the Centre for Analysis and Planning (of the Greek Ministry of Foreign Affairs), no. 70, 2011, and “The ‘structural collapse’ of the Greek economy”, Foreign Affairs Hellenic Edition Vol. 14, 2013 (in Greek).

3   Only Samuelson and Balassa refer explicitly to tradables and non-tradables. Nevertheless, Kuznets’ suggestions about the way that the structural composition of national economies evolves through time, as the bulk of manpower moves from agriculture to industry and then to services, following the average growth of productivity, belong to the same line of thinking. On the other hand, the economic sectors described by Baumol, where productivity increases exponentially through time, are identical to the main core of tradables, as we suggest in this article.

4   For both the Balassa-Samuelson theorem and the Baumol-effect hypothesis to hold and for non-tradables to “capture” the gains of productivity that occur in the productive, that is in the tradables, sectors of the economy the income elasticity of demand for non-tradables must be equal or greater to one or the price elasticity of demand for non-tradables must be less than one. Otherwise, non-tradables, such as traditional arts and crafts, are left to be produced by amateurs and go extra commercium.

5   equivalent to an appreciation of the real exchange rate

6   The third component of GDP, government spending, can grow faster (and did in Greece in the years 2000-2009), too, since an economy that is growing fast can be expected to require and be able to pay (by borrowing ample funds from abroad) for more government services.

7   The appreciation of the relative price of non-tradables in this case is the parallel effect of the appreciation of the real exchange rate.

8   There is bitter irony and injustice in the fact that the continuous toil of producers in the tradables sector leads to increased economic rents for producers in the non-tradables sector.

9   NACE (Nomenclature des Activités Économiques dans la Communauté Européenne, the nomenclature of economic activities in the European Union) codes 1-33, 50, 55-56, 62-63, 72 in “Gross Value Added by Industry (A64)”, 2000-2011. Source: Hellenic Statistical Authority (EL STAT).

10   having started with a handicap in the first place

11   One may legitimately ask how can a displacement of output from tradables to non-tradables of 4,5 percentage points of GDP over eight years (2001-2008) cause so much damage. To illustrate, one can consider the construction of dwellings in Greece. Total gross investment in this sector in the years 2001-2008 was around 150 billion euro ( at current prices Source : AMECO – EU). Assuming a normal rate of investment of around 14 billion euro per year (the figure for 1998, 1999, 2000 and 2009 suitably adjusted for inflation differences), one arrives at a figure of 38 billion euro of questionable investment (20% of 2012 GDP), just in that one sector.

12   In fact, the better-founded hopes of the Greek economy for recovery rest on the performance of those two sectors.