Κυριακή, 5 Σεπτεμβρίου 2010

The Greek Economic Paradox: Austerity and Inflation

Greek inflation has economists worldwide scratching their heads: how can a country, in which public-sector salaries and pensions were cut drastically (almost 20%), and a contraction of 4% is predicted for 2010, have an inflation rate of 5.5%? With money supply that low, how can prices be rising (the paradox becomes even more intriguing, if one considers that Greece shares a currency with 15 other countries, where inflation is much lower - and even fears of a deflation have been expressed - and cannot print its own money)? And, on a political level, the Minister of Finance is criticized for not doing anything to fight inflation (I guess the critics favor the imposition of price controls). Well, really, things are not so strange from the viewpoint of someone living in Greece.

It is true that an initial spike in prices was the result of an increase in the rate of the VAT from 19% first to 21% and, a couple of months later, to 23%, in accordance to the commitments Greece undertook, along with other austerity measures, as a condition for its bail-out by the European Union, the European Central Bank and the International Monetary Fund. Taxes on alcohol, cigarettes and gasollne were also raised sharply (the latter increasing the cost of transport, leading thus to another across-the-board price increase for all products). But, then, again, surely diminished demand would lead to prices falling.

Well, yes and no. For starters, demand did not diminish as fast as one might have predicted: no noticeable shift in the consuming habits of Greeks has occurred, although they mostly refrain from making big buys (like cars or homes). Automobile prices have plummeted. The prices for low-income housing have taken a fall, as well. But, other than that, the prices for most goods and services have risen. This is not hard to explain, given that Greeks have historically had large bank deposits and had supported themselves or acquired goods or services through the informal economy. The deposits, actually, are so large, that even a significant relocation of deposits to banks outside Greece (mostly Switzerland and Cyprus) affecting around 9% of all bank deposits left a total of 216.5 billion euros in the banks. This means two things: first, that there are many consumers who can tap into their (or their parents') savings to keep on the same lifestyle they have had so far; and, second, that prospective sellers (for example, those in construction of residences for the well-to-do) are in no particular rush to sell and can afford to keep their asking prices high, in the hope that some prospective buyer meets them at those prices.

This seeming paradox, then, can be explained. However, the question on what the government could do to curb inflation remains. Unfortunately, the government has been very slow to bring about the structural reforms required for the opening of many sectors of the economy to competition, which would lead to lower prices. There are many strange oligopolies in the Greek economy (the so-called "closed professions"), which the government has undertaken to dismantle. For example, there is only a limited number of licenses for the operation of large vehicles, which undertake road transports. The government has yet to open this sector to open competition. Moreover, inflexible labor laws mean that employers cannot adjust salaries or working hours for their employees, so labor cost remains very high, in relation to the average employee's productivity. Another reason for the very high cost of labor in Greece is that it is saddled with ridiculously high social-security contributions (more than 30% on the salary) - more than half of which do not even go for the payment of pensions, but are administrative costs. There are a lot of things for the government to do, and it is too obvious that removing unnecessary regulation and cutting on its own costs is a vital first step.

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