Ireland is often regarded as a success story for Eurozone
austerity, compared to the total failure of Greece. That can lead to nonsense
like this: instead of whingeing, the Greeks should
buckle under and get on with it as Ireland has done. An alternative narrative
is to explain the different experience of the two economies by looking at
structural factors, as in these two examples.
Whether you can describe Irish unemployment rising from 12% in
2009 to 14.7% in 2012 as a success is of course moot. But Ireland does give us
a clear example of how austerity is supposed to impact an open monetary union
member, according to standard theory. A permanent reduction in government
spending or higher taxes will increase unemployment, which will reduce wages
and prices. This will improve competitiveness, leading to higher external
demand for Ireland’s products (and less imports) which will eventually replace
the lost demand due to austerity. However, because wages and prices are
‘sticky’, this adjustment will not happen quickly.
The fact that Ireland is now growing strongly and unemployment
is falling reflects this process. The OECD estimates that growth in 2014 was
nearly 5%, and this was greatly helped by a 12% increase in the volume of
exports. In this sense Ireland’s response to austerity has been textbook. The
interesting question is why Greece has been so different. Here is growth in the
two economies (all data comes from the OECD’s Economic Outlook). .
Of course the 2009 recession affected everyone, but from 2010 until
2014 the Irish experience was bad, but for Greece it was a disaster.
The most important reason for the difference is
straightforward: there has been a lot more austerity in Greece. Here is one
summary measure: the underlying government primary surplus.
Looking at this measure the fiscal contraction between 2009 and
2013 in Greece has been 2.7 times greater than in Ireland. This measure is not
ideal because the impact of tax changes can be smoothed, but looking at changes
to government consumption gives a similar picture.
In both cases we have had what economists call ‘internal
devaluation’, which is the improvement in competitiveness that I described
earlier. Here is what has happened to wages.
The fall in wages in Ireland produced a significant improvement
in competitiveness, which is a major factor behind why exports are now booming.
With much more, and more persistent, unemployment in Greece, the fall in wages has
been much more persistent. So we would expect a much larger and more persistent
improvement in competitiveness and exports. But here we have a small puzzle:
neither has happened. Here are export volumes in both countries.
The pattern is similar, but if anything the improvement in
exports has been greater in Ireland than Greece.
Is this where stories of structural weaknesses in Greece come
in? In one sense yes. Greece certainly exports less than you might expect given
the usual (‘gravity’) models that economists use to explain such things, as this European Commission study shows. The
study also argues that you can explain this finding by institutional weaknesses
in Greece’s economy. That in turn is one factor behind a very important
difference between Ireland and Greece. Ireland is much more open, which means
that any percentage increase in exports will have a much bigger impact on GDP
and employment than in Greece. (It also receives much more foreign direct
investment.) In technical terms, if the
slope of the Phillips curve is similar in both countries, Greece’s adjustment
was always going to be more difficult, because it is a much less open economy.
However it is not clear why these structural differences should
make Greek exports less responsive to any change in wages. What appears to
explain this puzzle is that competitiveness in Greece has improved much less
than in Ireland, even though the fall in wages has been greater. Theodore
Pelagidis at Brookings has an explanation: other non-labour costs have gone
up to offset these lower labour costs, particularly energy prices. He writes:
“part of the adjustment program Greece had proceeded to significantly
increase excise taxes on energy used in productive activities…..The resulting
evolution of exports in energy intensive sectors like steel and textiles is
most revealing. In spite of the large fall in wages, the rapid increase in
energy costs meant that exports of these commodities, price takers on the
international market, plummeted…..These two sectors largely account for the stagnation
of Greek non-fuel exports”
To what extent these increases in energy taxes were sanctioned
by the Troika is unclear. However one of the measures imposed as part of the latest agreement is an
increase in VAT for the tourist industry, which of course will also hit
competitiveness in that industry. In both these cases, austerity measures have
and will actively hinder the way the economy adjusts to fiscal consolidation.
To sum up, the main reason Greece has suffered so much more
than Ireland is that the amount of austerity imposed on Greece has been much
greater. Any recession is also likely to be greater because Greece is a less
open economy, so a larger internal devaluation is required to offset the impact
of austerity. One final factor is that large cuts in wages have not been
translated into improvements in competitiveness, in part because of the way austerity