Sunday, 30 September 2012

Euro Area 12: Inflation and Regulatory Quality

I was just fumbling with the Worldwide Governance Indicators and I stumbled upon this, so I thought that I should share this chart with you. I tried to include as many years as possible to minimize as much as possible the probability that only one of the multitude of factors that can induce inflation is at work there. For example, during the 2002 – 2007 period, demand-pull inflation must have been present at peripheral countries. Enough with my blabbing here’s the chart.

source: Eurostat, World Bank, own calculations

Of course correlation is not causation, but with such a multi-factoral affair such as inflation this is not a bad fit so I couldn’t resist sharing it.

P.S. In case you're wondering what this indicator includes here it is

Thursday, 27 September 2012

Greece: High Income or Middle Income...?

I’ve been reading a few papers lately regarding the Middle Income Trap. It made me think about Greece. 

The World Bank runs a classification ofcountries to Low Income, Lower Middle Income, Upper Middle Income and High Income according to their Gross National Income per capita level. Greece is currently classified as High Income. This classification of course is desirable but is it sustainable and was this propelling of Greece to High Income status built on solid foundations?

Development is a rather wider notion than growth and it encompasses all kinds of aspects (and as a consequence the relevant indicators). If I wrote about all these, then the word-count and probably chart-count would go through the roof, so I’ll narrow it down with the danger of violating the statement that I just made about development and growth. So, besides growth metrics and relevant indicators, I’ll include a few indicators about governance.

If you want to take a look at a definition of Gross National Income, you can see how the OECD defines it here.

To draw some conclusions I look at Greece, Portugal and one of the World’s most widely cited success stories, Korea. These three countries share one feature; they crossed the $12,476 High Income watermark, the same year, namely, 2003 (Greece is the dark blue dot, Portugal the dark red one and Korea the light red one).

source: World Bank

source: World Bank

 From 2003 to 2008, where the peak for the above countries lies, Greece recorded the highest growth, followed by Korea, while from 2008 till 2011 Greece registered the biggest decline too, followed by Korea and not Portugal, maybe skewed by Korea’s larger reliance on international trade (great trade collapse 2009) and faster population growth (since this is a per capita figure).

source: World Bank, own calculations

To cut to the chase, I think it is really interesting and revealing to take a look at a decomposition of growth over the past 20 years.

Since, there are no data, at least that I know of, dissecting growth for these particular countries I tried to derive it myself using a rather primitive method. I took all GDP components, at constant Local Currency Units (as the World Bank puts it) and calculated each year’s change. Then I simply plotted the results for each of the three countries. It is rather facile, but I think that it is adequate to give us an idea of where growth came from. As a final note I want to remark that I used Gross Capital Formation, instead of Gross Fixed Capital Formation since the former includes changes in inventories.

Here’s the chart for Greece.

source: World Bank, own calculations

Now, the chart for Korea.

source: World Bank, own calculations

Finally, here’s the respective chart for Portugal.

source: World Bank, own calculations

Now that we have a full picture I can try to draw some conclusions. Out of the three, Greece’s growth that led to its ascend to High Income status (1993 – 2003), was mostly based on internal sources, i.e. private final consumption, Gross Capital Formation and to a lesser degree General Government Final Consumption. For a limited number of years (1997 – 2000), Exports made a satisfactory contribution. After Eurozone accession, growth came almost entirely from internal sources, namely, private final consumption and gross capital formation. 

Now, what about Korea? Before the Asian crisis broke out (1993 – 1997) growth came from Household Final Consumption Expenditure, Gross Capital Formation (adding weight to the notion that the fact that Korea ran a current account deficit during this time was due to machinery imports since it was building its industrial capacity). After the crisis, growth was based more on the external sector and to a much lesser extent to private final consumption. Gross capital formation’s weight was reduced too, compared to the pre-crisis time, maybe due to the fact that services were gaining in importance in the Korean Economy. 

Now Portugal, is a mid-point between the two extremes analysed above. Pre-Eurozone membership, growth was based on private final consumption and gross capital formation (the country underwent some kind of a boom in the construction sector). After the country exchanged Escudos for Euros, growth stemming from private final consumption was considerably subdued, while growth from gross capital formation was totally absent. Exports contributed more than they did in the previous period.

To sum it up, Greece’s growth after it attained High Income status came from its internal sources in its entirety, Korea derived the lion share of its growth from its external sector and Portugal lies somewhere in the middle.

Something that can and does shapes the trajectory of growth and where it comes from is governance. Here are some select indicators from the World Bank’s Worldwide Governance Indicators.

The first indicator is Control of Corruption.

source: World Bank

After entering the High Income group, the said indicator for Portugal is in broadly constant. The same, unfortunately, cannot be for Greece, which recorded a very low reading for 2011, while some progress had been made from the years prior to EA membership. Korea made some progress compared to the nineties but lately it appears that progress in that particular field has stalled.

The next indicator is Government Effectiveness.

A look at this indicator will produce some rather contrasting conclusions. While reading for Korea is in constant ascent, the same readings for Greece are in free-fall, with the country recording a very low reading again in 2011, the worst out of the three. As far as Portugal is concerned while during the first years of Euro membership readings were as good as those in the run-up to membership, after that, readings receded showing some complacency after the target was achieved. 

source: World Bank
The final governance indicator that I’ve plotted is Regulatory Quality.

source: World Bank

For Greece, there was some considerable improvement right after Euro accession compared to earlier years but a rapid fall ensued and again the country recorded the lower reading out of the three in this instance too. Respective reading for Portugal showed a slightly lower reading after the EZ membership goal was reached and a considerable fall in 2011. On the contrary, Korea is here too steadily rising. I think it is adequate to say that while the country exhibited the lowest reading for 1996, it did manage to rank higher than the other two countries in 2011.

Another feature of High Income countries is usually that their produce possesses a higher technological content. One area that this can be exhibited is a high % of knowledge intensive services (I’ve looked into that in an earlier post) but for countries just crossing the High Income threshold, the main arena that this is manifested is (even after the sustained de-industrialization that the western world has sustained for decades now) the % of value added that manufacturing of different technological content corresponds to.

Here’s Greece.

source: OECD

Here’s Portugal.

source: OECD

And finally, here’s Korea.

source: OECD

A few quick takeaways from the charts are more than enough to portray a rather clear picture. The technological content of Greek manufacturing is extremely low and manufacturing accounts for a very low share of total value added. In Portugal manufacturing accounts for a significantly larger share of total value added and the technological content is higher than that of Greece, but still is low. Korea is intensely industrialized and high tech along with medium-high tech manufacturing takes up the bulk of manufacturing value added.

There are some common themes that can be discerned from the charts, low and medium-low tech manufacturing produce an ever-decreasing chunk of value added. On the other hand in Portugal and Greece high and medium-high tech manufacturers show more resilience but just that, while in Korea, until recently they have been growing quite fast. 

I would like to include more indicators painting a fuller picture but, unfortunately, data for these are confined to the last few years.

To get back to my original point, my skepticism regarding Greece’s ascent to High Income, apart from the qualitative aspects outlined above, had to do with the sources (domestic sector growth) and its sustainability.

The sectoral balances of the engines of Greek growth, the general government and household sector more specifically, should give us a hint of the sustainability of Greece’s High Income status.

source: AMECO, own calcualtions

As the chart makes apparent, Greek households were and still are overextended (not getting into the reasons here). To acquire a more sustainable footing, significant scaling down of spending and scaling up of savings is needed. Given that this was the main engine of growth this past decade (the High Income decade) it becomes apparent that this is going to have (and already has) significant negative consequences on GDP and GNI. Portuguese households are less extended due to higher saving and lower investment but are significantly leveraged (not shown by this indicator). The trajectory of interest rates is going to be of paramount importance for Portuguese households then. Both countries’ household sectors have to scale back (immensely more in the Greek case) and this is going to be painful. Austerity being applied to both countries does make households more strained due to deterioration of incomes and increases in taxation hence making households’ deleveraging immensely more difficult. 

Finally let’s take a look at the general government.

The said deficit for Greece is still monstrous, making further austerity-only induced adjustment strenuous. Portugal’s case is more contained but further adjustment is still going to be very painful due to the simple fact that not all sector can deleverage at the same time without monumental pain ensuing.

source: AMECO, own calculations

To wrap this up, Greece did evolve after crossing the High Income threshold the way only natural resources-rich countries do. With weak governance, facing a gradual thinning of an already weak and with low technological content, manufacturing base and an increase in low-knowledge content services as well. If you’re wondering what played the role that resources play for aforementioned countries, you just have to take a look at the two last charts. In the original question that the post posed, my answer is that should Greece have been in another part of the world, it would have been a middle income country (and probably one stuck in the middle income trap). Though, since in my humble opinion location does matter, situated in Europe and being part of the EU and later the Eurozone (membership played an important role in Greece’s ascent since it is the reason for lower interest rates and transfers of EU funds), means Greece can be a borderline High Income country…