Does internal devaluation work? The case of Greek exports

When the Greek debt crisis erupted in 2009, the Greek economy was running large fiscal and current account (CA) deficits (15.2% and 14.9% respectively). The large CA deficit was initially explained by the loss of competitiveness during the first nine years in the Eurozone. The deterioration of competitiveness was basically attributed to real effective exchange rate (REER) appreciation and the strong Euro during most of the period. Greece’s creditors’ recommendation to restore both internal and external imbalances was internal devaluation, through a decline in unit labor costs and structural reforms. After six years of depression, with 26% cumulative decline in gross domestic product (GDP), a rate of unemployment around 27% and more than two and a half years of deflation, the competitiveness of the economy, as far as unit labor costs (ULC) are concerned has, to a large extent, been restored at levels similar to the early 2000s. The recent Euro depreciation has also contributed to a REER depreciation. In the meantime, during the crisis, the CA deficit contracted to around 2% of GDP. There is widespread belief that the improvement in the CA is attributed to these developments. However, a closer look at the components of the CA reveals that the improvement has mainly come from import decline due to the large decline in income, not from increase in exports. Greek exports have remained at or below the pre-crisis levels. This has important implications, since it seems that internal devaluation has not worked.

The purpose of this paper is to investigate the Greek CA dynamics by focusing on the exports of goods and the possible reasons for their poor performance. This important research question has essential policy implications. Unless Greek export production capacity increases, the long anticipated growth in the economy will cause large CA deficits as imports increase and external imbalance problems arise once again. We look at various factors that might have played a role in the poor export performance. We test for the impact of REER, liquidity constraints (high credit costs) for Greek businesses, and world demand. We believe that the negative business climate is an important factor, which we catch using business confidence and/or the net number of business closings. We expect to find that a combination of the above factors remains a barrier to Greek export growth. This indicates that internal devaluation is necessary but not sufficient to stimulate exports. Structural reforms are essential.