Yesterday on his blog, Paul Krugman argued
that it is incorrect to attribute the decline in GDP and concomitant rise in unemployment in Greece to misguided supply-side policies. Rather, the only factor that can be understood to have caused the massive Greek recession is the Euro
, i.e., Greece's inability to devalue its currency. (And fiscal austerity imposed by the troika presumably hasn't helped
I would argue that it’s very, very wrong to point to factors limiting Greek productivity and claim that these factors are the “cause” of the Greek crisis... The main answer, surely, is the euro: by adopting the euro Greece first brought on massive capital inflows, then found itself in a trap, unable to achieve the needed real devaluation without incredibly costly deflation... Every time someone asserts that the Greek problem is really on the supply side, you should ask, not whether it has supply-side problems––it does––but why this should lead to collapse.
To make his point, he draws a comparison with Poland, a country with similar productivity to Greece but which weathered the financial crisis remarkably well.
Consider, in particular, a comparison that should be made––between Greece and Poland. Poland, like Greece, is a country on Europe’s periphery, closely linked to the rest of the European economy. It’s also a country with relatively low productivity by northwestern European standards... But Poland has not had a Greek-style crisis, or indeed any crisis at all. Instead, it has powered through the turmoil of recent years.
Krugman is surely right that
Greece's inability to devalue has contributed substantially to the current mess that it's in. Equally however, one shouldn't ignore the supply-side altogether. If I understand the Keynesian model correctly, because wages are sticky downward
, excess involuntary unemployment occurs during a recession when the central bank fails to adequately bolster nominal wages through monetary expansion. This means that, all else being equal, any policies (such as minimum wages
, hiring and firing rules, bans on zero-hours contracts etc.) which prevent wages from adjusting downward should worsen unemployment during a recession. And Greece appears to have many such policies; certainly more than Poland.
In the Fraser Institute's index
, Greece is ranked 138 for labour market regulations, while Poland is ranked 34. In the Heritage Foundation's index
, Greece is ranked 131 for labour freedom, while Poland is ranked 101. And In the World Economic Forum's index
: Greece is ranked 109 for labour market flexibility, while Poland is ranked 79 (averaging across the 6 relevant metrics). Indeed, Greece ranks much lower than Poland on overall indexes of competitiveness too: on the Fraser Institute's index, the Heritage Foundation's index, the World Economic Forum's index, and the World Bank's index
I would therefore claim that it is not simply Greece's inability to devalue, but the combination of its inability to devalue and its particularly inflexible markets (along with the troika-imposed fiscal austerity), which explain the massive recession it has experienced. As Bryan Caplan has noted
When Keynesians want to gloat, they often point to the overwhelming empirical evidence in favor of nominal wage rigidity. For the latest example, see Krugman on the Irish labor market. Their unemployment is 14.5%, but the nominal wage index has only fallen by about 2.5%... The gloating is easy to understand. After all, nominal wage rigidity is the driving assumption of the Keynesian model... What's hard to understand, though, is Keynesian neglect of––if not outright hostility to––the logical implication of their argument: Wages must fall!
In point of fact, however, wages in Greece have fallen quite considerably
. Yet unemployment
there is still around 25% (but falling). This would seem to imply that the situation is a little more complicated than I have suggested. But I also can't see how it vindicates Krugman's argument. Why would reduced real wages only help to bring down unemployment when the reduction occurs through monetary devaluation? Perhaps someone with a better understanding of economics can explain it to me. One possibility is that Greece would be on the road to recovery by now if the country's lurch leftward
hadn't upset the animal spirits
of Greek entrepreneurs.