Article written for Il Sole 24 Ore
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The Greek elections are around the corner, but, unlike last January’s campaign, there is no deep ideological fracture between the supporters and the opponents of austerity. Greek Prime Minister Alexis Tsipras has signed the third memorandum with the European Union, and now he must defend it. Only the Popular Unity (PU) party, which welcomes Syriza’s ‘escapees,’ opposes the agreements, explicitly proposing an exit of Greece from the euro system. Its consensus, however, at the moment remains limited. Even though the political debate on the recipes imposed on Greece has calmed down, the economic debate has not. Questions about the reasons why the recipes proposed by the so-called Troika miserably failed in Greece while, instead worked so well in Ireland and Portugal, where their first effects are beginning to show, continue to linger.
One possible answer emerges in the latest paper written by Nobel Prize laureate Christopher Pissardes together with Yannis Ioannides: internal devaluations only work when the domestic market is competitive.

For non-experts, an internal devaluation is simply the attempt to reproduce, in a country with fixed exchange rates, the effects of a devaluation of the exchange rate. The most popular devaluation among Italian entrepreneurs is the cut of social benefits financed through an increase of the sales tax: in that case the cost of labor drops as if the exchange rate devaluated. In Greece and in the other countries ‘administered’ by the Troika, internal devaluation takes more socially painful forms. One is the reduction of real salaries produced by the combination of two kinds of policies imposed by the troika: an increase of labor flexibility and a reduction of pubic spending that produces, as an immediate effect—an increase in unemployment. The left calls it “social butchery”, but in fact it is a mechanism towards the reduction of real salaries—a result even the radical PU party tends to with an exit from the euro and a devaluation. Through this reduction, the hope is to help Greek products recover their lost competitiveness, making exports sore—and along with it, employment. Despite the fact that the first part of this mechanism worked (since 2009, the cost of labor in Greece has decreased by 20 percent) the second part did not. In nominal terms, Greece has never seen a spike in its exports. The question is: how come?

The simple answer is that, in response to a reduction of costs, Greek companies did not reduce prices. The effect of this has been devastating. Not only did this missed price reduction make an increase of exports impossible, it also caused a collapse in workers’ purchasing power (due to a reduction of salaries while prices remained the same), dragging down with it a collapsing domestic demand.

When workers are paid less and goods prices do not decrease, it means that profits grow. In a ‘normal’ situation, profit soaring should lead to growth in investments, supporting aggregate demand and producing (even though a little delayed) an increase in employment. In the long run, this increase of labor demand from businesses will bring pressure for a salary raise. Not only does this mechanism require a lot of time, it also requires normal conditions. In Greece, with growing economic and political uncertainties, an increase in profits more likely translates into more assets exported to London rather than an increase of investments in Greece.

This explanation also poses the question of why Greek producers did not reduce prices despite a reduction of labor costs. The simple answer is: lack of competition. It can be observed at the gas pump: when oil prices soar, gas prices raise almost contemporaneously. When oil prices drop, the price of gas does so much slower and often not proportionally. This delayed and partial response is more visible in the areas where the retail gas market is less competitive. In the extreme case of only one pump in a radius of 400 kilometers, why should that pump reduce the price of gas when the oil price goes down, given the fact that, in the short-term, the demand of gas is very inelastic vis-à-vis the price?

Greece represents an extreme version of this phenomenon. The goods and service markets are much less competitive than the Irish and Spanish ones. This is the reason why the International Monetary Fund (IMF) has grossly underestimated the multiplying effect of a spending cut. In the IMF model, the recessive effects of a spending cut were mitigated by a fall of goods prices that, on one side, reduced the negative effect on aggregate demand of a reduction of nominal salaries, and, on the other, favored an increase of exports.

What is the lesson? The lesson is: austerity works only with a competitive domestic goods and services market. If these markets are competitive, a reduction of public spending can be reabsorbed by the private sector in a short time. If these markets are not competitive, it cannot. Therefore, the Troika should have proceeded, first, to the liberalization of the goods and service market and, then—and only then—to the liberalization of the labor market and massive cuts to public spending. Unfortunately, two factors were conspiring against this optimal sequence: the enormous fiscal deficit—requiring immediate intervention, and the veto power of the many business lobbies opposing liberalizations.

Will it be possible for the government that will come out of this election to change route? If not even a radical leftist party such as Syriza managed to overcome the power of lobbies, why should New Democracy—traditionally the establishment’s party—or a grand coalition supposed to place everyone on the same page?

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Le elezioni greche sono alle porte ma, a differenza della campagna elettorale dello scorso gennaio, non c ‘è una profonda contrapposizione ideologica tra i sostenitori e gli oppositori dell’austerità. Tsipras ha firmato il terzo memorandum con la UE e ora deve difenderlo. Solo Unità Popolare, che raccoglie i fuoriusciti da Syriza, si oppone agli accordi, proponendo esplicitamente un’uscita della Grecia dall’euro. Il consenso di cui gode, però, al momento rimane limitato. Anche se il dibattito politico sulle ricette imposte alla Grecia si è attenuato, quello economico no. Ci si continua a interrogare sul perché le ricette della cosiddetta Troika abbiano fallito così miseramente in Grecia, mentre hanno funzionato bene in Irlanda e sembrano dare i primi frutti in Portogallo. Una possibile risposta emerge in un nuovo lavoro scritto dal premio Nobel Christopher Pissarides insieme a Yannis loannides. La risposta è molto semplice: le svalutazioni interne funzionano solo se il mercato domestico è competitivo.

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