See the question for Greek Voters…

Yesterday I wrote that we should think of Greece as a “demerging” economy. Some of the comments and questions I received made me realize the argument left an important question open: What is the special weakness of the Greek economy that is causing it to demerge? The short answer is productivity.

This also helps explain what would be required for Greece to reemerge — and, more immediately, what Greeks should ask themselves as they go to vote in Sunday’s referendum.

The vote is first of all about the future of the current Greek government, as Greek Finance Minister Yanis Varoufakis made clear in a Bloomberg TV interview this morning. Varoufakis said he’ll resign if voters say “yes” to the bailout package that he has rejected at such enormous short-term cost to the Greek economy. In deciding whether to dispense with Varoufakis or keep him and risk being forced from the euro, the question for voters is whether he and Prime Minster Alexis Tsipras can fix Greece’s underlying productivity failure.

Greece has so far not made good use of the structural aid and economic framework that Europe has provided. And although the country’s growth in output masked these failures until the crisis, a rough measure of productivity — gross domestic product per hour worked — reveals them:


As the graph shows, just after Greece joined the EU in 1981, it was just a little more efficient than Ireland. Over the next 30 years, though, Ireland’s productivity soared to match Germany’s while Greece’s trajectory was more like that of Turkey, a neighbor that didn’t join the EU.

Other EU countries also made significant gains in productivity during this period. Spain reached $51 per hour worked. Portugal, which started out poorer than Greece, has reached $35 — just about catching up with Greece. The eastern bloc economies, which joined the EU more than two decades later than Greece, already cluster around it in a spread from $28 (Latvia) to $43 (Slovenia). Note that these numbers are remarkably steady — the financial crisis hasn’t made a dramatic difference in productivity.

It’s important to note, too, that Greece’s lower productivity doesn’t reflect laziness. Greeks are among the hardest-working people in Europe, in terms of hours spent on the job. They don’t produce as much because their economy is so inefficient.

So Greece’s priority must be to boost productivity. Here’s what the Organization for Economic Cooperation and Development, an intergovernmental think tank for developed economies, said in a report on how to achieve a sustainable Greek recovery:

Ambitious structural reforms are needed to boost productivity and employment. Greek labor and product markets are rigid by international comparison, which points to the potential for productivity gains from further liberalization.

The same diagnosis and similar prescriptions can be found in a 10-year plan produced in 2012 by the consultancy McKinsey & Co.:

Chronic overconsumption in the public sector spilled over into the private sector, revealing major structural gaps in competitiveness and productivity.

The primary locus of inefficiency has been in the public sector. In 2007, before the financial crisis began, Greece had the highest proportion of public-sector workers to the general workforce of any country outside Scandinavia, and the proportion of public-sector compensation was even greater. In other words, Greek government employees were really well-paid:


That would be fine if the public sector were incredibly good at delivering services such as health care and education, or at creating a well-regulated environment for the private sector to generate wealth and pay taxes — as in, say, Denmark. But the Greek public sector is among the least efficient and effective in Europe. Greece has also had one of the most expensive pension systems in Europe.

Some change has been made under the International Monetary Fund’s structural reforms and budget cuts. But can the ruling Syriza Party enact more radical reform to free up an otherwise efficient private sector? Can Tsipras and his team slim the public sector and reduce the pensions burden to make room for growth in more productive sectors of the economy? Do they even want to?

One indicator of the party’s priorities is its constituency, which broadly consists of public sector workers and unions, pensioners, and the unemployed. Unsurprisingly, the salient issues on which Syriza has split with Greece’s creditors — in addition to debt relief — have been job losses in the public sector, pension reform and labor market reform. So the chances that the current rulers will carry out reforms to boost productivity are not promising at all.

The sad part for voters on Sunday is that there are no obvious alternative leaders who could take on the clientelism that has kept the country back. So a vote for the creditors’ package would in effect be one that says the IMF and euro group have a better chance than Syriza to force change.

Varoufakis and Tsipras are telling voters that Sunday’s referendum is only about getting a better deal from the creditors — and not Greece’s place in Europe. Greece can vote no and still remain in the euro, they insist. “Deposits in Greece’s banks are safe,” Varoufakis claims on his blog. “Creditors have chosen the strategy of blackmail based on bank closures,” but won’t let Greece go. This is simply untrue.

A return to the drachma or some scrip currency is very much in the cards. And if there’s one thing for sure in all this mess, a Greek exit from the euro with Syriza in charge would provide little remedy for what ails Greece. Bloomberg