NAIVE EXTRAPOLATION REDUX

Some time ago I wrote a rather controversial post demonstrating how far divorced Greek output per capita was from from the country's competitiveness levels. I wanted to demonstrate, among other things, how far Greece had left to fall - the difference between the country we were and the country we'd been allowed to pretend we were.

My rationale was simple - an open economy cannot sustain its standard of living indefinitely if it cannot offer the same risk-adjusted returns to human, physical and financial capital as other similarly developed countries. Both money and people are mobile and eventually they will move to where they are best utilised.

So I devised a simple -too simple- test: let's take the ten economies closest to Greece in terms of competitiveness and check out their average per capita product - to smooth out the noise. It suggested some pretty catastrophic stuff.

In fairness, that was a little too alarmist; not that the controversy was about this. Rather, the controversy revolved around the economics of the post, which are admittedly less than rigorous - I've got nothing but intuition to go by and that's never a good guide.

In any case, I thought I'd run a version of the same exercise now, using data up to 2012 and leaving non-European countries out of the equation. I used per capita GDP figures and forecasts from here and WEF competitiveness scores from here. Because I've restricted this to European countries, instead of averaging out countries of 'similar' competitiveness, I can simply fit a curve to the observations - the result is what you can see below:

This rule-of-thumb calculation suggests that, by the end of 2012, Greece was about half-way to the bottom of the well, which is EUR11,550 - that's another 23% left to fall, bringing us to the same real GDP levels as the Czech Republic.  However, in purchasing power standard terms, the Czechs actually live better than we do. Do the math and you'll find that the 23% reduction should bring real standards of living in Greece right below those of Poland.

What this means, in a simple enough comparison, is this - though the 2012 figures will have been worse.

I call this the worst-case scenario, in the sense that it assumes competitiveness will remain at 2007 levels, reflecting zero reform. This is not entirely accurate - since the WEF's index of competitiveness (and real-world competitiveness too) depends heavily on macro stability, our competitiveness has fallen dramatically lower than 2007 levels.

My assumption here is that once the current crisis abates, the impact of macro instability on competitiveness will be reversed, but this is not necessarily true - we might never return to stability, or we may do so at such a profound cost to the country's human and social capital that the 'crisis effect' will become entrenched. I will try to test this in future posts.

In any case, my 'worst-case scenario' could be improved by reforms - Greece would need to return to the competitiveness levels of Italy or Poland (near the 40-41-mark on the graph) in order to regain the real incomes of 2007. It's not entirely impossible, is it?

SO WHAT DID GREECE SPEND THAT DEFICIT MONEY ON? A NAIVE ANALYSIS

Some time ago, I wrote a post examining the puzzle of Greek public procurement, in which I argued that there's simply not enough dodgy public procurement in recent Greek history to justify calling all of our debt 'odious' even by a long stretch of the definition of the term.

I was called out for this by @talws, who -correctly- argued the following:

1. Α counterpoint: 70% of my personal income goes to eating, renting a house and basic expenses. 20% goes to gasoline, recreation etc and another 20% goes to gambling and 5% to binge-driniking.
In order to sustain my personal 10% deficit I have reverted to loans and credit cars, which I obviously can't pay up anymore as they are by now increasing my deficit.
According to the reasoning above, my main problem is that I eat too much and move to a cheaper flat. There is a fallacy here :-)

That hurt my fuzzy neoliberal feelings, so I thought I'd run some figures following his logic. He's right; when trying to get to the causes of supposedly odious debt, it doesn't matter what we spend on. What matters is what we spend deficit money on. Primary deficit money, to be precise. 

What I did was, admittedly, a naive analysis. I downloaded a breakdown of our spending broken down by COFOG categories, each representing a distinct purpose of government in the dramatically expanded statist universe. I figured that any type of spending that rose as a share of total primary expenditure when the primary deficit rose may have had something to do with causing the deficit. That should help us separate the wheat from the chaff - or the housing and eating from the binge drinking and gambling. I cannot disaggregate primary deficits into constituent parts because there aren't enough observations (hence this is a naive analysis), but I can run a simple linear regression and see what returns a large enough R square value - i.e. the ability to explain a substantial share of the variation in government deficits. 

COFOG figures are available from Eurostat as shares GDP, but to me that's inadequate. Realistically, ministers don't divide shares of GDP among themselves - they can't control that precisely enough. Instead they divide shares of total spending, although in some sectors, such as education, spending aspirations are typically benchmarked as shares of GDP. 

So I ran this analysis with COFOG categories expressed as % of total spending as opposed to % of GDP, which is simple enough to do as Eurostat also provides expenditure estimates as % of GDP. I also restated the deficit figures as % of total primary spending, to ensure consistency. 

Family-oriented spending and medical supplies are the types of spending best correlated with primary deficits, but agriculture and housing are also high on the list. So is the suspiciously named 'Recreation, culture and religion not elsewhere classified' - which by the way does not include church wages since they are elsewhere classified. Note that things such as survivor benefits also rank high in their correlation with the primary deficit, but the relationship with primary deficits is negative - essentially in times of fiscal relaxation governments would cut survivor benefits to fund waste. 

Now suppose we group together medical equipment, family and children, agriculture, recreation/culture/religion and housing into a 'Big Five' of suspicious spending. It would look a bit like this (watch out for the two axes):

Here' a more detailed breakdown of the Big Five:

Impressive, no? That's our culprits then. But wait - at their worst, the Big Five only accounted for some 9% of spending. The 2009 primary deficit was more than twice that. And besides, no government can cut all spending on medical supplies unless it privatises all healthcare. Similarly with other parts of the Big Five. But let's suppose we take the average of 2002 and 2003 as a 'normal' level of spending - that was the only two years in recent history when we ran primary surpluses after all. Back then, the Big Five made up 4.7% of spending. The 'excessive' spending on the Big Five is smaller than the total spending, and peaked at just 4.5% in 2009 - when, admittedly, it made up 49% of all spending on the Big Five.

In fact, here's what would have happened if spending on the Big 5 had frozen, as a share of total expenditure, at the 2001-02 levels. Remember, all figures are % of total primary spending, not GDP:

All in all, this tells me once again that there's just not enough dodgy spending to justify the 'odious debt' accusation. It may be that if we could trace figures all the way back to 1980, we'd find more evidence of odiosity, but I just don't have the figures.   

You can download my results from here. or just check them out below.