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Beyond Balassa and Samuelson: real convergence, capital flows, and competitiveness in Greece

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To better understand the convergence process prior and since the European financial and debt crisis, we scrutinize the role of capital flows for competitiveness in Greece and a set of six other euro area member countries (Portugal, Latvia, Estonia, Lithuania, Slovenia and the Slovak Republic). For this purpose the paper extends the seminal Balassa–Samuelson model by international capital markets with a particular focus on their impact on national wage policies. Capital flows are assumed to be able to invert the traditional direction of transmission of real wage increases from the tradable sector to the non-tradable sector and to make real wages increase beyond productivity increases. The augmented Balassa–Samuelson model is extended to trace cyclical deviations of real exchange rates from the productivity-driven equilibrium path. Panel estimations for the period from 1995 to 2013 reveal correlations in line with the Balassa–Samuelson effect, if Greece is excluded from the panel. For Greece, this in turn implies indication in favour of a credit-driven real wage increases beyond productivity increases what we call a “pseudo” Balassa–Samuelson effect.

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Fig. 1

Source: IMF: WEO

Fig. 2

Source: European Commission. Average for all 7 countries in the sample (Greece, Portugal, Latvia, Estonia, Lithuania, Slovenia and the Slovak Republic)

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  1. In general, the fluctuations of productivity increases over the business cycle tend to be larger in the traded goods sector than in the non-traded goods sector.

  2. The overall labor force of the economy \(\bar{L}\) is assumed to be constant \((\bar{L} = L^{T} + L^{NT} ).\)

  3. As \(\gamma^{T}\) and \(\gamma^{NT}\) are larger than zero and smaller than unity.

  4. With the weights \(\alpha\) and \(\left( {1 - \alpha } \right), \;with\; 0 < \alpha < 1\).

  5. Current account deficits may also indicate inter-temporal consumption smoothing or growth differentials. Therefore prior to the crisis, the capital inflows were perceived as contributing to productivity increases via higher investment and thereby a growing gap between investment and savings (i.e. the current account deficit). Post-crisis, however, part of the investment during the boom phase turned out to be unprofitable and therefore—with the benefit of hindsight—did not contribute to productivity increases.

  6. Goretti (2008) provides empirical evidence on the relationship between productivity increases and real wages increases. Furthermore, qualitative evidence suggests that public sector wage demonstration effects and institutional factors may play a role in wage determination.

  7. See also Grafe and Wyplosz (1997) on similar observations.

  8. Lindbeck (1979) linked the domestically driven wage bargaining process of Balassa (1964) and Samuelson (1964) to international goods markets. He assumed that trade unions in the traded goods sector of countries in the economic catch-up process do not negotiate wage increases higher than productivity increases and world market inflation. By doing this they help to maintain the competitiveness of the domestic export industry (and therefore prevent rising unemployment). Here, allowing for capital inflows this assumption of Lindbeck (1979) is resolved.

  9. On the reversal of international capital flows at the end of an overinvestment boom see the third generation of currency crisis models (e.g. Krugman 1998; Corsetti et al. 1999).

  10. De Grauwe and Schnabl (2005) show the circumstances under which real appreciation is achieved via relative price increases or nominal appreciation.

  11. The seminal monetary overinvestment theories by Hayek (1929) and Wicksell (1898) provide theoretical frameworks suitable to explain capital market-driven fluctuations in inflation, wages, asset prices as well as temporary departures of the real exchange rate from the equilibrium path.

  12. The IMF and the European Institutions became lenders of last resort in some Central and Eastern European as well as the southern European countries during the current crisis.

  13. BIS data of consolidated foreign claims of a country’s reporting banks.

  14. With capital flowing in, real interest rates are expected to fall. Real interest rates are determined by inflation, which is our dependent variable. However, correlation between inflation and change of real interest rates is moderate with a correlation coefficient of 0.45.

  15. We use the change of an overall commodity index (DJ UBS-Future Commodity) as well as crude oil prices (Crude Oil-Brent FOB).

  16. Using oil prices instead of a commodity price index produces similar results.


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Correspondence to Ansgar Belke.

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Belke, A., Haskamp, U. & Schnabl, G. Beyond Balassa and Samuelson: real convergence, capital flows, and competitiveness in Greece. Empirica 45, 409–424 (2018).

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