The long term view of the Greek current account deficit: from transfers to loans to Target2

J.W. Mason has a post, on The Slack Wire, which shows the importance of a good grasp of the arcania of economic statistics as well as the importance of the long term view:

* The current account includes income transfers, like EU agricultural subsidies
* But it does not include lending and borrowing, which are part of the capital account
* It seems that at least in Greece transfers were replaced by lending by foreign private banks
* Which, when private banks retreated, was replaced by Target 2 imbalances (Target 2 is kind of the VISA-card of countries at the ECB).

According to J.W. Mason (he corrects and greatly improves upon a Krugman blogpost, I leave the citations of the Krugman post,  if you’re interested consult The Slack Wire):

The blue line is the current account balance, same as in Krugman’s graph, again extended back to 1980. The red line is the current account balance not counting intergovernmental transfers. And the green line is the current account not counting any transfers… Greece was not earning enough money to pay for its imports before the creation of the euro, or at any time in the past 30 years. If the problem Greece has to solve is getting its foreign exchange payments in line with its foreign exchange earnings, then the bulk of the problem existed long before Greece joined the euro…it is true that Greece’s deficits got much bigger in the mid-2000s…this must have ben connected with the large capital flows from northern to peripheral Europe that followed the creation of the euro… The basic issue, again, is the need for structural as opposed to price adjustment…The fundamental question remains how important are relative costs. The way I see it, look at what Greece imports, most of it Greece doesn’t produce at all. The textbook expenditure-switching vision implicitly endorsed by Krugman ignores that there are different kinds of goods, or accepts what Paul Davidson calls the axiom of gross substitution, that every good is basically (convexly) interchangeable with every other. Hey Greeks will have fewer computers and no oil, but they’ll spend more time at the beach, and in terms of utility it’s all the same. Except, you know, it’s not.

From where I’m sitting, the only way for Greece to achieve current account balance with income growth comparable to Germany is for Greece to develop new industries. This, not low wages, is the structural problem. This is the same problem faced by any developing country… how to you convince or compel the stratum that controls the social surplus to commit to the development of new industries? In the textbook world — which Krugman I’m afraid still occupies — a generic financial system channels savings to the highest-return available investment projects. In the real world, not so much. Figuring out how to get savings to investment is, on the contrary, an immensely challenging institutional problem.

On this blog, I’ve mapped the changes in current account deficits in EU countries and expressed my surprise about how fast these increased in many countries, it might however well be that the mechanism shown by J.W. Mason and the problem he identifies holds for more countries than just Greece.