Reforming Greece

Nauro Campos, Fabrizio Coricelli

17 July 2015



One unappreciated dichotomy in the recent Greek crisis is embodied in the conventional view that its solution entails implementing ‘the structural reforms required for debt sustainability.’ Regarding debt sustainability, there are solid theoretical foundations, measurement expertise, and broad econometric consensus on offer by academic economists. In contrast, regarding structural reforms, academic economists remain puzzled over not only how these reforms start and evolve (and could thus hopefully help solve the crisis), but also how to properly measure and econometrically assess their implementation. It is ironic that both stances are ignored outside of academia, where evident certainties and obvious truths abound instead. This column argues that this unappreciated dichotomy played a role in over-extending the crisis. Had this advice been heeded (Baldwin 2015), the evidence properly assessed, and the lessons from the political economy of reform literature learned, structural reforms would have been dealt with differently – that is, the overly localised reform mix would not have been implemented in such a badly sequenced fashion, and nor it would have been instigated and implemented by short-sighted political elites.

Greece and Europe through the lens of reforms

Greece joined the European Communities in 1981 and their relationship since has been very politically charged. In 1974, Turkey invaded Cyprus and the Greek military dictatorship collapsed. The Karamanlis premiership (1974-1980) succeeded diplomatically in convincing Europe to open its doors to the ‘cradle of democracy.’ But only barely – in 1976, the Council of Ministers rejected the European Commission’s opinion that favoured delaying entry until Greek firms were able to compete in the common market. Yet Greece joined five years ahead of Spain and Portugal, despite French worries (over agriculture) and German concerns (over migration), with the latter clearly playing a key role.

Did Greece benefit from joining (early)? In Campos et al. (2014), we find that the effects from EU membership are large, significant and almost unanimously positive.1 Yet, for only one country (out of 17) we report a negative effect of EU membership and that country is Greece. Figure 1 suggests not only that Greece’s per capita GDP would have been higher if it had not become a full-fledged EU member in 1981 but also, and considerably more importantly, how the behaviour of these net benefits/losses changes over time.

There are two regimes. In the first (1981-1995), Greece experienced divergence (Vamvakidis 2003)2 In the second (1995 onwards), the gap decreases and seems to be on its way to closing until the 2007 Crisis. After 1995, the Greek economy progressively benefited from joining, thus making non-membership increasingly unattractive, suggesting that the broadening and deepening of structural reforms in Greece was delayed until about 1995.3

In this light, the IMF notion that “given the dismal productivity growth record of Greece before the program, a number of structural reforms were seen as necessary” (Blanchard 2015), should be qualified in that this record may indeed be dismal in the 1981-1995 regime, but it is clearly less so in the 1995-2010 period, which is arguably the more relevant. Figure 2 corroborates this point using the same data as the IMF in its analysis.

Greece is exceptional in Europe. It joined the EU thanks more to diplomacy than to economic readiness. Divergence lasted until the conditionality for euro membership was agreed upon. The notion that ‘Greece was bad for the euro’ has less empirical support than the idea that the ‘euro was good for Greece’ – by prompting structural reforms, it may have opened the way for a Greek peripeteia in Europe (that is, until the Crisis hit).

The Greek crisis through the lens of reforms

With the outburst of the debt crisis, many jumped to the conclusion that the crisis revealed that Greece was living beyond its means and that the pre-crisis growth was nothing but an unsustainable boom. Yet the OECD (2015) Going for Growth report estimates that during 2000-2012 Greece was one of the countries that benefited the most from structural reforms and it even goes further by indicating that in the crisis years (2007-2014), Greece was a frontrunner in structural reforms (together with Australia, Portugal, and Slovakia).

How come? We claim Greek reforms had three negative and inter-related features: they were overly localised, badly sequenced, and implemented by short-sighed political elites. More specifically, structural reforms in Greece were far from pervasive. They were focused and very localised. Structural reforms were implemented in the financial sector, but other starting points could have been superior, such as regulatory and gradual labour market reforms. Hence the sequencing of Greek reforms after 1995 was flawed (Dewatripont and Roland 1995, Roland 2000). It is also unclear whether, more recently, welfare gains are larger and more widely distributed when, for instance, privatisation follows labour market liberalisation, or the other way around.

Second, and related, these structural reforms were implemented by short-sighed political elites. In Campos and Coricelli (2012), we show that in countries with ‘partial’ democracy (or under what Acemoglu and Robinson (2008) call ‘captured democracy’) the state can be captured by powerful economic elites that push for restrictions in the financial sector and reversals of liberalisation policies. We argue that this is partly because de jure measures often translate, depending on the political regime, into sharply different de facto measures. We also provide evidence of a U-shaped relation in which ‘partial democracy’ regimes are typically characterised by lower degrees of liberalisation and by reversals in structural reforms, while both democratic and autocratic regimes tend to favour liberalisation. This is one important aspect in which Greece may show features of partial democracy. Greek elites alternate in office in what may look like a fully functioning democracy. Yet, these alternations also show a worrying feature of partial democracies, which is what we call the ‘bad tenant syndrome’ – burning down the house just before passing the keys to the new rightful owners. Mind that the disclosure of untruthful public deficit figures occurred amidst such a transition in 2009.

A related theoretical model with Greece and Southern Europe in the background is found in Kollintzas et al. (2015), which is based on a characterisation of society between insiders (those with political influence) and outsiders (those without political influence). From the perspective of captured democracy, or insider-outsider societies, this model generates a useful lesson – structural reforms that on paper look similar, will have sharply different effects in different political contexts. Moreover, and from this perspective, the challenge in Europe goes beyond the Greek case, as other Southern European countries, including Italy, seem to share some features of captured democracy. Notwithstanding enormous differences in terms of levels of income per capita, and strengths of industries in the world market, Greece and Italy share several institutional aspects. For instance, in the Transparency International ranking of perceptions of corruption for the year 2014, Greece and Italy share the same position of 69 in the world ranking. Similarly, in the latest World Bank ‘Doing Business’ ranking, Greece and Italy are very close (Greece 61 and Italy 56) at the bottom of the OECD countries.

In short, considerably more humility is needed in the debate on structural reforms in Europe. Babecky and Campos (2011) argue that the econometric evidence, even when focused on arguably the best possible natural experiment in this regard (the transition from communism in Eastern Europe), remains rather flimsy. Eggertsson et al. (2014) present a theoretical model showing that in a crisis when the nominal interest rate it close to zero, product and labour market reforms may unintentionally fuel expectations of prolonged deflation, increase the real interest rate, and depress aggregate demand. Hsieh (2015) admonishes that we are still a long way from understanding the policy mix that underscores productivity growth, and that it is highly unlikely any single policy will have a large effect by itself.

Concluding remarks

Greece has implemented substantial structural reforms, before and after the Crisis. Yet these reforms were unbalanced, localised, not properly sequenced, and – arguably the most important factor – implemented by short-sighted political elites. The Greek elites have been able to alternate in office in what looks like a fully functioning democracy and yet many of these alternations show worrisome features of a captured democracy. Although the future of the Eurozone depends on deepening political integration (Campos et al. 2015), one thing this crisis has shown is that accountability and other democratic principles should also be taken seriously, not only regarding Athens or Brussels, but also in many other corners of the Union. For a long time there has been widespread concern about the so-called ‘democratic deficit’. History will show that a key factor that prolonged the Crisis unnecessarily was an acute leadership deficit across the whole of the EU.

Figure 1. What would have been the level of per capita GDP in Greece if it had not joined the European Economic Community in 1981?

Source: Campos, Coricelli and Moretti 2014.

Figure 2. Total Factor Productivity in Germany and Greece, 1990-2011

Source: European Commission AMECO database.


Acemoglu, D and J Robinson (2008) “Persistence of power, elites, and institutions”, The American Economic Review, 98(1): 267-293.

Arkolakis, C, A Doxiadis and M Galenianos (forthcoming) “The challenge of trade adjustment in Greece,” in C Meghir, C Pissarides, D Vayanos and N Vettas (eds) Reforming the Greek Economy, MIT Press.

Babecky, J and N Campos (2011) “Does reform work? An econometric survey of the reform-growth puzzleJournal of Comparative Economics, 39(2): 140-158.

Baldwin, R (2015), “VoxEU told you so: Greek Crisis columns since 2009”,, June 21.

Blanchard, O (2015) “Greece: Past critiques and the path forward”., July 10.

Campos, N and F Coricelli (2012), “Financial liberalization and reversals: Political and economic determinants”, Economic Policy 27(71): 483–513.

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Campos, N, F Coricelli and L Moretti (2015) “Norwegian rhapsody? The political economy benefits of regional integration”, CEPR, Discussion Paper 10653.

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[1] In Campos et al. (2014), we estimate similar counterfactuals for all countries that joined the EU in the 1973, 1980s and 1995 enlargements and for eight of the 10 that joined in 2004. The statistical methodology (the ‘synthetic control method’) selects the optimal weighted combination of countries from a ‘donor pool’ that better mimic the behaviour of the target country (Greece) in the pre-shock period (in this case, the period before joining, that is, before 1981). This hypothetical or synthetic Greece is constructed as 49% Japan, 28% Australia, 14% Brazil and 9% Tunisia (the percentages are the estimated weights, the four countries are those statistically selected from the broader donor pool).

2 From 1981 to 1995 the dismal performance associated with the premature opening up of the uncompetitive Greek industry vindicated the Commission’s opinion about Greece’s highly protected manufacturing. In this period, unchecked regulation was allowed to flourish and strengthen its grip (Papaioannou et al 2015). It extended to various industries and professions making Greece one of the most cumbersome countries with which to ‘do business’ in Europe.

3 After 1995, the entry process into the economic and monetary union seem to have promoted growth rates well above EU averages for 1995-2010. The main reasons (Mitsopoulos and Pelagidis 2012) for this turnaround are competitiveness gains in selected industries such as tourism, finance, and telecommunications, as well as the construction boom around the 2004 Olympics (all non-tradables; Arkolakis et al 2015). The effects of even limited financial reforms were amplified by financial (and political) integration in Europe (Friederich et al. 2013), which may ultimately have helped shore up this convergence process. 



Topics:  Europe's nations and regions Global crisis

Tags:  Greece, Grexit, EU, EZ crisis, structural reform, debt sustainability, synthetic control, politics

Professor of Economics and Finance, Brunel University; Research Fellow, IZA-Bonn; and CEPR Research Affiliate

Professor of Economics at Paris School of Economics, Université Paris 1 Panthéon-Sorbonne; and CEPR Research Fellow