The Role of Labor and Product Market Institutions Leading up to the Greek Crisis

Starting from the view that the main reason for the Greek financial crisis is the loss of competitiveness - as increases in wages were not matched by improvement in productivity - this paper argues that product and labor institutions and the tax system contributed to this development.  Furthermore, since these institutions were not changed while the crisis was in its initial stages, therein lies a possible explanation of why the crisis turned out to be so deep.

Product market institutions that protect the interests of incumbent firms and the tax schedule in place can explain the composition of economic activity, the high rate of self-employment and the preponderance of small size firms.  Economic activity in Greece is geared mainly towards non-tradeable sectors, the rate of self-employment is the highest in the European Union and a very high share of individuals are employed in firms with fewer than 10 employees.  These features are in general associated with lower productivity levels and subdued productivity growth rates.  Regression analysis utilising sectoral and cross-country data are used to support these links: the link between self-employment and low productivity and the link between heavy regulation and self-employment.

Labor market institutions that encourage the decoupling of changes in wages from the financial performance of individual firms, that place the burden of social welfare on the business sector instead of the state - by imposing very high dismissal compensation costs - and that ignore competitiveness developments in the country placed Greek firms in a disadvantaged position relative to companies abroad.  Evidence from a firm-level survey, conducted by the Bank of Greece prior to the outbreak of the crisis, suggests that firms were indeed constrained with regards to wage flexibility and thus when faced with a demand shock tended to adjust numbers and not wages.  This could perhaps go someway towards explaining the very high unemployment rate that has been recorded since the start of the crisis.

In the last few years, labor market institutions have been transformed and product market reforms have also been initiated.  Flexibility, accompanied by the introduction of a robust social safety net, can support Greece in becoming more innovative and exploring its large untapped human capital potenital to achieve sustainable growth, lower unemployment, higher incomes and social cohesion.

Keywords: labor market institutions; product market institutions; productivity