European integration will change fundamentally the external conditions faced by EC member countries. Structural rigidities mean that adjustment in the Greek economy will be very different from more developed countries. Greece resembles a semi-industrialized economy both in the prevalence of agriculture and light and medium technology and in a marked duality in industrial structure. A small number of large private and public firms have commanded the bulk of available investment funds and state subsidies and have developed excess capacity. Through ownership of most of the commercial banks, the state controls a large and growing portion of domestic bank assets, leaving only a small portion for private loans. A second class of firms, a much larger number of small- and medium-scale units, operates in a competitive environment under financial constraints.

In Discussion Paper No. 364, Alexander Sarris considers the likely macroeconomic implications for Greece of opening the economy in both the current and capital accounts. Adjustment occurs in the first segment of the economy mainly by modifications of output under rigid prices and in the second through changes in product prices, given fixed and fully utilized capacity. External competition comes largely from differentiated consumer imports, as few intermediate or investment goods are domestically produced. Sarris models real and financial adjustment in the Greek economy, assuming that the overall level of investment is determined by available savings and that the economy operates with excess capacity and unemployment. The model reproduces recent patterns of development in Greece, whereby maintenance of high public expenditure and deficits keep GDP growth healthy, but at the expense of an appreciating real exchange rate.
Liberalization of the current and capital accounts will change rapidly the external conditions faced by the Greek economy but it is unlikely, Sarris argues, to alter as fast the inherent duality of Greek productive structure or the behaviour of the state in financing its deficit through crowding out the private sector. Without changes in economic structure, trade liberalization will bring an improvement in the external terms of trade without any short-run positive impact on GDP. This is because intersectoral factor movements are not automatic, so unemployment in some sectors induced by increased competition does not lead to reduced wages and increased employment in others. If the dual structure of production continues, growth will fall.
Financial liberalization, on the other hand, will force the state to pay market interest rates for its borrowing. In the long run capital account opening, and in particular greater exchange rate stability in the adaptation to the EMS, imply diminished reliance on the inflation tax or on preferential borrowing of private bank assets for financing the public deficit. If the public sector does not shrink, real wages will fall, because of the direct link in Sarris's model between the availability of investment funds and the financing needs of the public sector. While liberalized foreign capital inflows can ameliorate the situation, allowing a higher level of investment and growth, they cannot be relied on as a permanent source of finance for a persistent public deficit.

Rigidities and Macroeconomic Adjustment under Market Opening: Greece and 1992
Alexander H Sarris

Discussion Paper No. 364, January 1990 (IM)