Greece and the Euro Area: The cost of weak institutions

In the second decade of the Economic and Monetary Union, the convergence process between the less and the more developed members of the Euro Area weakened significantly, as disparities in the growth slow-down after the global financial crisis caused asymmetric losses in per capita income. The most pronounced divergence was between Greece and its Euro Area peers as prolonged austerity measures imposed in exchange for a debt bailout led to a serial collapsing of growth. At the same time, Greece had suffered from a dramatic deterioration of institutions, ranging from severe blows in Government effectiveness and political stability to market distortions and the weakening of the rule of law. An empirical growth model to assess the impact of such effects on convergence is estimated using the relevant World Bank indicators as explanatory variables and considering the other Euro Area economies as control countries. The model is then used to calculate the cost of crumbling institutions in Greece in terms of per capita GDP foregone. The estimate is so significant that Greece - alongside macroeconomic stabilization - should urgently focus on improving institutions if a convergence process toward the more developed nations of the Euro Area is to set off again.