ecoprastuti nmims euphoria

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Shraddha Kamat Aditya S [email protected] [email protected]

9222167824 9833692253

FTMBA Core, 2009-11 FTMBA Core, 2009-11

NMIMS NMIMS

Capitalism &

Freedom: Will theEuro crisis become a

Global Problem?

Team Name: Euphoria

mailto:[email protected]








Capitalism & Freedom: Will the Euro Crisis become a global problem?

2

Capitalism and Freedom: Will the Euro Crisis become a global problem?

Authors

Shraddha Kamat

MBA II Year, NMIMS

Aditya S Prakash

MBA II Year, NMIMS

Abstract: The effect of Greek crisis has spread to the Euro zone. Excessive consumption and

irresponsible spending has led Greece in an abysmal trap of debt. As monetary policy is not

controlled by the respective governments of the Euro zone and fiscal responsibility laid down by

the ECB is not followed, it has become difficult to bring the crisis under control. Having said

this, the crisis is peculiar to the Euro zone countries and can be contained within, albeit at a

high price. Capitalism and Freedom are just the flag bearers of the crisis and not the

underpinnings of it.

Introduction

Debt = GDP. This is the single and simple

equation which is governing Greece’s

economy today which holds a warning for

Europe – leaving the Euro zone in a

vulnerable and difficult state. There is again

a single and simple solution to come out

from this crisis and that is ‘default’ – which

carries, however, with it, disastrous

implications for Europe.

Various characteristics of this crisis include

– higher inflation than other north European

countries, disproportionate increase in

wages with respect to productivity,

overvaluation of currency which led to

rising debt burdens and a gradual loss of

investor confidence.

The problem starts with the fact that Greece

lied about its debt burden. It kept on taking

debt and flouting the EU norms about fiscal

prudence. Greece gave away more and more

entitlements and made promises for

pensions and benefits which the Greek

economy never supported.




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GDP Miscalculation

Greece was living on the assumption that

Debt to GDP ratio will not matter. GDP was

growing at a rate of 4-5%, actually fuelled

by a massive debt borrowing. During the

recession, with the liquidity crunch, the

Greek economy contracted; bringing down

the growth in GDP to 1-2% and making the

effect of additional debt evident.

Over Dependence on Few Industries

The economy of Greece is dependent on two

industries, namely, tourism and shipping.

The financial crisis of 2008 adversely

affected the tourism and shipping industry.

Moreover, the shipping industry is cyclical

in nature. Greece’s excessive dependence on

only these industries for economic growth

puts it at a greater risk than other countries.

Aging Population

The aging population of Greece is also a

cause of concern. According to OECD

estimates, 18.7% of Greek population is

above the age of 65 at the end of 2009, by

2050, it is estimated to be around 32.5%.

The aging population does not contribute to

the GDP but provisions have to be made for

them out of the exchequer in the form of

social security. To make matters worse, a

populist Greek government had not only

promised to increase the wages but also

decreased the retirement age. The pensions

for all these retirees will be borne by the

government.

Economic Rationale behind the Crisis

When Greece joined the Euro zone, it gave

up all control over its monetary policy.

Greece cannot print currency nor can it

devalue the euro. Thus, Greece is stuck in a

situation where Greek economy isn’t

competitive, has high debt and expensive

exports.

Greece also has great instances of tax

evasion. This has reduced the revenue of the

government.

Therefore, where,

consumption (Y) is broken down into two

parts – consumption fueled by domestic

(X - M)

ExternalDeficit

(C + I + G)

BudgetDeficitY




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spending and consumption of foreign goods.

There was high budget deficit as the

government was spending more than what it

was receiving. Some of the spending was in

the form of social security provided to the

aging population whose retirement age was

being increasingly reduced.

The second part of the fiscal deficit comes

from the net of imports and exports. The

high standard of living of the people of

Greece and excess money in the hands of the

people, in the form of low taxes, encouraged

imports. Adoption of the hard currency

regime initially spurred massive inflows of

foreign direct investment and hot money

inflows. This excess liquidity (which

monetary authorities couldn’t control)

increased currency in circulation. This led to

excessive consumption which has led to a

trade deficit in the balance of payments

(Figure 1).

This Twin Deficit has become unsustainable

and has reached almost 13.6% of the GDP.

Monetary Astringency

Due to unsustainable fiscal policies and an

unsustainable current account situation,

foreign direct investment and hot money

inflows suddenly waned and/or reversed.

The outflows through the trade account

coupled with hot money outflows

necessarily (due to the currency regime in

place) produced a contraction in the money

supply, triggering a spike in interest rates

and a deep recession.

Capitalism & Freedom

Although, both were present in the Euro

zone, neither Capitalism nor Freedom has

brought Euro zone to this state of affairs.

-19

-55

-34

110

-69

Portugal Italy Greece Germany Spain

FIGURE 1: TRADE DEFICIT/SURPLUS (IN BILLIONS)




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Capitalism encourages profits but not

reckless profits or risky profits. Freedom is

tempered with rules and regulations. The

crisis culminated due to characteristics

specific to Greece and the Euro zone and the

solution lies therein.

The only way out of this crisis is through a

radical change in lifestyle. New generations

are very pampered and are used to living in

a consumer society. A strict fiscal discipline

will prove to be a lifeline for the economy,

without which Greece will find it difficult to

survive.

Greece can take a long term loan from ECB

and repay later. This will enable them to

plan their economy and reduce the fiscal

gap.

Greece has to increase internal production

and stimulate the economy, possibly through

diversification into different industries.

It should also generate revenues by

encouraging tourism and shipping industry.

Greece attracts only high net worth

individuals which are primarily Europeans

and Americans. It can reduce tariffs and

make tourism affordable to even Asian

countries, by following the example of

Thailand and Malaysia.

They should diversify by investing in

industries in addition to tourism and

shipping as relying on only one or two

industries is very risky. Depending on few

industries for GDP growth, can again lead

the country into crisis which is double dip

crisis (W problem).

Moral Hazard and PIIGS Countries

A €110 billion bailout package and a

European Financial Stability Facility is the

outcome of the Greece crisis which can now

be called the Euro crisis. Such a bailout

would create a blueprint for future bailouts

of countries like Portugal, Italy, Ireland &

Spain, who also suffer major deficit

problems.

The more severe danger is that a default by

Greece will cause investors to lose faith in

other Euro zone countries. This concern is

focused on Portugal and Ireland, all of

whom have high debt and deficit issues.

Due to this crisis PIIGS countries, which are

in trouble, will be avoided by othercountries. For example, if India discourages

exports to these countries, these countries

too will discourage exports to India. India

will not be affected by this but as these

countries are export dependent, they will be




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highly affected. This shows that the Euro

crisis will only affect the Euro zone’s GDP

not the world’s.

Thus, even as yields of Greek bonds have

risen, the fear of contagion has abated. The

only thing global about the crisis is the

nature of greed.

References

http://europenews.dk/, Retrieved 11 August

2010

http://articles.moneycentral.msn.com/Investi

ng/JubaksJournal/, Retrieved 12 August

2010

www.wikipedia.org/, Retrieved 10 August

2010

http://rspruk.blogspot.com/, Retrieved 10

August 2010

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