The Euro crisis is currently focussing some economic and political minds while we witness the possible default of Greece and other Eurozone countries in slow motion. As with all economic problems, there are just as many opinions as experts, but more and more people agree, that eventually, there is only one outcome: Greece leaving the Euro. Many people in the UK (including myself) just feel lucky that we didn't join the Euro, yet, being a German, I also feel for my countrymen in this difficult moment. The question raised all over the airwaves is: Why aren't Germans simply digging into their pockets and bail Greece out? The sums needed are ridiculously small compared to German's GDP. The current installment due this Friday is a meagre 8 billion euro.
However, there is something called 'moral hazard' and its absence in national economies has a fundamental effect on how governments are behaving. Although I am not an economist, here is what I think about the 'moral hazard' of unlimited bailouts.
It's commonly known that Greece, after joining the Euro, lived way beyond its means. It also suffers from a serious lack of economic competitiveness and deep-seated problems with tax-evasion and low revenue. The shocking examples of public sector employees retiring at the age of 55 in Greece with pensions at the value of almost 80% of their last salary are well known. More interestingly, the public sector has also expanded dramatically over the last decade. The reasons are obvious. Having joined the Euro, Greek bonds were gold-plated and desirable. No one thought that a Eurozone country could default. Hence interest rates were low and the Greek government went on a spending spree of enormous proportions. A curious side effect of the massive expansion of state services is often that private enterprises are crowded out, which in turn means less revenue and more borrowing. That does lasting damage to any market economy.
Interestingly, this is not just the story of Greece. This summer I was in a small town in Spain. I was looking for a gym to work out and was told that there used to be several private ones but they had all shut down. Instead the town now had a huge brand new leisure complex that was run by the council. Private fitness studios just couldn't compete with the subsidized prices of the council leisure centre and had to close. The leisure centre was indeed impressive. For a town of about two thousand residents, the centre boasted a 50m swimming pool and a fully equipped gym with various sports halls. This was all available for 2 euros a go.
Now, needless to say, most of the equipment was little used and the swimming pool was almost always empty when I was there. Yet, this was all built and run by the council at an enormous cost to the taxpayer. Well, actually not: it was actually run on borrowed money and it is this what I call the lack of moral hazard. The Greek government, just like the Spanish one, knew one thing. If they couldn't foot the bills anymore, somebody else would. The Germans would always pay up since they benefitted from the Eurozone by exporting to the Eurozone countries.
That in effect meant that countries such as Greece and Spain could spend money like a drunken sailor and never be held to account for it. Until now that is. Wolfgang Schaeuble, the German finance minister, says he refuses to throw more money into a bottom less pit and Angela Merkel is under pressure by her own party not to release the latest bailout installment to Greece.
People say that the Euro is doomed and Greece should default and leave the Euro. Yet this scenario is fraught with problems. Few spell out exactly what would happen to Greece if it indeed left the Euro. Who in their right mind would buy the Drachme if it is re-introduced? The most realistic scenario is that Greece would experience a far worst run on its currency and its banks then it does now. Also, where will the recovery come from once it has left the Euro? Greece does not have any competitive industries. In fact, it is, as one observer called it, even now still a 'pretty much closed economy'. Once outside the Euro, currency exchanges would add to the costs of any producer. Who would invest in a country like that?
The harsh truth is that Greece needs to pay for its party, one way or another. What Germany can do is to stabilise the situation temporarily until the Greek economy recovers. Until then it needs to do what all governments do in these situations: sell the family silver, reduce the extent of bureaucratic controls that stifle private initiative and scale back public services where they hold back free enterprise.
If the Greek government is genuine in their reforms, I am sure the Germans will be willing to pay the bill for now. Yet as we say in German: 'Erst die Arbeit, dann das Spiel.'
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