From the Wall Street Journal Graphics page. Unemployment in the EU hits record highs – joblessness in the 17-nation currency area rose to 12.2 percent in April. Reuters stated that the greatest menace to the unity of the euro zone is now social breakdown from the crisis, rather than market-driven factors. What is of significant concern is that 5.6m young are without employment although it is getting desperate for Spain and Greece.
Here is yet another graphic from The Economist showing the change in stock markets since the peak before the financial crisis in 2007/8. Although Dow Jones Industrial Average surpassed its previous peak (though it is still around 7% off once inflation is taken into account) – see previous post. As you can see some stockmarkets are still struggling and Greece is more than 80% below its peak in 2007.
Time magazine ran an interesting article on the tomato market in the Holland and Greece. The Greeks produces twice as many tomatoes than the Dutch but very little of it is sold in export markets. This is a concern in that it is a missed opportunity for the Greeks to earn income. What is more ironic is the fact that in the summer imports of tomatoes come in from Holland because the Greek farmers are still struggling to grow a crop during the hottest time of the year – Holland employs high-tech green houses and is able to produce significantly more during the summer months than Greece.
However, Greece has the potential to produce tomatoes for domestic consumption as well as for export but only has two harvests a year and is at the mercy of the elements – poor weather = poor harvest. The Dutch in contrast have temperature controlled greenhouses helping to create ideal growing conditions and they can produce 70kg of tomatoes in a square metre of his greenhouse whilst the Mediterranean grower gets approximately 7kg. They can also produce all year round.
Single Currency and Productivity
With the introduction of the euro in 2002 Greece could no longer devalue its currency to control the price of its products. With a weaker currency their exports were much more competitive but this had the effect of making the Dutch work even harder to achieve more efficiency and greater economies of scale. Therefore the only way that the Greeks can now compete is by cutting costs and embracing technology.
But it is not just the tomato market that has been hard hit. Greece’s agricultural sector’s productivity levels are 44% below the European average and labour costs have increased by approximately 90% and this is in contrast to Germany where unions agreed to a 3% rise. What is more concerning is that the acreage given over to growing tomatoes in Greece is 10 times that in Holland but they hardly export any of them. The Dutch have seen their exports increase by 30% since 2005. Some economists have laid the blame on the oligopoly market structure that controls the distribution. These middlemen pay farmers low prices and take a big mark-up on tomatoes even as they have failed to put in place a more efficient distribution system, including for exports.
The Greeks could become a thriving exporter of tomatoes once again but will need to embrace the Dutch technology and make use of its natural conditions – sunshine.
Here is a very funny video from Paddy Cullivan who first performed this at Kilkenomics 2011. Worth a look.
The Greek economy is now into its sixth year of recession and it is no surprise that its economy is in tatters. Brian Gaynor from the NZ Herald wrote a very good summary of how Greece got into the mess that it is currently in. Below are some statistics over the last 6 years and this year sees a fifth year of recession – negative GDP for two consecutive quarters.
So what were the reasons for such a collapse on the Greek economy.
1. Tax avoidance has been endemic within the country especially amongst the higher income groups. Therefore there is a huge shortfall in government revenue relative to their expenditure. This means a government debt-driven recession.
2. The Greek economy boomed, like many others, with the availability of cheap credit in the early 2000’s and with the Olympics in Greece in 2004 economic activity was moving very nicely indeed.
3. Hosting the Olympics proved to be very costly in the long-run and there was little planning regarding the use of facilities post games. Many stadiums lie idle.
4. The Greek government was borrowing heavily overseas to fund its deficit.
5. Low interest rates and cheap money from overseas fueled a residential property boom – prices went up 100% from 2000-2008
6. Investment in assets with borrowed money that generated no overseas income.
Today the building industry has collapsed and residential property prices are down 20% from their peak in 2008 – isn’t this a familiar story worldwide especially with the sub-prime escapade. Also, as in Spain, there is a huge level of youth unemployment in Greece – 52.8% of under 25s are unemployed. As Brian Gaynor said at the end of the article
“The basic problem is that most Western countries, including New Zealand, have lived well beyond their means over the past 20 years, and Greece is just the worst example of this. The borrowing party is over and we are now experiencing the hangovers, particularly in Europe. These hangovers are not easily cured.”
Ben Cahill of Senior College put a cartoon on the Tutor2u blog about the role Angela Merkel has in determining the destiny of Greece. The cartoon below has Merkel showing the Greeks to their only option ie. the labyrinth to be consumed by the minotaur. What she basically saying to the Greeks is that you have no choice but to stick to the reform measures and strict austerity measures. Furthermore one could say that after the soccer quarter-final on Friday “One gone, one to go”.
This cartoon also reminded me of book that I recently read called the Global Minotaur by Yanis Varoufakis. The Minotaur is a tragic mythological figure. Its story is packed with greed, divine retribution, revenge and much suffering. It is also a symbol of a particular form of political and economic equilibrium straddling vastly different, faraway lands: a precarious geopolitical balance that collapsed with the beast’s slaughter, thus giving rise to a new era.
According to the myth’s main variant, King Minos of Crete, the most powerful ruler of his time, asked Poseidon for a fine bull as a sign of divine endorsement, pledging to sacrifice it in god’s honour. After Poseidon obliged him , Minos recklessly decided to spare the animal, captivated as he was by its beauty and poise. The gods, never allowing a good excuse for horrible retribution to go begging, chose an interesting punishment for Minos: using Aphrodite’s special skills, they had Minos’s wife, Queen Pasiphae, fall in lust with the bull. Using various props constructed by Daedalus, the lengendary engineer, she managed to impregnate herself, the result of that brief encounter being the Minotaur: a creature half-human, half-bull (Minotaur translates as ‘Minos’s Bull’, from the greek taurus, ‘bull’).
When the Minotaur grew larger and increasingly unruly, King Minos instructed Daedalus to build a labyrinth, an immense underground maze where the Minotaur was kept. Unable to nourish itself with normal food, the beast had to feast on human flesh. This proved an excellent opportunity for Minos to take revenge on the Athenians whose King Aegus, a lousy loser, had had Minos’s son killed after the young man won all races and contests in the Pan-Athenian Games. After a brief war with Athens, Aegus was forced to send seven young boys and seven unwed girls to be devoured by the minotaur every year (or every nine years according to another version). Thus, so the myth has it, a Pax Cretana was established across the know lands and seas on the basis of regular foreign tribute that kept the Minotaur alive.
Beyond myth, historians suggest that Minoan Crete was the economic and political hegemon of the Aegan region. Weaker-city states, like Athens, had to pay tribute to Crete regularly as a sign of subjugation. This may well have included the shipment of teenagers to be sacrificed by priests wearing bull masks.
Returning to the realm of the myth, the eventual slaughter of the Minotaur by Thesus, son of King of Aegeus of Athens, marked the emancipation of Athens from Cretan Hegemony and the dawn of a new era.
Aegeus only grudgingly allowed his son to set off to Crete on that dangerous mission. He asked Theseus to make sure that, before sailing back to Piraeus, he replaced the original mournful black sails with white ones, as a signal to his waiting father that the mission had been successful and that Theseus was returning from Crete victorious. Alas, consumed by the joy at having slaughtered the Minotaur, Theseus forgot to raise the white sails. On spotting the ship’s black sails from afar, and thinking that his son had died in the clutches of the Minotaur, Aegus plunged to his death in the sea below, thus giving his name to the Aegean sea.
This suggests a tale of a hegemonic power projecting its authority across the seas, and acting as custodian of far-reaching peace and international trade, in return for regular tributes that keep nourishing the beast from within. The role of the beast was America’s twin deficits, and the tribute took the form of incoming goods and capital. Its end came from the collapse of the banking system. The book is well worth the read and not too long either.
Here is the first half of an interview on Hardtalk. Nobel economist Paul Krugman continues to see that the way out of the economic crisis is to spend more. He says that Greece will have to leave the euro as there is no alternative but whoever makes the decision for Greece to go would simultaneously be ending their own political career. He does state at the end of this clip that somebody who tries to bring in Weimar German and Zimbabwe as examples of hyper-inflation with further spending should be ‘ejected from the conversation’. Well worth a look.
Jame Surowiecki in the recent edition of The New Yorker likened the euro zone crisis to the fairness trap. With Greek politicians looking at renegotiating its aid package and austerity measures, the German government has indicated that they are running out of patience and money to lend to Greece. Policymakers have talked about a Greek exit from the Euro – Grexit – which would mean they would default on their debts and no longer be part of the Euro currency.
As many economists have pointed out when economies go through a recessionary or contractionary phase their exchange rate starts to depreciate. This makes exports more competitive and imports cheaper which ultimately helps growth. However for Greece to leave the Euro it would destroy vast amounts of capital as well as costly for the rest of Europe. Greece owes almost half a trillion euros and containing the damage would mean the recapitalisation of banks, continent-wde deposit insurance and more aid to Portugal, Spain, and Italy. However it seems that this would be a much more expensive option than Greece staying in the euro zone.
Rationally there should be some sort of compromise with maybe a relaxing of austerity measures and giving Greece a bit more time to bring about some serious structural reforms especially to its tax system. However according to Surowiecki Europe isn’t arguing just about what the most sensible economic policy is but what is fair.
The Germans see it as unfair that they have to bailout Greece especially as the Greeks have continued to live beyond their means – how did they afford to host the Olympic games in 2004? Borrow more money? Why should the Germans be obliging when there is no meaningful reform in Greece?
From a Greek perspective it is equally unfair that for them to suffer years of slim government budgets and high unemployment in order to repay foreign banks and richer northern neighbours.
This fous on fairnes could prove disastrous – remember the Ultimatum Game.
The Ultimatum Game by Werner Goth 1982
In this game somebody offers John £100 under the condition that he shares it with Sarah. The two of them cannot ex- change information and John can make a single offer of how to split the sum. Sarah, who is aware of the amount at stake, can say yes or no. If her answer is yes, the deal goes ahead. If her answer is no, neither John or Sarah gets anything. In both cases, the game is over and will not be repeated. You may not be surprised to learn that two thirds of offers are between 40 and 50 percent.
From research carried out (Karl Sigmund et al.), only four in 100 people offer less than 20 percent. Proposing such a small amount is risky, because it might be rejected. More than half of all responders reject offers that are less than 20 percent.
However, why should anyone reject an offer as “too small”? The only rational option for a selfish individual is to accept any offer, as £1 is better than nothing. A selfish proposer who is sure that the responder is also selfish will therefore make the smallest possible offer and keep the rest.
This game-theory analysis, which assumes that people are selfish and rational, tells you that the proposer should offer the smallest possible share and the responder should accept it. But this is not how most people play the game.
The fairness problem is exacerbated by the fact that our definition of what counts as fair typically reflects what the economists Linda Babcock and George Loewenstein call a “self-serving bias”. This is even more pronounced when both parties feel they are not part of the same community – known as “Social Distance”. For instance:
1. The Greeks’ resentment of austerity might be attenuated by the recognition of how much money Germany has already paid and how much damage was done by rampant Greek tax dodging.
2. The Germans might acknowledge that their devotion to low inflation makes it much harder for struggling economies like Greece to start growing again.
The pervasive rhetoric that frames the conflict in terms of national stereotypes is the following:
Hardworking, frugal Germans v frivolous, corrupt Greeks
Tightfisted, imperialistic Germans v freewheeling, independent Greeks
This makes it all the more difficult to reach a reasonable compromise.
A hat tip to colleague David Parr for this piece from the BBC. According to the OECD the Greeks put in the hours at the coal face but when it comes to productivity they do lag behind the power house of Germany. The average Greek worker is at the workplace for 2,017 hours per year which is more than any other European country. This compares to the German worker who is there for 1,408 hours per year. However, according to the OECD, there are two reasons for this:
1. The Greek labour market is composed mainly of people who are self-employed who tend to work longer hours.
2. There are different numbers of part-time workers in each country. In Germany one in four are in part-time employment. As all workers are included in the calculation this brings down the average in Germany. Fewer people work part-time in Greece.
But if you look at productivity you see that Germany ranks 8 in productivity per worker out of the OECD countries – while Greece comes in at 24th.
Here is a clip from CBC in Canada that discusses the issues associated with a run on Greek banks. Shows UK Prime Minister David Cameron who must be pleased that they still have the UK pound. Some interesting facts:
$894 million was withdrawn from Greek banks last Monday – 14th May.
Total Greek deposits are $215bn
Deposits down 17% in 2011
Even with the G8 meeting at Camp David how can the Greek economy get out of this mess. I suppose it really is in the hands of the Germans and what they decide. To bail them out sets a dangerous precedent for the likes of Spain, Italy and Ireland.
With the change of government in France and the calamity of the Greek economy there has been a flight of Euros into the London property market. New French President Francois Hollande has proposed significant changes to the tax structure in France:
- 75% tax on income earned above €1million
- 45% tax rate for people making €150,000 more.
In recent months the real estate market in London’s most exclusive areas have become a safe haven for those holding euros as they fight to maintain the value of their money with the euro depreciating rapidly. Furthermore as Greeks start to withdraw euros from their own banks one wonders how long they can stay in the eurozone. What is for sure is that the London real estate sector is doing very well out of this. Below is a clip from CNN.
With increasing debt, out of control unemployment and a general strike Spain has some serious economic problems. However, before the financial crisis of 2008 Spain was seen as a prudent member of the Eurozone with GDP debt being half that of Germany at 36%, and a well regulated financial sector. But since the aftermath of the financial crisis it has been all downhill for the Spanish economy with unemployment now at 24% and public debt at 66%.
Causes of the downturn
Like most economies before the financial crisis Spain had access to cheap credit. This was especially prevalent since entering the Eurozone interest rates, which were set by the European Central Bank ECB) in Frankfurt fell from 12.75% in 1995 to 3% in 2005.
Spain’s banks and households realising that they had massive debts whose collateral was overpriced housing. Property values have fallen 27% and the building of new home is down 80% and given the size of the construction sector mentioned above this has some major implications for the Spanish fundamentals.
The Spanish economy is in serious trouble. With unemployment at 24% and the subsequent fall in consumer spending can it get much worse? Well, rating agency Standard & Poors have proceeded to downgrade Spain to BBB+ rating, which means “adequate payment capacity” and is only a few notches above a junk rating.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.
Greece’s bailout by the EU and the IMF is the largest in history – €245 billion.
The seriousness of the Greek debt problem is clear to see – see graphic below. Next month the Greek government must make it clear to those euro-zone governments and the IMF that they have made €11.5billion worth of cuts to its own spending. If it doesn’t make these cuts access to further loans will be suspended and Greece will eventually have to print its own currency. For Greece there are two major challenges as well as paying back the debt:
Debt is still rising at 1.5 times the size of the economy and
Wages and prices need to be forced downward to make the country more competitive.
In the past 3 year the Greek economy has contracted by 14% and the expectation is that it will be 6.4% by the end of this year.
IMF v Germany
In order to protect the economy the IMF suggested that there should be:
– structural reforms to the economy and
– spending cuts but over a longer period of time.
However, Germany demanded that both the structural reforms and the austerity measures should take place at the same time. This involves bringing down the budget deficit from 15.8% of GDP in 2009 to under 3% by 2014. But the spending cuts and tax increases pushed the economy into such a deep recession that the deficit got stuck at around 10% of GDP.
The exchange rate problem with the euro.
It is usual that when the IMF imposes austerity measures, it makes a country devalue its exchange rate in order to make its exports more competitive and therefore offset weak domestic demand. However, Greece doesn’t have its own currency so this is policy option is not on the table.
So where does Greece go from here? With having to impose structural reforms as well as austerity measures the country is caught between a ‘rock and a hard place’. One wonders how they are going to generate any government income with virtually no growth and increasing unemployment.
The major concern for the world economy is that if major economies are going to follow austerity programmes at the same time it will be left to the private sector to generate aggregate demand. But if they don’t borrow and increase consumer spending there is a real risk of an economic depression.
Central Banks worldwide have agreed to provide cheap loans in US$’s to banks in Europe and other parts of the global economy. There is obviously serious concerns about the economic climate in Europe but will it calm the markets? The truth of the matter is that more liquidity alone is not going to solve the economic problmes of the eurozone countries. The graphic below does show some positive signs with bond yields on the way down which suggests that there is less risk associated with their purchase. However there is still a long way to go for stability to return. See graphic below from the WSJ.
Central banks have offered cheaper credit before:
March 2011 – interevened to reduce the value of the Yen following the earthquake and tsunami.
October 2008 – central banks cut rates to reduce the shock on financial markets when Lehman Brothers went under.
“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.” combined statement form the 6 central banks. These include:
-US Federal Reserve,
-Bank of Canada, the Bank of England,
-Bank of Japan,
-European Central Bank and
-Swiss National Bank.
Recently The Economic Focus column in The Economist had an article that discussed how successful austerity is in generating growth in an economy. Barack Obama said “We have to cut spending we can’t afford so to put the economy on sounder footing and to give our businesses the confidence they need to grow and create jobs”. The UK and the European Central Bank (ECB) are also followers of Obama and argue that cuts to government deficits add to the GDP of an economy. The ECB argues that a fiscal contraction (reduced government spending and increased taxation) may turn out to be expansionary if expectations of lower future taxes and higher lifetime earnings become particularly strong. However, recent research states that this hardly ever happens. A study of 173 fiscal-policy changes in developed economies between 1978 and 2009 showed that cutting a budget deficit by 1% of GDP on average:
* reduces real output by about 2/3 of 1%
* increase unemployment 1/3 of 1%
There have been some cases where economies have grown with the implementation of austerity measures.
In Denmark between 1983-86 budget cuts actually led to a rise in domestic demand and consequently GDP. However its economy was already growing at 4% when austerity commenced. Furthermore, interest rates already at 23% came down as the fiscal environment improved. House prices rose by 60% increasing wealth and confidence.
Between 1987-89 improved budgetary conditions led to greater growth in the Irish economy. Again, like Denmark, Ireland had high rates of interest (13%) and with a more prudent approach rates dropped as did the Irish currency (the Punt) at the time. This led to an increase in exports by 10% from 1987-90 accounting for most of the growth of the Irish Tiger.
From 1991 – 1998 budget surpluses were used to pay off debt. But it was Italy’s exit from the Exchange Rate Mechanism (ERM) – see previous post on ERM – that led to a 40% decrease in value of the Lira against the D-mark. Again a weaker exchange rate led to more competitive exports and the Italian current-account went into a surplus and GDP increased.
The success of austerity programmes are characterised by initially high interest rates and weaker currencies which have led to export growth. However, America will struggle to replicate these as:
1 Their interest rates are near 0% already
2 Export volumes will be hampered by weak demand because of debt reduction in other developed nations.
3 Exports only account for a small proportion of their GDP
4 With China holding so much debt in US$ they will not want to see a dollar depreciation.
With the CIE and NCEA exam fast approaching there is usually a question that refers to economic policy in economies. Monetary and Fiscal Policy are two that are covered in significant detail and you will be aware of the following:
Monetary Policy - the way in which interest rates and money supply are used to manage the overall level of economic activity and achieve government targets for inflation, unemployment, economic growth and balance of payments.
Fiscal Policy – the use taxes and spending by the government to manipulate aggregate demand and influence the overall economic activity in the economy.
It is puzzling to observe the implementation of monetary policy by the European Central Bank when you consider the correlation between the interest rates movements and the economic environment in the euro area. I have put together a flow diagram below that shows the steps taken by the ECB since 9th July 2008.
* 9th July 2008 ECB IR↑= 3.75% – Just before finaincial crisis – ECB concerned about inflation
* 21st Jan 2009 ECB IR↓ = 2% – Sept 2008 – global economy collapses and inflation not an issue
* 13th April 2011 ECB IR↑ = 1.25% – Europe – high unemployment, low growth, debt crisis. ECB raises interest rates?
* 13th July 2011 ECB IR↑ = 1.50% – Debt crisis worsens and no growth. ECB raises interest rates again?
* Austerity measures – slash gov’t spending and raise taxes = little or no growth.
The euro zone’s concerns are that debts levels are too high and economic growth is too low. But are the debt levels this large because of too slow growth or the fact that some countries don’t have an efficient tax collection system – eg. Greece? When you relate the ECB policy with that of the US Federal Reserve there are differing opinions on how to use monetary and fiscal policy.
US Fed Model
Expansionary Fiscal Policy – extension in unemployment benefits and temporary tax breaks for low and middle-income households.
Expansionary Monetary Policy – low interest rates and quantitive easing.
Contractionary Fiscal Policy- strong austerity measures
Contractionary Monetary Policy – higher interest rates
The ECB might be concerned with dampening inflation but with the CPI at 2.5% prices are not really unstable. Are they repeating the mistakes of the early 1930′s? Then the tight monetary policy and austerity measures led to the Depression. Furthermore it appears that neither the policies of the US Federal Reserve nor the ECB are actually working.
You might have come across this on the BBC news. Alessio Rastani is an independent trader and dreams of recessions to make money. He states that the market doesn’t really care about rescue packages for euro zone countries as they believe Greece etc are going to default anyway. His suggestion that we should buy US$’s as a safe haven was an interesting point – surely they are in enough trouble as it is. He did say that:
“Goldman Sach runs the world NOT your goverments”.
However, markets have risen on the news that the Greek parliament approved a new property tax, a key condition of gaining more financial aid for the debt-laden country.
The recent OECD* survey on the Icelandic economy paints a rosey picture when you consider what has happened to its economy over the last 3 years. Iceland’s approach has been different to that of the US and Euro Zone counterparts. Instead of introducing policies of quantitative easing and bailouts of banking institutions the Icelandic authorities allowed its banks to fail. Foreign debt, which totaled US$62 billion, left the country with no real choice but to default on the banks’ creditors. This policy has been called “Bankrupting your way to recovery”. In a recent radio interview on the BBC Iceland’s president Olafur Ragnar Grimsson said that Iceland’s approach is about much more than getting the banking sector operational but affirming the will of the people over the financial institutions. Iceland’s GDP for the last quarter is 2% and unemployment is at 5.8% – the latter being high by Icelandic standards.
Compared with the likes of Greece and Ireland who have gone through similar debt problems the one key option with is not open to its eurozone counterparts is that Iceland had its own currency the Krona. As the economy and banking system collapsed so did its currency which has its advantages and disadvanatges.
* The price of visiting Iceland has effectivley halved – Reykjavik was seen as one of the most expensive places to visit as a tourist
* As most of Iceland’s consumer goods are imported this has meant higher prices of cars, food, electronics etc.
Should Greece and Ireland learn from this? According to Stephanie Flanders – BBC Economics Correspondent – Greece already had huge amounts of debt before the crisis unfolded and it doesn’t hold much relevance as Iceland had no public debt at this time. However Ireland, like Iceland, had handled its public finances well but its financial framework poorly.
*Organisation for Economic Cooperation and Development – The OECD provides a forum in which governments can work together to share experiences and seek solutions to common problems.