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Global Business 3rd Edition by Mike Peng
Edition 3ISBN: 978-1133485933Global Business 3rd Edition by Mike Peng
Edition 3ISBN: 978-1133485933 Exercise 11
In May 2010, Greece suffered from an economic collapse, which brought the biggest bailout in EU history. The €110 billion ($146 billion) bailout loan was jointly funded by the EU and the IMF, and the harsh medicine associated with the rescue dictated that the Greek government unleash sweeping reforms to put the country's financial house in order. Public sector pensions and wages were cut 15% to 20%. Value added and excise taxes were raised twice in 2010. Such shock therapy generated widespread misery and protests. Yet, the Greek government, led by the American-born prime minister George Papandreou, who came to power in 2009, stood firm. The prime minister argued that Greece must "bite the bullet" to avoid the totally tragic ending of this tragedy, such as sovereign debt default (known as national bankruptcy in layman's terms).
What led to this mess? Consumer demand increase and government spending binge fueled by the 2002 adoption of the euro and the 2004 Olympics. Excessive borrowing and budget deficits supported by low interest rates. Widespread corruption and tax evasion. The shadow (informal) economy that produced no tax revenue was estimated to be between 20% and 30% of the GDP. The upshot? Rising wage levels not justified by productivity growth, which made Greece lose competitiveness in export markets relative to countries such as Germany that held down their wage levels. Another symptom is skyrocketing government deficit (15% of GDP) and crushing national debt (€300 billion-115% of GDP or $27,000 per citizen by 2010). In early 2010, when the bond market realized that Greece was approaching insolvency, the interest for bonds that the Greek government had to pay (technically known as the bond yield) rose sharply from a more normal 7% to 18%-within one month. Facing the unbearable cost to borrow and the inability to service debt, the Greek government had to ask for help from the EU and the IMF. Within one week of the bailout, Greek bond yields went down to 12%.
While the tragedy was Greek in origin, its script had been in the minds of officials from Greece and other euro zone countries who signed the Stability and Growth Pact (SGP) in 1997. To reduce the hesitation from Germany and other more disciplined countries that they might have to bail out bankrupt members, the SGP committed all euro zone countries to bringing their budget deficit to be no more than 3% of GDP. Otherwise, countries could be fined. Essentially, the SGP meant "no bailouts." However, even before the 2008-2009 global economic crisis, Germany and France failed to curtail their own deficits to be less than 3%. In other words, they were in open defiance of the SGP, essentially free riding. When the recent recession hit, virtually all EU members adopted fiscal stimulus measures to cope. In 2009, the EU fingered not only Greece, but also France, Ireland, Latvia, Malta, and Spain as violators of the SGP, because they ran a budget deficit of more than 3% in 2008. But it was hard to imagine how the EU could fine these countries in the middle of a recession. Overall, the SGP failed: Greece's deficit was more than four times what the SGP allowed.
"The best way to think of it is to think of Greece as a teenager," noted one expert, who continued:
Many Greeks view the state with a combination of a sense of entitlement, mistrust, and dislike similar to that of teenagers vis-à-vis their parents. They expect to be funded without contributing; they often act irresponsibly without care about consequences and expect to be bailed out by the state-but that only increases their sense of dependency, which only increases their feeling of dislike for the state. And, of course, they refuse to grow up. But, like every teenager, they will.
While these comments described the relationship between Greek citizens and the state, they also provide a great deal of insight into the relationship between Greece and the EU. But the metaphor can only go so far. At the end of the day, Germany is not Greece's parent. Although both countries belong to the "euro family," German citizens and politicians were naturally furious as to why in the middle of their worst postwar economic crisis, they had to foot the largest bill to bail out the profligate Greeks.
The tragedy was not only Greece's or Germany's, but also the EU's. It severely tested the logic of the EU-and in particular the logic of the euro-whose member countries are not only unequal economically but also different in their spending and saving habits. Dumping the euro by individual countries was no longer unthinkable, but was increasingly discussed. During a crisis, leaving the euro zone would allow Greece to depreciate its own currency, which would enhance its export competitiveness. Dumping the euro would also relieve Germany's responsibility to come to the rescue. But here is the catch: a revived Deutsche mark would certainly appreciate and undermine Germany's export competitiveness. In the end, a reluctant Germany-and a reluctant EU-had little alternative.
In addition, the EU set up a €750 billion ($980 billion) euro zone stabilization fund (including €250 billion from the IMF), which is called European Stability Mechanism (ESM). Germany, which pledged €220 billion, demanded stronger fiscal discipline in the name of better "economic governance" from all members, and threatened sanctions (such as being fined and losing voting rights) if certain members failed to meet the necessary criteria. Otherwise, the EU risked becoming a "fiscal transfer union" draining funds from the wealthier and more thrifty North to the less wealthy and more heavily spending South. Since these proposed new rules could not name any individual countries, they had to apply to all member countries. But then, Germany and France would never agree to being fined or denied a vote. So, debates raged and feelings became bitter.
At the same time, other PIGS countries (Portugal, Ireland, Greece, and Spain) entered deeper crises one after another. In November 2010, Ireland had to be rescued by €85 billion ($113 billion). In April 2011, Portugal requested to be bailed out. Spain and Italy were widely reported to be the next. In July 2011, it became increasingly clear that Greece, despite the €110 billion first bailout, would default. The same drama of the Greek government requesting assistance, of EU governments debating what to do, and of the Greek public protesting in the streets unfolded again-in a dramatically worsening way. Thanks to the harsh austerity measures, the Greek recession since 2008 worsened. Overall, the Greek GDP had its worst decline in 2011, with 27%. About 111,000 firms went bankrupt (27% higher than in 2010). Unemployment rose from 8% in 2008 to a record high of 20% in 2011, while youth unemployment during the same time rose from 22% to 48%. There were only so many austerity measures that a frustrated and largely unemployed public (especially the youth) could take. Street protests became a daily routine.
By the end of 2011, Papandreou announced that his government would subject new austerity measures demanded by the EU to a referendum, which most likely would not approve such measures. For the first time, "merkozy"-German chancellor Merkel and French president Sarkozy-broke the taboo and openly threatened to kick Greece out of the euro zone. While Greece would be free to devaluate its revived old currency (the drachma) to avoid hitting rock bottom, the chaos of defaulting on all domestic and international contracts denominated in euros and then renominating everything in drachmas, with no further help from the EU, would have been more unbearable to Greece. In December 2011, Papandreou resigned. A new interim national union government led by Lucas Papademos committed itself to new austerity measures in order to sail out of the storm. By the end of 2011, euro zone leaders agreed to provide a second, €130 billion bailout loan, conditional not only on another austerity package but also that all private creditors agree to write off 50% of (some part of) Greek government debt, the equivalent of €100 billion. After implementing all of the above, Greece's debt load would be reduced from about 200% of GDP in 2012 to a more manageable 120% by 2020. The second bailout package was finally signed off by all parties in February 2012 and activated in March 2012. As Greece continues to struggle, how (bitter) the tragedy will end remains to be seen.
Case Discussion Questions :
What are the benefits and costs of using a common currency for Greece, Germany, and the EU?
What led to this mess? Consumer demand increase and government spending binge fueled by the 2002 adoption of the euro and the 2004 Olympics. Excessive borrowing and budget deficits supported by low interest rates. Widespread corruption and tax evasion. The shadow (informal) economy that produced no tax revenue was estimated to be between 20% and 30% of the GDP. The upshot? Rising wage levels not justified by productivity growth, which made Greece lose competitiveness in export markets relative to countries such as Germany that held down their wage levels. Another symptom is skyrocketing government deficit (15% of GDP) and crushing national debt (€300 billion-115% of GDP or $27,000 per citizen by 2010). In early 2010, when the bond market realized that Greece was approaching insolvency, the interest for bonds that the Greek government had to pay (technically known as the bond yield) rose sharply from a more normal 7% to 18%-within one month. Facing the unbearable cost to borrow and the inability to service debt, the Greek government had to ask for help from the EU and the IMF. Within one week of the bailout, Greek bond yields went down to 12%.
While the tragedy was Greek in origin, its script had been in the minds of officials from Greece and other euro zone countries who signed the Stability and Growth Pact (SGP) in 1997. To reduce the hesitation from Germany and other more disciplined countries that they might have to bail out bankrupt members, the SGP committed all euro zone countries to bringing their budget deficit to be no more than 3% of GDP. Otherwise, countries could be fined. Essentially, the SGP meant "no bailouts." However, even before the 2008-2009 global economic crisis, Germany and France failed to curtail their own deficits to be less than 3%. In other words, they were in open defiance of the SGP, essentially free riding. When the recent recession hit, virtually all EU members adopted fiscal stimulus measures to cope. In 2009, the EU fingered not only Greece, but also France, Ireland, Latvia, Malta, and Spain as violators of the SGP, because they ran a budget deficit of more than 3% in 2008. But it was hard to imagine how the EU could fine these countries in the middle of a recession. Overall, the SGP failed: Greece's deficit was more than four times what the SGP allowed.
"The best way to think of it is to think of Greece as a teenager," noted one expert, who continued:
Many Greeks view the state with a combination of a sense of entitlement, mistrust, and dislike similar to that of teenagers vis-à-vis their parents. They expect to be funded without contributing; they often act irresponsibly without care about consequences and expect to be bailed out by the state-but that only increases their sense of dependency, which only increases their feeling of dislike for the state. And, of course, they refuse to grow up. But, like every teenager, they will.
While these comments described the relationship between Greek citizens and the state, they also provide a great deal of insight into the relationship between Greece and the EU. But the metaphor can only go so far. At the end of the day, Germany is not Greece's parent. Although both countries belong to the "euro family," German citizens and politicians were naturally furious as to why in the middle of their worst postwar economic crisis, they had to foot the largest bill to bail out the profligate Greeks.
The tragedy was not only Greece's or Germany's, but also the EU's. It severely tested the logic of the EU-and in particular the logic of the euro-whose member countries are not only unequal economically but also different in their spending and saving habits. Dumping the euro by individual countries was no longer unthinkable, but was increasingly discussed. During a crisis, leaving the euro zone would allow Greece to depreciate its own currency, which would enhance its export competitiveness. Dumping the euro would also relieve Germany's responsibility to come to the rescue. But here is the catch: a revived Deutsche mark would certainly appreciate and undermine Germany's export competitiveness. In the end, a reluctant Germany-and a reluctant EU-had little alternative.
In addition, the EU set up a €750 billion ($980 billion) euro zone stabilization fund (including €250 billion from the IMF), which is called European Stability Mechanism (ESM). Germany, which pledged €220 billion, demanded stronger fiscal discipline in the name of better "economic governance" from all members, and threatened sanctions (such as being fined and losing voting rights) if certain members failed to meet the necessary criteria. Otherwise, the EU risked becoming a "fiscal transfer union" draining funds from the wealthier and more thrifty North to the less wealthy and more heavily spending South. Since these proposed new rules could not name any individual countries, they had to apply to all member countries. But then, Germany and France would never agree to being fined or denied a vote. So, debates raged and feelings became bitter.
At the same time, other PIGS countries (Portugal, Ireland, Greece, and Spain) entered deeper crises one after another. In November 2010, Ireland had to be rescued by €85 billion ($113 billion). In April 2011, Portugal requested to be bailed out. Spain and Italy were widely reported to be the next. In July 2011, it became increasingly clear that Greece, despite the €110 billion first bailout, would default. The same drama of the Greek government requesting assistance, of EU governments debating what to do, and of the Greek public protesting in the streets unfolded again-in a dramatically worsening way. Thanks to the harsh austerity measures, the Greek recession since 2008 worsened. Overall, the Greek GDP had its worst decline in 2011, with 27%. About 111,000 firms went bankrupt (27% higher than in 2010). Unemployment rose from 8% in 2008 to a record high of 20% in 2011, while youth unemployment during the same time rose from 22% to 48%. There were only so many austerity measures that a frustrated and largely unemployed public (especially the youth) could take. Street protests became a daily routine.
By the end of 2011, Papandreou announced that his government would subject new austerity measures demanded by the EU to a referendum, which most likely would not approve such measures. For the first time, "merkozy"-German chancellor Merkel and French president Sarkozy-broke the taboo and openly threatened to kick Greece out of the euro zone. While Greece would be free to devaluate its revived old currency (the drachma) to avoid hitting rock bottom, the chaos of defaulting on all domestic and international contracts denominated in euros and then renominating everything in drachmas, with no further help from the EU, would have been more unbearable to Greece. In December 2011, Papandreou resigned. A new interim national union government led by Lucas Papademos committed itself to new austerity measures in order to sail out of the storm. By the end of 2011, euro zone leaders agreed to provide a second, €130 billion bailout loan, conditional not only on another austerity package but also that all private creditors agree to write off 50% of (some part of) Greek government debt, the equivalent of €100 billion. After implementing all of the above, Greece's debt load would be reduced from about 200% of GDP in 2012 to a more manageable 120% by 2020. The second bailout package was finally signed off by all parties in February 2012 and activated in March 2012. As Greece continues to struggle, how (bitter) the tragedy will end remains to be seen.
Case Discussion Questions :
What are the benefits and costs of using a common currency for Greece, Germany, and the EU?
Explanation
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Benefits and costs of common currency fo...
Global Business 3rd Edition by Mike Peng
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