Monday, March 29, 2010

Will Greece Government Be Able To Raise Sufficient Money To Finance Itself Out?

The recent Greece’s economic woes have certainly made its way into the heart of media. Economists, policymakers and politicians from all over the world are aroused once more. All are eager to see how the whole Eurozone economies come as one during stormy days and whether the single currency plan is viable or not in long term

How Greece end up with such mess?

Put in simple. Greece has been living beyond its mean in the past decade. To sustain such lifestyle, the government engaged in heavy borrowing and went on something of spending spree. As a result, public spending soared and public sector wages practically doubled that time. Unfortunately, this was not matched by the increase in tax revenue due to the widespread of tax evasion. However, stern action was not taken as the Greece government thought that the economic boom is likely to last ‘forever’ and they will always have their ways to finance themselves out

Hence when the global financial crisis hit out of nowhere, Greece was too ill-prepared to cope. The reported budget deficit was 12.9% last year, somewhat 4 times above the permissible level under the Growth and Stability Pact. Meanwhile the forecasted national debt is expected to exceed 130% in year 2011, again overshooting the stipulated level of 60%

Will Greece be able to get the funding needed?


(1) Initiative to fix its balance sheet. Whatever is the argument, it seems that this round the Greece government is really committed to bring the deficit under control. It has enacted an unpopular but necessary measure of fiscal austerity. There will be freeze on public sector wages. Retirement age on the other hand is increased to reduce the burden of pension payments and lastly the fuel taxes raised. If all these are successful to hammer the deficit, ideally market participants would be less ‘disturbed’ and once more willing to buy the bonds issued

(2) Higher interest rates. Usually, private sectors will be very glad to snap up government-issued bonds. This is because it is perceived as safe, upon the assumption that governments usually don’t default. Furthermore, investors are guaranteed a steady stream of income periodically, depending on the promised interest rate. However, this is not the case for Greece. Its government had overspent in the past and signs of defaulting are imminent. Even rating agency like Fitch downgraded its credit rating to BBB+, the lowest among 16 euro nations. Given that the risk of lending has increased, the only way to get the finances needed is to increase interest rates offered. That is a must to compensate the risk that bond buyers are assuming

(3) Joint-bail out programme. The plan was worked out in Brussels, and yes Greece is guaranteed a safety net of up to 22 billion euros if it fails to obtain the credit needed. But of course, the move has irritated some of its European partners like Germany. Chancellor Angela Merkel has strongly urged that Athens itself can solve the problem and any form of bail-out shouldn’t be allowed under the single currency rules

I personally feel that she should be more rationale and flexible. Such rigidity will only force Greece to fall out from the common currency area where once again it could allow its currency to fall in value and therefore gain some competitive ground. If that were to happen, we know that Portugal, Ireland and Spain (PIGS) will soon be tempted to do the same. The financial exodus would cause huge ruptures in the financial markets as investors are fearful that other nations might follow suit, thereby leading to the breaking up of monetary union

May not be able to get sufficient funding:

Fall in income. This is the most fundamental economics argument. Slash in public spending followed by rise in taxes will only worsen the current economic pain. This is because fall in economic growth will lead to falling average income. Households will have lesser to spend and firms facing deteriorating profits will be more reluctant to invest, thus igniting the vicious cycle over and over again through the negative multiplier effect. Putting elderly people to two more years of work will never help either, due to poorer health condition and also declining productivity. Not to forget, lower take-home pay will further erode the level of savings in Greece’s banks, which are also the biggest fans of government bonds

(2) Shaky investors’ confidence. When it comes to financial market, all I can say is sentiment. Consider Japan with its national debt of 190% of GDP and Singapore 118% of GDP. Despite close to or much higher than the level of Greece for some time, there is not much fuss about it, all because these two countries have high income per capita and of course better reputation in debt repayment. On the other hand, Greece just like Argentina has varying degrees of debt default. Therefore they are having such tough time convincing the investors that it will not happen again

Well, maybe investors are right this time. Debts too high for such size of economy, unemployment of 10%, fiscal and monetary constraint all sum to one word-default. The evidence is there and it is just some of us choose to ignore. Greece’s two-year government bonds are persistently on a heavy sold off. As the supply of bond in market increases, its price will fall. But investors are promised a fixed amount of return, which means that the effective interest rate attached onto it must increase. Because of this, Greece government has to pay 6%, double what Germany has to pay. This indicates how risky investors think it is to hold Greece debt. Most of the money fled to other safe haven

Friday, March 26, 2010

Does Globalisation Benefit Developing Countries More Than The Developed Ones?

Until now, there is no single generally accepted definition of globalisation. Put 10 different economists together and you will get 11 different definitions. However, most acknowledge that it is the process of freer movement of human, goods, capital and information due to increase in economic integration. Down the road, we have seen that level of international trade increases dramatically over the past decade, especially creation of new trade ties between the rich and poor countries

Some economists argue that such process actually benefits rich and developed nations more than the poor ones. On the other hand, some argue that the benefits accrued by third world countries have been underestimated

Why developing countries benefit more?

(1) Lift many out of poverty. It is not difficult to see why. When a transnational company (TNC) decides to relocate in low-cost economies, many new jobs will be created. It can be in production line, technical areas and also management. People who are once unemployed will now have an opportunity to improve their livelihood while those who already have working experience may be able to climb to a higher corporate platform, thus earn better pay. Consider China. It has the largest poverty reduction in history, from 250 million in 1978 to about 34 millions in 1999. Indian government, has successfully cut poverty rate by half despite late in opening up their economy

(2) Backbone of growth. With globalisation, goods can easily penetrate the borders of other countries, thanks to the prominent role played by WTO. With its establishment (previously was GATT), global tariffs on average has been reduced from 40% to just 4%. Low-cost Asian economies have the most to benefit from this. This is because of the comparative advantage in manufacturing sector. Unskilled labours are in abundance and yet level of productivity is comparable. Besides natural resources are easily obtainable which further reduces the production costs. As such local economies can pursue export-led growth, a buzzword synonymous with China. Such strategy allows economic diversification, rather than just having a typical primary sector. The impact onto local economy can be magnified through multiplier effect. Perhaps this explains, why China can register double-digit growth in the past few years

(3) Exposure to competition. Firms which were once operating behind walls of barriers will now be forced to be more competitive. Failure to do so, will force them to exit the industry very soon. Local firms will now be more careful with the allocation of scarce resources to ensure there is no wastage. They will employ the most efficient techniques of production. Innovation and R&D activities will increase to ensure the rolling-out of new products, to satisfy consumer needs. Workers must continuously improve their productivity to ensure that they are still relevant. All these when combine, will have a powerful supply-side effect that will ensure the success of local economy in long run

(4) Cheaper price and more choice of goods. That’s simple. Say, a country produces barley. When barley is also sourced from outside that means supply of barley in the economy will increase, causing its price to fall. That’s something to be cheered by most consumers who are best categorized as low to middle income earners. Consumer surplus will increase too since the gap between what they are willing to pay and what they are actually paying increases. On top of that, standard of living will also increase when there are more choice of goods

Why rich countries benefit more?

(1) Widening income inequality. Fragmentation of production process is driven by the goal of cost-minimising. In many parts of Asia, labours are cheap, productivity is considerably high, raw materials are easily obtainable and cost of shipping has fallen. Goods are produced with the lowest cost possible and in most circumstance, cost saving will not be passed on to foreign buyers when the goods are shipped back to home country. Entrepreneurs are reaping higher supernormal profits, while management will reward themselves with fat bonuses leaving nothing for those grass-root workers. Even if there is, the reward might be insignificant. This partly explains for the widening income inequality between the developed and developing nations. While I agree that very few people will make a huge fortune out of this, they are normally the firm owner which runs business that supply raw materials to foreign firms

(2) Low reinvestment onto local economy. In theory, foreign firms will reinvest part of their profits into the local economy hence giving the economic growth a boost. In reality, most of the post-tax profits will be repatriated towards home country, hence very little left to generate value for local economy. Local suppliers of raw materials and capital goods may not benefit from this. In some worst case scenarios, local firms will relocate to another place when the period of tax concession is over. All I can say is no reinvestment and no tax proceeds for government

(3) Source of environmental hazard. There is no way we can claim that standard of living in developing nations has increased when those countries become the house to so many factories which over-operate. Water and air pollution are inevitable. Noise pollution is out of control when houses are located near to factories or construction sites. Congestion is becoming more prominent when an area is designated for factories. It is worth to note that 1st world countries have ‘shifted their problems’ to the 3rd world. Air is cleaner over the other side. Their factories use clean technology unlike those in Asia. What’s more when the environmental law is weak

(4) Exploitation of labour. Perhaps proponents of globalisation have exaggerated their stand. Claiming that the standard of living in developing countries has increased based on real GDP per capita may not be that accurate. While it is true that unskilled workers have received an increase in their paycheck, it is nothing close to an increase in their workload. In short, an increase of wages by 10% leads to an increase of 50% in works. One does not need to be a genius to see how factory workers are exploited in China. They are paid peanuts and yet overworked. Women suffer the most in terms of discrimination in workplace. Labour union is weak and the existing law is just too fragile to uphold justice for them. Also some workers may be put to work under unsafe conditions. For instance, child labour in mines

(5) Put more into poverty. While it is true that many jobs are created when foreign factories and firms are opened, there are even more unseen job losses. Some claim that every one new job created, up to three will be lost. Think about this. How many local firms that really have the competitive edge to race against giant conglomerates? Nearly none. In short, industrial liberalization rewards the competitive firms and penalizes those uncompetitive ones which are made up of majority. Job creation is insufficient to offset the amount of job losses. If globalisation brings so much benefit, then how come 80% of the global populations earn only 20% of global income?

(6) Domination of local economy. Poor countries often become the subject of biasness. The WTO although in theory is said to be an independent organization, is not more than a puppet to rich and powerful nation like US. Poor countries are often urged to open up their economy to the import of agriculture goods from 1st world. On the other hand, it does not take any serious action when US and EU have such thick tariffs protecting their agriculture and dairy industry against agricultural produce from the 3rd world. Also through influential organization like IMF and World Bank, powerful countries have become the shadow that meddles with the fate of HIPCs (Highly Indebted Poor Countries). Many ill-suited policies are fed onto 3rd world which creates more harm than good. The intention is to keep them begging for more financial aid and hence being locked into more pricey agreement which they cannot commit

What Expedite Globalisation?

(1) Advancement of transportation system. Transport efficiency whether through the sea or air is as a result of continuous innovations. Ships and cargo planes have not only become larger but also faster. Goods that are ordered from another country can reach in another country in a matter of weeks. On top of that, the cost of doing so is cheap too. One of the reasons is emergence of many firms which create price competition. Secondly is due to the principles of dimension, where increase in cost is slower than the rate of increase in capacity. This will definitely encourage more goods to be delivered, since cost per unit of delivery is lower now

(2) Fast-evolving communication technology. There is no longer the need for someone to travel to another country just to have a look and place an order for the goods. One can easily view the goods online and communicate with the overseas supplier through channels like e-mail, phone calls or even through messages. Channels to promote these are like Facebook, Yahoo, online forums and especially e-bay

(3) Emergence of MNCs. MNCs (Multinational Companies) refer to firms that have operation in more than one country. There are many reasons why MNCs would like to expand their operation worldwide. Some of them are like saturated market in home country, to increase supernormal profits, to take advantage of weaker environmental law and especially abundance of cheap labour. For whatever reasons, their decision to relocate overseas has big impact. For instance, I will not be able to enjoy Krispy Kreme, Burger King, Starbucks and many more if these foreign firms do not relocate to Malaysia. By operating in other countries, goods and services which used to be available only in US, can now be enjoyed by people worldwide

(4) Establishment of trading blocs. Also known as trade pacts. Countries which belong to the same pact will give trade preferential to one another such as reduction of tariffs while at the same time imposes trade barriers to non-members. Most commonly cited examples are like EMU, NAFTA and MERCOSUR. This is said to expedite globalisation since member countries will trade with one another at greater intensity. Main reason is because of cheaper cost. For instance Germany may find cost of importing lamb from France is now lower than from New Zealand. However some may argue that the globalisation process is not expedited. It merely diverts one to another

(5) WTO. The role of WTO is instrumental in promoting the spirit of free trade. Here WTO will oversee the rules of international trade and policing countries that engage in such activity. As a result, the average world tariffs have fallen from 40% to just 4%, ever since the Second World War. This means it will be easier for foreign goods to penetrate local economy hence facilitate globalisation. WTO is also said to be very strict in accepting new member countries. Applicants must be able to prove that the remaining protectionist measures are not excessive or likely to be scrapped off in near future. That explains why Russia and Iran still fail to gain admission