Capitalism &

Freedom: Will the

Euro crisis become a
Global Problem?
Team Name: Euphoria

Shraddha Kamat Aditya S Prakash

shraddha.kamat@nmims.edu aditya.prakash@nmims.edu
9222167824 9833692253
FTMBA Core, 2009-11 FTMBA Core, 2009-11
NMIMS NMIMS
 Capitalism & Freedom: Will the Euro Crisis become a global problem?

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 wages with respect to productivity,

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
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.
in

2
 Capitalism & Freedom: Will the Euro Crisis become a global problem?

GDP Miscalculation them out of the exchequer in the form of

social security. To make matters worse, a
Greece was living on the assumption that
populist Greek government had not only
Debt to GDP ratio will not matter. GDP was
promised to increase the wages but also
growing at a rate of 4-5%, actually fuelled
decreased the retirement age. The pensions
by a massive debt borrowing. During the
for all these retirees will be borne by the
recession, with the liquidity crunch, the
government.
Greek economy contracted; bringing down
the growth in GDP to 1-2% and making the
effect of additional debt evident.
Economic Rationale behind the Crisis

When Greece joined the Euro zone, it gave

Over Dependence on Few Industries up all control over its monetary policy.
Greece cannot print currency nor can it
The economy of Greece is dependent on two
devalue the euro. Thus, Greece is stuck in a
industries, namely, tourism and shipping.
situation where Greek economy isn’t
The financial crisis of 2008 adversely
competitive, has high debt and expensive
affected the tourism and shipping industry.
exports.
Moreover, the shipping industry is cyclical
in nature. Greece’s excessive dependence on Greece also has great instances of tax
only these industries for economic growth evasion. This has reduced the revenue of the
puts it at a greater risk than other countries. government.

Therefore, where,

Aging Population

The aging population of Greece is also a

(C + I + G) (X - M)
cause of concern. According to OECD
Y Budget External
estimates, 18.7% of Greek population is Deficit Deficit

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

2050, it is estimated to be around 32.5%.
consumption (Y) is broken down into two
The aging population does not contribute to
parts – consumption fueled by domestic
the GDP but provisions have to be made for

3
 Capitalism & Freedom: Will the Euro Crisis become a global problem?
FIGURE 1: TRADE DEFICIT/SURPLUS (IN BILLIONS)
-69
-55
-34
-19
Portugal Italy Greece Germany Spain

110
spending and consumption of foreign goods. This Twin Deficit has become unsustainable
There was high budget deficit as the and has reached almost 13.6% of the GDP.
government was spending more than what it
was receiving. Some of the spending was in
the form of social security provided to the Monetary Astringency
aging population whose retirement age was
Due to unsustainable fiscal policies and an
being increasingly reduced.
unsustainable current account situation,
The second part of the fiscal deficit comes foreign direct investment and hot money
from the net of imports and exports. The inflows suddenly waned and/or reversed.
high standard of living of the people of The outflows through the trade account
Greece and excess money in the hands of the coupled with hot money outflows
people, in the form of low taxes, encouraged necessarily (due to the currency regime in
imports. Adoption of the hard currency place) produced a contraction in the money
regime initially spurred massive inflows of supply, triggering a spike in interest rates
foreign direct investment and hot money and a deep recession.
inflows. This excess liquidity (which
monetary authorities couldn’t control)
increased currency in circulation. This led to Capitalism & Freedom
excessive consumption which has led to a
Although, both were present in the Euro
trade deficit in the balance of payments
zone, neither Capitalism nor Freedom has
(Figure 1).
brought Euro zone to this state of affairs.

4
 Capitalism & Freedom: Will the Euro Crisis become a global problem?

Capitalism encourages profits but not They should diversify by investing in

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
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.
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
by 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 other
countries. 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

5
 Capitalism & Freedom: Will the Euro Crisis become a global problem?

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