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Saturday, September 21, 2013

A Dutch Disease in Greece?

Economists are a special breed: they are so wonderfully eloquent when it comes to explaining the past and, oftentimes, so terribly incapable of predicting the future in simple ways. Personally, I prefer their wonderful explanations of the past over their wrong predictions of the future because those explanations can really open one's eyes: one suddenly understands something by which one was puzzled before.

This is what happened to me when I learned about the Dutch Disease. I learned about the Dutch Disease through an article by Prof. Hans-Werner Sinn about Mongolia. This theory suggests that when a country generates a lot of foreign revenue through activities which have little domestic economic value creation (such as the export of natural resources), it tends to damage the domestic manufacturing and/or agricultural sectors.

The logic is simple: a country exports a lot of natural gas (little domestic employment) generating a lot of foreign revenue; foreign revenue drives up domestic prices and makes the country's manufacturing and/or agricultural sectors uncompetitive. According to Prof. Sinn, Mongolia lives on the export of natural resources.

Greece had invented the ultimate export product which generated virtually zero domestic employment: Greece exported promissory notes for debt. In a way, those promissory notes were the entry visas for capital desperately waiting to cross the border into Greece. Foreign capital flowed into Greece; domestic assets prices and other costs exploded; imports became cheap; the domestic manufacturing and/or agricultural sectors declined. Unemployment could be avoided as the government hired 'surplus people'. All of this worked well until foreign demand for Greek promissory notes collapsed.

Capital flows have a lot to do with confidence and confidence is an intangible value. When a Drachma-Greece joins the EU, confidence goes up and capital starts flowing. When an EU-Greece joins the Eurozone, confidence explodes and the capital flow turns into a tsunami. A tsunami of foreign capital can endanger ANY economy which allows free capital flows, even the strongest one. The verdict is still out whether Switzerland will ultimately be successful with its measures to keep the value of the CHF under control.

When capital flows in the form of debt (instead of equity), things get particularly chancy because interest must be paid on the debt and, eventually, the borrowed money must be given back. On the other hand, debt is not bad per see. It all depends what it is used for. If I could borrow USD for 30 years at a fixed rate of, say, 1% and use the debt to buy 30-year treasuries at a fixed yield of, say, 3%, I would have a 2% profit margin locked in for 30 years. The more I borrow, the better it is.

Whatever the EU decides to do by way of an economic recovery plan for Greece (if it ever decides to make such a plan), the key issue will be the question of how such recovery monies should be used. If they are used the wrong way (as in the past), they will only increase the damage of the Greek Disease in the longer term.

Personally, I have a strong bias that monies are best used when they are used by those who own it. Many of the terrible decisions in the world of finance have their origin in the fact that bankers deal with other people's monies and not their own. In practice, this would suggest that support monies for Greece would be best used if they came directly from foreign investors and not through intermediaries.

Suppose the EU established a 20 BEUR Reconstruction Fund for Greece to be administered jointly by the EU and the Greek government. Does anyone want to make a guess how much of those funds would end up where it is supposed to end up? (i. e. in value generating enterprises and projects). Or could someone imagine that part of those funds will end up in places where they should not be?

Suppose, instead, that the EU established incentives and support mechanisms (such as guaranteeing the political risk, including that of a Grexit, on foreign investments) which lead to 2.000 foreign investments of 10 MEUR each in new middle market enterprises/projects in Greece. Would those 2.000 foreign investors who still carry the economic risk of their investments not make sure that their monies are spent wisely?

And one alternative is always not to send money but to send machinery & equipment instead.

1 comment:

  1. This is interesting, althought i disagree in some.

    Prof. Hans-Werner Sinn is always ingenious. He means that even if we discover natural gas still we'll be like Mongolia? lol
    The analysis is very good about "zero domestic employment" .

    I have a different view, for "when capital flows in the form of debt (instead of equity), things get particularly chancy ... the more I borrow, the better it is.

    eg budget -Greece in 2007. We had around +2.5% in gdp and around +2.5% inflation. The nominal income was increasing around 5%.
    There is an empirical rule that says: only 5% in 2007 can increase budget deficit without increasing the debt-income analogy. In Greece budget deficit increased at least 8% in 2007 more than 10% in 2008
    So its not matter only of fixed rates or 30-year treasuries, its a matter of really bad management plus as you said government hired and the next years 'surplus people'!
    About the strong bias look this in Greek

    795.000 € for 2 years for a site Vignette platform (not open source), 45.000 € only the next 2 years for open source Drupal, and again open source the following years from the personel of City of Athens free of charge!

    Where is CK?

    I am honest about how to administrate money.

    20 BEUR Reconstruction Fund, compensate 600.000 unemployed as i said yesterday, or send machinery & equipment instead of money ? Its all proposals. Your last however presupposes we have found promising industries, with good advantages to promote.
    Even NOKIA failed to tackle competition.

    The issue. Troika should emphize to build not to follow the theory. Industries are leaving, only government to gain 200 m € in taxes. Industries had a total participation 25% of Greek economy in 60'-70', only 15% 2013.
    It's a mistake to force companies to leave without having a sufficient plan, 10 years ahead troika read it ever?


    Viohalco is a good company, in Belgium debt might be 60% lower in servicing than Greece, (3E, S&B, FAGE left also ).
    Confusing taxation, bureaucracy, cost of energy, difficult to understand investment laws AND banks without liquidity.
    In Germany SIEMENS if decided to leave what would happened ?

    Viohalco has around 8% of total Greek exports.