Monday, February 25, 2013

The crux of the matter - Foreign funding

An apparently very informed person who writes anonymously (a British consultant who has lived in Greece since 1998) wrote the following in another blog:

"The Greek economy in its entire history has been dependent on loans, external aid, privileged access to markets, etc. At no point since 1832 has it ever been a viable economy, in the sense of balanced internal and external accounts while being able to employ its population. Even with massive loans and inflows, the economy was not able to achieve a reasonable employment rate. The closest was in the mid 1990s, with cheap, illegal and plentiful Albanian labour — which represented a form of subsidy to Greek small businesses."

I cannot confirm that this is correct, but it sounds very plausible. What is the lesson from that?

Picture an oasis in the middle of the desert where the water supply is sufficient to make everything blossom. Picture that very same oasis where the water supply declines and about one-third of the oasis is drying out. Now, there are at least the following two possible consequences:

One, foreigners send enough water to the oasis so that it can blossom again. Two, foreigners invest money into the wells of the oasis so that the oasis can produce enough water for it to blossom again.

Greece is the oasis which has lost the water supply out of its own wells (it may not ever have had it). The focus seems to be on sending more water to Greece. The focus should be on investing money into the repair of Greece's own water supply. 

From 2001-10, the Greek economy has received about 30 BEUR annually in the form of foreign water supply. Still, the economy never reached more or less full employment. One can imagine where the economy would be if it had not received water supply from abroad, i. e. funding from abroad.

Today, the foreign water supply, i. e. the foreign funding, has very much dried out. Greece was forced to live on its own water supply (i. e. the current account was brought into balance). The result is unacceptable unemployment. The conclusion is that, at the present stage of the Greek economy, it cannot employ its people unless there is water supply from abroad (i. e. funding from abroad).

What is 'funding from abroad'?

The unequivocal measure is a country's current account. The current account represents something like the 'cash flow from operations of a country'. It shows how much a country earns abroad by exporting products and services and how much it spends abroad for imports. If the current account is in surplus, the country will automatically export capital (net) in the capital account. If it is in deficit, the country will need to import capital (net) in the capital account. 

Typically, a country which is still very much in an economic development phase will need to import capital for the simple reason that its own economy does not generate enough savings to finance the necessary growth. Importing capital is not at all bad per se. On the contrary, it can become the gasoline to fire the engine of domestic economic growth.

What are the classic sources of capital imports? Here they are:

* Remittances by nationals working abroad - this is the classic story of the 'Greek guest-workers' in Northern countries. They literally worked their asses off, spent nothing on consumption and sent all their savings back home where they were invested in housing, perhaps new businesses and - above all - in the education of their children. From 1950-74, the remittances by Greek guest-workers were by far the largest source of foreign revenue of the country. I am still waiting for the 'Construction of a Monument in Honor of the Greek Guest-Workers'!
* Grants and subsidies from abroad - examples here would be EU-subsidies or, for that matter, the Marshall Plan after WWII.
* Direct investment from abroad - particularly in the last decade, foreign direct investment has declined dramatically in the case of Greece.
* Loans from abroad - this is the catch-all category. If nothing comes from remittances, from grants/subsidies, from foreign direct investment - then it has to come in the form of loans. Remittances, grants/subsidies and foreign direct investment have the great advantage that they carry no obligation to repay them nor do they carry interest. Loans carry both - the obligation to repay them and the obligation to pay interest. The Greek economy was brought to where it is today by the wrong choice of capital imports, i. e. by loans which carry the obligation to repay them and to pay interest.

Now, someone like Alexis Tsipras may well convince Greeks that they should be giving foreigners 'the shaft', that Greece could live very well within its own means if it only were given the freedom to choose. Maybe yes, maybe no. I would argue that Alexis Tsipras is up against the facts of economic history of Greece of almost 200 years.

Greece MUST pursue a strategy of importing capital to finance the economic growth which it needs (I hasten to add that 'importing capital' includes the return of foreign deposits of Greeks). However, there are provisos:

One: to import water because one's own wells have dried out and to use the water only for drinking is not a good idea because one makes oneself totally dependent on others who send water.

Two: to only borrow water is not smart because someone will sooner or later require that the water is given back.

And the conclusion is...
Greece MUST focus on capital imports which stay in the country because the importers of capital think that their capital is put to profitable use in the country.

There is only one alternative to this. Greeks could discredit foreign investment (or investment in general because investment is ideologically bad per se since it only make the capitalists rich). That would be a legitimate choice.

Whoever proposes this choice ought to understand that they will put Greece on a road to become something like a Cuba in Europe.

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