The following analysis of the European Debt Crisis is a composite work by a number of Flex MBA students and Full-time MBA students who participated in recent international travel to Europe to explore the European Union’s financial issues in person with Professor Dick Flood. — Amy Blackburn
It is important as Americans to understand the European economic crisis in order to gain insight to apply to our own lives and businesses to repair and build a better global economy. While we are facing many similar hardships, Italy and Greece are dramatic examples of the consequences of a recessionary, if not depressionary, economy. The European Union (EU) formed a single currency in 1999 as a way to promote free trade within Europe as well as to stimulate Europe’s global relevance. When this happened, the world economy overall was very prosperous as emerging economies began to flourish and spending was on the rise. Unfortunately, as economic bubbles began to be revealed, many countries did not have a strong economic foundation to support payments accrued due to excess. The most obvious error that Italy and Greece made during the time of prosperity was the growth of the public sector.
The early 2000s should have been a time of innovation and development of private enterprise. Many countries had the means to build up their markets to levels that could become self-sustaining. Capitalism had a chance. Instead, Greece borrowed too much and Italy simply did not grow enough.
So in the year 2013, our William & Mary MBA class found both countries in a state of political stalemate and capital collapse. Visits with a senior economist from the U.S. Embassy in Rome; Deloitte in both Italy and Greece; Ernst & Young; and the Bank of Greece gave great insights into what happened as well as why, and what we might expect in the future from Italy and Greece. Those meetings evoked thoughts of how these foreign cultures, attitudes, policies and politics can affect our domestic future, our country and the generation we leave behind.
Marco Vulpiani of Deloitte in Rome pointed out that there are no venture capitalists or angels in Italy, no one willing to extend financial assistance to entrepreneurs. He suggested having a large capital base to be successful as a business, but this is problematic because Italian companies are traditionally small, family-owned businesses and must be very creative in raising capital because of the high leverage as banks consider them at high risk of default. From 2008 to 2012, the growth of Italian small business enterprise was close to zero because as new businesses emerged, the same numbers of businesses closed their doors or were acquired by larger firms. Bureaucracy prevents new entrants to the economy. Ross Campbell of the US Embassy in Rome noted that it could take several piles of paperwork for a prospective business owner to get even a license, let alone a lease or financing.
Additionally, Italy’s official GDP does not include the enormous underground economy, the results of which include substantially lowered tax revenue. In Italy, unemployment is high (11.7%, not including the almost 38% of youth unemployment) and there is a strong contract labor employment system in place. This results in a closed system of employment with very little upward mobility, in which most employers will only hire workers for incredibly short contracts, usually three to six months.
The main motivation behind this system is the huge cost of laying off contracted workers. Employers can be obliged to pay up to three years’ salary to laid-off employees! Italy has recently undergone elections in which no party gained a majority in Parliament. This result has only served to generate greater uncertainty as to Italy’s economic prospects.
The trouble in Italy centers on debt payments that the central government is finding it hard to pay with rising interest rates. These rising costs chip away at other programs and raise costs for small and medium businesses in Italy with a flight to quality. The major issues can be resolved with reforms in taxes, cutting corruption and reducing the government bureaucracy that holds back businesses with cumbersome rules and legislation.
Italy also has a bigger problem, requiring general reform to their economic structure which is largely composed of family-owned conglomerates and few public companies. Most of these family companies rely on debt instead of equity to provide liquidity and in times of high interest rates, they suffer. Greater liberalization of companies to public ownership (publicly traded) can provide companies with non-debt options while making firms more obligated to shareholders, rather than being personal piggy banks for the Italian elite.
Geoffrey Van Gelder
For Greece, the gears of debt burden may have been set in motion when Greece became a member of the EU. By doing so, Greece lost the ability to control its monetary policy and exchange rates, and hence its ability to competitively price its exports on a level with other EU countries due to its high wage base. Greece also gained access to cheap debt backed by the European Central Banking System. Subsequently, Greece engaged in a period of rapid, inexpensive credit expansion, financing a trade deficit and importing consumables such as food rather than using debt financing to invest in needed infrastructure improvements which could produce a return on investment and grow the economy.
This rapid credit expansion and dependence led to a budget deficit that reached up to 15% of GDP in 2009. Greece’s banking sector gradually lost access to money markets and cheap borrowing due to rising levels of debt. Greece then became increasingly reliant on the European Central Bank for financing and less self-sustaining in its fiscal policies. Finally, non-conforming loans rose to over 20%, requiring banks to write down the value of loans. This made banks more reluctant to provide loans, which are a key source of financing for small businesses. Politics are also driving the economic woes of Greece. Its political alignment problem has created a huge public sector which continues to justify its existence by working less productively, following “Parkinson’s Law” that work expands to fill the time allowed for its completion.
Based on our meetings, Greece has limited areas in which it can leverage industry to help draw it out of its economic problems. However, several speakers agreed that Greece needs to do a better job of taking advantage of its temperate and sunny weather to grow agricultural items for export. In addition, it was recommended that Greece do more to promote the country as a destination for tourism. Recently, many other traditional tourist destinations such as Egypt have become less desirable to visit due to high levels of political instability and violence and Greece could gain tourism consumers with the proper marketing campaign. Finally, experts we met in Greece agreed that the shipping industry represents a huge untapped resource for Greece. The country has the potential to reinvent itself as the shipping port for all of Europe by taking advantage of its strategic location with respect to Asia.
Heavy government spending seems to be the major factor affecting the Greek economy’s recovery plans. One of the most surprising revelations was that when Deloitte helped implement a SaaS system to collect data and monitor government spending, the firm realized they could not account for over 40% of the government labor force and expenditures. For a country in which government work is seen as a lifetime appointment, this number is mind-boggling.
Unemployment in Greece exceeds 25%, and the unemployed are entitled to compensation to the tune of 70% of their last salary. Prior to the trip, I was aware of frequent strikes and labor demonstrations in Athens. We experienced this firsthand when a strike by the security union closed major tourism sites in the entire country on the day we were to visit the Parthenon. For a country that is heavily reliant on tourism income, this was a surprising interaction between politics, culture and the economy.
For any progress to be made in Greece, the government needs to be shrunk considerably. The unanimous proposed solution is privatization, with the aim of private investors streamlining operations to reach profitability sooner rather than later. The hope is that this move will provide the “shock” needed to jump-start the Greek economy. The downside to this solution is that short-term unemployment will increase as private industries streamline operating costs.
I think in the near term the European Union will limp along. Italy and Greece seem to be trying to fix their problems, but they are slowed by disapproval from the public, who do not want to see life get harder. However, despite there being no light at the end of the tunnel, the economically stronger European countries will continue to assist the weaker ones because it is in their best interest. For there to be a real change and for the European Union to really come together, I believe there needs to be a seminal moment.
The United States got out of the Great Depression by entering World War II, and it might take something equally drastic — hopefully not a war — to get Europe united, with each country willing to sacrifice for the common European good.
I feel that many of the issues we learned about are taking hold here in the United States as well. Our government is expanding at a rate unseen in history and our public entitlements already account for a massive percentage of our budget. National debt is higher than ever and borrowing and spending is not slowing down.
We seem to be unable to learn from the world around us. Although our economy is more robust and able to handle the debt better, recent developments we have seen involving Russia, China, India and Brazil deciding not to continue trading in the dollar suggest that our economy may in fact take a massive downward turn.
Overall, this was a trip I will never forget and the perspectives I was afforded by the speakers were priceless. I will watch as events move forward and I hope for the best for the good citizens in both of these countries. I will never forget the beauty of Rome and the absolutely wonderful people of Greece.
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