Zhang Chengliang / China Daily

After a close election, Athens is left standing at the edge

A year ago, talk of Greece moving out of the European Union would no doubt have been dismissed as idle speculation. But such talk about the European nation's exiting the world's most integrated economic bloc has failed to dissipate, even though the election on June 17 has resulted in the possibility of a pro-bailout coalition government being formed.

Indeed, European leaders are now discussing the issue openly. Even Germany, the stalwart member of the single-currency zone, has conceded that Greece could go its own way.

In elections on June 17 the conservative New Democracy party came first, followed by Syriza, which opposes austerity, and Pasok, which favors a bailout. New Democracy's and Pasok's haul of seats has allowed them to form a government with the support of the smaller Democratic Left party, but Syriza has vowed to keep opposing the bailout.

Be that as it may, the three parties that garnered the most votes are eager for the country to stay in the eurozone. It's just that they differ on how the country should deal with the EU on the debt crisis.

However, the fundamentals of the Greek economy remain unchanged.

Greece essentially has two choices: It can apply for more aid from other EU members to delay its default, or it can walk away from the euro and readopt the drachma so that it can independently map out its monetary policies to help repay debts and shore up the economy.

If Greece goes for the first option, it means the country, accounting for about 3 percent of the EU economy, will have to adopt tighter austerity measures, something that will upset many Greeks.

The alternative is that it cannot be sure it will receive aid from the rescue fund offered mostly by Germany and France, the two core EU members that have been increasingly inpatient with endless bailouts. In a best-case scenario, Greece may persuade the EU and the International Monetary Fund to soften the tough terms of the bailout deal. But even if Greece is given the aid with more lenient terms, all that will do is to put default off for another day.

If Greece chooses to readopt the drachma, its currency will depreciate against the euro by at least one third, resulting in shrinking assets and a sudden brake on its financial system. In return, Greece will get back the financial autonomy to allow it to print more banknotes to repay debts, increase people's salaries and attract foreign investment with a weak currency. However, by doing so, inflation pressure will be high.

Greece seems to be in a quagmire, and political and economic turmoil are likely to keep it there until the world economy rebounds robustly to revive the country's shipping, tourism and property markets.

Greece's collapse is sudden given the fact that just a few years ago its people basked in all the benefits a welfare nation can offer.

There are two lessons for China in all of this.

First, never let the currency appreciate beyond its strength.

Greece is one of the smallest and least competitive economies in the eurozone. Its weak economic strength and comparative advantage determines that the country will be the first to be hit in times of crisis.

The euro is a strong currency, so those countries that have adopted it have used it to beat competitors with high-end technology and expertise instead of labor costs. Despite the crisis, France and Germany can support the value of the euro with technology and expertise, which, unfortunately, are weak spots for Greece.

So when the crisis hit, Greece found that a strong euro made it even less competitive. With a relatively strong euro, international investors and tourists got cold feet about putting their money into Greece.

A simple way to win back investors and tourists is to depreciate the currency. But since the euro is the common currency of the region, Greece itself cannot decide the movement of the unit, so it had to swallow the bitter pill stemming from the strong euro.

China, which is gradually appreciating its currency to better reflect its economic strength, should be mindful. A strong currency sounds cool and pleases the public, but if the country's economy is not strong enough to sustain the currency globally, it is better to maintain it at a lower level. After all, in a time of global recession a weak currency, which helps attract investors and boosts exports, is the best tool to cushion economic slowdown.

One recent example is Switzerland. The country, highly reliant on exchange rate-sensitive industries such as hospitality and tourism, pegged its franc against the euro late last year to protect its economy from the European debt crisis.

The move effectively brought down the value of franc and prevented Switzerland from being hit hard by global investors looking to the franc as a safe haven. Switzerland's move has stabilized its economy, at least for the time being. However, Athens cannot copy the move as it has given up a large part of the monetary autonomy by joining the eurozone.

The second lesson is that building a welfare state does not mean everyone must be "equal" or that there must be reckless spending.

Greece's failure, in large part, lies in its high government spending. Spending on welfare is too high. It would be easy for the government to collect enough taxes when the economy is good to support high welfare payments. But when the economy takes a sudden hit, the tax collected cannot help the government make ends meet. So it has to issue debt to sustain the payout.

What is worse is that generous welfare, usually coupled with hefty taxes on businesses, hinders entrepreneurship and creativity. Since residents can easily get everything from the government, they see no point of running the risk of doing business or of hard work. Ultimately that means the country loses competitiveness globally, as has happened with Greece.

As China proceeds to enhance equality by improving welfare, it must bear in mind that the process should not undermine the role of personal wealth.

To be sure, reaching a perfect balance between equal rights and personal riches is a challenge for any government. But if the exact point cannot be hit, it is better to lean a bit toward the latter. The reason is simple. It is always difficult to get back from the people what has been given. That point has been proven by Greek people's overwhelming and violent objection to fiscal austerity policies the government had to adopt to reduce debt.

For China, an alternative to high amounts of welfare is to cut taxes. Doing that has four advantages. First, it returns wealth to the people. Second, it helps boost entrepreneurship and creativity. Third, it helps boost consumption. Fourth, it saves on administrative costs for the government, as maintaining a generous welfare system requires a government to manage its fiscal spending well.

The author is an independent financial analyst in Shanghai. The views do not necessarily reflect those of China Daily.

(China Daily 06/22/2012 page11)