When financial crisis is an opportunity

The troubles in Greece, Spain, Portugal, Ireland, have forced these countries to refocus their priorities. On the other hand, so-called successful economies like Brazil, India and China may have to pay, perhaps very soon, for lop-sided growth

Investors don't like trouble. Instinctively, like vast herds of wildebeest running across the Serengeti Plain, investors will also often stampede away from assets, markets, and countries that are having problems. Although it often sounds both prudent and cautious to follow the herd, over time it may be a bad idea.

Recently, investors have been savaging the so-called peripheral countries of the euro zone. For one reason or another, countries' sovereign debts have been considered very risky, at least by the default swap markets. Certainly if you look at some of the numbers this appears to be true. However, it might also be prudent to think of something else.

As the American White House Chief of Staff, Rahm Emanuel, said, "You never let a serious crisis go to waste." What he meant was that crises, especially the ones forced on countries or companies by the market, create a climate where reform goes from should to must. The greatest contribution that the market can make to efficiency, and ultimately economic growth, is discipline. And market discipline is never as effective as during periods of economic stress.

One of the most economically stressed countries has been Greece. Prior to the recent economic crisis, the Greek economy benefited broadly from its membership in the European Union and the euro. It allowed the Greeks to borrow at lower rates without the requirement of fiscal prudence.  But it was not simple profligacy that brought the Greeks down. Their monetary problems stemmed from an economically inefficient legal infrastructure.

The Greek regulatory environment is a major detriment to growth. The economy is filled with inefficient state-owned industries that were a heavy burden on both the economy and Greek taxpayers. Its tax system is complex and compliance was a bad joke. There are substantial barriers to entrepreneurship and the labour system fails to align wages with productivity.

Before the crisis, reform of all these barriers to economic growth seemed politically impossible. But the cost of international help required that the reforms proceed. The resulting strikes and riots were evidence that the political fears were justified. Nevertheless, the reforms have gone forward and they will increase Greece's productive potential and economic growth whether it remains within the euro zone or not.

Spain is another country that has recently been a victim of the markets. Like Greece, Spain suffers from inefficiencies within its legal infrastructure. One of the most severe problems is a two-tiered labour system. Centralised, compulsively collective bargaining agreements, indexing of wages and protection for permanent employment worked exceptionally well for those people with jobs, especially those within the civil service. But the system discouraged new hires and so discriminated against the young. The result is an unemployment rate stuck at over 20%.

Earlier this year, Spain's prime minister initially refused to attempt any reform and steadfastly maintained that Spain was not Greece. The recent troubles with the Irish banks and Portuguese sovereign debt have happily refocused his priorities. If market pressure continues, the result will be real reform followed by real growth.

In contrast to the problems of developing countries, economic growth in emerging markets seems positively stellar. The economies of Brazil, India and China were almost untouched by the global recession. They are all now growing at an impressive rate. This is a problem. Over the past two decades all three countries have undergone extensive and often painful reforms of their regulatory systems. The fruits of these reforms are evident in their more recent economic growth and resiliency. Sadly, their success has led them to rest on their laurels.

In Brazil, economic growth has created a new middle class intent on using credit to purchase imported consumer products whose price has been lowered by the strong real. The result has been a deficit and inflation. Since there has been little need, the Brazilian government has not dealt with its tangled bureaucracy, inefficient tax system and poor infrastructure.

The booming Indian economy and the stronger rupee have also pulled in more imports than exports. This trade deficit is being filled by short-term capital. Like Brazil this could easily lead to a disastrous balance of payment crisis.

China's growth has led to a new assertiveness which is based on the false conclusion that their market-controlled economy functions far better than a market system. The optimism and exuberance masks massive problems with their financial system, real estate market and mercantilist export strategies.

In time, perhaps very soon, the markets of China, India and Brazil may have to pay for their success. In contrast, the productivity forced upon Greece by the markets will no doubt reap rich dividends. What investors need to understand is that investment in regulatory reform during a crisis is a signal to change direction and run away from seeming success toward apparent failure.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected])

nagesh kini
1 decade ago
The PIGS - Portugal-Italy-Greece-Spain now added Iceland-Ireland all free market countries like the South Asians and Mexico are under going the pangs. Russia and the so-called Eastern Bloc has managed to stay out.
India under no circumstances should opt for rupee convertabilty.
Reduce imports of Californian oranges, Washington grapes and Chinese Ganesha's ( I've been gifted one!), now onions from Pak.
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