P.I.G.S.

There is this unfolding drama in Europe that will be instructive for us.

Four member-countries of the European Union are in some degree of fiscal trouble. The four countries are: Portugal, Ireland, Greece and Spain. In the memos doing the rounds in financial circles, the four countries are collectively referred to by the acronym PIGS.

It’s just an acronym, although it might seem to indicate some amount of derision.

Of the four fiscally-challenged countries, the worst situated is Greece. For years, the country ran deficits of up to 12% of its GDP. To cover the deficits, Greece borrowed heavily. Over the last few weeks, it seemed nearly certain to default on its debts.

As Greece’s financial troubles began to be evident, the European Union decided earlier to reject any bailout. That decision was intended to force the government of Greece to take tough measures to rein in its deficits and stabilize its fiscal situation.

That is easier said than done, however. For decades, the Greek public has gotten used to large subsidies and low taxes. Political popularity explains this. A series of Greek governments relied on deficit spending to win popular support — until it became too politically costly to change course and return to fiscal discipline.

The reluctance to undertake tough fiscal reforms grew even more after Greece was admitted to the EU. As an EU member, Greece enjoyed the common credit rating of whole Union. That credit rating was much lower than what might be assigned Greece independently if the country was not an EU member.

The EU credit rating made it possible to avail of loans at lower interest rates. That proved to be a moral hazard. The lower interest rates Greece enjoyed as an EU member-economy encouraged the country to borrow even more while doing nothing to improve revenues and close the deficit.

Every attempt to cut the deficit by raising taxes, withdrawing subsidies and cutting back on social services was met with large street protests by Greece’s powerful trade unions. It has become simply too politically costly for Greece to set itself aright.

Over the last few days, even as the specter of default loomed larger, the unions were still marching in the streets against any government attempt to restore fiscal discipline. Greece has become a country habituated to living well beyond its means.

The possibility of Greece defaulting on its debt service penalized all the other member countries of the EU — and, beyond that, affected stock markets all over the world. The euro began falling. Stock prices began declining. All of a sudden, when it seemed the world has finally climbed out of a painful bout with recession, a new financial collapse appeared to be forthcoming.

The EU could not afford a Greek default, with all the financial repercussions that event would entail. There was horror at the prospect of the euro falling through the floor and stock markets taking another dive.

Last Thursday, the EU reversed its position: Greece will be bailed out.

With that reversal in the EU position, the euro quickly recovered. The stock markets perked up. Literally overnight, some sense of stability was restored in the world’s financial markets.

But Greece must not be allowed to continue on its merry ways. The EU must be tough on this country. Either it returns to fiscal prudence or it should be expelled from the EU. It must not, once more, succumb to the moral hazard to accumulating debt by taking advantage of the EU’s strong credit rating.

The Greeks will not easily accept the idea of fiscal discipline. They will not want to pay more taxes nor have their subsidies reduced. But it is the responsibility of the government in Athens to educate its people in the ways of fiscal prudence.

Either they do that or the Greek economy will collapse under the weight of gross indebtedness. When that happens, Greece will drag down the entire euro zone and, when it does, damage the entire global economy.

In the borderless global economy we now have, every government must exercise fiscal responsibility or court disaster down the road. No government can wallow in fiscal imprudence without taking down its own economy at some point.

Citizens, when they demand so much in subsidies from their governments, must also be prepared to pay more in taxes. That will cause so much distortion in their economies that growth could be hobbled. It is much simpler if governments refrain from playing so large a role in their domestic economies. That will better enable them to resist the temptation to overspend in order to buy popularity.

Should Noynoy Aquino become president and carry out his simple-minded pledge not to introduce any new taxes, our credit rating will immediately drop and the interest rates on our borrowing will rise steeply. We could, very soon, fall into the same situation as Greece finds itself in today.

Someone should instruct him quickly about the primacy of maintaining fiscal stability in safeguarding our economy. Without fiscal stability, everything could unravel very quickly.

We can, of course, not raise taxes. But anyone who promises that must be fully transparent and say that fiscal disaster will be averted only by government cutting back on spending drastically. That will require substantial trimming of the bureaucracy, cancellation of infrastructure projects and withdrawal of subsidies on rice and sugar.

We will have low taxes and a stagnant economy. There is, unfortunately, a price for everything in the real world — quite different from the fantasyland politicians peddle to voters. –Alex Magno (The Philippine Star)