The Eurozone Crisis and the Future of Europe

The Great Recession of 2007–2009 and its persistent and powerful effects will be recorded in economics textbooks both for their dramatic consequences on the real economy and the proven inability of the dominant economic theory to help solve this crisis. Among the numerous side effects of the Great Recession, one was of particular importance to the Euro area: the Great Recession exposed in full light the deep seated institutional and policy flaws of the Euro project, which threaten to bring it to an end.

In order to provide a guide to the readers of this book we think it worthwhile to offer them a sketch of the way the Euro is expected to work as a single currency area. This chapter should therefore be seen as a theoretical guide rather than an additional paper on the Euro experience.

The external debts of the European countries are at the core of the current crises. Generally, the crises are attributed to government budget deficits in excess of the values stated in the Stability and Growth Pact (SGP) and the Maastricht Treaty. Proposals for reform involve increasing the powers of the European Union to monitor fiscal policies of the national governments and increasing bank regulation. This chapter seeks to explain the inter-country differences in the debt crisis in Europe. The SGP and the EU focused upon rules concerning government debt ratios and deficit ratios. They ignored the causes of external debt ratios in the entire economy that led to a crisis in the financial markets.

The recent crisis, which originated in the United States, resulted in a chain of events in the world economy. One of them is the sovereign debt crisis in Europe. At the beginning of 2013 this crisis still represents significant risk to the future development of European and global economies.

In the aftermath of the Second World War, European citizens shared the belief according to which an economically integrated Europe would prevent European peoples from fighting each other again. If this argument still remains valid, many younger European citizens, who did not go through the war atrocity, are supporting the European project insofar as it associated to an image of modernity, openness, and, ultimately, higher living standards.

The European Economic Community, starting in 1958, left monetary policy as a national responsibility. Art. 105 and 108 EEC Treaty only weakly restricted monetary autonomy by demanding the member states to treat their economic and exchange rate policy ‘as a matter of common interest’. At the time of the Bretton Woods Monetary Order, exchange rates were fixed to the US-$ with a small bandwidth of +/-1 per cent. EC founding member states agreed to narrow the bandwidth for their currencies to 0.75 per cent — a first small hint of ‘a common interest’.

The Euro is first and foremost a diplomatic creation, an act of will by the participant states using Europe’s more traditional and also newer instruments of diplomatic statecraft.¹ As divided Germany became embedded in the two alliances dominated by the US and the USSR, West Germany sought security in the Atlantic alliance and reconciliation with France through European integration (Bulmer and Paterson, 1987; Bulmer, Jeffery and Paterson, 2000). France, too, sought security from a repeat of the disasters of 1870, 1914 and 1939 through membership of the Atlantic alliance and by efforts to create a European political structure from which war would be banished (Kolodziej, 1974; Jean Lacouture, 1993; Duchene, 1994). European economies were launched on the path to reconstruction through the creation of initial institutions designed with US support, to co-ordinate national economies on a European scale (Milward, 2006). Since the late 1960s, monetary politics have lain at the heart of Franco-German relations, as the DM began its ascent on the back of widening trade surpluses to replace sterling as the world’s second reserve currency after the dollar. French diplomacy quietly jettisoned de Gaulle’s policy in favour of a Europe of the states for a more integrationist stance with regard to the EU, and came to focus on the Bundesbank as the bastion of Germany’s financial and corporate power nexus, and the prime partner of the US Federal Reserve in managing the central exchange rate between the dollar and the DM.

It is one of the great misnomers to call the present Eurozone debt crisis a sovereign debt crisis. The reality is that the European sovereign debt crisis started when the debt of the private banking sector was transformed into public sector debt via bail-outs. Blythe and Newmann refer to this discursive shift as the ‘greatest swindle of modern times perpetrated on the European Public by their governments on behalf of their banks’ (2011: 2). If we compare public debt as a percentage of GDP with private debt in percentage of income in 2008 in those supposedly problem sovereign debt countries, we find that they in fact had a slightly better record than Germany. Ireland had a public debt as a percentage of GDP in 2008 of 44 per cent (private debt in percentage of income 197 per cent); Spain’s public debt was 41 per cent of GDP (private debt 128 per cent); Portugal’s public debt was 66 per cent (private debt 135 per cent); Germany’s public debt was 66 per cent (private debt 89 per cent). The accumulation of private debt in Spain and Ireland had to do with the massive build-up of private household debt as a result of the housing bubble. House prices rose in Spain by 120 per cent in the period 1997–2008, which was the highest in the Eurozone. The only exception to the accumulation of huge private debt levels was Greece. Greece’s public debt was a high of 97 per cent in 2008 (increasing to 115 per cent in 2009) versus 42 per cent of private debt (Dodd, 2010, cited from Eurostats).

More than a decade has elapsed since the Euro’s start. The world economy is not in good health and most of the EU is in recession. Italy is experiencing its second worst year since the end of the Second World War. The need for a reflection on what the Euro has meant and on its future is strongly felt.¹

The case of Greece is a striking example of how ‘rescue efforts’ can transform a minor problem into an outright catastrophe. ‘Rescuers’ managed to increase Greece’s debt burden substantially, shrink her GDP sizeably, inflict avoidable damages on the Greek people and their economy, taxpayers in other Euro member states, and the private sector. They damaged future capital market access for Euro countries, brought the European Central Bank (ECB) into the delicate position of a bad bank, and stimulated speculation against other Euro countries. Even democracy is meanwhile threatened, and technically unfounded fears about the survival of the common currency were triggered. Inflicting more damages seems technically impossible.

This chapter has three objectives: (i) to demonstrate that from Asia’s experience and perspective, in managing a financial crisis it is critically important to distinguish between the proximate and the root causes and to focus on the latter rather than the former, because otherwise the patient may be given the wrong medicine which could worsen the disease; (ii) to apply root cause analysis to recent financial crises and point out the similarities and differences with a focus on the on-going Eurozone crisis; and (iii) to assess the impact of the Eurozone crisis on Asia.

The European Monetary Union (EMU) is in a crisis. Without doubt the recent rescue packages of the past years were necessary to stabilize the Euro area and the financial markets. However, it remains questionable whether this rescue path will lead to a sustained framework of economic governance. There is a danger that the policymakers will follow the wrong path which may lead to a future break-up of the Euro area. The current rescue philosophy of helping the indebted countries with guarantees on the one hand and demanding austerity on the other hand is rather limited to short-run stabilization. This way of thinking does not solve the structural problems in the medium- and long-term (Herzog, 2011, 2012). An effective economic therapy requires a profound analysis of the structural and hidden issues of the so-called ‘Euro Crisis’.

For the member states of the European Union, where collective coverage of modern social risks is comprehensive, with welfare spending accounting for 16 to 30 per cent of GDP, the global financial crisis marks a serious ‘stress test’. Considerable employment growth across the EU over the past decades has been wiped out overnight while unemployment soared to 23 million people. Joblessness rose from 6.5 per cent in 2008 to over 10 per cent across the EU in 2012 and, most dramatically, to close to 25 per cent in Spain, with Greece trailing behind at 20 per cent. Most worrisome is the surge in youth unemployment. One in five under the age of 25 in the European labour force is out of work, again with Spain leading at a staggering rate of close to one in two youngsters. In other troubled economies, Greece, Portugal, Ireland, and Italy, youth unemployment figures hover above 30 per cent. Meanwhile joblessness has also become increasingly structural. In Italy half of those out of work have been unemployed for more than a year. Youth and long-term unemployment leave deep social scars in terms of falling income and earning capacities, social-psychological distress, lower life expectancy, skill erosion, and strained public finances. In old age pensions, public systems have suffered losses of financing and contributions, due to the effect of the crisis in employment.

Analysing the longer-term future of the Eurozone (and of the European Union) today is certainly not an easy exercise. Given the crisis, this is likely to result in a much less optimistic outcome when compared to similar exercises in the past, such as the 50 years exercise carried out by Maurice Fraser in 2007. Indeed, a sober look at the current situation could easily give rise to pessimism: Europe is still immerged in its worst crisis since the end of the war, with some countries in a seemingly never-ending spiral of recession and indebtedness which is eroding their social structure. Europe faces a number of significant long-run challenges, including ageing populations. Moreover, looking at the political institutions, there is a decrease in reciprocal trust among member states and a persistent lack of authority and capacity of the central institutions to cope with current challenges. Dangerous waves of nationalism and populism are on the rise once again. All these aspects interact, producing a complex and fundamental challenge to Europe’s economic and social system, requiring a comprehensive solution.

The sovereign debt crisis has created enormous anguish in the European Monetary Union (EMU) and emergency measures are used in order to prevent its breakdown. The European Council summit of October 2010 considered a report with a telling name: ‘Strengthening economic governance in the EU’. This document is to be examined in conjunction with the governance reform proposals issued by the European Commission and related documents. In March 2011, the Council adopted the Euro Pact and the European Parliament approved the ‘Six pack’ measures later in the year. A Treaty on Stability, Coordination and Governance (European Council, 2012d) was signed by 25 governments in March 2012. At the end of 2011, the European Central Bank (ECB) embarked on extending ultra-cheap credit lines aiming at keeping banking groups afloat. And in 2012, the ECB announced its determination to help Eurozone governments via purchases of sovereign bonds in secondary markets. Several meetings of the European Council focused on the setting up of a banking union. However, this demarche to reform governance is not an attempt to deal with a terra incognita. From the very beginning of the Eurozone, there was some discomfort with its institutional underpinnings and there were misgivings regarding its optimality as a currency area.

Exploring one’s future, particularly during hard and highly uncertain times, is a very difficult task which may seem to not a few to be ‘mission impossible’. However, such a task is not without merit and it can be undertaken by analysing the past and the present, carefully, by keeping in mind previous lessons. Remembering history may be helpful in order to circumvent rash policies and avoid repeating mistakes. In other words, evaluating the pluses and minuses of past and existing systems, and searching for the institutional and policy foundations of the good and bad times may drive to a better future. The present volume makes an attempt to scrutinize the future course(s) of the European Union (EU) against the backdrop of the on-going crisis of the Eurozone and in the context of a deep financial crisis in the industrialized world and entailed reverberations in emerging economies. Through probing the political economy of this multifold crisis and the flaws of EU institutions and policies, the chapters in this volume point towards possible directions of further integration or fragmentation of the Eurozone, of the EU.