European Sovereign Debt Crisis Since the End of 2009

The European Union debt crisis began in 2009 after the revelation that Greece could default on its debts. The government then indicated that the previous regimes underreported subsequent public debts resulting in violation of the debt-to-GDP ratio capped at 60% (Barth & Bijsmans, 2018). Coupled with the 2007-2008 financial crisis in the US, the phenomenon escalated to potential sovereign debt defaults among peripheral countries such as Italy, Spain, Ireland, and Portugal. Austerity measures, which could mitigate the resurgence in public debts, further caused more harm to several economies. An imbalance in monetary and fiscal policies led to inflexibility, which created an uncomfortable belief among member states who felt some measures could deprive them of their sovereignty. The establishment of the European Central Bank (ECB), International Monetary Fund (IMF), and European Financial Stability Facility (EFSF) to bailout stressed institutions has not been effective as anticipated. Some countries such as the United Kingdom resorted to exit the European Union through Brexit, creating waves of instability in the region.

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Causes of Eurozone Crisis

High public debts and deficit spending are some of the causes of the financial crisis felt in the entire world and, more specifically, in Europe from 2009. Following the financial recession, most European countries had to borrow more money to finance national budgets and boost their economies. Nations such as Portugal, Italy, Ireland, Cyprus, and Greece accumulated too much debt, which was unsustainable. The latter country, for instance, accrued a 113% debt of GDP, which was twice the capped rate of 60% by the European Union (Sarımehmet Duman, 2018). Greece was further involved in deficit spending by recording higher expenditures than its revenue collection. For instance, its expenditure from 2004 to 2009 increased by 87% against 31% in taxation (Sarımehmet Duman, 2018). In Portugal, the scenario was similar to Greece, with the government incurring expenses on redundant civil servants and extravagant reparations to employees. The records of unsustainable expenditures continued despite the Maastricht treaty capping deficit spending and debts at 60% of GDP (Barth & Bijsmans, 2018). Some administrations violated this agreement by covering their deficit and debt levels through erratic bookkeeping, complex loan structures, and inconsistent transactions. Since 2009, the trend continued from Greece and escalated further in 2012 to other peripheral countries with potential debt defaults and rising spreads of sovereign bonds, as illustrated in Figure 1 below.

Yields in ten-year sovereign bonds in percentage, from October 2009 to June 2012 (Hurrelmann et al., 2016).
Figure 1: Yields in ten-year sovereign bonds in percentage, from October 2009 to June 2012 (Hurrelmann et al., 2016).

Eurozone adopted a single currency for all its member states as a monetary union, preventing them from acting independently or creating their Euros to pay creditors and avoid defaulting. They cannot devalue their currency to sell their products at low prices. This has promoted a balance of trade and taxation; however, some countries holding assets in devalued currency have suffered losses. For instance, in 2011, the investors in Pound Sterling suffered 30% losses following a 25% fall in exchange rates and a 5% rise in inflation (Sarımehmet Duman, 2018). National central banks and ECB controlled the monetary policy. There were severe criticisms of the system for exposing European states to the risks and problems of other members. Germany struggled for a long to redeem countries such as Greece and Ireland. Therefore, the Euro-system poses a threat to the survival of the ECB and the European Union.

Another issue is the inconsistency between the monetary and fiscal policies of individual member states. Although all Eurozone countries are under the same monetary policy, governments are free to establish their fiscal procedures allowing them to borrow, spend, and adopt tax guidelines of their choosing. There serious objections by small economies towards the attempts to create a Fiscal Union due to the possibility of sovereignty violations by developed countries.

Internal economic problems and struggles of some member states have contributed to the Eurozone crisis. Not all countries can enjoy the same economic privileges. Due to unfortunate circumstances, nations have been faced with hard economic times plunging them into crisis. Forcing them to trade with other members has resulted in calamity transfer from one state to another. For instance, due to a run-up in housing prices, the Irish government had to incur debts to caution banks and other financial institutions from defaults by property developers and homeowners following the long-term increase in real estate prices (Frieden & Walter, 2016). Greece struggled economically after engaging in borrowing and spending extravagantly on unsustainable policies for its citizens. Greece’s tourism and shipping sectors collapsed following the global economic recession, forcing it to borrow more money to finance recurrent expenditures and sustain the economy. In Spain, an increase in housing prices, which resulted from a 200% increase in the prices of residential properties, plunged the country into a financial crisis (Frieden & Walter, 2016). Increases in the prices of fossil fuels resulted in a rise in inflation by 5% (Frieden & Walter, 2016). Additionally, the subsequent decline in fuel prices and run-up in property prices later resulted in deflation, impeding investment.

After Germany compelled the rest of the Eurozone members to enter a trade with China, they lost their competitiveness. Industries from affected countries such as Portugal and Spain could not compete fairly in the market resulting in the closures of businesses, unemployment, and defaults on debts. Some nationals decided to seek employment in stable economies such as Germany and the United Kingdom, further affecting the competitiveness of their home countries.

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The failure of the American financial system caused by the subprime mortgage crisis also affected the European financial sector. The US financial crisis of 2007-2008 slowed down the global economy, especially for those countries that depended on America for trade. The Eurozone countries and institutions invested in the US financial markets suffered huge losses and duplicated the problem in other regions. Since most economies have a direct connection with the US through trade, exchange rates, and loans, any financial crisis experienced by the country always affects the global economy. Therefore, when the subprime mortgage crisis struck, most countries in Europe suffered as a result.

Due to attempts by the United Kingdom to exit the European Union through Brexit, Eurosceptics and speculations for mass exodus by other countries soared. Such assumptions sent shock waves among investors, some of which fled for safety, depriving other member states of revenue and growth. As one of the larger economies, the collapse of the Italian banks also created bigger risks to the European economy. To reduce debts, prosperous countries such as Germany and France decided to adopt austerity measures limiting the expenditures of struggling states such as Portugal, Greece, and Spain. The affected countries had to reduce their healthcare spending, resulting in a health crisis. Attempts to raise more revenue through taxes by these countries did not work out either, as investors fled due to low yields.

Solutions to Eurozone Crisis

Some countries apply fiscal policies, which do not match their expenditure and revenue collection. Excessive spending is not affordable, and any country indulging in such indulgences has always plunged into a financial crisis. Unavoidable circumstances can also land economies in unfavorable situations. When such occurrences happen, as the European Union sovereign debt crisis, proper mechanisms are necessary to mitigate the problems and prevent further escalations. Through the EFSF, EU member states agreed to establish financial stability facilities to aid countries facing financial difficulties. The body provides bonds or loans to members in economic trouble. Each state has a lending capacity of €440 billion, €60billion in terms of loans from EFSM, and €250 billion from IMF (Rohac & Christensen, 2017). There was a need to expand the EFSF instrument through certificate creation to allow for up to 30% bonds to a new member state. It is safer than the German bond as it can weaken the diabolic loop and diffusions across member countries.

The issuance of direct loans to banks rather than states have reduced sovereign debts. This approach was adopted in 2012 and was facilitated through the European stability mechanism. Banks with strained financial operations can directly acquire loans through EFSM instead of going through the state, hence reducing public debt (Rohac & Christensen, 2017). The adoption of policies with minimal austerity and more investments is preferred. For instance, tax hikes and rigid spending cuts embraced by Greece have never worked out for them since they are a hindrance to economic growth. The fiscal stimulus approach adopted by Germany and Austria is more suitable since it provides a conducive economic environment for investors. The increase in competitiveness is another mechanism that has proven effective in mitigating any economic shock in a region. By increasing international competitiveness, a country can grow its economy and thus successfully restructure its debt. The same mechanism has worked for Iceland following the financial crisis it experienced.

Although internal devaluation is a painful economic adjustment, it can restore competitiveness. The adoption of relative wage moderation has worked in Ireland, reducing wage levels by 16% (Pickert, 2017). This is opposed to Greece or Portugal, where wage cuts occurred, thus reduced the purchasing power and consumption levels within the countries. Their change in unit labor cost was minimal, as illustrated in Figure 2 below. The best approach is to shift to a long-term process involving the production of higher-quality products and services. Fiscal devaluation can also improve economic competitiveness by lowering corporate tax to increase purchasing power. This approach was adopted by Germany, France, and Portugal, with positive results recorded. The establishment of the European fiscal union, where a central body controls budgets and tax policies, can reduce fiscal imbalances. The political and fiscal union can enhance oversight possibilities, barring some member states from engaging in unfavorable economic practices, which can harm the entire region.

Change in unit labor costs between 2000 and 2017 (Pickert, 2017).
Figure 2: Change in unit labor costs between 2000 and 2017 (Pickert, 2017).

Conclusion

The Eurozone crisis was one of the greatest economic shocks ever experienced globally. Many financial institutions closed due to its effects, and public debts escalated, affecting economic growth. The main cause was an imbalance in the fiscal policies of individual member states, which did not match with monetary policy. The global financial recession forced governments to borrow as much as they could to finance expenditures without evaluating their tax collection capabilities. Internal economic challenges, such as an increase in the prices of housing, further deteriorated economies. To mitigate such challenges, several mechanisms were adopted, including the establishment of a financial stability facility to aid member states during economic difficulties. The ECB decided to issue international loans directly to banks instead of states to reduce sovereign debts. Further adoption of internal and fiscal devaluation enhanced economies’ competitiveness, purchasing power, and consumption levels.

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References

Barth, C., & Bijsmans, P. (2018). The Maastricht Treaty and public debates about European integration: The emergence of a European public sphere? Journal of Contemporary European Studies, 26(2), 215-231. Web.

Frieden, J., & Walter, S. (2016). Understanding the Political Economy of the Eurozone Crisis. Web.

Hurrelmann, A., Baglioni, S., Gora, A., & Wagner, A. (2016). The Eurozone Crisis and the Politicization of European Integration. Web.

Pickert, J. (2017). The Eurozone Crisis: Short‑run versus Long‑run solutions. Horyzonty Polityki, 8(24), 215-234. Web.

Rohac, D., & Christensen, L. (2017). After the Eurozone crisis: Causes, consequences, and lessons for European and US policymakers. American Enterprise Institute. Web.

Sarımehmet Duman, Ö. (2018). The political economy of the Eurozone crisis: Competitiveness and financialization in PIIGS. Journal of Balkan and Near Eastern Studies, 20(3), 211-229. Web.

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