THE EURO CRISIS: GREECE, SPAIN, PORTUGAL and IRELAND
On January 1, 2009, the euro celebrated its tenth anniversary. The real economic conditions in the EU member economies continued to be robust, of course, with notable variations amongst its twenty-seven member states. Several member states over-borrowed and became in violation of the Maastricht Treaty guideline limiting budget deficit to 3 percent, and national debt to 60 percent, of a member economy’s GDP. Greece made top of the list of the four debtor economies, which included Ireland, Portugal, and Spain. The record shows that these four economy’s of the original EU-15, were called weaker sisters when the remaining eleven, led by Germany, France, the UK and Italy, were much stronger.
Following the success of European continental economic integration, which facilitated free flow of trade and investment funds plus free movement of labor, the family median income-gaps of these four economies, compared to that of Germany, which were overwhelmingly large at the dawn of the European Economic Community (EEC) , became notably narrowed. The four were less industrialized and offered supply of labor at a relatively low wage rate, offering a market for manufactured products from their mature industrialized neighbors.
The four also became members of the euro-zone and the exchange rate fluctuation risks ceased to be of concern. The flow of funds from their richer, savings-surplus neighbors of the Community for investment in these less industrialized economies with relatively lower wage rates became an optimal situation. It created jobs and incomes for the peoples in these four economies, whose consumption became a pull factor for their respective economic growth.
The marginal propensity to consume of the peoples in the four newly industrialized
economies became a notable factor. On the other hand, the profit-income of the investors from the richer EU member countries continued to grow. The EU member economies enjoyed a win-win situation. . Following the success of the European economic integration, the income gap amongst the EU member economies became much, much smaller over time.
The relatively higher rate of economic growth of the four contributed to a situation of irrational exuberance where over-borrowing and over-lending became
a mode of operation. Recent economic history in the mature industrialized economy of the United States of America warrants attention. The Reagan supply-side economics and tax-cut led to the robust consumption-led high rate of growth, which proved to be unsustainable. As a result, Wall Street recorded a collapse of the stock market in the late 1980s. Similarly, in the 1990s, the growth of the U.S. economy under what has been called Clintonomics, came to be followed by the housing bubble a la the practice of sub-prime mortgage, to be followed by the recession of the post-Clinton years The unfolding of the stories of over-lending and over-borrowing became a critical issue.
The four EU –member economies, as they progressed in industrialization and consequent income-and-consumption led growth, encouraged themselves to engage in over-borrowing from investment bankers, who were willing to make irrational lending. Led by the global investment bankers from the rich economies of the world, inclusive of Goldman Sachs, Morgan Stanley of New York, the process led to the euro crisis, involving violation of the numerical guidelines of the Maastricht Treaty. The loans were made by innovative financial instruments inclusive of derivatives, hedge funds, junk bonds which often remained outside the official accounting processes and failed to be counted as debts. The day of reckoning finally came. The European Central Bank issued directives for strict conformity to the terms of the Maastricht Treaty of 1992. In the absence of a political integration, the EU lacks a powerful central European Government. To that extent, the ECB has limited ability to make its monetary policy conform to the fiscal policies, independently adopted by the Member States of the Euro-zone. On this shore of the Atlantic, in 2009, the United States, led by the Obama Administration, for the first time in its history, adopted the law for its comprehensive regulations of the financial market, requiring transparency for creation and marketization of all financial products. The response of the financial market remains to be observed.
The global dimension of the Financial Tsunami has been much discussed. From the perspective of the EU member economies, we analyze the two distinct phases. In each phase, men made mistakes and then went on to correct the mistakes. A select group of leaders in the money and financial markets, made mistakes and contributed to the market-failure. Members of the economy rose to command the wisdom of correcting their mistakes (Dutta 2010). The euro has forcefully retained its place in the global currency market. The maxim is: true strength of a currency depends on the gross domestic product (GDP) it represents.
On September 3, 2009, the European Central Bank (ECB) created the new institution - European Systemic Risk Board, a major step to prevent recurrence of the financial market failures inclusive of asset bubbles. The Board, attached to the ECB, will watch the irrational exuberance of the financial market, with powers to monitor the banks and insurance companies. Creation of financial products, inclusive of derivatives and hedge funds, will be subject to proper supervision and transparency. Approval and implementation of the ambitious agenda by the
EU member-governments became an issue of concern.
On the same occasion, the ECB president assured the commercial banks for making funds available to them at the benchmark interest rate, left at 1 percent, as long as necessary, at least until mid-January 2011. Command and control must draw its sanction from cooperation and collaboration.
The stability of the banks to sustain its normal functioning, overcoming possible economic shocks, has been studied both in Europe and the USA. Much attention has been on the recent global banking conference in Basel, Switzerland, attended by the financial authorities from twenty-seven countries. The Federal Reserve Bank of the USA and the European Central Bank have been working on developing a set of global banking guidelines. The capital-asset ratio of a bank is, of course, the key issue. The recommendation of the group will be subject to approval by the G-20, and then enactment by the governments of the individual nations. The group set a deadline of January 1, 2013 for member nations to begin to phase in the rules, referred to as the Basel III.. The banks will then raise the amount of common equity they hold to seven percent of assets from two percent, as it is now. Of course, the banks will incur consequent costs. The capital-asset ratio limits the lending ability of a bank and they earn profit by lending. The game plan for the banks and financial institutions will be to seek a balance between stability and profitability. Critics point to the institutional limitations of enforcement of an international agreement. Hugely devastating cost of a global tsunami for all economies of the world must be avoided. In what follows we review each of the four countries – Greece, Spain, Portugal and Ireland.
GREECE
In 2009, Greece ran a deficit of 15 percent of its GDP, far beyond the Maastricht Treaty benchmark. Its national debt/GDP ratio also failed to meet the guideline.
In 2010, the projected budget deficit of Greece at 9.4 percent came to be as high as 10.5 percent of its GDP. Greece’s official forecast of its national debt/GDP ratio for 2012 is as high as 159 percent. Greece has been advised to adopt austerity measures toward correcting the economic situation. Will there be any limit to austerity measures? How will the austerity measures impact on economic growth? Can the rest of the world respond affirmatively to Prime Minister of Greece and leave “Greece in peace to do its job”. The European Central Bank (ECB) and the International Monetary Fund (IMF) make the point that the member countries of the EU-27 will do their respective shares of the job. The collapse of the Greek economy can and must be avoided. Klaus Regling, Director of the European Financial Stability Facility, has argued (The New York Times, May 10, 2011) that the possible “Lehman Moment” of the Greek economy, is fear-mongering. It is critically important to draw upon the lessons of the demise of the Lehman Brothers in 2008. To revisit the FINANCIAL TSUNAMI is not a true option. Restructuring of the Greek debt, paying back less than face value – will contribute to loss of confidence in the financial market. The collapse of the global financial market will initiate the process of demise for the free market economy. Marketization of government-owned-and-managed business enterprises – railways, airlines, racetrack, and national lottery – will, of course, be an option to raise Greece’s liquidity
A suggestion has been made that Greece should be allowed to leave the euro-zone. It will then manage its exchange rate independently and derive trade gains. The proponents have failed to note that the membership of the euro-zone facilitated inflows of funds for investment from its riche neighbors of the euro-zone. This has been a major contributing factor to the growth of the Greek economy.
Greece is negotiating a second bail-out arrangement, whicht merits support. Some economists remain convinced that the land of Socrates and Plato will never be able to manage their economy and they oppose any further accommodation. The absence of a central government of the EU-27 is a truly limiting factor. Greece as a member country operates under its own fiscal policy, managed by its elected government. The political movements in Greece are to be recognized. Let us add that the political factors define economic policies in all countries who are not members of a continental group, as is Greece in the EU. One can draw upon the experiences in the mature industrialized economies - USA, Canada, Japan, and also in the newly industrialized economies with fast rates of economic growth, - Brazil, Russia, India, China (BRIC).
SPAIN
Spain with its share of world GDP at about 3 percent ( 2.52 percent in 2005) is one of the larger economies of the EU-27, next to Germany, France, the U.K. , Italy, in that order. Its debt crisis has been far less overwhelming, with its budget deficit and national debt relatively well managed. Spain with its natural resources which remained to be exploited and a relatively larger population base with labor supply at a relatively low wage rate, successfully invited inflows of investment funds from its savings-rich EU neighbors and enjoyed a period of economic boom, led by
construction-activities. Housing and infrastructure added to economic growth of Spain. The people excelled in consumption and contributed to consumption-led growth of the Spanish economy. Savings became scarce. Management of monetary and fiscal policies called for more aggressive measures. To sustain competitiveness in the euro-regime a deflationary policy became an option, which invited consequent problems, ( Paul Krugman - The New York Times, Magazine, January 16, 2011).
In 2009, Spain experienced a huge budget deficit. Spain’s debt crisis
became serious. However, confidence in the Spanish economy remains more upbeat, and the economy’s credit-rating may win confidence of the market in due course..
PORTUGAL
The economy of Portugal continued its dismal performance in terms of
the numerical guidelines of the Maastricht Treaty. Portugal failed to meet its budget deficit target in 2010. The official forecast of Debt/GDP ratio at 107 percent was far above the norm.
On May 3, 2011, Portugal has agreed to accept a huge loan of US$ 116 billion. Let others evaluate if Portugal did better than Ireland and Greece for negotiating the deal with the European Central Bank (ECB), the International Monetary Fund (IMF) and the European Commission. The Portuguese Government will undertake “a comprehensive economic program” which will reduce budget deficit/GDP ratio to 5.9 percent in 2011, to 4.5 percent in 2012, and to 3 percent in 2013, thus reaching the Maastricht Treaty limit. The Portuguese political opposition has been in close dialogue with the country’s majority party, presiding over the government. For the EU-27, the bailout deal is being negotiated by the European Commission, its executive committee. The formal approval by the EU-27 is expected. The IMF officials at the negotiation expressed confidence in Portugal’s ability to deliver the anticipated outcome.
IRELAND
Ireland is one of the many EU-member countries whose shares of world GDP remains at less than one percent. Ireland elected to join the euro-regime from the day the euro became a common currency on January 1, 1999. Inflows of investment funds from the savings-rich EU member countries, with immunity from exchange-rate fluctuation risks, followed. The rate of interest became low. The UK, Ireland’s close neighbor and a fellow EU-member, declined to join the euro regime. It was convenient for ranking industrialists in the UK to take advantage of finding ad hoc corporate homes in Ireland, a member of the euro-regime.
The Irish economy grew at an average rate of seven percent in the following years until 2007. Indeed, the Irish growth rate outscored the rates of growth of most other EU member countries. The people of Ireland had a life of affluence and their consumption of goods and services reached a new high. The system came to an abrupt end and the Irish faced the great recession which had its acutely painful message for the people of Ireland. The fiscal policy field to be well-managed. Bank-failures became a challenge for the monetary authorities of Ireland. The Irish economy went from a budget surplus to a huge budget deficit in 2009. The recent official forecast of Debt/GDP Ratio at 118 percent far exceeds the limit of the Maastricht Treaty. Can Ireland repay its debt? Ireland has now joined Greece, Portugal, Spain as one of the four debtor economies of the euro-regime. The stability of the euro regime continues to be the subject of much debate.
Based on data of 2005, the four with a share of 3.98 per cent of world GDP - Greece ( 0.50), Portugal ( 0.41) , Ireland (0.45), Spain ( 2.52) , are too small to be saved. In the same year the EU’s share of world GDP at 30.43 percent is larger than that of the USA at 27.81 percent. If the four with their total share of 3.98 percent will cease to be EU-members, the EU-23 share of the world GDP at 26.55 percent will be marginally smaller than that of the USA. The EU-27 is now the largest economy of the world, the USA the second largest. The choice belongs to the EU-27.
The Euro and the European Union
Nobel-Memorial Laureate economist, Professor Paul Krugman of Princeton University has asked the question, “Can Europe be saved?” (Sunday Magazine, The New York Times, January 16, 2011). The British Prime Minister, Winston Churchill forcefully pronounced his reservation if the U.K. would be a member of the European Union. The U.K. did become a member of the EU in 1973. The British imperial authorities convinced themselves that the “COTTON-GROWERS of Virginia” could never run the independent colonies, giving birth to the United States of America. George Washington proved how wrong they were. The half-naked FAKIR of India, Mohandas Karam Chand Gandhi, successfully brought about the liquidation of the British Empire in the Indian ub-continent, and in 1947, India became an independent country, flying its national flag. Following the victory of the Communist Revolution in China, for the next quarter of a century, we were taught that China did not exist. The Chiang Kaishek regime in the Chinese Taipei became China. President Nixon helped us to rediscover China by putting his signature to the Shanghai Communique in 1968 with commitment to ONE CHINA THEORY.. Long after the Proclamation of Emancipation, signed by President Lincoln in 1853, the USA has elected its first President of the African American heritage in 2008. Europe has its place on the map of the world and the family of Europe is a real entity. No effort to save Europe is called for. The decades of the World War-II and the Cold War under the unique leadership of the USA are part of history.
One USA to one dollar is the story of more than one hundred years ( see chapter 1). The progress from one Euro to one Europe is unfolding with all its eventful majesty. The budget deficit and the national debt crisis, relative to their respective share of GDP, have become a forceful debate in the USA in recent years. It is critically important to note that as of May, 2011, the credit-rating of the USA has become a subject of global financial concern IN 2011. How much of the national debt, the present generation can rightfully pass on to the future generations? The wars in Iraq and Afghanistan, and expenses for winning of the political support from our allies, even when some of them have proved to be questionable allies, are for national security and peace for all future generations. Debts incurred for renovation and reconstruction of the infrastructure and for education, health, environment which will augment the stock of national economy’s human capital will be a plus for all future generations. Are we ready for the question of setting up a legal directive for the debt/GDP and the deficit/GDP ratios? The European Union adopted the Maastricht Treaty in 1992 , and set up numerical guidelines. Does the USA need to take such a step? Indeed, the global initiative is what is called for. Will progress of the G-8 to the G-20 provide a proper forum (see chapter 10)/
The European Union has a specific problem. The euro was introduced on January 1, 1999 without a common EU-authority for the management of the EU fiscal policy. The European Central Bank (ECB) has done its job for managing the intra-EU monetary policy with its numerical guidelines. The intra-EU monetary policy cannot be operationally successful in the absence of intra-EU fiscal policy. The Compact of Growth with Stability, signed by the Finance Ministers of the member states of the Euro-regime in xxxxx has proved to be a weak link. There exists no enforcement mechanism? Finance Ministers, back to their respective home states, must go by the fiscal policy formulated by their respective state governments, led by the leader of one or another political party with majority, or by the leader of a coalition of parties, commanding a majority ,as is the rule in democratic form of government in all member states..
In a federation, the revolt of member states in protest against one or another facet of the national fiscal policy, lawfully enacted by the federal government, has been on record in the USA. Several states in the USA have acted to oppose specific federal laws of the administration, led by President Barack Obama. In recent years, bank failures in the USA have reached a record high. Institutional provisions to take care such failures with guarantees for bank deposits have protected the men and women, engaged in business with failing banks. Even large banks, too big to fail, have been successful in overcoming odds with loans from the government. Many leading industries, including the American automobile industry, obtained federal loans, to successfully overcome challenges. An economic policy of managing the economic odds, be it sub-prime mortgage crisis, manipulation of innovative financial products, such as derivatives, and hedge fund, have become the economic policy parameters in modern capitalist free market economy of the USA.
The EU lacks substantive institutional provisions. On Thursday, June 2, 2011, Jean-Claude Trichet, President of the ECB, has called for the institution of central Finance Ministry to oversee and ensure enforcement of the intra-EU fiscal policy. The Compact for Growth with Stability has been found to be inadequate.
Political integration of the EU and one membership of the International Monetary Fund with full voting right will be the optimum solution.
