The European Sovereign debt crisis

Temporary challenge or death sentence for the EU?

Scientific Essay , 2012 , 11 Pages

Economics - Monetary theory and policy

Since the End of 2009, Europe has been suffering from low trade and economic struggles and has slowly entered into a state of sovereign debt crisis, mainly due to the difficulties faced by its weakest members.
In response to this worsening situation, the Union has undertaken a series of assistance packages, bail-outs and austerity measures in order to stop the crisis and stimulate trade. But as the months pass by, the situation remains far from solved and greater measures have to be considered.
This essay will tackle the different aspects of this sovereign debt crisis, from its origins and current state to its future prospects. As the crisis contaminated the European members one after another, tensions have appeared that have brought a new debate into light: will the Eurozone survive this crisis or will it collapse?

The European Sovereign debt crisis: temporary challenge or death sentence for the EU?

Introduction

Since the End of 2009, Europe has been suffering from low trade and economic struggles and has slowly entered into a state of sovereign debt crisis, mainly due to the difficulties faced by its weakest members.

In response to this worsening situation, the Union has undertaken a series of assistance packages, bail-outs and austerity measures in order to stop the crisis and stimulate trade. But as the months pass by, the situation remains far from solved and greater measures have to be considered.

This essay will tackle the different aspects of this sovereign debt crisis, from its origins and current state to its future prospects. As the crisis contaminated the European members one after another, tensions have appeared that have brought a new debate into light: will the Eurozone survive this crisis or will it collapse?

I. The origins of the crisis

a) European fragility: the 2007 financial crisis

The reason why the sovereign debt crisis has affected the European Union so hard is because of a previous fragility.

Indeed, the last years have witnessed a chain of negative financial events with which Europe has had troubles dealing. Barely was the financial crisis of 2007 over, that Greece made its avowal and dragged its fellow European members down into a new genre of crisis. As an indicator for this still actual fragility is the announcement from European Commissioner for Competition Policy, Joaquin Almunia, who declared that the European Central Bank’s support would remain available for European countries at least until early 2012. This liquidity support is meant “to remedy a serious disturbance in the economy of a member state” and would therefore have been cut, were the European Union members in a more stable situation.

Following this financial crisis, the European Union failed to take measures to restructure the banking sector. Indeed, only a few banks were dismantled and merged into others because of their bad financial state. Moreover, no particular campaign was conducted in order to encourage new investments in the institutions before September 2009. The investors went on distrusting the banks and investments and capital remained insufficient despite this stress-test. A few more of these tests led to a better identification of the undercapitalized institutions in July 2011 but still, the results were not specific enough to assess the needs and measures to be taken.

This lack of drastic measures can however be explained by two main factors. The first is the size and importance of European banks. As a matter of fact, non-bank financial institutions are not so developed in Europe, leaving the financial intermediary role to the banks and thereby yielding their share of total credit and market to them. The European banks also have a huge part of their activities taking place abroad -57% on average - which implies more support from the home-country taxpayers and therefore more risk in case of banking restructuration. The second reason is the correlation between the policy making institutions and the bank institutions in most of the European Union member countries, making a reform of the banking system a threat for the national economy as a whole. Let’s add to that a question of national pride; In Europe, it seems that the banks are a showcase for the country’s prosperity. The bank and the national interest are somehow associated and countries therefore encourage their banks to grow and develop sometimes beyond reason.

These three reasons explain clearly the European country’s reluctance to admit the problems of their bank systems and take reforms that could seriously damage their financial system and national prosperity for a long-term period.

b) The Greek avowal and the Maastricht treaty’s flaw

Another reason for the actual sovereign European debt crisis resides in the Maastricht treaty, which was signed in 1992 and created the European Union as we know it. This treaty established what we call the “convergence criteria”, that is to say a number of economic requirements that countries had to meet to enter the Eurozone.

These criteria were the exchange-rate development -stability of exchange rate of the country’s currency - the price development - stability and degree of inflation - and the fiscal development -budget deficit and total sovereign debt amount.

These requirements were supposed to ensure that no unstable country would enter the Eurozone and bring the other members down. However, the treaty doesn’t mention any measures to be taken, should a state member fail to meet these requirements. We can thereby understand how the lack of punishment and the attracting economic rewards of entering the Eurozone can have attracted countries such as Greece to lie about their debt level. Once part of the Eurozone, the countries can borrow money and the temptation for a country not to overburden itself is huge, the reprisal being close to inexistent.

Greece was able to fake figures and enter the Eurozone, announcing a budget deficit of 1,7% of GDP in 2003 instead of its real level of 4,6%. This lie had repercussions not only on Greece but threatened all the members of the Eurozone, as Greece officially asked for help to its fellow members, thus extending the problem to the whole Union at the edge of the financial crisis of 2007.

c) The lack of flexibility of the EU institutions

As mentioned previously, the reluctance of European Countries to reform their banking system did not improve the situation. Advice was given by several institutions such as the IMF to address this issue at the beginning of 2010 and had it been taken, the consequences of the Greek situation could probably have been reduced.

Leaders have of course tried to react but often one step behind the actual state of the crisis. Despite efforts from the European Commission has not been able to provide the Union with effective tools and steps of action to bring the situation under control, even though it succeeded in building a clear and precise representation of the situation. The reason for that is mainly the lack of flexibility of the EU institutions in terms of decision making. Indeed, most of the decisions have been taken by the Council, composed of representatives of the member states, which struggled to find agreements that would suit each country and its interests.

But let us not accuse the countries’ leaders. The core problem in this situation has been the insufficient power of the Commission and the difficulty for countries to decide for the common European interest instead of their national one. Compromises are easy to reach in ordinary times but not in those of crisis.

On occasions, some EU bodies have succeeded in building agreement between the countries. A good example would be the “Securities Markets Programme” launched in May 2012 by the European Central Bank, which enabled it to buy sovereign bonds from some EU countries in difficulty. But even this measure has been long argued and criticized as dangerous. The core role of the European Central Bank is to ensure stability and remain independent from the countries while doing so. Its intervention through the purchase of bonds links it strongly to the weak countries of the European Union, therefore threatening its own stability and the stability of the rest of the European countries.

In order to bridge the leadership gap and have a broader view of the crisis, three supervisory authorities have been created in 2009: the European Banking Authority, the European Securities and Markets Authority and the Occupational Pensions Authority. These authorities do reinforce the European system, even though they, as well, are subject to limitations and lack of flexibility.

Other arguments have taken place since the beginning of this crisis. In 2009, Germany accused the European Parliament of lack of democracy. This accusation was based on the fact that the number of members of European Parliaments elected by each country is not proportional to the size of the population, thus making smaller countries considerably more powerful than large ones in the decisions and influencing the decisions taken in terms of sovereignty.

II. Actual situation: the PIIGS and the rest of Europe

a) The PIIGS

The European Union is now divided between the countries in real difficulty and the others. Those in trouble are unflatteringly called the PIIGS (Portugal, Italy, Ireland, Greece and Spain). These countries have several characteristics in common making them the weakest in this crisis, namely their high unemployment rate, their low economic growth and their high budget deficit combined.

Indeed, if we take the example of Portugal for 2011, the unemployment rate was about 12%, while the economic growth lost 2,2% compared to the previous year and the budget deficit reached 5,9% of the GDP. However, at the end of the year, the GDP was evaluated at 4,5% of GDP, thanks to some measures the country took about pension funds. Even though the situation is still bad, the country shows efforts and has set itself targets for the future. The country received its first assistance package from the IMF in April 2011.

• College: Tongji University
• Author: Mathilde Marcoux (Author)
• Publication Year: 2012
• Pages: 11
• Catalog Number: V195804
• ISBN (eBook): 9783656215448
• Language: German
• Tags: European, crisis, sovereign debt, European Union