The great Recession of 2007-2009 laid deep penalties on the real economy and revealed the incompetence of the leading economic system to solve this crisis. Along with many other side effects, the Great Recession exposed the inherent weaknesses of the euro project pertaining to its institutional and policy defects. The euro crisis exposed the true nature of the European economies that gave a wrong impression of being resilient and strong. Eurozone has performed poorly with the slowest GDP growth and the highest unemployment rate during all significant periods. The reasons are many such as: dearth of stabilizing international strategies, controlled internal economic policy and a universal monetary policy for all members. Now, Europeans require finding ways to rescue the single currency and think about the benefits that can be obtained from it, however, it is not easy to find a way out keeping in view the political nature of the crisis.
Globalisation drifts have noticeably shaped the growth and competitiveness in eurozone over the past decade. The emergence of the cost competitive nations increased difficulties for eurozone and other developed industrial economies by reducing their export market share. The impact was severe and eurozone was more affected than the other developed nations. Eurozone was hit by 10% decrease in the export price competitiveness during the period between 1999 and 2008, whereas other developed economies like the US and Japan and to some degree the UK also experienced noticeable gains in price competitiveness. The financial crisis was an additional shock to eurozone, predominantly replicating the severe drop in global demand and critical progresses in price competitiveness (Claessens et al 119).
The great Recession of 2007-2009 laid deep penalties on the real economy and revealed the incompetence of the leading economic system to solve this crisis. Along with many other side effects, the Great Recession exposed the inherent weaknesses of the euro project pertaining to its institutional and policy defects.
It compelled Eurozone to re-evaluate its economic policies and understand the underlying faults in the tax system, banking sector and labour costs. Its economies exhibited weak and insubstantial features. Moreover, the inefficient tax system and exorbitantly high unit labour costs caused the financial distress. The banking sector depended majorly on debt and it had not enough control due to the country specific and vague prudential norms. The European Central Bank could not support the troubled governments as it was not in its scope legally. Above all, the inadequate arrangements with respect to important policies were responsible for the eurozone crisis.
Now Europeans require finding ways to rescue the single currency and think about the benefits that can be obtained from it, however, it is not easy to find a way out keeping in view the political nature of the crisis. Germany has sustained the shock successfully and has come up as a leader imposing its policy line on other members of the eurozone.
The euro crisis has exposed the true nature of the European economies that gave a wrong impression of being resilient and strong. The innate flaws of eurozone scheme have presented a great challenge for the policy makers as it may affect the very existence of eurozone. EU, besides being a major trading bloc in global market is home to many influential banks and financial institutions. Moreover, it has been an active promoter of the globalization initiative together with the US. Therefore, the financial crisis in the eurozone will surely impact the eurozone and the world economy as well.
Eurozone seems to be learning from the past mistakes and a country like Greece, that has the maximum policy defects, is making striking adjustment to come out of the distressed economic situation. The efforts to turn the economic growth positive are seen in its 2013 primary budget surplus and decreased interest rates on the treasury bonds. Portugal, Ireland, Italy and Spain are also recovering gradually. Such modest attempts seem to relieve eurozone from the financial distress in near future, however, finding success in becoming an adequately functioning single currency zone is still doubtful (Daianu 146).
Performance of the eurozone during financial crisis
The global crisis that initially exhibited itself in the subprime mortgage market in the US, swept rapidly through the Atlantic financial markets and later transformed into acute recession. Many factors were responsible for the rise of European sovereign debt including poor competitiveness, stagnating export markets, low interest rates, domestic political pressures, the cost of bank bailouts and stimulus programmes” (Overbeek 39).
Creation of euro in 1999 was a move towards the unification of Europe and is considered a significant event in the European history. Ever since it came into existence it has experienced many positive and negative surprises. The positive aspect is that ECB (European Central Bank) has been able to uphold inflation rate close to 2% creating robust reputation for itself for price solidity. Further, there has been the integration of money and bond markets, disappearance of home bias and enlargement of capital markets in the eurozone that has reduced the cost of capital.But the negative impact is greater than these positive outcomes.
There are some major shocks that eurozone has faced during and after the financial crisis. The performance of the eurozone has been rather disappointing as it failed to boost growth in Europe. A strong difference between the eurozone members and non-members in EU is perceptible.
The end result is that despite being a great financial and monetary success in financial markets and banking sectors, euro has not contributed to the economic growth and employment of the eurozone members. We can see the difference between the yearly growth rate and the long-term growth rate between the eurozone and other EU countries with the help of the following graphs.
The above graph shows that the non-euro EU has been ahead with 2.3 long- term growth rate whereas the eurozone could attain only 1.8.Further, eurozone has remained below long-term growth for a more extended period (DeGrauwe 7).
The excessive debt reaching up to 85 % of the GDP by 2010, for the overall eurozone was a miserable experience for the eurozone governments (Overbeek 39).The economic performance of the eurozone during the several significant periods with respect to the GDP growth and rate of unemployment had great consequences for the member countries. These periods include: the completion of Single Internal Market to the fixing of exchange rates for eurozone countries(1993-98), the operation of the eurozone prior to the Great Recession (1999-2007) and of the Great Recession itself (2008-2011)” (Demetriou 82).
During 1980-98, eurozone showed the average annual economic growth of just over 2%. Undoubtedly, this growth rate was comparatively lower than countries like Australia, the U.S, and Canada; however, it was similar to that of Sweden. The growth rate was higher than Switzerland. The succeeding years (1999-2012) were not very impressive dropping down to 1.5% only.
The economic environment in other countries, too, was also filled with abundant upheavals during this period, but it is noteworthy that the economic performance of the eurozone was significantly low. The unemployment rate too ascended from high to the highest when compared to the group of countries including Australia, the US, Canada and the UK during the years 1999-2012.
With respect to trade, there is a downward trend seen in trade between the member countries. The exports have increased from eurozone countries to non- eurozone countries. This situation has been disadvantageous for the eurozone as it has not been able to strengthen the economy of the members of single currency union (Bootle 4).
Eurozone has performed poorly with the slowest GDP growth and the highest unemployment rate during all significant periods mentioned earlier. It has been unable to sustain the weather shocks and has underperformed critically. The reasons are many such as: dearth of stabilising international strategies, controlled internal economic policy and a universal monetary policy for all members. Moreover, the problem of balance of payment (BoP) has been another critical issue that has been experienced by few members. The discrepancy of peripheral balances between members has added to the problem. “In relation to the rest of the world (RoW), then countries in the North( e.g. Germany, Netherlands and Austria) have persistently experienced current account surplus’, while those in the South/Periphery (e.g. Greece , Ireland, Portugal and Spain) have experienced persistent current account deficits despite an approximately balanced overall position” (Holinski et al.2012 as cited in Demetriou 82).
Sawyer (2012) believes that these discrepancies are responsible for the existing eurozone crisis (as cited in Demetriou 82). The imbalance in the BoP requires revising policy alternatives for distinct eurozone members along with assessing their standing. Despite the fact that individual members do not have several policies available for them Jaumotte and Sodsriwiboon (2010) feel that they can replicate this in very short period of time through internal devaluation by means of reduced labour cost and comparative price levels (as cited in Demetriou 83).
As per the northern Europeans, breach of EMU fiscal rules by the southern Europeans and mainly the Irish initiated the trouble. This is true to some extent. The crisis initiated in December 2009, when a new Greek government revealed that its budget deficit had exceeded massively. The national debt of Greece was already very high (113%of the GDP) and these new figures worsened the situation. The crisis was experienced at the international bond market and soon extended outside the boundaries of Greece reaching other members like Ireland, Spain Italy and Portugal. ECB also helped them with funds to ensure liquidity in their banks. However, this is not the whole story as the first countries to violate the terms of the pact were France and Germany. The unreasonable excitement demonstrated in Spain’s unjustified growth in house construction and insurmountable inflation in the Irish banks balance sheets. These instances indicated the imprudence of the lenders and the borrowers both. International financers considered all the eurozone safe (being a single currency area) and provided them fund in abundance and on the other side firms and governments in the eurozone took advantage of the surplus funds for their growth.
The deeper cause is considered the increasing imbalance within the members. The southern Europeans used euro illogically, beyond their worth by trading in more from northern Europe than they sold there and that too on loans.
Causes of weak performance: There are many causes that led to the weak performance of the eurozone.
An institutional discrepancy
An institutional discrepancy: An institutional disproportionateness built into EMU right from its inception was the major factor leading to euro crisis. “The northern Europeans entered monetary union with institutional frameworks well suited to the export-led growth strategies that yield success in such contexts, whereas the southern Europeans entered with ill-suited frameworks-and lost capacity to devalue on which some had relied” (Hall par.18).
Same monetary policy for all
With the start of the single currency, the control of the monetary power of all euro members was rested on ECB. ECB had the right to set interest rates for all members of eurozone. In view of the poor growth rate of some of the large countries like Germany, it set a relatively low rate. This step gave rise to the housing market bubble in countries with flourishing economies such as Ireland and Spain. Further, omission of independent monetary policy and currency made it difficult for the countries to repay their excessive debts by using their individual progressive ways. They could not permit higher inflation in order to reduce the debt problems and depreciate their currency in order to encourage export. They were not free to buy their own debt to avoid non-payment.
Inappropriateself-reliance and assessment of risk
The creation of euro congregated borrowing costs for all eurozone governments. Countries that offered higher interest rate earlier such as Greece, now had to borrow more cheaply coming down to the level of Germany. Private sectors, too, faced the same situation. This led to the accumulation of government debt in Greece and Portugal. Countries like Portugal, Spain and Ireland had to face accumulation of debt at private sectors too. This situation made the financial markets identify every country in the eurozone with the same risk of defaulting on their loans. The implications were visible with the start of the financial crisis in 2008 when the investors started avoiding countries with heavy debts and miserable economies such as Greece giving rise to their borrowing costs.
Economic discrepancy and trade discrepancies
There was a widening gap in the growth rate economies of eurozone in the 2000s.The low productivity and competitiveness levels created requirement for bailouts for the countries. With the beginning of the financial crisis, the borrowing costs began augmenting for these countries. Their repaying capabilities were suspected and their financing became more challenging. The eurozone countries had no option of devaluing their currency to redeem competitiveness, however, Germany, had accumulated huge trade surpluses by decreasing its labour costs.
On the basis of the traditional price competitiveness analysis of these discrepancies, it is considered that other factors like varied degree of openness and export specialization in different countries were responsible for the economic distress in the area.
There are significant differences in trade openness between the members of eurozone and between eurozone and the other countries of the world. This intra vs. extra trade openness has significant direct or indirect consequences for countries with respect to their export performance. However, these differences do not affect the price competitiveness of distinct countries. “Historically, there has been a very high correlation between developments in individual countries’ price competitiveness indicators computed vis-à-vis only the other Eurozone countries and those computed with respect to the rest of the world” (Claessens 119). It means that the advancements in domestic prices and costs that determine the price competitive position of individual Eurozone countries within the Eurozone affect their competitiveness in the extra-Eurozone as well (Claessens 119).
Together with price competitiveness, it is important to consider the export composition of individual countries. To compete in the global market, it is important to concentrate on the fast evolving market segments and to remain stable with proportional gain. Though this specialization has been beneficial for the eurozone, it has not shown, over all, any significant advancement towards specialisation in the rapidly developing high-tech zones. It shows the rigidity of eurozone firms to adjust with the fast growing advancements or their inability to realize the importance of making substantial changes to their specialisation. The countries like Greece, Portugal etc., having direct exposure to competition from low-cost countries have specialised relatively better in low-and medium-tech zones (Claessens 120).
Reaction to the crisis
At the time of the creation of euro, there was no rescue system designed to deal with debt crisis. Therefore, when the financial crisis hit, emergency rescue strategies had to be planned in panic. “The long drawn-out affairs that became synonymous with these bailouts were viewed unfavourably by many. It also created the impression that the larger eurozone countries that were providing the bulk of loans were split as to how best to resolve the crisis. This lack of decisive action weakened confidence in international markets, prolonging the crisis” (Harari par. 3).
The overall growth of the eurozone has been moderate and is indicative of further solid and consistent improvements in future. Despite this positive economic environment, the slow and bleak growth rate in the eurozone and the widening gap between the members with respect to growth rateis alarming. These differences are mainly due to the enactment of structural reorganisations. The overall growth performance of eurozone has not fulfilled the expectations and the recent inflation figures i.e. 0.5 % in May have disappointed the ECB, which expected it to be 2 per cent (Borsch par.3)
Though the economic sentiments with respect to Eurozone are positive, the varied economic performance seen in different member countries has affected growth and inflation significantly. The varied indications of the economic situation in the eurozone have led the European Central Bank to make a somewhat simpler and accommodative monetary policy. The initial period of the 2014 showed some key economic improvements in the eurozone. Greece and Portugal’s reappearance in the capital market, lessened spread on bond and anticipated economic certainty in the eurozone indicates that the crisis will not exist for a longer period. To deal with the crisis, the ECB has introduced some measures that may prove productive in diminishing the distress. The main objective of the ECB is to sort out deflation and support lending to the existent economy. The measures include “lowering the key interest rate, offering cheap loans to banks on condition that they increase their lending to corporates and imposing a negative interest rate on bank deposits parked at the ECB overnight” (Borsch par.6).
The success of ECB’s attempt to jump start the recovery will be determined by their effects on investment activities. The processes allow the banks to deliver credit to the corporate sector at cut-rate rates for further investments. However, the chief concern of the small-medium firms is to find customers. They were not concerned much about accessing finance as it was not responsible for deterring investments but the lack of growth opportunities was. For instance, German companies had a growing economy and favourable financing settings, they were careful about their investment strategies. It denotes that changes in the monetary policy can only act as a part of solution and cannot work as a substitute for organisational reforms that may actually lead to recovery and growth in eurozone.
Eurozone has not been able to accelerate the growth rate meeting the past standards; however, they are nearer to the trend of eurozone’s average sustainable long –term growth rate. The trend rate shows the structural pace threshold for growth, whereas the actual growth rate can be fluctuating around the trend growth rate.
According to the speculations of the European Commission, the financial crisis has affected the growth rate tremendously and its impact could be visible in the coming decade. However, the main reason behind this miserable growth rate is the decreased productivity performance that initiated prior to the financial crisis, but, was noticeable during the years of financial crisis and later. Moreover, the stagnated aging European societies are also responsible for the present growth performance. It is essential to focus on policies that help in increasing productivity for improving the growth potential in the eurozone. Hence, there is a requirement for an active monetary and fiscal policy to overcome low growth performance in the eurozone and have sustainable future impact.
The policy makers believe that eurozone will exhibit speedy growth in near future. Their belief is based on its unexpected faster growth in the first quarter of 2014. The 0.3% growth in the overall eurozone and 0.7% growth in Germany have generated a ray of hope for the policy makers. It is expected by the European commission that eurozone may experience 1.3% growth in the year 2015.
However, the stagnation experienced by the significant economies like France and Italy in the last quarter of 2014 and Greece’s performance has led to the speculations that eurozone may fall into deflation (“Taking Europe’s Pulse” par. 2).
Lack of trust among the marketers regarding the long-term capability of the eurozone members has led them to insulate themselves against the future default.
“The future of the European integration project is staggering with the uncertain future of euro. Government’s inability to handle the sovereign debt crisis has made the situation worse raising questions about the very survival of the project” (Overbeek 39).
The European sovereign debt has not become an acute problem because its level has passed some absolute and objective point of no return, but rather the markets are demanding an exorbitant premium when lending to peripheral eurozone governments” (Overbeek 39).
The prospects for a single market in Europe have drastically been affected by the euro crisis. Even if it remains in existence its shape and size will not be the same as it was before the crisis. Dullien (2012) feels that “In any of the plausible outcomes of the euro crisis, the single market will emerge in a different, diminished shape-completely shattered, reduced in depth and size” (1).
He feels that the economic imbalances that set off with the establishment of single market will continue to haunt Europe even after its transformation and would demand serious prices.
After twenty years of its inception, the single market has not been able to sustain a bright future for itself. This may affect the position of Europe in the world that had been an epitome of peaceful integration for years. The initiative for single market too was a great step taken towards European integration; however, it lost some of its appeal after the setbacks caused by the financial crisis (Dullien 2)
Claessens ( 2015) recommends, “As the prospects for improving the overall country competitiveness in the medium term more broadly depend on the outlook for aggregate productivity growth, eurozone countries should foster innovation and continue to enhance the flexibility of national goods and labour markets, including a healthy process of selection of the most productive firms”(Claessens, 121). Moreover, efforts should be made to foster market integration within Europe contributing to the enlargement of the local markets and attract foreign competitors. Openness to international trade and imports would also prove beneficial for eurozone economies. Thus using a comprehensive approach can support eurozone exports to relative advantage (Claessens 121).
Dullien (2012) asserts that “A leap towards more integration at the core seems to be the least bad option for the single market, even if it risks being reduced in size and there is some disintegration at the fringe” (Dullien 2).He suggests that business leaders should be more focused on the benefits of single market and come up with strong determination and power to deal with the situation. They should be ready to take certain unpopular steps while supporting closer integration. Dullien (2012) states that after twenty years of the signing of the Single European Act, that established the single market, there is a need to gather collective support from Europe to keep the integration alive.
Europe has been struggling for the survival of the euro. In this scenario, the proclamation of the European Commission on the honor of its new currency seems extremely mocking that says: “Ten years into its existence, the Euro is a resounding success. The single currency has become a symbol of Europe, considered by Euro-area citizens to be among the most positive results of European integration…” (Hall par.1).
The real picture is that the crisis has raised the unemployment rate highly in southern Europe (Greece and Spain) forcing number of families to spend their lives in depression. Salaries of employees are slashed and companies are going bankrupt in a great number. Germany, despite its relatively better performance in the eurozone, is being affected by this depression.
The German chancellor Angela Merkel seems to be realistic while proclaiming that “the euro crisis is the greatest Europe has faced since the signing of the treaty of Rome in 1957” (Hall par.1).
Those who commended the measures to integrate Europe are criticizing it now. It is being realized now that the creation of economic and monetary union is not appropriate and fruitful. Adoption of monetary union was not only an economic decision but a political decision as well. EMU came into existence because the EU members were not happy with the previous system that was too complex and needed painful negotiations in settling matters of current account imbalances between EU members. However setting up of eurozone only increased the complexities (Hall par.2).
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