By Jeffrey Fung
Something that was meant to be a unification of several European nations has now turned into a situation filled with turmoil and confrontations.
Beginnings of the Eurozone
In 1949, the first predecessor of the European Union – Council of Europe – was formed as a result of World War II in order to improve cohesion and cooperation in Europe. Fast forward to 1992, and the Maastricht Treaty officially formed the European Union, granting EU citizenship to its members and introducing the single European currency in 1999. With 28 members in the European Union and 18 of those members in the Eurozone (countries that adopted the Euro), Europe seemed set for a period of stability and peace. Essentially, the Eurozone is only a monetary union in which each member’s monetary policy–regulations affecting money supply–is controlled by the European Central Bank.
However, with the interdependency that came with the Eurozone, there were also problems that eventually led to what was known as the Eurozone Debt Crisis. The loss of independent monetary policy led to low interest rates and borrowing costs for all members as the ECB were determined to help struggling Germany improve its GDP growth. Countries such as Spain took advantage of this opportunity and eventually assumed excessive debt, creating housing market bubbles along the way. The enormous build-up of debt, spending, and inflation led to increases in imports and trade deficits in many countries.
In 2008, when the global financial crisis hit, borrowing costs skyrocketed, and a credit crunch ensued. Countries such as Portugal, Spain, and Italy struggled to survive the recession. However, throughout the entire time, Germany controlled its debts prudently and became an exporting nation, all while keeping labor costs relatively constant. As a result, Germany became one of the healthiest economies in Europe and even had to lend its excess money to other European nations in order to keep the Eurozone afloat.
Greece’s Struggle Amidst the Eurozone Crisis
Of all the nations that were struggling throughout the Euro crisis, Greece was hit the hardest. As a rule of thumb, Eurozone debt for a nation is not to exceed the debt-to-GDP ratio threshold of 60%. By late 2009, Greek debt had breached the limit and reached 113% of GDP. To make matters worse, Greece’s most important industries such as shipping and tourism were hit especially hard due to their sensitivity to changes in the business cycle, and the government attempted to keep their economy alive through increased spending and debt. In an attempt to soften the blow, the Eurozone collectively decided to launch a €110 billion rescue bailout loan to Greece after it agreed to a series of austerity measures, steps taken to reduce government budget deficits. Ensuing protests and anger in Greece in response to such measures caused further conflict in Europe as they vehemently opposed spending cuts and tax increases. Despite the assistance, Greece’s private markets could not recover enough to help Greece solve the problem on its own and the nation’s position only got worse.
A second bailout eventually came to pass in 2012 as the Eurozone members again agreed to hand another €130 billion in bailout funds to Greece. Along with that, private sector holders of Greek bonds also accepted a 50% write-down on the debt, which eased the country’s problems by reducing Greece’s sovereign debts by around €100 billion. However, all this did not come without a price and Greece had to agree to the key condition of cutting its spending by €325 billion. Such measures were bound to provoke even more protests and conflicts in the country, which was already struggling to contain its unemployment rate of 20%.
In early 2015, Greece appointed a new Prime Minister, Alexis Tsipras, who promised citizens of his nation that he would fight for an extension of existing funds and to get rid of the austerity measures that were negatively affecting the poor, foreign immigrants, and the overall social structure of Greece. This worried many around the world as anticipation of further conflict and the inability to reach a resolution between Germany and Greece became increasingly prevalent. David Cameron, Prime Minister of the UK, said at the time, “What the Greek election will show is that there are warning signs…in the Eurozone [and] less rapid growth…”
Many feared a “Grexit” was now truly a realistic possibility to end the entire situation. Germany and Greece were initially at a standstill as Tsipras was adamant on removing austerity measures that he claims to have harmed Greece’s economy. However, after some time, Tsipras has softened his stance and the two parties have finally been able to agree on a four-month extension of Greece’s second bailout. Germany has also forced Greece to introduce and adhere to additional measures, such as cracking down on tax evasion and reforming the pension and savings system. Even after all this, there are still doubts about Greece’s ability to pay off the remaining debt and survive without further financial aid.
Moving Forward: Path for the Eurozone
As the never-ending situation with Greece lingers on, there still has been no ultimate solution to the increasingly despairing Greek debt levels. Some Eurozone members such as Spain are even suggesting that a third bailout might be inevitable to provide Greece with more flexibility.
One thing is for certain. Germany and Greece should do their utmost to prevent the Eurozone from splitting up. A breakup would lead to huge ramifications, a loss of credibility, and price instability. From the Eurozone’s perspective, a Greece default would have severe repercussions. A Grexit would set a precedent for other similar-minded nations like Spain and Italy, which are both borrowing funds from the Eurozone, to pull back on its own austerity measures and create further unnecessary chaos in Europe. Germany would not benefit either, being a large provider of the loans to Greece. From Greece’s point of view, a Grexit may seem attractive to patriots who do not believe their nation should suffer economically and socially in order to adhere to Germany’s austerity requests. Living within its own means in itself involves a huge, arduous adjustment; its disappointing GDP performance and astounding 25% unemployment rate completely overshadow the primary budget surplus that Greece has recently achieved. On top of that, the private sector and the Greece taxpayers, even with eradication of tax evasion, would not be able to make enough payments to cover any significant portion of debt anytime soon.
To improve the situation, Germany and the rest of the Eurozone should focus on solutions that aim to spur economic growth. For instance, investment by European Union nations into other member economies, particularly into the struggling ones, would be beneficial to everyone in the long run. Though this may go against the instinct of the healthier individual countries and their people, in a union, each country heavily depends on the performance of the other union members. As such, the short-term costs of investing can have long-term gains in terms of growth, GDP, and economic stability.
Lastly, a long-term viable solution for preventing similar crises from arising in the future is a European fiscal union, as opposed to the current European monetary union. Again, although countries like Germany may be unwilling to accept the idea of sharing fiscal risks and debt, this will ultimately benefit the entire Europe and better unite countries by creating a more economically balanced environment. It could more effectively unite European nations ,as measures such as controlling government spending of all nations–which was the cause of the crisis to begin with–and using German cash reserves and taxes to pay for Greek welfare benefits will alleviate the burdens on nations like Greece while also making good use of Germany’s surplus revenues. Capital fungibility amongst the Eurozone members would increase the economic competitiveness of Europe as a whole by making it easier to do business across the entire Europe and facilitating the flow of investments within the continent. However, with this movement, Europe must be careful not to discourage government spending when necessary at acceptable levels while also encouraging investment and capital inflows, as money flows into the economies.
Striking such a delicate balance is easier said than done, but Europe is moving in the right direction with the Treaty on Stability, Coordination and Governance and the Fiscal Compact, which is to be incorporated by 2018.