The inception of OECD goes back to 1948 when the countries came together for better integration of economies ravaged by the war. The organization founded on the principle of co-operation comprises major nations of Europe along with developed countries like USA, Japan and developing countries like India and China (OECD, 2017).
An analogy, if we preview back to see the economic trade cycles in the global arena, undisputedly we can infer, the global economy has a cycle, after every destruction, there was construction, after every recession, there was a boom. If left unmanaged than after every boom there was a bubble. A bubble is a proliferation in values of resources (oil or asset or derivative products) which often is projected high or subjugated less by laissez-faire market to the point which compels a market to crash. Perfect apotheosis could be a great depression 1930, OPEC oil price crises, sub-prime mortgage crisis of USA 2008 and EU debt crises 2008 which created a global economic, social-political and cultural turmoil in the history of the world and had given a fundamental economic doctrine to the humanity.
The paper herein will focus on conceptualizing the causes and implication of EU debt crises underpinning the factors like public debt, budget deficit, government social expenditure, exchange rate and its implication in global trade competitiveness. Let’s retrospect European Union (EU) from 1999 the year when Greece, a so-called lucrative global investment platform for many countries was enlisted as a member of EU. The cluster of debt-ridden and burdening budget deficits countries; Portugal, Ireland, Italy, Greece, and Spain initially celebrated under the canopy of countries like Germany and France where they enjoyed low-cost borrowing but unfortunately the generosity of these pro-socialist countries with their implied self-interest approach (Appleyard & Field, 2014) created a financial imbalance as the use of debt went into unproductive sector or for the settlement of recurring expenses of the country
The three main reasons as summarized by (European Commission, 2009), i. Upward pressure on European exchange rates with the US dollar ii. Carry trades which disharmonized the global liquidity in the European financial markets; investors borrowed currencies with low-interest rates and invest them in higher return yielding currencies and iii. The large capital flows made viable by the integration of the global financial market which was unfortunately invested in the unproductive sectors of the economy like real estate which created a global economic negative repercussion.
The countries were identically different in terms of their socio-cultural dimensions. Germany, on the one hand, was precise when it came about its financial obligation whereas PIIGS seems to be procrastinating. The convergence of multi-variability of various countries into single monetary mechanism was also a reason for the failure, PIIGS already overrode the Maastricht accord and other major players of EU like Germany and France had already crossed the threshold of public debt and budget deficit by 60% and 3% respectively (Steiner, 2012)
The aggressive lending by the US banks and financial institutions, where the original loans were securitized and distributed to other institutions created leniency in determining the creditworthiness of the initial borrower, creation of the new convoluted financial derivative markets, overutilization of the capital by the banks, high leveraged, weak supervision in the off-balance sheet activities all ignited and fuel the creation of the subprime housing effects in the USA and collapse of so-called “too big to fall” banks like Lehman and Brothers in the US cascading global financial turmoil which soon penetrated into the EU countries which were financially linked to the US financial markets.
The non-reciprocity for less developed countries where the euphoria of low-cost borrowing that created a fiscal imbalance could also be seen as the laid foundation for the EU debt crises. The event synchronization could be depicted as in the figure below.
Source: www.bankrate.com, (Steiner, 2012)
Economic crisis never happens at once as an unexpected nightmare, the failure of the economy is a catastrophe brought by series of symptoms that are manifested by ineffective policies and practices. The same happened in PIIGS, the budget deficit to GDP ratio of these countries had already breached the level required by Maastricht Accord, as shown in the graph below
Source: www. economics.rabobank.com.
Each year budget is allocated by the government of the country to come across its current and capital expenses. These gaps, either be a deficit or surplus has an impact on the way government forms its taxation and spending policies and directly or indirectly impacts various economic parameters like inflation, foreign exchange rate, interest rate et cetera.
Globalization and liberalization have not only opened the borders for free trade and cooperation between the countries, but these also been a mechanism for the flow of contagious financial crisis as we can see the impact of subprime housing effect of the US that reached to EU countries as investments were made across the countries.
In general, the portion of deficit budget of the overall OECD countries was on the rise, except for some limited countries in EU, the deficit was alarming. As mentioned above about the Maastricht Criteria in 1993, it was made compulsory to limit the government deficit and debt to 3% and 60% of the GDP respectively(Ismet & Mehmet, 2012). To put in the layman views, high public spending but in contrast decreasing public revenue is also the reason for the collapse of PIIGS.
Table: 1, Government Budget Deficit, 2008(Source: OECD Factbook 2014)\
Admits populism and intent to be voted back, Greece government opted for unaffordable pensions for the country which was amalgamated with falling tax collections; ultimately raising the deficit in the budget (Buckley, 2015). This self-interest approach (Appleyard & Field, 2014) of the political alignment though temporary glamorized Greece but jeopardize it in long run. PIIGS are the neo-socialist where they unfavorably pressured the private sector to bear the burden of public initiatives.
In an event of gloomy economic failure, the budget deficit was followed by the high amount of public debt. The economic crises in PIIGS were so deeply embedded that the crises started to proliferate at various sectors of the economy. The countries in PIIGS were already losing their government revenues, Spain and Ireland lost them in the form of property tax brought by the asset bubble which was one or other way around affected by US sub-prime housing effect and Greece by higher cost of borrowing which was twice the rate being enjoyed by Germany. The bubbling sovereign debt was to burst with significant microeconomic ripples. Due to higher debt and deficit, the cost of doing business increased exponentially in PIIGS in compare to other stronger economics leading to crowd out the private investment which significantly reduced the government tax revenues impacting their fiscal balance. The higher tax, heavy regulations, and globalization were the force to induce producers to outsource resources from other developing countries or go into China, drastically reducing the export of the country. The line graph below provides us some insight on increasing borrowing cost for PIGS.
Source: www. economics.rabobank.com
Interestingly, if we analyze from table 1 and 2, the percentage of the budget deficit and public debt for countries like France, Germany, Norway, and Finland were relatively lower increasing their reliability in the eyes of investor and ultimately with low cost of borrowings.
Table:2, Government Debt, 2008 (Source: OECD Factbook 2014)
As per IMF study, a percentage rise in the global debt/GDP ratio escalates the long-term interest rate by 0.1. The debt ratio of the PIIGS and most of the EU countries were on the rise, pushed the real interest upwards leading to crowd out private investment and rise in unemployment rate. (Davies, 1995)
Source: www. economics.rabobank.com
The soaring debt of PIIGS exponentially raised the tax rate which was to come across sovereign financial obligation, the recurring and repetitive debt requirement during the recessionary turmoil drastically raised the cost of borrowing. The increased demand for the debt also raises the cost of doing business within the nation and crowd out enterprises. In 2010 Athens planned to issue $75 billion bonds to come across its financial obligations. By 2010, Spain, Greece, Ireland, Portugal has the budget deficit of 11.1%, 15.4%, 14.4% and 9.3 % respectively and the debt of 53.2%,126.8%,65.5% 76.1% of GDP (The Telegraph, 2010). Greece public debt (177%) was highest among the EU countries which are followed by Italy (132) and Portugal (129) as per 2015 data provided by Eurostat.
Alarmingly five EU countries; i.e. United Kingdom, Italy, Germany, France, and Spain alone has a debt standing over €1trn (Wikipedia, 2017).
The balance of payment (BOP), on the other hand, is also a prime indicator in depicting the financial health of the economy. Generally, other things remaining constant, a positive BOP refers higher exports in compare to the imports and it could be in goods as well as services, on the happening of this, countries with higher BOP holds more foreign exchange reserves making their economies stronger in the global trade platform. If we follow the OECD Factbook, PIIGS have negative BOP from 2007 onwards. Unfortunately, Greece only has continued with this in 2014 whereas Germany and Norway had maintained their positive BOP to date.
Figure: 1, Bar graph of BOP for year 2007, 2008 and 2014, (Source: OCED Factbook 2015)
From the above figure 1, we can see countries in PIIGS were underperforming since 2007 but with tightening regulatory measures from European Central Bank (ECB) and other stern monetary measures countries except for Greece in PIIGS has positive BOP from 2014 onwards manifesting a growth in intra-Eurozone trade.
Till the point, on inferring the economic and financial history of above mentioned EU countries we found, three economic parameters which also has direct implication in the international trade, i.e. budget deficit, public debt and balance of payment (BOP) were underperforming, the impact of which was higher cost of doing business leading to crowd out private investment (capital flight) and tax revenue for the governments along with other socio-cultural violence, leading to run the country into deficit and low public saving.
Similarly upon the analysis of the disposable income and saving in the same time among the above mentioned sampled countries it was observed that disposable income as well as saving as the percentage of disposable income was in decreasing trend for the countries under PIIGS which can also be seen from the table below.
Table: 3, Percentage increase in the disposable income, 2008 (Source: OCED Factbook 2015)
From the table 3, we can infer that the impact of the national economic crisis has been throughout the Eurozone, Greece has the greatest percentage of decline in disposable income in 2010 whereas France, Germany was able to maintain their economy
Table: 4, Percentage increase in the saving as a portion of disposable income, 2008 (Source: OECD Factbook 2015)
Similarly, the impact of low income can be seen in the private household saving in table 4. From the data of table 3 and 4, it can be concluded that not only the PIIGS were lacking in public saving (i.e. their budget deficit) but also were having lesser private saving, the impact was the supply of lesser loanable fund for the investment and lesser national output. The lesser output forced for higher imports but depreciated currency in the PIIGS leading to increase in the trade deficit even more. The household debt and non-profit institutions serving households as a percentage of net disposable income increased between 2007-2014, France and Germany, Greece recorded the largest
Interesting, a trend has been observed among the population growth rate and GDP growth rate in sampled countries. To put it another way, it could be concluded that the countries that were under-performing had higher population growth rate relative to the growth in GDP. And these could have a direct implication in their social expenditure.
Graph: 1, Comparison between GDP and population growth rates of sampled countries for 2008.
The developing countries of Asia, namely China and India were doing relatively better than countries under PIIGS and other Eurozone, probably as the developing models of those countries was focused more in internal consumption whereas the EU countries relied heavily on intra-Eurozone trading.
The social expenditure, the amount that the country spends to protect and promote the standard of living of marginalized and poor people of the country could be an additional financial and fiscal burden during the time of recession. These could be in the form of sick allowances, unemployment allowances, pension et cetera. These pro-socialist countries of PIIGS were in no mood to reduce the generosity they have been granting their citizens, the reason could be i. nationwide mass protest ii. government natures to be benevolent so that they can be re-elected back.
Graph: 2, percentage of social expenditure of sampled countries for year 2005,2009,2014, Source OCED Factbook 2015.
The social expenditures of all the sampled countries have increased throughout the observed period 2005, 2009 and 2014. The only difference was how the burden was born in the country. In case of most of the EU countries, they were assumed by the government itself which pressured their fiscal deficit grossly but some well-performing country were shifting these kinds of burden to the private sectors, releasing more funds for economic development and capital investment. The pension burden of PIIGS in 2008 ranges from 10-15% of their GDP whereas at the same period it was just 5.9% of GPD in the USA.
Sooner bailout was inevitable, in 2010 Athens planned to issue $75billions bonds to come across their financial obligations and Greece and Ireland was the first to be bailed out. The bailout came with the cost in the form of extreme and stern austerity measures shrinking the economy deeper. International Monetary Fund (IMF) reciprocated tightening fiscal balances, i.e. increased tax, social expenditure, wage cut, these created political and social havoc in already jeopardized economics, a massive protest came in streets against the austerity apparatus.
A pervasive euro currency did also create problems for countries in PIIGS as they lost the control over their monetary policies and its apparatus. A state of fixed exchange rate regime and un-autonomous monetary policy leads to decrease the output of economy (Appleyard & Field, 2014). As the countries like Greece, Italy, Portugal, Spain, Iceland, and Ireland started to have the trade deficit, the option left to them was to incline towards the lender of last resort; European Central Bank(ECB). These countries could neither depreciate their currency so that they make their export cheaper.
Ultimately it created a detrimental situation for the net importing country (due to trade deficit), they were spending the huge amount of their weak currency to import the goods and services. Had the government of the country been able to print their currency upon requirement or been able to devaluate or reevaluate their currency, to some extent crisis could have been managed. Interestingly, United Kingdom (UK) pulled it out from the same currency regime and protected itself whereas Greece currency appreciation and Germany devaluation during the joining into Eurozone make the export dearer for Greece whereas cheaper for Germany, a strong reason for current account surplus of Germany.
Whereas countries like France and Germany were doing satisfactory from the very beginning as well as were less harmed by the EU debt crisis relative to those in the PIIGS. From the OCED Factbook, it was seen that GDP growth rate was higher than population growth rate, savings were higher with higher income of public and BOP was positive in the countries that were found to be less devastated by EU debt crises. The same could be found in other sampled countries like South Korea, USA, Finland et cetera. The line graph depicting the current account surplus of Germany also provide us clear stance on disused points.
Source: www. economics.rabobank.com.
France focused on learning from others approach, i.e.it benchmarked with other soundly performing EU countries to reduce its ballooning public debt. It centralized public expenditure to control social expenditure and focused on the fiscal savings; prioritize maintenance rather than uncontrolled expansion of public spending. (Hallaert & Queyranne, 2016)
Having gone through the above-mentioned facts, figures, cases, and illustrations, can we now infer that the sovereign debt was the only possible cause for the turmoil in EU that propagated throughout the globe. Perhaps, economist and Nobel laureate Paul Krugman denies. In 2016 the amount of GDP to debt ratio of the USA and Japan was 106.1 and 250.40 respectively, has the case been so than these two countries should also have fallen into economic crises but Krugman says PIIGS were collapsed by the higher interest spread, i.e. higher cost of borrowing.
Graph: 3, Proportion of debt as the percentage of GDP for the USA and Japan
Due to the significant amount of risk perceived by the investors, PIIGS were paying up to around 30% as interest rate when Germany was just paying around 2-3 %. These higher costs of borrowing had an economy-wide shock that makes the PIGS, even more, worse off.
Nevertheless, debts are not bad either, many economies of the world are performing excellently well with their budget deficit which they had fulfilled by debt. The debt was utilized by the well-performing countries by investing in capital and social infrastructure whereas those in the PIIGS were used for the repayment of debt and its interest.
As per (Arkoh, 2013) government often takes debts so that it can use it to come across its capital expenses and uses the taxes for recurring expenses. Furthermore, the use of the debt prevents the economy from the inflationary pressure that could come due to the printing of new currencies. In 1988-1990 the increase in 1264% of money supply in Argentina created an inflation of 1912%. As per (Kenny, 2017), 2010, 2011 and 2012 were volatile EU periods as the country like Greece was too small to save whereas Italy and Spain, too big to be protected.
Whatever be the scenario then, now the circumstance has changed, slowly the PIIGS economy has started to recover after the imposition of strict austerity plans followed by the bailouts. And the EU debt crises could be termed as the financial turbulence occurred in the EU zone due to higher leverage in the utilization of debt by the country's, deteriorating monetary policy due to the loss of control in monetary policy and inflating trade deficit.
To conclude, the escalated Debt and Budget deficit increased the cost of borrowing for the PIIGS, it makes doing work harder, private sectors were crowd out declining the government tax revenue, meantime asset bubble in Ireland and Spain was impacted by US subprime mortgage crisis, due to negative BOP; trade deficit enlarged, stern austerity for refinancing hit the domestic economy hard and controlled Monetary Policy by European Central Bank (ECB) but individualized Fiscal policies by the countries make the EU debt crises happen in 2008.
But for the mankind, EU debt crises will remain as an undisputed history of global macroeconomic shocks which was triggered by the euphoria of low-cost borrowing by EU countries into their unproductive sectors, where the regular citizens in that time had experienced inflation through depreciated currency, students and scholars might had practiced shifting and moving of IS and LM curve the way that increases the interest rate and had decreased the BOP and national output. And last but not least, these all events have focused on better integration within the EU with tightening regulation because if there were no measures from ECB, IMF and other stronger economies like Germany, France, it would have been hard for the countries in PIIGS to bounce back
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