European causes of its 2012 economic crisis - Term Paper Example

? European Causes of its Economic Crisis Introduction In 1992, the Maastricht Treaty officially formed the European Union (EU), and initiated the adoption of the euro currency. The Maastricht outlined the conditions for European nations aiming to be a Eurozone member. Each member had to organize its finances by: (1) guaranteeing an annual inflation not exceeding 1.5 percent; (2) maintaining finance debits only up to a maximum of 3 percent of GDP; and (3) keeping a debt-to-GDP ratio below 60 percent. To pass the criterion, the European nations agreed to tighten budgets by decreasing public expenditures and increasing tariffs. 1 The euro, being the EU’s sole currency since 2002, strengthened the major trading area in the globe and quickly challenged the dollar for international dominance.2 However, some peripheral European nations failed the strict execution and enforcement of the EU conditions. These nations accrued enormous and unjustifiable losses and dramatically increased public debts, thereby risking the entire European financial system. Access to funds at minimal interest rates and poor imposition of EU regulations regarding debit limits facilitated the onset of today’s European sovereign debt dilemma.3 The crisis accentuated the economic interdependence of the EU, as it highlighted the deficiency in the Eurozone’s political integration which was vital for the provision of a well-harmonized and effectual financial response. To ease the debt crisis and improve economic status, the European leaders and the richest members encouraged the most highly indebted EU members to cut down on government expenditures and programs and to increase their taxes. Despite efforts, market instability continued until 2012, thus questioning the future of the euro.4 Global Meltdown, European Sovereign Debt and Banking Crisis Subsequent to the global economic downturn of 2007, the financial crisis in the peripheral states of the EU worsened: economic activity quickly dwindled; international trade plummeted; and prospects for Europe’s exportation industry diminished.5 Moreover, the high rise of unemployment and distress over the burgeoning fiscal and economic chaos sparked public protests and thus increased the political risks for EU governments and their leaders.6 The economic disaster was weakening the bond between the EU nations and challenging EU’s unity and shared goals. Rapid exhaustion of liquidity left the periphery with unsustainable shortfalls and monetary obligations larger than their GDP. In 2010, a sovereign debt catastrophe, particularly in Greece, stretched throughout the periphery and jeopardized any economic opportunity for the EU. In 2011, the European Union and the International Monetary Fund took actions to rescue Greece, Ireland, and Portugal.7 Governments of Iceland and Latvia have disintegrated resulting from the public complaints over their administrations for mishandling their economies throughout the tragedy. Sparking the protests even more was the International Monetary Fund’s issuance of emergency loans to the following EU nations: Belarus ($2.48 billion), Bosnia and Herzegovina ($1.52 billion), Hungary ($15.7 billion), Iceland ($2.1 billion), Latvia ($2.35 billion), Moldova ($118.2 million), Poland ($20.58 billion), Romania ($17.1 billion), Serbia ($4.0 billion), and Ukraine ($16.4 billion). In February 2009, the World Bank in alliance with the European Investment Bank and the European Bank for Reconstruction and Development announced a financial assistance grant amounting to $31 billion over two years to aid near-bankrupt banks and industries in Eastern and Central Europe.8 The economic turmoil caused a quick fluctuation in the Euro currencies of Eastern European countries and caused their government debits to climb, destabilizing the attempts of several countries to join the European Union. $1.5 trillion assets in EU banks were exposed in Central and Eastern Europe. In spite of the exposure of the major Western European banks for East European countries and the Russian Federation to East European banks, still, the EU leaders could not concur on a unified approach to the fiscal catastrophe and refused Hungary’s plea for financial assistance for East European nations. While some East European members insist on generous financial aid from the EU; other members conveyed slight concern in accepting financial aid.9 European Factors that Facilitated the Onset of Today’s European Debt Dilemma The five European countries: Greece, Ireland, Italy, Portugal and Spain (GIIPS) that risked the future of the EU economy and caused various crises regarding the Euro are discussed below. Greece Before the introduction of the Euro, Greece was one of the worst economic players in the European Union even with its surplus in the beginning of the second millennium. In 2000 to 2007, Greece became one of the top budding countries in the EU with a growth rate of 4.2% per annum.10 In the later part of 2009, existing alarms concerning the sustainability of household finances in some European nations started when the sentiments of financiers turned against Greece. Over the past ten years, Greece had loaned deeply in the global capital markets to sustain soaring government expenses, banking system inflexibilities, weak income collection, and deteriorating competitiveness.11 The state’s debt is more than 100% of its Gross Domestic Product (GDP) and its deficit is roughly 13%, whereas 3 % is the allowable limit in the European Union membership conditions. The government of Greece has proposed a resurgence scheme to the EU concerning temporary efforts to reduce public sector wages and employees, however the scheme disregards the elemental concerns of public sector modernization and ignores the battle against corruption.12 Spain In the near future, Spain, being the European region’s fourth biggest economy, is forecasted to become the most indebted country, next to Greece. Spain is still not out of danger and should sustain momentum in reforming its economy to fend off contagion from the European debt crisis. Even if Spain’s debt is relatively small at 54% of its GDP, trepidations arise that if the country goes into an economic depression the situation could be more catastrophic than in Greece as the Spanish economy is four times as big. In 2005, Spain’s economy prospered because of a boom in the real-estate division, which has been destroyed by the financial crisis. However, since the burst of the housing bubble, the budget deficit soared to 11.2 % of its GDP in 2009. This trend is predicted to amplify.13 Portugal Portugal faces years of austerity and low economic growth. Over the past decade, the country’s GDP, output, and wage growth declined. In 2009, the country’s budget deficit has climbed to 9.3 % of its GDP. Its reliance on foreign debts made it more vulnerable to the dilemma sweeping the peripheral nations of the EU. Investors gambled against Portugal, increasing their premiums, and making it all the more impossible for the country to fund itself in debt markets. Portugal’s public deficit is around 77% of GDP, which is still within the European standard, however it is predicted to rise to over 85% by 2012. While the Portuguese government has reduced civil service employment and incomes, there is little hope of governmental or structural reforms. Despite the temporary focus of the current reform actions, detractors have predicted that more economic collapse is still ahead. Portugal’s appeal for financial aid was implausible to cause any major decrease in the country’s continuing debt yields.14 Italy Even before the outset of the debt dilemma, Italy’s financial system is fairly steady, compared to all the indebted EU countries, because it has been suffering for more than 5 years already. Partially due to the strict guidelines concerning bank oversight, Italy’s financial division has managed to stay moderately impassive by the economic catastrophe. Furthermore, Italy’s economy will most likely not get any poorer in the near future. Actually, in spite of a national debt of over 100% of GDP, its economy is recovering from its economic dilemmas of the previous years.15 However, markets had lost confidence in Prime Minister Berlusconi's capacity to execute long-pledged austerity measures, sending yields on ten-year government bonds beyond the unsustainable level of 7%. Other EU nations requested financial support from EU leaders and the IMF when costs reach high levels. However, for Italy which has a national deficit of $2.6 trillion over 115% of GDP, a bailout was not an option.16 Ireland The financial system of Ireland has been deeply distressed by the crisis, thus causing a general recession in its economy. In 2009, the economy reduced in size by 7.5percent and accrued a national debt of almost 13 %. Comparable to Italy, Ireland’s government has already faced similar economic challenges by Greece, Spain, and Portugal. The Irish government is trying to balance out the bank sector and stabilize the budget by cutting down on civil servant salaries and paying off bad loans. At present, the prospect of Ireland’s economy is still uncertain although its market is gradually picking up.17 Reforming the EU The response of the EU to the recession had been fast and influential. Besides the intervention to steady, re-establish and restructure the banking sector, the European Economic Recovery Plan (EERP) was commenced in 2008 for re-establishing reliance and reinforcing demand by increasing the economy’s purchasing power through balanced tactical financial schemes and measures that would support the business and employment sectors. The entire economic incentive, as well as the outcomes of regulated fiscal stabilizers, totals 5 percent of European GDP.18 The execution of crisis measures by European members momentarily sustained the labor markets and heightened investments in the public communication and transportation companies. To guarantee the economic resurgence and to continue the European nations’ future development possibilities, the focus must progressively change from temporary demand administration to a long-term supply management. If not, it could hamper EU’s reformation or build damaging deformations to the Internal Market. Furthermore, although obviously crucial, the daring economic incentive is sacrificed. On its present route, the European debt is predicted at a hundred percent of GDP by the year 2014.19 To date, Greece, Ireland, and Portugal have been given considerable financial supports by the International Monetary Fund (IMF), the Eurozone and EU monetary institutions. Moreover, the generous contribution and dynamic mediation of the ECB to European fiscal stability supported the European administration and banking system. Analysts feared an impending contagion or extending crisis to the top European economies, such as Spain and Italy, in spite of the assistance.20 Sovereign default jeopardy continues to be remarkably high and several analysts forecast that one or more European members would fail to pay its public debt.21 Conclusion The European financial disaster is having extensive and lifelong consequences. The euro currency which is the most determined venture in the European integration now faces danger of survival. European officials realized that the euro’s survival, as well as the continued existence of the Eurozone cannot be merely ignored. It relies heavily on the cautious management of tensions in the Eurobond markets and the poor financial handling, transformations to economic administration and the determination to deal with system difficulties. Although the biggest and most powerful European nations and their organizations have implemented unparalleled emergency scheme to mitigate the debt dilemma, and have encouraged the most highly indebted EU members to reduce government expenditures and programs and to raise their tariffs, the market volatility still continued and economic recovery seemed doubtful and distant. Moreover, with the persisting recession, the entire Europolitical environment would likewise be at risk of disintegration. References 1 Alessi, Christopher. “The Eurozone in Crisis.” Council on Foreign Relations. 2012. 2 March 2012. 2 Ibid. 3 Nelson, Rebecca M., Belkin, Paul and Derek E. Mix. “Greece’s Debt Crisis: Overview, Policy Responses, and Implications.” Congressional Research Service. 18 August 2011. 2 March 2012. 4 Alessi, Christopher. “The Eurozone in Crisis.” Council on Foreign Relations. 2012. 2 March 2012. 5 Jackson, James K. “The Financial Crisis: Impact on and Response by the European Union.” Congressional Research Service. 24 June 2009. 2 March 2012. 6 Pan, Phillip P. “Economic Crisis Fuels Unrest in E. Europe.” The Washington Post 26 January 2009: A1. 7 Alessi, Christopher. “The Eurozone in Crisis.” Council on Foreign Relations. 2012. 2 March 2012. 8 Shin, Annys. “World Bank to Offer Aid to Eastern Europe.” The Washington Post 27 February 2009: A10. 9 Forelle, Charles. “EU Rejects a Rescue of Faltering East Europe.” The Wall Street Journal 2 March 2009. 10 Levine, Jeremy and Mark Gerow. “European Economic Crisis 2010.” European Union Committee. 2010. 2 March 2012. 11 Nelson, Rebecca M. “Sovereign Debt in Advanced Economies: Overview and Issues for Congress.” Congressional Research Service. 26 May 2011. 2 March 2012. 12 Levine, Jeremy and Mark Gerow. “European Economic Crisis 2010.” European Union Committee. 2010. 2 March 2012. 13 Ibid. 14 Ibid. 15 Ibid. 16 Alessi, Christopher. “The Eurozone in Crisis.” Council on Foreign Relations. 2012. 2 March 2012. 17 Levine, Jeremy and Mark Gerow. “European Economic Crisis 2010.” European Union Committee. 2010. 2 March 2012. 18 “Economic Crisis in Europe: Causes, Consequences and Responses.” European Economy. 2009. 2 March 2012. 19 Ibid. 20 Patnaude, Art and Mark Brown. “European Funding Costs Hit Record Highs.” Wall Street Journal.12 September 2011. 2 March 2012. 21 Moses, Abigail. "Greece has 98% Chance of Default on Euro-Region Sovereign Woes." Bloomberg Business Week. 13 September 2011. 2 March 2012. Read More