The Effects of Membership of the European Union to Member Countries - Article Example

Topic: To develop an understanding of the effects of membership of the European Union to member countries. Introduction Member s of the European Union submit their annual macroeconomic and budgetary projections for surveillance and coordination of their economic policies. This happens under the stability programme for those European countries that have the common currency Euro. As the economic crisis has been worldwide, the European countries under the canopy of European Union are trying to cope with the crisis under the aegis of the European Economic Recovery Plan (EERP) with a good number of member states opting for excessive deficit procedures to go along the lines of Council decisions taken in 2009. All member countries of the EU need to assess their budgetary strategies in the light of the recommendations made for each member country on how to apply corrective measures to control their deficits within set time frame (European Commission, 2010). Many European countries are facing the risk of economic recovery with GDP growth measures showing improvement in emerging markets but Spain and Greek crisis is a major source of risk. Both countries share their problems of rising public debt and loss of competitiveness with other Euro member states like Portugal, Ireland and Italy. The debt crisis will affect the pace of European growth, the euro and lead to the confidence crisis. Any economic crisis in the member country of EU has to be provided help in debt restructuring from Germany and other European member countries, which is a time consuming process (GovMonitor, 2010). Role of European Central Bank According to Jean Claude Trichet, President of the ECB, (26 March, 2010), the euro area has been stable since 1999 with average inflation rate below 2%. Price stability impacts all euro member states because of monetary attachment with the Union whether it is Germany or some other member states. The role of Central Banks in price stability is very crucial particularly in the time of crisis. The European Central Bank (ECB) and the Euro-system work in the direction of price stability, defined by the Governing Council not to occur an increase in the Harmonised Index of Consumer Prices, which need to remain below 2% in the medium term. The ECB has been making strenuous efforts for the past many decades via stability-oriented policies for making the monetary policy a success, as all depends on the price mechanism, the primary tool of a market economy (Press Conference, 2010). Debt situation in some member states like Greece and Spain have gone out of control, which has generated fear among member states of pushing such members out of the euro region but Trichet preferred not to express views on “absurd hypotheses”, in his words. The Governing Council of the ECB has been taking measures on fiscal policy front for all member countries. In the context of Greece, whether it will succeed in reducing its deficit budget to less than 3% by 2012 with its ratings of BBB+, the collateral rules, according to Trichet, won’t change for a particular member. ECB has been reforming the financial system of the EU by taking bold decisions especially by the Financial Stability Board (FSB), the Basal Committee and the Governing Council in finding suitable ways to come out of the crisis. The ECB has stopped sanctioning loans to private, non-financial and domestic sector and is checking the situation in the wake of recession to save from the lagged effects for outstanding credit growth in non-financial and private sector. Respective governments have taken bold decisions to meet the crisis situations. Each EU member state is benefitted because of its belonging to the euro area by getting financial help for their current account deficit. It is because of credible and common currency sharing. For ECB, running the euro currency in 16 member countries where level of competitiveness is not similar; some members like Greece are far behind by just running their structural reform programmes while others are ahead in competitiveness. ECB operates on the lines of Federal Reserve System with its set of countries on the economic indicators like growth, inflation and unit labour cost evolution. The extent of deviation among the members is more or less of the same order as it is found in the United States (Press Conference, 2010). ECB under the euro system helps in technical terms to affected economies like Greece where the affected country’s role like the Bank of Greece lies within the wider euro system although supporting through different ways the suffering economies is the responsibility of the Commission and the EU Council (Press Conference, 2010). Greek Economy According to Hugh (13 Feb. 2010), the Greek economy has been showing signs of shrinking in the fourth quarter by 2.6% while revisions made a down turn throughout 2009, making the recession affects severer since 1987. Greece cannot improve the fiscal deficit without clearing the roadblocks to overall economic growth. As per the Greek National Statistics Office, the GDP shrank by0.8% in the fourth quarter of 2009, which was above the Reuter forecast of 0.5%. It has cast shadows on the growth path and issues regarding the evolving of the debt to GDP ratio. The total contraction has been 2% for the whole year while the government had estimated it to contract by 1.2%; it is the worst yearly projection in the last 30 years. The credibility of the Greek government is at stake. Revisions have been far above the estimates for all quarters of the year, strengthening the impression that figures are “doctored”. The government, it seems, has no idea what is happening in a particular quarter of the year. The figures for the budget deficit will “finally” reach to about 12.8% while the debt to GDP ratio may touch 114.6%. The Greek Finance Ministry has made improvements in December expenditure on the website, adding 6 billion Euros, which increases the deficit further to full year 37.9 billion. The changing of numbers raises a big question mark on the incapacity of the government to bring the spoiling economic scenario under control. Industrial production, domestic demand and retail sale is also showing downward trend indicating no relief in sight. Unlike Spain, Greece has not seen the credit boom as was in Spain before the bubble in housing prices. Construction activity by private developers has been also on the down side since 2003. Deficit in Greece current account became huge due to non-competitiveness in domestic manufacturing sector. Although the deficit has been reducing but the fall in the export of goods and services has made the scenario tense (Hugh, 13 Feb. 2010). Any help from the EU to Greece to put it to default position will raise hopes for other suffering economies like Spain and Portugal. At stake is the reputation of European institutions due to strains Greece is putting on Europe. The Northern Europe should be tenser to face the situation on helping other members if they help Greece in bailing out (Hugh, 13 Feb. 2010). The Greek Prime Minister Papandreou has been critical of the European Union’s response to the crisis faced by Greece as “timid and too slow” in the battle against rumours and market psychology. The remarks of Papandreou might be made to impress the domestic spheres but member countries cannot make commitments without knowing the size of the loan, limit of the burden sharing by the Eurogroup countries, the terms of the loan and finally determination of the conditions in case execution of programmes falls below the expected targets. Members of the Eurogroup are also hesitant as entering new institutional areas, particularly France and Germany may not like to go too far in helping the Southern neighbours at the cost of affecting relations with the UK and Sweden (Hugh, 13 Feb. 2010). According to Societe Generale, The Economic News, as things stand now, any planned improvement in Greek economy won’t provide positive results in the next 4 to 5 years with a temporary bridging loan. Greece debt level as % of the GDP has been one of the highest in OECD countries. As per the EU Commission estimates, the debt burden will rise steeply to 135% in 2012 from 99% in 2008. Fiscal deficits that were minimum to12.7% in 2009 were due to the sudden increase in the downturn of the economy. By 2011, this deficit will be going upward because of incessant downfall in the tax revenue. The government of Greece also agrees that the deficit budget would be remarkably above the EU limit of 3% until 2012 (Hugh, 13 Feb. 2010). Greece has presented to the EC its Stability and Growth Programme (SGP) on 14th January2010, which is quite impressive considering the country’s previous dismal record in implementing fiscal measures. It has chalked out a plan to reduce the fiscal deficit of 10.7 percentage points of GDP in the next four years from 12.7% of GDP in 2009 to 2% of GDP in 2013. The size of the promised fiscal measures raises doubts over the credibility of Greece in the light of lack of political will. Further, expectations have crossed the level of IMF predictions and also of the EU (Hugh, 13 Feb. 2010). Spanish Economy Economy of Spain since its joining the European community in 1986 has shown continuous 5% average annual growth. Spain is situated in the Iberian Peninsula in south-western Europe. Spain and Greece are members of the Euro zone. Spain is a constitutional monarchy; King Juan Carlos is its head. It is a representative parliamentary democracy as Prime Minister is appointed through general elections by the King. Spain has been an active participant in EU affairs; particularly it played constructive part in reviving the EU Constitutional project (CIVITAS, Jan. 2010). Spain’s economy was affected due to Europe wide recession but it managed to reach the rest of the Western Europe in raising its per capita levels of income. Spain was member of the earliest group of countries opting for Euro as their common currency. With an average growth of 3% annually, Spain has stabilized its economy and is developing; economic growth reached 3.8% in 2007 with service sector making 67%, industry 30% and agriculture 3% of the growth chart (Economy Watch, 2010). Financial crisis started impacting the Spanish economy, according to the Financial Times, with the increasing trade deficit reaching 10% of the country’s GDP in 2008. Loss of competitiveness with the trading partners was the primary reason besides the higher inflation rate, housing boom and oil prices. Forecast of Spanish government was revised from 2.3% to 1.6%. Actually, growth in GDP became negligible due to increase in the number of immigrants. By the third quarter of 2008, GDP showed sign of shrinking and by February 2009, it was officially stated that Spain was under the impact of recession (Wikipedia, 2010). Spain’s economy is the fourth biggest from the euro zone; it is five times bigger to that of Greece. So if Greece succeeds in clearing the road to growth through flaunting of bonds, it’s not that easy for Spain to clear the road to growth likewise Greece. Spain’s social Prime Minister plans to increase the retirement age to meet the challenge of 11.4% fiscal deficit; wage freeze is also an option to reduce the deficit by 2013 to 3%. According to the International Monetary Fund, the economy will contract further. The most alarming thing is rate of unemployment, which has reached 20%, the double of euro zone and may reach 22%. Labour rates have been constantly increasing at 4% yearly, making Spanish products uncompetitive in most of the export markets (Stelzer, March 2010). EU bailout seems to be the last option. If the rating agencies get adamant and the market reacts proactively to Spanish bonds, then even Germany would see to it to ensure that Spain does not become a defaulter on its bonds. In comparison to Greece, Spain is less in debt. The debt-to-GDP ratio of Spain has been less than Greece, Italy, Portugal, France and even Germany due to the previous governments’ sound fiscal policies. Another contributing fact of Spain’s economy has been its clean record of not manipulating figures unlike Greece. Spain’s credibility in comparison to Greece in discussion with the rating agencies and bond market remains intact. Spain need not pay 3 percentage points more than Germany as Greece had to beg before the bond market. But Spain cannot carry itself long on its clean image due to heavy budget deficit, lack of planning, structural drawbacks of the economy and slow pace of economic activity. These loads will be heavier to carry in the over-burdened debt market of Spain in the coming years (Stelzer, March 2010). Spain’s growth is built on cheap credit that charged the construction industry but after recession it is not going to re-emerge on the economic landscape with recovery. There seems to be no indication of a tourism boom either to work as stimulus for the next-generation industries (Stelzer, March 2010). The responsibility all lies on the shoulders of private sector to bring the country back on the track. Entrepreneurs in Spain have already given evidence of business acumen of performing on the global platform. Spain had invested heavily in Latin America and a number of success stories are waiting to be repeated through the next generation of entrepreneurs, the Conquistadores, to land on the South American business horizon (Stelzer, March 2010). Spanish banking system has been a strong backbone of the Spanish economy. According to the C.I.A., it “has been relatively insulated from the global financial crisis”. Being “relatively” means all is not well in Spain’s banking system. The country’s smaller local banks, the cajas de ahorros that fulfill about 50% loan requirements have gone to the extent of delaying by not registering the failed credits to postpone identification of losses realised, which should not be the escape route. These bankers are not heeding to the calls of Miguel Angel Fernandez Ordonez, governor of the Bank of Spain, to assimilate with bigger and better resourced institutions like the CCM (Caja Castilla la Mancha), the only local savings bank to be taken over by the Banco Central de España (equivalent of the US Federal Reserve). The banking system is shielded from outside affects of recession (Stelzer, March 2010). Effective banking system and private entrepreneurs alone are not sufficient to take the boat of economy from tidal waves to calm waters. Rigid labour market has been a negative factor. Most of the labourers work by entering into a contract that comes in the way of mobility of the workforce by their employing companies. There are no incentives in the contract to boost the spirit of work. In such a scenario, government has not taken the path of reforming the labour market to instill the spirit of work (Stelzer, March 2010). Another negative factor is the downgrading of Spain by the rating agencies. There is a lack of faith in the government growth stats. Since 75% of the expenditure in the public sector is incurred by independent regional governments and the social security institutions, markets expect commitment on becoming spendthrift (Stelzer, March 2010). Credit rating agencies have gone to the extent of giving a warning to the Mediterranean countries in general to bring a basic transformation in their budget policies to save their ratings from going down further. Markets have further taken the precautionary step of including in these countries self-regulated bond yields the probability of defaulting on their outside autonomous debt payments in the approaching five years. Such reasoning behaviour by the rating agencies shows how significant is to reform the affected economies by taking appropriate action within the eurozone.   Another challenge that countries like Spain, Greece, Portugal and Ireland will put on the eurozone is related to adjusting their internal and external imbalances. Due to not owning a currency of their own, these countries cannot resort to devaluation to correct their external imbalance. For that drawback to recover from, these countries will have to implement severe fiscal policies for a long period until internal devaluation is realized to support external sustenance. In comparison to Germany, the core member of the eurozone, that has very low rate of cost and price inflation to compete, which the Mediterranean countries at present cannot until they reduce their price and wage levels to decisively get an edge in competitiveness with Germany. It implies that eurozone non-core members have to bear and withstand the price and wage deflation for many years to come until they are able to compensate the losses for remaining cost competitive in the present (Lachman, March 2010). Same is the situation of Greece that also does not have its own currency and is bound to bear the negative repercussions from huge budget consolidation on domestic demand. Until the European Central Bank takes some remedial steps to maintain price stability in eurozone, Greece can get back its global competitiveness only via lowering wages and prices to 20-30% in a given span of time. As a result economic growth will slow down and unemployment will rise in the coming times in Greece. After effect will be increase in Greece’s public debt-to-GDP ratio by 150%. If the Greece government consolidates its budget by reducing deficit to 10 percentage points to match the deficit with the Maastricht criteria (the criteria countries are expected to follow once they have chosen the euro) could be a guaranteed formula for a weak Greek economy. If it is taken for granted the working of Greek Keynesian multiplier relationship between governments spending reduction and slow down in GDP to be as minimum as 1.2—a rough guess—reducing expenditure by 10% of GDP would result in shrinking of Greece GDP by 12% (Lachman, March 2010). The Greek social and political set up would not be able to bear the resultant recession of the fiscal measures taken. A bailout from the European Commission seems to be the alternative. Actually, the crisis has become the catalyst of testing the economic stamina of eurozone countries and the European Union. According to David Owen, chief European economist at Jeffries Group Inc. in London, “The euro system desperately needs a weak euro”, as a shrink in euro at this time will provide a soothing effect to the European economy by encouraging exports. Actually, drawbacks of the system have become visible to be addressed, as remarked BlueGold’s Jen, “It may be a blessing in disguise” (Kennedy, March 2010). References: CIVITAS, 2010. EU facts. Available from: http://www.civitas.org.uk/eufacts/FSMS/MS8.htm [Accessed 30 March2009]. Economy Watch, 2010. Spain economy. Available from: http://www.economywatch.com/world_economy/spain/ [Accessed 30 March2009]. European Commission, March 2010. Economic and Financial Affairs Commission assesses stability and convergence programmes of ten EU Member States. Available from: http://ec.europa.eu/economy_finance/articles/sgp/2010-03-24-sgp_en.htm [Accessed 30 March2009]. GovMonitor, 21 March 2010. Greek crisis, Europe and new risks for economic recovery. Available from: http://thegovmonitor.com/world_news/united_states/greek-crisis-europe-and-new-risks-for-economic-recovery-26423.html [Accessed 30 March2009]. Hugh, Edward Feb. 2010. Economics and demography: few surprises as Greece’s economic contraction accelerates. Available from: http://fistfulofeuros.net/category/afoe/page/3/ [Accessed 30 March2009]. Kennedy, Simon March 2010. Greek crisis may provoke Fed-ECB split. Bloomberg. Available from: http://www.bloombergutv.com/news/latest-business-news-europe/47800/greek-crisis-may-provoke-fed-ecb-split-.html [Accessed 30 March2009]. Lachman, Desmond March 2010. Payment imbalances and global economic peril. AEI Online. Available from: http://www.aei.org/outlook/100943 [Accessed 30 March2009]. Press Conference 14 January 2010. ‘Introductory statement with Q&A: Jean-Claude Trichet, President of the ECB, Lucas Papademos, Vice President of the ECB Frankfurt. Available from: http://www.ecb.int/press/pressconf/2010/html/is100114.en.html [Accessed 30 March2009]. Stelzer, Irwin March 8, 2010. So Greece has cleared some obstacles, but will Spain overcome its hurdles? Wall Street Journal Europe. Available from: http://www.hudson.org/index.cfm?fuseaction=publication_details&id=6817 [Accessed 30 March2009]. Trichet, Jean-Claude March 26, 2010. The euro: a stable currency. Available from: http://www.ecb.int/press/key/date/2010/html/sp100326_1.en.html [Accessed 30 March2009]. Wikipedia, 2010. Economy of Spain: 2008–2009 Spanish financial crisis. Available from: http://en.wikipedia.org/wiki/Economy_of_Spain#cite_note-22 [Accessed 30 March2009]. Read More