EU's Breaking Point: The Winning Essay

By: Pichanon Nantavaropas (Nud)

It is apparent to all that Europe is in an economical crisis. With Greece spending in deficit for years, nothing could be more obvious. After Greece declared its bankruptcy, Portugal, Spain and Ireland followed suit. Later, Italy soon joined them as one of the largest European Union nation who finally submits to its debts. Bail out packages had been distributed, but the situation continues to regress. The magnitude of this crisis is so great that many Europeans proposed the dissolution of the European Union to save their nations from the wrath of their neighbor’s debts. The effects of this crisis are felt globally. Banks in the Far East are beginning to back their assets with insurances and stock prices are dropping. The question is: where did this all begin? One could simply trace the origins of this crisis to three rudimentary elements consisting of the disproportion of spending to income, external economical turmoil and the government’s inability to manage their spending.

Why does Europe owe the world so much?

To begin with, one must investigate the most basic principal of an economy: household spending.  As an Old World region, Europe is the cradle of human development and culture. Deceived by the façade of their former glory and wealth, Europeans continues to indulge various articles of luxury while their productivity decreases. The bottom line: the people are spending more that they can’t afford to.

With the influx of competent Asian competition, the European’s productivity prowess is challenged. Once deemed inferior to the Old World craftsmanship, Asian products soon became a threat to the classic European way of life. Japanese and Korean electrical appliances and automobiles proved to be equal, if not better than its Old World counterpart at a fraction of the cost. Asian goods soon replaced the European’s in the world market.  This brought the decline of European industries, especially in the field of electrical appliances, which they once reigned supreme.

Currently, the only profitable trade that still lingers in Europe is tourism, which does not involve any material productivity. For instance, tourism accounts for 15% of Greece’s GDP. The result is decreased revenue for both the European firm and its employees. In addition, typical Europeans often work for only six hours in average and overtime is unlikely. Unemployment rates are also raising rapidly, the reason in which 23% of Spain’s workforce are out of jobs presently. Labor productivity in Europe is constantly decreasing from 0.9% of the GDP to 0.3% by the end of 2011 and if forecasted to go below 0 in the next quarter.

The decreased income, coupled with irrationally high spending is definitely the catalyst of such an economical crisis. To prolong their way of life, the people resorted to loans, putting theirs assets and their future on the line.  In Greece, an average individual would owe about 31,000 Euros in debt and with a total of approximately 340 billion Euros nationwide. (5) These statistics are indeed staggering, and this is an example of how what a nation would become if they are using the money they would receive in the future to satisfy their desires of the present. This concept clearly does not sound, but ironically, it worked for a couple of years until Greece became bankrupt, coupled with the worldwide recession. (7)

Europe continues to deceive the world that they are wealthy nations and is backed by the people’s consumption habits. As home to ultra luxurious products such as the Ferrari supercar to Louis Vuitton handbags, it is plausible to some that Europe is still ‘rich’ while the truth is the opposite. This is the reason why the Europeans got away with such conduct for far too long.

It is an inevitable fact that the root of EU’s debt crisis began with household and individual debt, which quickly escalated to a national level. This is proved by the EU’s low inflation rate, which hovers around 2% according to the Consumer Price Index and dropping at a record breaking -0.70% in July 2009. It is expected to be around 1.7% in 2012. This evidence indicates a sign of recession in Europe. A recession is an event where the people do not have enough money to spend, thus causing the economy to decline. With the towering debt, European households must act fast before they are consumed by their deficit spending.

 America: The Catalyst to the EU Crisis?            

The European economy is definitely on their way to the bottom, but what makes the process more severe is the effects of external economical crisis, specifically, the downturn of the US economy.

The US economical crises began in 2008 with the rising cost of real estates, and with the people were willing to buy it. The brief economical boom gave the prospectors leverage in the demand for real estate as people became wealthier. This led individuals to purchase property in installment preceded by the down payment and then sold for to those who would pay them large sums of money that satisfies both the original price of the estate and costs of their installment plans. Individuals rushed to purchase multiple properties by loaning banks, paying only the down payment, and waiting for a buyer. This process is called speculation where the prospectors were expected to gain money from their retail of their mortgages to cover the other property’s installments. In that process, the dealer could reap a fair amount of profit in the process while they do not need to make large investments.  (4)

With the rising prospects of dealing real estates, individuals soon were mortgaging more homes than they could afford to do so. The purchase of real estate caused their prices to increase beyond its true value. With the hyperbolic inflation of home prices, people soon realize that they simply cannot afford them. Then the sale of property dropped and individual dealers, without customers to help pay the installment of their property, were in debt to banks. This stirred up the bubbles in the economy. As a result, banks are holding heap loads of unpaid mortgages.

Desperate to regain their investments, banks grouped their mortgages into funds and sold bonds to these properties with promising benefits. This is called the “Subprime”. It became a hit in the mortgage bond market until again, the people realized that the values of the real estates and their bonds were dropping as a result of the recession caused by speculation. The bond owners lost their faith in their real estate bonds and reclaimed their investments all at once. The bubble bursts when the market was saturated with subprime real estate bonds and the dealer’s mortgages are due.

Banks were now bankrupt and are at the mercy of government bailouts. The “Subprime” crisis had claimed the business of the world’s largest financial institution, the Lehman Brothers. When the loans are claimed, the once prosperous dealers were stripped of their properties and the nation is once again in the greatest depression since the Wall Street Crash in 1929. Banks are holding mortgages that won’t sell and individual prospectors were bankrupt. (3)

This event is an American variant of the Tom Yum Goong crisis of Thailand in 1997 where the concept similar to “Subprime” was introduced with similar effects.  Banks, after confiscating a considerable amount of money and is now in charge of the mortgages, decided to allow foreigners to invest on these debt and mortgages. This jeopardizes not only the Thai economy but also the whole region of South East Asia who invested in Thailand’s property market. The situation was lifted when the US came in with a bailout package and a plan to subsidize the bank’s debt. It took at least a decade for Thailand to recover, and traces of this crisis are left in a multitude of abandoned property in Bangkok.

Fast-forward to the present, Paul Krugman, an economics Nobel Prize Laureate, stated that China is in a similar scenario with “Real estate investment has roughly doubled as a share of G.D.P. since 2000, accounting directly for more than half of the overall rise in investment.” Which, as stated before, the rise of real estate investment could only mean a start of a depression “…and a world economy already suffering from the mess in Europe really, really doesn’t need a new epicenter of crisis.” Krugman, Will China Break?, The New York Times. (1)

Today, the US is still recovering from the “Subprime” crisis and matters are about to get worse. The Americans are spending beyond their income. With the economy in rough shape and is yet to recover from a recent depression, the nation cannot afford to spend. Similar to the Europeans mentioned, household spending became a problem that yields dire consequences, not only to the nation, but also throughout the world.

The US is the one of the world’s largest markets and with its citizen in debt, the trading will cease, thus forcing the Obama administration to allow additional debt to be made to the GDP. This not only increases America’s deficit spending but also forced the treasury to print out more money resulting in the decrease in the value of the dollar. With the decrease of the dollar and the credit rating, the US dollar is worth less and the investors suffer.

This shook the world economy, affecting all nations with trade affiliations to the US, including the EU. With people with barely any money to spend and investors bugging out, the EU too languished for their top consumer is going under.

The aftermath of the US subprime can be seen in EU’s dropping GDP. Starting from the US top supplier of automobiles, Germany had seen a GDP decrease of 3.1% and its growth rate is now at 0. GDP’s of other EU nations such as Ireland (-2.4), Greece (-4.1), Portugal (-3.9), and Italy (-1.8) had seen their GDP drop below 0 by 2012.  By the end of 2011, the EU had seen a 5.8% shrink in export with respect to its GDP. The effects low labor productivity coupled with the troubling trade partners are taking its toll on the Europeans as the average unemployment rate rose to 10%. This not only suggests the effects of the declining foreign markets like the US, but also the end of the European superiority in economics.

           

The Sovereign Debt Crisis

The term “Sovereign Debt Crisis” often came to mind when mentioning the current European economical downfall. Sovereign debts are debts that a government issued as bonds or other forms to be invested by foreign nations. These are the debt that is currently constraining the progress of Europe. To satisfy the government’s lavish spending and political marketing ploys, the nation had to loan from the others.  

It began as early as 2004 when Greece went over its budget in hosting the Athens Summer Olympic Games. As the revenue of the EU is decreasing, government spending reflected the opposite. In nations such as Greece where there are no real sector productivity, the government retains its high payroll for its officers and civilian social services. Tax evasions are common and that reduces the government’s revenue even further, especially in Greece. (5)

International loans are issued liberally these days and even the US had bonds held by emerging nations like China. In many cases, for a nation to retain its credit rating, it has to pay off its debt. Failure to do so will turn the nation into a state what is called a default, and of course, being degraded in credit.

Default is the state that occurs when a debtor breaks the promises of a loan by either failing to pay in time, or not being able to repay the loan at all. When a country is in a default, it is a no man’s land for private sector investors; therefore, they are at the mercy of bailouts. Greece is currently in a default and they have 340 billion Euros that is due. This represents the government’s failure to manage national debts, forcing them to succumb to the conditions of the bailout. Typical conditions of a bailout would include the introduction of austerity policies in the government, which is essentially, determines the spending cuts and tax raise.

George Papandreou, the Greece prime minister, is forced to resign as a result of the previous government’s heap of debts. It is a shocking fact that Papandreou ‘discovered’ the debt according BBC; one could speculate that this process had been going on for a while. Similar to household debt issues, the government had spending that is way over their annual revenue, which could result in a sovereign debt crisis.

By having debt in the government, the nation suffers. For instance, the credit rating of the nation decreases, causing existing investors to withdraw their investments and preventing investors in the future to invest in the country. This greatly decreases the nation’s revenue and shatters its reputation. Greece fits this bill as all major credit raters rated Greece to the lowest possible level, beyond its previous BBB-.

In a Sovereign Debt crisis, not only the debtor suffered but also banks and investors, whose loans are not paid. Greece had issue bonds that were bought by various nations in the EU and throughout the world. It is apparent that France suffered most for they have invested in over 56.7% of Greece’s debt followed by Germany who had 33.9%.  It is an inevitable fact that sovereign debt in Europe is an imminent cause of the current economical turmoil, and this should serve as a warning for governments to not spend beyond their potential or face consequences similar to the modern day Greece.

             

Europe’s “New Deal”

It occurs to many that this is a grave moment for the EU and the threat of dissolution is looming. Yet for every problem there will be a solution, and that includes those of the EU. The first solution that came to mind is austerity, the most common method to tackle a debt crisis where slashing spending and raising tax is of the essences. Austerity policies are taking place in Greece, Spain, Portugal and other failing nations of the EU.

The concept of austerity, is however, proved to be unpopular amongst the people, resulting in pickets and protests against the government. This is especially apparent in Greece and riots broke out nation wide against the austerity policies. It is not difficult to fathom the causation of such phenomena. Firstly, a considerable amount of civilians are employed in Europe’s public sector, in nations such as Greece, the public sector accounts to 40% of the national GDP, which federal spending cuts would only mean a curtailed salary for the government employees. Secondly, the tax rate in the EU is already high, if not the highest, with tax contributing at the staggering rate of 39.2% of GDP in Greece. No doubt the people display such discontent. (8)

Experts too were not satisfied with the EU’s rash solution; one of them is Krugman.  He stated, “By demanding ever harsher austerity have played a major role in making the situation worse.” This is because “…the combination of austerity-for-all and a central bank morbidly obsessed with inflation makes it essentially impossible for indebted countries to escape from their debt trap and is, therefore, a recipe for widespread debt defaults, bank runs and general financial collapse.” Krugman, Killing the Euro, The New York Times. Krugman’s claim was confirmed by 17^th -23^rd September 2011 edition of The Economist’s cover article: How to Save the Euro, which stated that “… [EU] needs to shift the euro zone’s macroeconomic policy from budget-cutting towards an agenda for growth.” in one of the four things the EU had to do to save the Euro How to Save the Euro, The Economist. (9)The European authority, however, denies these claims as the European Central Bank (ECB), Jean-Claude Trichet replied, “The idea that austerity measures could trigger stagnation is incorrect.”. Surely, the EU’s petty pretenses won’t do in a time of crisis like these but immediate action in a massive scale would. (2)

By only cutting spending, the EU would ironically slow down their own economy, without spending, matters could only worsen as spending is a vital element in keeping a market up and running. Yet, the expenditures should be maintained at a realistic level. The EU should be focusing on increasing productivity, rather that slicing budgets because to create a self-sustainable economy, for a nation must revitalize its industries rather than relying on foreign aid. Starting with Greece, the government should create productive, real sector industries that actually turn out goods that can be exported (that is after the debts are dealt with, of course) and soon Europe would be on the road to its recovery.  (6)

The Bottom Line

           

            In conclusive, it is clear that the major causes of the current EU crisis would be the disproportional ratios in consumption to productivity, economical downturns in the USA and the failure of governments in managing spending. As stated numerous times in this article, spending is the element that often spells an economy’s boom or bust. In an economy, spending both fuels and lubricates the engines of a market. The problem today is how to keep it balanced. Too much expenditure would lead to the EU’s current situation and too little would keep an economy in an eternal regression. Indeed, the European aristocrats cannot seem to find a midway between the two where spending comes in harmony with revenue. Once the center of human advancement in technology, philosophy and economics, Europe is soon to become the world’s largest debtors and the worse is yet to come.           

           

Bibliography

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