Great Lakes Institute of Management (Chennai)GLECONOMICS Club

Euro Crisis

The European Union

• Shared values: liberty, democracy, respect for human rights and fundamental freedoms, and the rule of law.

• Largest economic body in the world.

• World’s most successful model for advancing peace and democracy.

• A unique institution – Member States voluntarily cede national sovereignty in many areas to carry out common policies and governance.

• Not a super-state to replace existing states, nor just an organization for international cooperation.

• World’s most open market for goods and commodities from developing countries.

27

7

30

490million

Member States

Combined population of

EU Member States

Percent of world’spopulation

Percent of global GDP

55Percent of combined

worldwide OfficialDevelopment Assistance

Timeline

• 1951 – European Coal and Steel Community

• Early 1950’s – EDC and EPC

• 1957 – Treaty of Rome – EEC and Euratom

• 1967 – EEC, Euratom and ESCC merged into EU

• 1989 – Fall of Berlin Wall, set the stage for unifying Europe and EU enlargement

Why EU formedWar experience: - 25 million people died in WW-I and 40 million died in WW-II - EU formed to prevent Germany from regaining military might as

well as future Europe-wide conflicts - put war-making industries (coal and iron) under international

control - constrain nationalism through web of political rules

Cold War: - end of Western European great powers, imperial rivalries in Africa,

South America, and Asia - formed EU to unite against rising Soviet threat - US was main catalyst of EU formation because they wanted a

strong Europe next to the USSR

Economic Benefits: a. Comparative advantage b. Economies of scale c. Bargaining power

EU InstitutionsEuropean Commission

• EU’s executive branch proposes legislation, manages Union’s day-to-day business and budget, and enforces rules.

• Negotiates trade agreements and manages Europe’s multilateral development cooperation.

Council of the European Union

• EU’s main decision-making body, comprised of ministers of 27 Member States, representing Member State’s point of view.

• Decides on foreign policy issues.

European Parliament

• Voice of European citizens – members elected for five-year terms.

• With the Council, passes EU laws and adopts EU budgets.

• Approves EU Commissioners.

European Court of Justice

• Highest EU judicial authority.

• Ensures all EU laws are interpreted and applied correctly and uniformly.

• the ECJ can only deal with matters covered by the Treaties.

European Commercial BANK

The European Central Bank (ECB) is the central bank for Europe's single currency, the euro.

The ECB’s main task is to maintain the euro's purchasing power and thus price stability in the euro area.

The euro area comprises the 15 European Union countries that have introduced the euro since 1999.

The ECB operates independently from Member State governments.

The euro was introduced in 1999

Euro Zone

It is defined as economic, monetary and geographic

union of17 member EU countries who have accepted Euro as

commoncurrency after satisfying entrycriteria

Why Eurozone was formed

• Convergence than confrontation• Compete with Mighty US dollar• Ease of trade

Entry Criteria• Maastricht treaty – 1992 – to bring price stability

– Inflation rates < 1.5 (avg. of 3 best performing EU countries)

– Govt. deficit to GDP should not exceed 3%– Gross govt. debt to GDP should not exceed 60%

(Germany and France violated this rule)– Applicant country must have joined the Exchange

rate mechanism under EMS– Long term interest rate must not be more than

2%

• Copenhagen Treaty – 1993 – to preserve democratic governance and human rights– Political – democracy, rule of law, human rights

and respect for minority countries– Economic – functioning marktet economy– Legislative – legal laws in unison with EU laws

Agriculture

• France benefitting the most from Common Agriculture Policy which provides agricultural subsidies whereas UK opposed to it as it does away its competitive advantage, hence uses annual UK Rebate to subsidize further.

• Tourism• France- world's number one tourist destination followed by

Spain, Italy & UK.• The enlargement was "a gift" for the Baltic States leading

to increased international travellers, overnight stays and rural tourism development.

• New company Formation

• The low labour costs in Poland helps the bottom line, while the sustained 5% annual growth guarantees market expansion.

• Right next door in Lithuania, friendly tax rates are the main attractant, with their 15% corporate tax schedule among the lowest in the EU.

Reduced administrative hurdles

• Dutch companies have saved the most due to reduced overall administrative hurdles resulting from EU formation.

General Drawback for the EU as a whole

• Optimal currency theory first posed by American Robert Mundell in 1961, in order for a single currency to succeed in a multinational area several conditions must be met. No barriers to the movement of labor forces across national,cultural, or

linguistic borders within the single-currency area. wage stability throughout the single currency area. Area-wide system to stabilize imbalanced transfers of labor, goods, or

capital within the single-currency area. • These conditions do not exist in present-day Europe particularly

between those in the West and in the East.• The challenges faced by the Economic and Monetary Union (EMU)

countries are far more complex than the current sole focus on sovereign debt suggests. 

• Many internal factors such as a political consensus in favour of wide-ranging economic reforms, the structure of the debt, the quality of the financing and, above all, the economic policy lessons learned from the crisis (concrete form of the austerity measures and reforms) diverge considerably from country to country.

• Unemployment• Highest in Greece and lowest in Austria.• The countries within the EU which were most affected

were Spain, Ireland and the Baltic countries with the unemployment rate doubling or in case of the Baltic countries nearly tripling.

Greece

Before Entering Euro• In Greece the banks didn’t sink the country. The country

sank the banks.• In the 1980’s and 1990’s Greece were considered far less

likely to repay their loans.• In late 1990’s they had a chance to get rid of their currency.• In 2000, after a flurry of statistical manipulation, Greece hit

the targets. • Greek-government statisticians did things like remove

(high-priced) tomatoes from the consumer price index on the day inflation was measured.

After Entering Euro• Greeks could now borrow long-term funds at roughly

the same rate as Germans—not 18 percent but 5 percent.

• In 2001, entered Goldman Sachs, he investment bankers also taught the Greek-government officials how to securitize future receipts from the national lottery, highway tolls, airport landing fees, and even funds granted to the country by the European Union.

• For these trades Goldman Sachs—which, in effect, handed Greece a $1 billion loan—carved out a reported $300 million in fees. Inside Greece there was no market for whistle-blowing, as basically everyone was in on the racket.

After Entering Euro…….• In just the past decade the wage bill of the Greek

public sector has doubled.• The average government job pays almost three

times the average private-sector job.• The Greek public-school system is the site of

breathtaking inefficiency: one of the lowest-ranked systems in Europe, it nonetheless employs four times as many teachers per pupil as the highest-ranked, Finland’s.

•  As a result of inefficiency, Greek goods have become increasingly expensive and uncompetitive, causing loss of market share and further reducing revenues.

The Scandal• Votapaidi Monastery Affair• They basically are Greek Cypriot Monks

Truth comes out………

The Greek government had estimated its 2009 budget deficit at 3.7 percent. Two weeks later that number was revised upward to 12.5

percent and actually turned out to be nearly 14 percent.

A projected deficit of roughly 7 billion euros was actually more than 30 billion. They had no Congressional Budget Office and no

independent statistical service.

 

The reality………….• The structure of the Greek economy is collectivist,

but the country, in spirit, is the opposite of a collective. Its real structure is every man for himself. Into this system investors had poured hundreds of billions of dollars. And the credit boom had pushed the country over the edge, into total moral collapse.

• Steps taken-----

• IMF and EU agreed to lend Greece up to $146 billion over three years.

• Greece to increase sales taxes, reduce public sector salaries, pensions, eliminate bonuses.

Spain

A Brief Overview of the Spanish Economy Spain’s mixed capitalist economy saw the fastest

economic development in Western Europe since the 1960’s

Tourism, agriculture, industry, trade were the dominant players in the country’s economy

Much of its growth was dominated by the housing bubble Many of the new jobs created were restricted to low wage,

low-productivity parts of the economy The economy attracted significant amounts of foreign

investments

How it all happened for Spain As Spain’s economy was rising rapidly before 2008, its

debt-to-GDP ratio was falling sharply When Spain joined the Euro the Spanish Government

resisted the lure of cheap loans but most ordinary Spaniards and its banks did not

The country experienced a long boom, underpinned by a housing bubble, as Spanish households took on bigger and bigger mortgages

The economy which grew 3.7% per year on average from 1999 to 2007, has shrunk at an annual rate of 1% since then.

Repercussions Real estate prices have dropped significantly (by 25%) The banking sector is highly indebted. Bankia, the

country’s 4th largest bank, recently asked for a 19 bn Euro bailout

1 in 4 Spaniards are in risk of poverty or social exclusion Spain’s unemployment rate has become the highest in

the EU zone post the crisis - 24.3% (total) and 51.5% (youth)

Spanish banks have 155.84bn euros of loans at risk of not being repaid

Reasons why Spain might be the 1st to exit the Euro Zone Spain’s economy is too big to be rescued Spain is tired of austerity already Spain has a real economy. Its export to GDP ratio is 26%,

similar to the U.K, France or Italy Spain is politically secure Spain has bigger horizons. It can look to global markets

rather than constraining itself to European markets only

Republic of Ireland

Origin• Eurozone is monetary union but not fiscal union• Differences in economies and their fiscal policies

lead to crisis• Irish economy expanded rapidly from 1994-2007

because of low corporate tax, low ECB interest rates etc.

• ISE went down from 10,000 points in April 2007 to 1,987 points in Feb., 2009 (a 14 year low).

• Reasons for Ireland is same as that of Greece i.e., property bubble burst, effect of 2008 Economic crisis, ever increasing debt Asset-liability mismatch.

The Recession• In September 2008, Ireland has been announced to

be under recession. It is the first country to enter recession in Eurozone

• Emergency budget 2008 - Withdrawal of HPV vaccines, medical cards, university fees, closure of military barracks in the northern border

• Political turmoil and many protests. About 120000 people protested against pension levies, layoffs

• Government debt increased, businesses closed, unemployment increased

• On April 2011, Moody’s downgraded Irish bank’s debt as Junk

• The debt to GDP ratio of Ireland is

The impact• Anglo Irish bank – Hidden loan

controversy and illiquidity• Economic contraction and

unemployment• Property market slump• Emigration• Political unrest and recession

The rescue plans• Austerity plans of the Government

are met with protests and political coups

• November 21, 2010 Ireland formally requested support from EFSF and IMF

• On November 28, 2010 85 bn euros rescue package *doubt*

• Ireland might need a second bailout

Italy

About Italy is the world's 7th largest exporter of goods.

It exports most of its products.

Southern Italy : less developed, high unemployment.

Italy supported the US-led invasion of Iraq in 2003 , causing dismay amongst some members. Which was opposed by France and Germany placing strain upon relations between member states.

• The famous 4 Fs: Food, Furniture, Fashion and Ferrari.

• Italy accounts for 16.8 per cent of eurozone GDP, behind Germany and France in importance, compared with 2.3 per cent for Greece.

REASONS

• Starting in 2001, Italy's GDP growth turned absolutely paltry, which was managing the large debt since long time.

• Productivity: International Monetary Fund found that compared to other euro zone countries, Italy suffered from excessive regulation and a dearth of R&D spending. Another reason was weak labour laws.

• South region: Unemployment, crime, and black market labour are also concentrated in the South. GDP per capita in the North and centre is more than 40% higher than the south.

EURO CRISIS• Italy's debts now top $2.2tn, or 120% of gross

domestic product. • Hit hard by rising borrowing costs on its

government debt• Interest rates on its sovereign debt surging well

above seven per cent, there is a rising risk that Italy may soon lose market access.

• It is too-big-to-fail but also too-big-to-save, this could lead to a forced restructuring of its huge public debt

What next Their tourism industry is expected to grow in the next

five years because they’re bringing travellers from emerging markets.

Italy will offer up to 3 billion Euros of zero-coupon bonds and up to 750 million Euros of bonds linked to euro zone inflation at its regular end-month auction on Aug. 28,

Italian PM Mario Monti  is urging Berlin to present a "clear action plan to achieve a democratic, federally structured Europe”.

A large part of Europe would find itself having to continue to put up with very high interest rates, that would then impact on the states, and also indirectly on firms

Which is the direct opposite of what is needed for economic growth.

What nextBerlin has strenuously opposed the issue of

joint debt, or Eurobonds : as their cost of borrowing would increase.

Italian PM Mario Monti, said that Italy needs no assistance of any kind.

But if Italian economy slows down any further, it would not be able to maintain its massive debt burden on its own

Monti suggests to buy up countries' debt on the open market and reduce borrowing costs for Spain and Italy

Impact of crisis on India

FDI Spread

Further in Euro Zone, distress countries contributed to India’s GDP only marginally, Italy (0.7%), Spain (0.6%) and Greece 0%. Together the contribute a marginal share of 1.3% to India’s FDI’s flows

FII

The share of India’s FII in the emerging and developing markets has declined from 19.25 in 2010 to 3.8 % in 2011.

India’s exports are well diversified across countries. The share of PIGS countries is quite low at around 3% and will not directly have an impact on our growth prospects in exports.

Positive correlation between India’s exports and world economic activities except 2006 and 2007

Impact on India