What Are The Main Learnt Lessons by Eurozone Crisis?

What Are The Main Learnt Lessons by Eurozone Crisis

The year 2009 was marked by the Eurozone crisis, which has befall a generalized climate of global economic decline started in 2007. This climate of economic instability in the Eurozone had repercussions on the economic level and, consequently, on the social level. The stock market crisis was followed by a climate of market pessimism leading to a slowdown in growth, rising interest rates and stock market and asset price depreciation, among others. Some of the causes of this crisis in the Eurozone were the high indebtedness of some Eurozone countries, namely Greece, Portugal, Spain, Italy and Ireland, as well as the lack of political coordination within the European Union to solve these problems.

With this essay we intend to analyze the lessons learned from the crisis in the Eurozone, focusing on the reasons that led to this crisis, and strategies used for its resolution. Economic and financial issues, as well as social, political and trustworthiness among the States members of the Eurozone will be analyzed. This approach will help to recognize measures to avoid or lessen the impact of similar future situations, as well as to make resolution quicker.

The main reasons identified today for the instability and crisis in the Eurozone are the irresponsible practices in the financial sector, the high and unsustainable public debts of some states and the lack of competitiveness and productivity of some member States. The economic monetary union (EMU) is the only modern economic and monetary union with centralized policy, however with dispersed responsibility among the State members. Eurozone’s monetary and economic union rules are based on three essential assumptions: (1) cross-border financial integration; (2) financial stability; (3) national financial independence (Obstfeld, 2013, p.2). This model proved not to be effective with the debt crisis of some Eurozone countries. Within the financial plan, it is worth noting the economic boost that some countries have experienced with the entry into the Eurozone. For example, Portugal and Greece saw their economies strongly boosted by the entry into the Eurozone, with strong monetary appreciation and attractiveness to foreign markets, but also with the cost of a high inflation rate in subsequent years (De Grauwe, 2010, p. 7). These developments have fueled the growth of private sectors of the economy, often with the need to use credit to keep pace with economic acceleration and grow even more.

According to Constancio (2013, p. 5), the financial problem arose due to the granting of excessive credit by the banking entities of both the so-called central bloc countries and the peripheral countries to the private sector. Up to 2007, the granting of “easy” credit at attractive interest rates meant that much of the private sector in these countries incur debts that were proving unsustainable in the long run. Between the years of 1999 and 2007 the Eurozone private sector debt ratio has increased by 26.8%, but has increased 217.5% in Greece, 101.0% in Ireland, 75.2% in Spain, 71.2% in Italy and 48.9% in Portugal (Constancio, 2013, p. 4). On the other hand, the increase in public debt began after the increase in financial debt. With the onset of the economic recession, many of these private sector companies have ceased to have the financial capacity to pay their credit, or even without credit loans, they went into insolvency because of their inability to generate revenue.

With these events there is a sharp decline in countries tax revenues and an increase in social commitments such as unemployment benefits for workers who have lost their jobs due to recession (Constancio, 2013, p. 5) and a subsequent increase in public debts. However there are also opinions contradictory to the vision of Constancio (2013).  It is the case of Verney (2009, p. 3), who argues that the crisis and the outcome of events prior to 2009, namely the global economic crisis that began in 2007,  has raised  the risk of some “southern countries” not being able to support competitiveness that the single currency brought them, and were forced to abandon the Eurozone.

According to this author, the countries of southern Europe (notably Portugal, Spain, Italy and Greece) lost their competitiveness by joining Eurozone (Verney, 2009, p. 3). Until then, these countries could make use of currency market fluctuations to increase economic competitiveness, but this hypothesis disappeared with the integration in the Eurozone. This loss of competitiveness is seen in the average relative unit labor costs in the Eurozone between 1999 and 2010. In Greece, it has raised from 110 to 123, from 104 to 118 in Portugal, from 101 to 113 in Spain, from 96 to 111 in Italy and 90 to 100 in Ireland. On the other hand, countries such as Germany (down from 100 to 90), France (stable around 95) or Austria (stable around 105) saw this index lower or stabilize (De Grauwe, 2010, p.6).

The competitiveness factor and undoubtedly one of the reasons that aggravated the crisis in the Eurozone, however it cannot be considered the main factor or determining factor. The over-indebtedness of the private sector, and subsequently of the public sector, are the main drivers of the climate of instability, default, and the deterioration in the public debt rating that has followed. This has led to an increase in spreads and bonds and countries have no longer been able to finance themselves (Mody, 2012, p.202), and have lost the capacity to honor their financial commitments or to ensure current public spending.

What Are The Main Learnt Lessons by Eurozone Crisis
What Are The Main Learnt Lessons by Eurozone Crisis

With the rise in public debt for the reasons listed above, Greece was the first of the five countries to resort to international monetary aid in April 2010 (Takagi, 2016, p. 1). This international monetary aid has come through the informally called Troika mechanism, composed by the European Central Bank, IMF and the European Commission. In the following month the financial aid to Greece was approved, without any kind of budgetary counterparts or economic reforms in the country.

The formalized agreement consisted of a 3-year plan amounting to 26.4 billion Euros. This has been designed on the basis of the risk of contagion to other member states, so aid has been approved quickly and unconditionally, even if at the date of approval the risk of non-compliance by Greece with the troika was already high (Takagi, 2016, p. 1). However, it became clear before the end of the three years that Greece would not be able to comply with the agreement with the Troika, and on March 14, 2012 this plan was canceled, starting a new plan on March 15, 2012 with rigid restructuring measures.

In December 2010, despite attempts to safeguard the risk of contagion, Ireland also signs an economic aid plan with the Troika, and Portugal follows the same steps in May 2011 (Takagi, 2016, p. 1). Spain and Italy were not directly involved in the IMF aid, but the IMF intervened as an external technical entity to help formalize the programs to these countries by the European Commission and the European Central Bank. The IMF’s intervention in these countries has had some peculiarities never before observed in this monetary entity. In particular, the monetary aid was designated to economically developed countries, with an open economy and a currency shared by other countries with good financial health (Takagi, 2016, p. 2).

Perhaps for this last reason, the common currency, there was also a large exception in terms of the IMF loan, and the amounts committed were extraordinary large, exceeding 2,000 percent of the quota when the normal quota limit was 200 percent. It was also the first time that the IMF provided joint assistance with other financial and political institutions, the European Central Bank and the European Commission (Takagi, 2016, p. 2). However, there were also critical voices in the IMF-mediated Euro-Zone Troika financial aid project. The criticisms are directed essentially at the assumptions of the aid, and the target of that aid. Critics point out that the financial adjustment program only serves to reduce the country’s debt through cuts in social benefits and not to the growth of the economy. This aid is essentially aimed at “saving” the banks that have irresponsibly granted the loans (often banks located in countries with stronger economies such as France or Germany) and that the fiscal readjustment was too intense that led to the retraction of the economy so strong that it left these countries in a state of economic depression (Takagi, 2016, p. 3-4).

On the part of the IMF, the European Commission and the European Central Bank, it was argued that the objectives of economic readjustment are economic and fiscal restructuring, recapitalization of the financing banks and economic boosters, the promotion of other forms of non-bank financing and the improvement of mechanisms for supervision and regulation of banking activities (Gottlieb, 2015, p.13). Financial readjustment programs led by the IMF at the outset of the crisis in 2007, essentially to countries outside the Eurozone, would prove to be very effective and able to prevent the widening of income inequalities, thus protecting the scales of lower incomes of the economy and the working class. In the case of the Eurozone countries, these readjustment programs have not proved to be as effective.

This can be explained by the fact that the aid has been to countries with different economic characteristics from the countries aided during the first phase of the crisis. In the Eurozone countries, there was an increase in capital income during the readjustment program and a decrease in labor income, suggesting the worsening of inequalities (Gottlieb, 2015, p.11-15). This effect can be seen in the median capital and social expenditures index that showed a slightly decrease in capital revenue in Caribbean countries receiving IMF aid from 100 to about 95 and an increase with social expenditures from 100 to 120, or in middle east countries with a strong decrease in capital income from 100 to about 60.

In the Eurozone countries with IMF aid it was seen an increase in capital revenue from 100 to more 125 and a decrease with social expenditures (Gottlieb, 2015, p.16). There is a shared responsibility for the harshness and extremism of some adjustment programs in the countries that receive the help of the Troika, mainly in Greece. While on the one hand these countries are responsible for past irresponsible policies that have led or over-indebtedness, the troika will also have to take responsibility for excessive economic retraction, aggravation of social inequalities, and loss of income and implementation of direct taxes as a measure of increasing tax revenue.

The recourse to the financing of the Troika which some Eurozone countries were obliged to resort to because of the risk of non-compliance with their obligations was also a source of political and social conflicts inside the union. These outbreaks of conflict were mainly driven by the need to implement strict austerity measures in the intervention countries aimed at reducing public investment, reducing social support and raising taxes. These strongly unpopular measures were contested primarily by the lower-class and middle-working classes who saw their incomes decline.

The contestation was also driven by populist ideologies spread by the media and by the idea that economic aid was aimed at the profits of the countries of the central bloc (namely France and Germany) with the revenues of high interest rates. This ideology is centered on the fact that the credit control mechanisms of the European Central Bank have failed and allowed the peripheral countries to over-indebtedness, even knowing the risk that this type of procedures implies. With these premises, it has grown the number of defenders that it would be fair not to honor commitments with the Troika and to default, by applying those funds to the domestic economy (Panico, 2013, p.586). For its part, the European Central Bank argues that in order to support and guarantee financing to countries at risk of default, these countries have to implement fiscal reforms and comply with economic stability pacts, since this body can not only act as a last resort when those countries can no longer finance themselves, without receiving any guarantee.

However, while acting as a lender and mediator, the European Central Bank is in a dual position with potential conflict of interest in this process (Panico, 2013, p.587). One of the possible solutions advanced to this dilemma and defended essentially by the pro-EU political forces is a proposal for a common Eurobond (De Grauwe, 2009, p. 1-4). These bonds representing all the countries of the Eurozone, whose associated interest would be a weighted average of each country. If there was a fiscal union in the euro zone, the biggest advantage of the Eurobonds in the short term is that the countries in difficulty would gain time to solve their problems and the markets would calm down.

At the same time, the invoice paid for redemptions to countries such as Portugal, Ireland or Greece would substantially decrease. In this way, the level of debt and the joint deficits would be added, that is, everyone would respond for all. The main negative effect of Eurobonds is reflected in the stronger economies, which would see a visible increase in their financing costs. For this reason, the countries with more solvency refuse to take on the losses of the rest. The creation of Eurobonds requires the creation of a European Debt Agency and a common fiscal policy. A massive issuance of Eurobonds also counted on having a European government, which is currently impossible. Another problem raised by the countries who have been receiving financial aid from Troika is the legality of the implemented measures of budgetary restraint that represents a loss of national sovereignty (Scicluna, 2014, p.546). According to Scicluna (2014, p.546), the Eurozone crisis has contributed to exacerbate a democratic deficit at European Union. The author called the phenomena as “post-democratic executive federalism”, mainly because important decisions in European Union are taken within the European Council and “formerly apolitical technocratic institutions such as the European Central Bank” (Scicluna, 2014, p.546). It can be said that the reasons for conflicts between Eurozone countries seen with the crisis are essentially due to three factors: (1) the search for shared responsibility, (2) the loss of national sovereignty, and (3) political and legal issues of the very constitution of the European Union and European Council representation.

A formula that limits itself to injecting money into the economy without other growth measures is not an appropriate way to achieve long-term economic recovery. Appropriate policy decisions and adequate regulation are as important as the simple injection of funds. Just as the crisis process is affected by political choices, so political choices are influenced by the crisis (AlBassam, 2013, p.2). However, it remains to be clarified whether good governance leads to economic growth, or whether economic growth leads to good governance (Acemoglu, Johnson, & Robinson, 2001; Arndt & Oman, 2006; Dixit, 2009; Kaufman, Kraay, &Mastruzzi, 2009b; Smith, 2007 as cited by AlBassam, 2013, p.2). Measures implemented in countries under Troika aid were not the same in all countries.

These measures were rather a reflection of the structural problems identified in each of these countries by the tripartite evaluation commissions: IMF, ECB and EC. In Portugal these measures, called austerity measures, aimed at reducing social benefits and imposing value added taxes (Vieira, 2015, p. 414). In May 2014, some economic indicators started to improve and GDP growth reached 0.4% in the last quarter of 2015. However, the government debt-to-GDP ratio remained unsustainable since 2013, with 136.9%, 140.7% and 149.9% in 2015 (Vieira, 2015, p. 414). In the case of Ireland, the main problem was household debt. The pump in Ireland imploded in 2008, and government intervention aimed to save banking institutions from financial collapse. There was a nationalization of several banks, and to compensate for these expenses saw a decrease in the salaries of public officials, a decrease in the range of social benefits and increase of taxes. Ireland is abandoning the Troika’s financial aid plan in 2014 successfully and now has positive economic growth indicators (Vieira, 2015, p. 415). In Greece there was too much government debt that had been accumulating for many years, mainly since 1999.

Greece was the country with the largest increase in indebtedness of the whole Eurozone. With the outbreak of the crisis in 2007 and the climate of economic pessimism that has abated, Greece is no longer able to self-finance. Then the Eurozone countries intervened in the aid to Greece to avoid the contagion and disqualification of the whole Eurozone (Vieira, 2015, p. 416). Contrary to the results seen in Portugal and Ireland, in Greece the implementation of austerity measures has further aggravated the economic situation. The results were an even greater retreat from the Greek economy and greater reliance on borrowing. In 2015, Greece cannot honor its debt to the IMF and claims that the measures imposed on the country by the Troika are humiliating and unacceptable (Vieira, 2015, p. 416). Why was not Greece seen the same recovery as in Ireland and Portugal? Because these funds could never be used to boost the Greek economy, and were always used to pay the increasingly large loans that the country was being forced to contract. The funds were used to pay debts to external creditors, and their passage through Greece only served to increase interest and debt of this country (Vieira, 2015, p. 417).

Some lessons can be learned from Eurozone crisis:

  • Access to cheap money has led to over-indebtedness in countries such as Portugal and Greece. However, this accumulation of debt may be related to the entry into circulation of the single currency and the associated loss of competitiveness. The growth of these countries between 1999 and 2007 was due to the increase in public and private debt (Beker, 2014, p.7). Measures that limit the indebtedness of the Eurozone countries may be useful in preventing similar situations from arising in the future;
  • Reform in monetary system of Eurozone: the current model of the monetary system has allowed the over-indebtedness of some countries, but also facilitated and encouraged the aid of countries with healthy economies to the countries in crisis. Rethinking the economic union means for the countries in crisis a loss of national government automation, and for others a debt assume for which they are not responsible (Noth, 2016, p. 1445). These issues are of enormous political, legal and social complexity.
  • Overly rigid measures of austerity can lead to even greater economic shrinkage. Measures should be put in place to stimulate sustained economic growth. Just injecting money in exchange for reducing public waste is ineffective and socially disastrous (Mody, 2013, p. 715-716).
  • Despite the difficulties faced by the Union with the crisis, the system has proved to be strong and resilient enough to withstand such a complex crisis (Obstfeld, 2013, p. 34). Many new economic factors were faced, from the amounts that have been allocated as financial aid and the fact that aid has arrived as multi-organizational system (Troika) and were allowed to economically developed countries.
  • The creation of a Eurozone cannot be based solely on financial matters. Social union, which encourages a spirit of belonging to Europe and makes citizens feel treated fairly (which has not happened in the case of Greece) is as important as the regulation of financial matters (Verhaegen, 2014, p.2).

In conclusion, the crisis over the Eurozone collapsed when over-indebted countries were no longer able to self-finance themselves and honor their financial obligations. Greece was the first country in need of external aid, which was promptly activated, but it was not enough to prevent the contagion and credibility crisis that hit these countries. The blame for excessive credit in these countries is mainly due to low competitiveness and productivity, which increases the state’s effort in the cases of Portugal and Greece. In Ireland the case was different, it was essentially due to the housing bubble. In Spain a crisis of banking credibility that called into question the capacity of the state, but that ended up being resolved without recourse to the IMF. In the case of Italy was essentially the loss of economic competitiveness, but also no intervention of the IMF. Despite some contestation, the austerity measures imposed as counterpart by the financial loans eventually resulted in Portugal and Ireland. However in Greece they have proved to fail and further aggravate the already very serious economic situation of the country. Despite years of difficulties, Eurozone showed the power of its union, coming out even stronger when doubts about the continuity of the project came to light. In the future, measures have to be taken with the aim of further strengthening the monetary union, and avoiding further crises of over-indebtedness or economic distrust and thus maintaining the stability of the whole Eurozone.


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