Petrakis et al european economics and politics in the midst of the crisis (2013)

1 Part I The European Crisis 2 The Evolution and the Current Status of the European Financial Crisis.. Introduction 1This book reviews the Great European Recession of 2008 and monitors E

European Economics and Politics in the

Midst of the Crisis

Panagiotis E Petrakis

Pantelis C Kostis

Dionysis G Valsamis

From the Outbreak of the Crisis to

the Fragmented European Federation

European Economics and Politics in the Midst of the Crisis

Panagiotis E Petrakis • Pantelis C Kostis • Dionysis G Valsamis

European Economics and Politics in the Midst of the Crisis

From the Outbreak of the Crisis to the Fragmented European Federation

Springer Heidelberg New York Dordrecht London

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1 Introduction 1

Part I The European Crisis 2 The Evolution and the Current Status of the European Financial Crisis 7

2.1 Evolution of the European Union 7

2.2 The Historical Evolution of the Crisis 13

2.3 An Initial Approach to the Crisis 16

References 20

3 The Great European Recession 21

3.1 The Costs of the Great Recession 22

3.2 The Redistribution Consequences 25

3.3 The Comeback Lag and the Divergence Evolution 30

References 31

Part II The Structural Elements of the Crisis 4 The European Suboptimal and Segment Areas 35

4.1 The Limitations of Eurozone Member Countries 36

4.2 The Segmented Economic and Social Areas 38

References 42

5 European Stock Asymmetries 43

5.1 Population and Geostrategy Asymmetries 43

5.1.1 Population Balances 44

5.1.2 Geostrategy Balances 47

5.2 The Economic Stock Imbalances 48

5.2.1 Debt: Public and Private 48

5.2.2 Tangible and Intangible Assets 49

References 51

v

6 European Flow Imbalances 53

6.1 Public Deficits 53

6.2 The External Accounts 54

6.3 Savings and Investments 58

6.4 Employment and Inflation 59

6.5 The Competitiveness Imbalances 60

References 64

7 Culture, Institutions and Politics as Crisis Generators 65

7.1 Cultural Background 65

7.2 Political Balances 67

7.3 Governance 70

7.4 Institutions and Incentives 71

References 75

Part III The Policy Response 8 The Growth Lag and Strategic Choices 81

8.1 The Long-Term Growth Lag 81

8.2 The Growth Priorities 83

8.3 The Attainment of Long-Term Competitiveness and Export Orientation 84

8.4 The Bank-Based Growth 87

8.5 Debt Management 88

References 94

9 Fiscal Policy and Consolidation 97

9.1 The Effectiveness of Fiscal Policy 97

9.2 Contractionary or Expansionary Austerity Policy 99

9.3 Tax-Based Versus Spending-Based Fiscal Consolidations 101

9.4 The Size of Fiscal Multipliers 102

9.5 Fiscal Tightening in a Liquidity Trap 104

9.6 The Role of Perceived Risk of Sovereign Debt 105

9.7 Can Austerity Be Self-Defeating? 106

9.8 Synchronized Fiscal Consolidations and Spillover Effects 109

9.9 Fiscal Consolidation Programs After the Euro 110

References 115

10 The Supply Side Policies 119

10.1 Supply Side Rationale 119

10.2 Structural Reforms 120

10.3 The Required Adjustment and the Adjustment Speed 123

10.4 The Effectiveness of Economic Policy in Europe 126

References 131

11 Monetary Policy 133

11.1 The Imbalanced Monetary Policy 133

11.2 Rebalancing and Inflation 137

11.3 The Effectiveness of Monetary Policy and the Liquidity Trap 140

11.4 The Financial Transaction Tax 141

References 142

12 The Policy of the European Central Bank 145

12.1 The Open Market Operations 145

12.2 The ECB as a Treaty Changer 149

12.3 The Multiple Bond Equilibria 150

12.4 The Euro’s Confidence 153

12.5 The Role of the Lender of Last Resort 155

References 158

13 Restoration of the Banking System and the Banking Deleveraging Process 159

13.1 Contagion and Systemic Risk 159

13.2 The Financial Market Fragmentation 161

13.3 Weak European Banks 163

13.4 The Credit Crunch and the Financing of the Real Economy 165

13.5 The Deleveraging Process 166

References 173

14 The Role of the IMF in the European Evolution 177

14.1 The Character of the IMF 177

14.2 Global Financial Governance and the IMF’s Role 181

14.3 The IMF in Europe 181

14.4 The IMF and Sovereign Debt Management 183

14.5 Conditionality and Supply-Side Policies 185

14.6 The IMF and Domestic Policies 187

References 189

Part IV The Political Economy of European Synthesis and the Medium Future 15 Debates and Choices 193

15.1 The Political Economy Approach: Ideas and Cultural Background Diversification 193

15.2 The Critical Debates 195

15.3 The Social Model Controversy 198

References 201

16 The European Synthesis 203

16.1 The European Response to the Crisis 203

16.2 Fiscal and Macro Management 204

16.3 Financial Stabilization, Banking Sector Reorganization and the Deleveraging Schedule 206

16.4 The Structural Readjustment 213

References 221

17 The Medium-Term Future for the World and Europe 223

17.1 The Medium-Term Future for the World: 2015–2025 223

17.2 The Two Potential Worlds 226

17.3 The European Evolution 228

References 232

18 Economy and Politics 235

18.1 An Integrated Approach to the Crisis and Politics 235

18.2 The Political Economy of the European Crisis 239

18.2.1 Geostrategic Issues and Economic Nationalism 239

18.2.2 Beggar-Thy-Neighbor Policies 243

18.2.3 The Euro as an Exchange and Reserve Currency and the Internal Repercussions 244

18.2.4 The Democratic Deficit and Monetary Policy 245

18.2.5 Political Shift and Economic Policy 247

18.2.6 Towards an Indebted Fragmented European Federation 249

References 258

Introduction 1

This book reviews the Great European Recession of 2008 and monitors Europeandevelopments, and particularly developments in the Eurozone, at an economic andpolitical level until mid-2013

It is impossible to predict the future However, the more powerful the tional framework within which action unfolds, the more powerful the prediction Inthe case of the European Union (EU), its institutional framework and its evolution,function together and influence each other, making projections difficult However,

institu-it is possible to assemble scenarios through which the future will emerge winstitu-ith agreat degree of probability The assembling of scenarios is based on knowledge ofthe forces that determined the past and now determine the present To understandthem we need an appreciation of their origins and should try to understand theirnature We can thus understand the active forces that play, or will play, a role inshaping the future We can develop an appreciation for how the forces aretransformed, what new forces are born of existing ones, and how and from wherethey integrate new elements for change and the shaping of future developments

One need not necessarily be a supporter of the Hegelian theory of history torealize that reality is a fruit of the tug of war between opposite and compositeforces After all, basic European imbalances and basic asymmetries drive Europeanevolution The nature of such dialectical conflict is in fact shaping the future.However, we should not seek conflicting forces solely in the economic field Thefields of ideology and cultural background also constitute significant driving forcesfor evolution

The EU, however, is above all a political creation It was not imposed through amilitary or civil-war conflict Its creation was not the product of the end of theSecond World War The reason for this is simple: Europe was divided (east-west)and, thus, it was not possible for the western powers to impose unification as ameans for preventing future conflicts Consequently, European unification is apolitically voluntary process that was triggered much later

Economic theory and economic policy were called on to remedy and cover theknown and unknown circumstances that emerged from the political decision on the

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creation of European unification The economic reality gave rise to an independentdynamic of its own that in turn influenced politics.

This constant dialectic relationship between politics and economy is very cult to interpret in a collective manner by economic theories that focus on the logic

diffi-of balance, and human economic behavior that is based on optimal expectations.Reality is probably driven by forces that influence each other, leading dynamicallyfrom one point of imbalance to another

By this rationale, certain thoughts are expressed on the evolution of Europeanunification in the next decade It should be noted that effort is made to objectivelyassess the developments, without presenting economic policy suggestions thatwould shape a more preferable future The presentation and critique of the factsincludes many calculated judgments

This book serves an additional purpose It monitors the evolution of economicthinking and the conduct of economic policy as they evolved over time during thecrisis, in parallel with the evolution of the crisis itself It thus depicts the inter-influence of the triptych reality-theory-politics that provides an integrated level ofreference for shaping the future

The end of 2012 and the beginning of 2013 is not merely a change of calendaryear The end of 2012 was the landmark for the emergence of change in theEuropean Central Bank (ECB) stance on the provision of unlimited liquidity forcontrolling risk in the European bonds markets, within the context of its role of aLender of Last Resort It also signals a change in European opinion to an apprecia-tion that the Great European Recession does not have (no longer has or does nothave solely) fiscal fragility or competitive recklessness features, but hascharacteristics directly linked to the peculiar European Monetary Union TheDecember, 2012 Summit summarized and established the – up to that point –institutional formations in the fiscal union (significant decisions on this sectorwere already made in 2011–2012) and banking union sectors Additionally,throughout the crisis structural reforms were promoted (competitive union) aimed

at improving competitiveness The developmental grid for all three sectors tioned above aims at promoting the political union It is not known how and whenand if a level of European unification will even be achieved, in the sense of the word

men-“union” Our research leads us to the conclusion that it is much more possible that

we will be living in a fragmented European Federation in the next decade, ratherthan in a European Union We are now aware of the fact that, during periods ofcrisis the rate in which supranational entities are shaped accelerates When theevolution rate of supranational collaborations is accelerated under the pressure ofopposing forces, then this may lead either to conflict, or to collaboration and theachievement of further unification Today, in mid-2013, the nature of the EUevolution, with the Eurozone as its core, is one of the top three most importantglobal dynamic components, without a precisely determined evolution

Ultimately, the reason why the European unification procedure is particularlycomposite and attractive to scientific observation is its peculiar nature

This book has four parts Part A is devoted to the evolution and the current status

of the crisis Part B analyzes the structural elements of the crisis Part C analyzes the

piecemeal policy responses to the crisis Part D presents a political Europeaneconomy synthesis and looks at the medium-term European future Hence, thebook monitors the facts from the outbreak of the European crisis to an indebtedfragmented federation of European states.

This book became a reality with the assistance from the entire research andadministrative team aiding our research work Particular reference must be made to

K Kafka, N Daniilopoulou and K Stratis, and to S Zacharogianni for the tronic manuscript preparation Furthermore, I would like to thank the administrativesupport team and, particularly, to its head, E Gkioyli

elec-Part I The European Crisis

The Evolution and the Current Status

of the European Financial Crisis 2

A useful initial examination of the European financial crisis can be based on a stockand flow analysis of critical variables, and on a short and long-term time analysis.The main issues shaping the crisis are: weak actual and potential growth; competitiveweakness; liquidation of banks and sovereigns; large debt-to-GDP ratios; and consi-derable liability stocks (government, private, and non-private sector) The fourfeatures (stocks/flows, and short/long-term maturity) are impacted by the problematicstructure of the European crisis, and suggested policy solutions for one feature tend tohave a negative influence on the opposite feature Short-term solutions do not favorlong-term prospects, and vice versa Stock rebalancing policies do not favor flowimbalances, and vice versa

The cycle of austerity, deleveraging and deflation experienced in Europe inrecent years has been amplified by excess debt, contagion between sovereignsand banks, and the economic policies chosen by member states Although the crisis

is following a predictable evolution, it is difficult to estimate how long it might last.This chapter provides a background to the evolution of the European Union as apolitical entity and to the European financial crisis from its outset to its currentstatus The first Sect.2.1describes the evolution of present-day political Europe, thesecond Sect.2.2analyzes the evolution of the European crisis, by outlining the mostbasic facts, and the third Sect.2.3provides an initial introduction to the causesbehind the crisis

The Eurozone (and the European Union in a wider sense) emerged through theunification of the national economies of Europe with the aim of overall economicunification Balassa (1961,1976) noted five stages in the process of cross-countryunification In the first stage, custom duties between the participating countries areeliminated In the second stage, a customs union is established to deal with externaleconomies In the third stage, an internal market is organized (lifting of tradebarriers, elimination of restraints and free movement of capital) In the fourth

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stage, synchronization of individual national economic policies is developed.Finally, in the fifth stage, the unification of monetary, fiscal, social and anti-cyclicalpolicies is achieved In this final stage the decisions of the supranational entityprevail over the decisions of national governments However, interim provisionalunion forms may emerge between the fourth and the fifth stage In these cases thesupranational structure undergoes four different phases: Political Union, TransferUnion, Monetary Union and Fiscal Union This is the situation that the Eurozonehas found itself in and it is, to date, dominated by the notion of the Transfer Union.Political union is at an embryonic stage of development, and Fiscal Union is at aneven more premature stage The reformation of the Maastricht Treaty (March 2012)aimed at introducing elements of political and, more particularly, fiscal union.Sorens (2008) defines five basic characteristics of a Fiscal Union:

1 It is composed of separate entities (sub-central political entities) having nomous powers in relation to taxes and expenditure

auto-2 Individual governments are subject to strict fiscal controls, and there are no out procedures (bail-out rule)

bail-3 There is a single market based on the free trade of goods and services, and thefree movement of labor and capital, within the fiscal union

4 There is a specific institutional framework for the operation of the system,ensuring that no government of any member state can change it at will

5 There is a single currency

It is hard to distinguish whether the evolution incentives during the first stages of

an economic unification are merely commercial, or if they are also political(Sapir 2011) The political character of the unification is established in laterunification stages

The European Union first emerged in its primary form in 1951 (Table2.1) TheEuropean Union was a French-inspired postwar creation, with its main goal beingthe prevention of future war crises in Europe The European Union experiencedhigh growth rates from 1958 until 1968, and then entered a period of immobilityuntil the early 1980s (Fig.2.1) During this period, the “Single Market Program”came about, signaling Europe’s entry into the third stage of unification Thecollapse of the Bretton-Woods system in 1971 led to the establishment of theEuropean Monetary System (EMS) in 1979, a mechanism for the stabilization ofexchange rates The fall of the Berlin Wall in 1989, however, changed the character

of European unification To ensure French support for the unification of East andWest Germany, Germany agreed to abolish the Deutsche Mark and accept a newsingle currency, i.e the euro The concept of “One Market, One Money” wasestablished in 1990, aiming at tackling the three contradictions inherent betweenthe free movement of capital, stable exchange rates and monetary policy Thisconcept was incorporated into the Treaty of Maastricht in 1993, and led to theadoption of the euro on 1 January 1999 Throughout this process, new memberstates were acceding to the European Union, resulting in its enlargement to theSouth, North and East Two further treaties contributed to its enlargement: theTreaty of Nice in 2003; and the Treaty of Lisbon in 2009 By virtue of the latterTreaty, the EU became a legal entity

8 2 The Evolution and the Current Status of the European Financial Crisis

Table 2.1 Historical evolution of the European Union

1951 European Coal and Steel Community ! 1) Preferential Zone

European Economic Community EEC ! 2) Free Trade Area

European Atomic Energy Community EURATOM

European Coal and Steel Community ECSC

Community EC ! 3) Customs Union

1979 European Monetary System (EMS), including the ECU as a basket currency

1985 Schengen Treaty signed The Schengen area came into existence 10 years later

in 1995

First major treaty revision since 1957

Agreement on full removal of all tariff and non-tariff barriers in the European Single Market until 1992

1993 Maastricht Treaty: ! 4) Common market, treaty reform – three pillars:

EC (supranational)

Common Foreign and Security Policy (CFSP, intergovernmental)

Justice and Home Affairs (JHA, intergovernmental)

Agreement on 3 stages to European Monetary Union (EMU):

1990: Free capital movement 1994: Convergence of macro policies 1999: Launch of the euro

1994 European Economic Area (EEA): European Free Trade Association (EFTA)

plus EU-12 minus Switzerland

1996 Broad Economic Policy Guidelines as a means for economic policy

coordination ! 5) Economic Union

1999 Amsterdam treaty: More power for the European Parliament, strengthening the

rights of citizens

1999 Third stage of EMU: European Central Bank, Launch of euro as an accounting

unit ! 6) Currency Union

2003 Treaty of Nice: Amendment of majority rules in the Council Strengthening the

principle of qualified majority, weighing population

2009 Lisbon Treaty: Institutional reforms, qualified majority voting, closer

economic coordination between EMU member states, EU becomes a legal entity

(continued)

The 2010 financial crisis resulted in the amendment of Article 125 of the Treaty

of Maastricht This led to the purchase of government bonds by the EuropeanCentral Bank (ECB) from the secondary market (initially from Greece, followed

by Spain and Italy) This significant move separated the ECB from its fundamentalpremise, the preservation of price levels It also implied that national states were nolonger exclusively responsible for their public economics Since then, the Europeanstructure has sailed in the uncharted waters of the debt crisis

History has shown that the creation of a single monetary union without agreeingpolitical unification at the same time is a dangerous undertaking There were twoprevious monetary unification attempts in Europe, both of which failed In 1865

Table 2.1 (continued)

2010 Euro Crisis: EMU countries agree on support programs for Greece (2 May) and

other EMU countries (9 May) Founding of European Financial Stabilization Mechanism (EFSM) and European Financial Stability Facility (EFSF)

2011 Signing of European Stability Mechanism (ESM) Treaty

Source: Deutsche Bank Research ( 2011 )

Note: The organization founded in 1957 originally had six members: Belgium, France, Germany, Italy, Luxembourg and the Netherlands Denmark, Ireland and the United Kingdom joined EU on

1973, Greece on 1981, Spain and Portugal on 1986, Austria, Finland and Sweden on 1995 On

2004 ten new countries join the EU: Czech Republic, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Poland, Slovakia and Slovenia The latest stage of evolution to date was in 2007, with the accession of Bulgaria and Romania and in 1st July of 2013 with the accession of Croatia Iceland, Montenegro, FYROM, Serbia and Turkey are candidate countries, while Albania, Bosnia and Herzegovina and Kosovo are potential candidates

Fig 2.1 European growth rate and main initiatives (Source: AMECO Database Note: The data for the period 1960–1990 relates to the ΕU-15 [including West Germany] and the data for the period 1991–2014 relates to the ΕU-27 The data refer to GDP growth rate at current market prices)

10 2 The Evolution and the Current Status of the European Financial Crisis

France, Belgium, Italy and Switzerland formed the Latin Monetary Union The fournations were joined by Spain and Greece in 1868, and Romania, Bulgaria, Venezuela,Serbia and San Marino in 1889 It was dissolved in 1914 because of disagreementover the funding of public debts by increasing the money supply The ScandinavianMonetary Union (Sweden, Denmark on 1973 and Norway on 1975) was formed in

1873, and subsequently dissolved in 1914 for the same reason as the Latin MonetaryUnion Their pegged exchange rates system, mainly in the form of a link to the goldstandard, prevailed after 1914 and was in place until the Great Depression of 1930.Another monetary management system which previously operated within Europe,the Bretton-Woods postwar pegged exchange rates system, was dissolved in 1973.Descriptions of such actual or “quasi” monetary unions show that various forms

of fiscal vicissitudes (wars) or private explosive deficits led to the establishment ofconsiderable national fiscal deficits These deficits contributed to the creation ofsignificant disequilibrium in the balance of payments and their monetization, andled to the breaking up of the monetary unions Such historical lessons are one of thefundamental reasons behind today’s desire to preserve the control of fiscal deficits.The enlargement of the European Union to include Southern European countriesresulted in immediate serious concerns relating to (a) fears that, because of its lowcompetitiveness level, Southern Europe would lose its industry to the benefit ofNorthern Europe, and (b) fears that high wage earners in Northern Europe would bereplaced by cheap workers from Southern Europe, or from Eastern Europe at a laterstage The first concern was upheld to a greater extent than the second mainly because,

as is discussed later, competitiveness was greatly shaped by production, prices andnon-wage costs In general both Southern and Northern Eurozone member statesenjoyed a prosperous period prior to the financial crisis of 2008 The economic benefits

of the single currency were particularly apparent during this period PeripheralEurozone countries such as Spain, Portugal, Greece and Italy enjoyed access tointernational capital markets, low borrowing levels and significant investmentopportunities Eurozone core countries (Germany, France, and the Benelux) experi-enced increased exports, attributable to the rapid growth of peripheral countries,

in addition to high investment returns from companies and assets located in SouthernEurope Therefore, the benefits of the single currency were distributed between thecore and the periphery of the Eurozone

The good years, however, soon came to an end because of key differences in theeconomic behavior of the peripheral countries to those in the center of theEurozone The increase in fiscal deficits, accompanied by a drop in private savings,led to the expansion of the current payments balance deficit This, in turn, createdthree deficits: current account deficit, fiscal deficit, and savings deficit in relation toinvestments

Imbalances between goods and services and capital transfers (either as investments

or in the form of net transfers) were evident, even within the European Union It isclear that the Eurozone crisis is of a systemic nature Hence, it is useful to reevaluatethe macroeconomic history of European peripheral and debtor countries in the light ofthis (Fig.2.2)

The large deficits observed in current account balances were an inevitable result

of increased capital flows from the center of the Eurozone, poor fiscal administration,

and the phenomenon of overconsumption In addition to high levels of inflation andthe drop of competitiveness, which constituted indicators of ineffectiveness in thejob market and the fiscal tax policies, the appreciation of the actual exchange rateswas inevitable.

From the moment the countries of the Eurozone adopted the euro, certain forceswere born, laying the foundations of a possible financial crisis This situation seemedinevitable, irrespective of peripheral country governmental policies Peripheralcountry policies certainly contributed to the Eurozone crisis, but only to a limitedextent The primary reason lies within the existence of the single currency

The shaping of the Eurozone led to the formation of a supranational entity withimperfect supervision and without formulated plans relating to: macroeconomicimbalance management; crisis management; institutional production of solutions;and satisfactory banking supervision During the current financial crises with suchweaknesses to the fore, the Eurozone has operated an ad hoc intervention approachthat has proved insufficient, and has given rise to multiple levels of moral hazard

It is important to note here that the situation that has emerged in the Eurozonehas exceeded the strict characteristics of a fiscal union, given that during the crisis

of 2008–2012 it intervened with bail-out programs in Greece, Portugal, and Ireland.The real question to be posed is, whether such interventions have triggered moralhazard bursts This would imply to member state governments that, no matter whathappens, there will be a plan for their bail-out If this is the case it would sooner orlater cause the collapse of the European Union as we recognize it today, orsignificantly impact on its conversion to a new structure with special “made inEurope” characteristics Hence, for European unification to successfully continue,the union itself will have to develop its ability to learn from and adapt to changingeconomic and political circumstances

A survey on the evolutionary conversion of European member states (Bordo

et al.2011) showed that global economic crises played catalytic roles in their formation A distinctive example is that of the Great Depression of 1930 During the

trans-Fig 2.2 Net foreign asset position 2012 (GDP percentage) (Source: OECD Database)

12 2 The Evolution and the Current Status of the European Financial Crisis

crisis, and after it ended, federations underwent a process of centralization Thiscentralization made it easier for federal governments to introduce, or extend, measuresaimed the equalization of incomes across regions Thus, expenditure distributionbefore the crisis was 50 % local, 20 % state and 30 % federal government, whereasafter 1940 the respective percentages were 30 %, 24 % and 46 %.

The 2008 economic crisis has a determinative impact on the direction and thequality of European unification To put it in Jean Monnet’s (1976) words, “Europewill be forged in crises and will be the sum of the solutions adopted for those crises”

“Crisis represents an opportunity I’m not saying that I enjoy being in a crisis ButI’m not worried Europe always moved forward in times of crisis Sometimes youneed a little pressure for certain decisions to be taken” (Scha¨uble2011).1

The US subprime crisis of 2008 laid the foundations for a wider global crisis Thestarting point of the crisis in Europe was in October 2009, when the new Greekgovernment revealed that the size of the fiscal deficit was much larger than theprevious government had claimed, with fiscal holes being greater than 10 % ofGDP Two weeks later the fiscal deficit was officially estimated at 12.7 % of GDP.This immediately impacted on investor confidence in the fiscal sustainability of theGreek economy, and a call for higher interest rates on government debt InDecember 2009 the three credit rating agencies – Fitch, Moody’s and Standardand Poor’s – downgraded Greece’s sovereign credit rating The lending rate of theGreek economy reached 8.7 % in April 2010, an increase of 270 base points overthe previous month The need for the country’s bail-out by the European Union andthe International Monetary Fund (IMF) subsequently became obvious in May 2010.The sum of the 3-year bail-out package for the Greek economy amounted to€110bn: initially comprised of€80 bn in bilateral loans and €30 bn from the IMF.During this period, European Finance Ministers announced the establishment ofthe European Financial Stability Facility (EFSF), a fund of€500 bn, and the ECBlaunched the Securities Market Program (SMP)

In October 2010 the credit rating agency Fitch downgraded the sovereign creditrating of Ireland Furthermore, the Irish government announced that to achieve itsdeficit goals by 2014, funding of€15 bn over a 4 year period was required, i.e almost

10 % of the Irish GDP A direct impact was the increase of the 10-year governmentbonds by 250 base points, reaching levels in excess of 9 % In November of the sameyear, Ireland too had to accept aid through the bail-out mechanism, amounting to€85

bn Concerns over the high cost for the bail-out of the Irish banking system created arun on Irish sovereign debt In December of the same year both Moody’s andStandard and Poor’s credit rating agencies downgraded the country’s sovereigncredit rating

1 Quoted in Reuters ( 2011 ).

In March 2011 the Eurozone leaders agreed to lower the interest rates on Greekloans to 5 % and to increase the length of program loans to 7.5 years, in exchange forthe swift completion of a€50 bn privatization plan They also agreed to make theEFSF’s€440 bn lending capacity fully effective, to include debt buybacks, bankrecapitalizations and pre-emptive loans Finally, they agreed to allow the EFSF andthe European Stability Mechanism (ESM) to intervene in the primary sovereign debtmarkets as an exception, and only in the context of a financial assistance program.During the same period of time, the three large credit rating agencies down-graded the sovereign credit rating of Portugal Exactly 1 year after the Greek bail-out, Portugal became the third member state to avail of the bail-out mechanism The3-year program amounting to€78 bn: of this €26 bn was to be provided by the IMF.The wider European economic situation started to worsen in the summer of

2011, with intense market worries relating to rumors of Greece exiting theEurozone and the implementation of a second program of fiscal adjustment inthat country The direct outcome was a large increase in the yields on Spanishand Italian sovereign bonds, with the Italian president green-lighting thegovernment’s austerity package in July 2011 As a result, Greece accepted a newassistance package amounting to €109 bn including: maturity extensions (from

15 to 30 years); some private-sector involvement (with a net contributioncorresponding to a 21 % haircut); a secondary market debt buy-back program;and the lowering of the interest rate on assistance loans (to approximately 3.5 %).Furthermore, significant problems within European banking systems emergedaround the same time Banks faced significant difficulties relating both to lack ofliquidity, and relationships with their sovereigns Such difficulties arose becausesignificant amounts of government bond-funding came from banks within theEurozone, while it was apparent that the banks in the Eurozone were correlated

It was clear that a bank failure, or a sovereign default, could lead to a huge systemiccrisis In late August 2011 the IMF claimed that losses for European banks fromexposure to sovereign bonds could potentially reach€200 bn

In an attempt to tackle these problems, the ESM was established, as a follow-up

to the temporary EFSF, with a capacity of€500 bn However, this mechanism didnot seem able to support the restructuring of larger economies, such as those of Italyand Spain In August 2011 the ECB extended the SMP by purchasing Italian andSpanish bonds in the secondary markets, to suppress their borrowing costs Suchmoves offered little more than short-term relief to the troubled economies becausethey took place on a sterilized basis and under the condition that the EFSF wouldeventually take over responsibility for secondary purchases In September 2011, theEuropean Council, the European Commission and the European Parliamentconcluded the agreement on the “six-pack” legislation on macroeconomic surveil-lance (which entered into force in December 2011)

The credit rating agency Standard and Poor’s downgraded the sovereign rating

of Italy in September 2011 thus highlighting its negative growth prospects and thecountry’s fragile political environment One month later, Italy and Spain, werefurther downgraded by the three big credit rating agencies

In November 2011, contagion had spread to France Furthermore, sovereignyields in Italy and Spain had reached the highest levels in Europe (almost 7 %), and

14 2 The Evolution and the Current Status of the European Financial Crisis

pressure on the banking system was enormous In the same month, the EuropeanCommission proposed a “two-pack” of budgetary surveillance and monitoring.Furthermore, it launched “Stability Bonds” among the euro member states.

In December 2011, EU leaders agreed on the establishment of a European FiscalCompact, setting a deficit limit of 0.5 % of GDP, and including a requirement toreduce public debt in excess of 60 % of GDP by one-twentieth per year The onlycountry that did not agree on the establishment of the European Fiscal Compact wasthe United Kingdom This did not pose a significant difficulty as the consent of

12 out of the 17 Eurozone countries was required by January 2013 for the treaty tocome into force

One positive intervention was the 3-year Long-term Refinancing Operation(LTRO) provided by the ECB on 21 December 2011 Through these, the ECBprovided approximately €1 tr in cheap funding to many European banks Fivehundred and twenty three banks participated in the first 3-year LTRO (€489.2 bn),primarily from Italy and Spain This had positive impacts on bank funding, sovereignand corporate bond yields and the climate of the markets Hence, in early 2012,overall the European banks managed to cover their finance needs, and the yields onthe Italian and the Spanish 10 year sovereign debt dropped to between 5 % and 5.5 %.Furthermore, the Credit Default Swap (CDS) values of peripheral countries dropped

to half their peak level However, the bank-sovereign nexus was reinforced by thebanks operating in peripheral countries, as they were enticed to buy even more oftheir governments’ debt

In January 2012 the agency Standard and Poor’s downgraded the sovereigns ofnine European countries, namely Austria, Cyprus, France, Italy, Malta, Portugal,Slovakia, Slovenia and Spain Austria and France were stripped of their triple-Astatus at that time, with Finland, Germany and the Netherlands being the onlyEuropean countries to retain their triple-A rating This suggests the inability ofEuropean leaders to confront the crisis and the failure to recognize that not all of theproblems stemmed from fiscal profligacy in particular countries

On 3 February 2012 the Spanish government adopted a series of new measuresaimed at reforming and strengthening its banking sector These mainly includedcleaning-up balance sheets and the creation of incentives to continue the bankingsector restructuring through mergers and acquisitions

On 21 February, European leaders agreed on the terms for a second rescueprogram for Greece, with a marginally higher contribution from the private sector(53.5 % haircut instead of the 50 % agreed in October 2011) The official acceptance

of the second program was delayed for a few days until the completion of aPrivate Sector Involvement (PSI) operation,

Additionally, on 28 February 2012 the second 3-year LTRO (€530 bn) wasconducted, to which 800 European banks participated

In March 2012 following a positive report from the Troika on the implementation

of previously agreed actions and the high private sector participation in the debtexchange offer, the Eurogroup (the finance ministers of the Eurozone) decided tomove on to the second adjustment program for Greece In the same month, theSpanish government finally presented a budget for 2012, including€27.3 bn of newausterity measures

In April 2012, the agency Standard and Poor’s downgraded the credit rating of

16 Spanish banks, including two large international banks To relieve marketanxiety, the Spanish government adopted a comprehensive new package ofmeasures to strengthen the banking sector Spain was the first country to requestfinancial assistance to recapitalize its banking system within the framework of a

€100 bn program focused solely on the banking sector Concerns were raised overrumors that the assistance would not be solely destined for the recapitalization ofbanks Ultimately, on 11 July 2012 Spain was given an additional year to correct itsexcessive deficit, with the deadline for returning below 3 % being pushed back until

2014, and the goals for 2012 and 2013 being adjusted accordingly

On 9 October 2012 Portugal was also given an additional year to correct itsexcessive deficit, owing to downward revisions to the country’s growth prospects

In the same month, the IMF admitted for the first time that the fiscal multipliersmeasuring the effects of fiscal consolidation on growth had been grossly under-estimated since the beginning of the crisis

In December 2012 the agency Moody’s downgraded the creditworthiness of theESM and the EFSF from Aaa to Aa1 Furthermore, the agency Standard and Poor’sdowngraded Greece from the high risk category (CCC) to a state of selectivedefault, because of the upcoming repurchase of the debt: however, just 13 dayslater the same credit rating agency upgraded Greece to B-

Finally, in December 2012 the presidents’ of the European Council, the EuropeanCommission, the Eurogroup and the European Central Bank released a reportrelating to the achievement of a genuine Economic and Monetary Union (an issuefirst tabled in June 2012) They presented a specific and time-bound roadmaptowards deeper EU integration, by identifying “four essential building blocks” forthe future of the EMU – an integrated financial framework, an integrated budgetaryframework, an integrated economic policy framework, and strengthened democraticlegitimacy and accountability

The global crisis was triggered by the subprime mortgage crisis in the United States,leading to it being initially known as the Subprime Crisis (Cecchetti2007) Later itwas defined by the collapse of Lehman Brothers (Eichengreen et al.2009) It took itscurrent form as the Eurozone crisis in 2010 (De Grauwe2010) Eight hundred years

of crises experience, as analyzed by Reinhart and Rogoff (2009), classified two crisestypes: financial and non-financial The present crisis falls into the first group.Financial crises can be further separated into four sub-categories (Claessens andKose2013): currency crises, sudden stops (in capital flows), debt crises, and bankingcrises However, this typology does not contribute towards an understanding of thecurrent crisis, and we examine instead its basic characteristics

Throughout the evolution of the European financial crisis there are two basicsectors of reference: the public sector and the banking sector The crisis influencedeach of these two sectors separately, by refueling itself An ineffective and expensivepublic sector resulted in the creation of deficits in many Eurozone countries, such as

16 2 The Evolution and the Current Status of the European Financial Crisis

Greece and Portugal Additionally, the banking system – infected by doubtful titles –faced survival issues State interventions for rescuing the banking sector wereconsidered imperative Hence, private debt was converted to public debt, whichcaused the national debt crisis in Europe At the same time, the debt crisis in Europe

is the outcome of the low competitiveness of peripheral member states, fuelingdeficits and increasing national debt

Managing the banking crisis included a series of priorities: ensuring fiscal andbanking liquidity, ensuring adequacy of banking capital, and encouraging stateintervention with a possible privatization of banking institutions Each of theseelements is intrinsically linked to the national debt crisis

The fiscal crisis increased lending rates It led investors to abstain from thepublic debt market and, ultimately, to the establishment of bail-out packages Thisresulted in the emergence of problems relating to banking viability Therefore, thespillovers from the banking system to sovereigns played important roles Mody andSandri (2011) consider that government bond spreads reflect the weaknesses of thedomestic national banking system, and this feedback loop has a wider impact oncountries with high debt-to-GDP ratio Acharya et al (2011) believe that thefinancial sector bail-out is translated into fiscal aggravation and the simultaneousdecrease of sovereign creditworthiness

In actual fact, the trust crisis that emerged with regard to fiscal credibilityresulted in the loss of the advantage created after 2000 by the convergence of thepublic lending rate of the various economies of the Eurozone

The refueling of the crisis drove the need for a series of actions and policiesaimed at safeguarding financial stability in the Eurozone Overall financial stabilityand, consequently, the stability of the euro were both under threat

The problems that emerged in the Eurozone can be depicted on the basis of twocriteria: their time-frame and their nature, i.e depending on whether they refer toflow or stock variables (Table2.2) (Roubini2011) They can also be categorized bytheir cyclical or structural nature

Short-term flow problems mainly include three phenomena: weak actual andpotential growth, weak competitiveness in relation to the role of monetary, fiscaland exchange rate policies, and lack of liquidation in the capital markets wherebanking and sovereign bonds are traded

Short-term stock problems include the high debt-to-GDP ratio Long-term flowproblems include: growth rate asymmetries in the EU; weakness in long-termcompetitiveness (resulting in loss of shares in international markets, particularly

in EMs); an emphasis on labor intensive low valued-added sectors; and the realappreciation level (attributable more to wage growth than productivity) Long-termstock problems include the huge stock of liabilities (Governments, privatenon-financial sector, banking and financial systems, and external debt)

Short-term problems lead to long-term problems: accumulated flow problemslead to stock problems The distinctions are useful, particularly when they illustratealternative confrontation policies Hence, if a policy is identified that deals with astock problem only without considering any flow issues, it has a limited effective-ness range even on a long-term basis Furthermore, when a policy is aimed ataddressing flow problems without also remedying stock problems, then it does not

set the necessary requirements for achieving a level of trust for the policy to proveeffective Examining the short-term and long-term nature of problems is of partic-ular importance Certain structural measures can have a positive impact on growth,while also having short-term negative repercussions Thus, the time dimension ofproblem repercussions is of particular importance.

Three basic problems can be observed when confronting short-term flows:a) growth rate decrease, particularly in peripheral countries, b) credit tightness andexchange rate appreciation leading to a competitiveness drop, and c) lack of bank andsovereign liquidation (becoming insolvent as a self-fulfilling bad equilibrium).Increased market uncertainty and lack of liquidity led to restrained public debtpurchase by the private sector This fact proved prohibitive for Eurozone memberstates access to the bond markets

The high debt-to-GDP ratio is important when examining short-term stockproblems: this was a critical factor determining the behavior of investors in manyEuropean countries The climate of uncertainty prevented public investment, bothwith regard to the purchase of government bonds and to the undertaking ofentrepreneurial actions

Long-term stock problems can be traced to historical peak liability stocks, either

in the public sector (Greece) or the private sector (Portugal)

By examining the European crisis from a different perspective, it has all thetypical traits of a deep recession, characterized by the existence of austerity,deleveraging and deflation procedures (Fig.2.3)

Figure 2.3 shows that the normal levels of savings and investments that areinitially dominant in an economy, lead to an increased level of investments andexcessive demand This in turn leads to excessive debt, excessive investments andexcess capacity At this point, the price mechanism function is weakened Underausterity conditions, the resolution can come from the invigoration of exports,brought in by either internal or external devaluation A process of synchronizeddevaluations, however, weakens the effectiveness of the policy in question and may

Table 2.2 Flows and stocks versus short and long-term problems

Flow

problems

Weak actual and potential growth Chronic slow potential growth in some

areas versus other areas of the EU Competitiveness weakness (Monetary policy,

Fiscal policy, exchange rate appreciation)

Long-term competitiveness weakness Lack of liquidation (banks + sovereigns) Loss of market share to emerging

markets (EM) Labor intensive low value-added sector

Real appreciation from wage growth over-productivity

Stock

problems

Government The private non-financial sector The banking and financial system External debt

18 2 The Evolution and the Current Status of the European Financial Crisis

lead, at least in theory, to investment disorientation Strangely, in the crisis to datethere has been no explosion of protectionism aimed at protecting domestic employ-ment This can be attributed to the existence of the negative (in this instance) globalinstitutional framework (Krugman 2013), depicted to a certain extent in G20agreements since 2008 At this point in the graph there is a wave of bankruptcies

in the private sector Depending on the concurrence, this is also the point whereentire countries can default (economies without the ability to print money), and theprice of all assets (shares and real estate) collapses

When the deleveraging process is completed in the private sector and the to-disposable-income ratio has decreased to healthy levels, i.e when the privateportfolios have been purified, consumers return to the markets and increase theirconsumption The power of the price mechanism is reinstated and, ultimately, therecovery of economic activity is realized at the end of this painful procedure.For many, the 2008 crisis is known as the “Minsky moment”, because its entireevolution corresponds to the theoretical description of the explosion of financialbubbles Minsky (1986) claimed that after long periods of economic stability,endogenous destabilizing forces start to emerge in an economy, leading to economicinstability He maintained that this occurs when high leveraging reaches dangerouslevels The Minsky moment comes after a long period of prosperity and increasinginvestment values has encouraged large amounts of speculation using borrowedmoney It is a situation in which investors who have borrowed large amounts ofmoney are forced to sell good assets to pay back their loans, and concerns the period

debt-in the credit cycle (or the busdebt-iness cycle) where debt-investors are facdebt-ing liquidityproblems because of spiraling debt incurred by financing speculative investments

At this point, a major sell-off begins As no party can be found to bid at the asking prices previously quoted, this leads to a sudden and precipitous collapse of themarket, wiping out asset prices and hugely decreasing liquidity in the market.Recovery necessitates the consolidation of private portfolios through the decrease

high-of debt Consolidation can be achieved in three ways: (1) through paying high-off, orrelatively paying off, the debt (growth, inflation), (2) through transferring the debt to

Fig 2.3 The cycle of

austerity, deleveraging and

deflation (Source: Comstock

Partners Inc 2012 )

the public sector: however, this requires either swelling Central Bank balance sheetsthrough quantitative interventions increasing the monetary basis, or the exercise of afiscal policy, and (3) through transferring the debt externally (bail-out interventions),primarily to institutions of the European Union (EFSF, ESM) and to bodies such asthe IMF In theory, all three alternatives can lead to a restart of consumer demand.The direction of the debt rollover will also depend on how it is allocated among thethree basic economy sectors, public, financial and non-financial.

Figure2.3includes an additional and valuable lesson: it clearly shows that in theupcoming stages of the crisis (in early 2013), with the exchange war (Beggar-Thy-Neighbor) and the debt defaults, Europe is reaching the last stages of the great cycle.The duration of these stages, however, is a different issue and is one of the subjects ofthis book

References

Acharya VV, Drechsler I, Schnabl P (2011) A Pyrrhic victory? Bank bailouts and sovereign credit risk, NBER Working Papers 17136 National Bureau of Economic Research, Inc

Balassa B (1961) The theory of economic integration Richard D Irwin, London

Balassa B (1976) Types of economic integration In: Fritz M (ed) Economic integration: wide Regional Sectoral Proceedings of the fourth congress of the International Economics Association in Budapest Macmillan, London, pp 17–31

world-Bordo M, Markiewicz A, Jonung L (2011) A fiscal union for the euro: some lessons from history NBER working paper no 17380.

Cecchetti S (2007) Federal reserve policy actions in August 2007: answers to more questions, VoxEu.org, 27 August Available at: http://www.voxeu.org/article/subprime-crisis-progress- report-and-more-faqs

Claessens S, Kose MA (2013) Financial crises: questions and lessons VoxEu, 7 April

Comstock Partners Inc (2012) Special deflation report

De Grauwe P (2010) The financial crisis and the future of the Eurozone, Bruges European economic policy briefings, n.21

Deutsche Bank Research (2011) The political economics of euro Available at: http://www dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000275211.PDF Eichengreen B, Mody A, Nedeljkovic M, Sarno L (2009) How the subprime crisis went global: evidence form bank credit default swap spreads, NBER working paper

Krugman (2013) The protectionist non-surge, April 29, The New York Times, the conscience of a liberal Available at: http://krugman.blogs.nytimes.com/2013/04/29/the-protectionist-non-surge/ Minsky H (1986) Stabilizing an unstable economy Yale University Press, New Haven

Mody A, Sandri D (2011) The Eurozone crisis: how banks and sovereigns came to be joined at the Hip, WP/11/269 November International Monetary Fund

Reinhart CM, Rogoff KS (2009) This time is different: eight centuries of financial folly Princeton University Press, Princeton

Reuters (2011) Special report: the maverick behind Merkel, 14 December Available at: http:// www.reuters.com/article/2011/12/14/us-europe-merkel-schaeuble-idUSTRE7BD0IU20111214 Roubini N (2011) Four options to address the Eurozone’s stock and flow imbalances: the rising risk of a disorderly break-up Roubini.com

Sapir A (2011) European integration at the crossroads: a review essay on the 50th anniversary of Bela Balassa’s theory of economic integration Journal of Economic Literature 49:1200–1229 Scha¨uble W (2011) Quoted in Reuters (2011) special report: the maverick behind Merkel, 14 Dec Sorens J (2008) Fiscal federalism: a return to theory and measurement Working paper Depart- ment of political science University of Buffalo SUNY Available at: http://www.acsu.buffalo edu/~jbattist/workshop/Sorens_s09.pdf

20 2 The Evolution and the Current Status of the European Financial Crisis

The Great European Recession 3

This chapter describes the shaping of the Great European Recession from threeperspectives The first Sect.3.1presents the economic and social costs of the greatrecession The second Sect.3.2addresses the redistribution consequences of thecrisis among, and within, EU member states (debtor/creditor countries, southern/northern countries) Finally, the third Sect.3.3compares European recovery to therecovery in the United States, as well as to interregional convergence and diver-gence tendencies Hence, a dynamic image emerges of the costs incurred during thecrisis evolution in terms of the relative position of the European economy within thewestern world

The analysis of the crisis costs will show that direct costs are the losses in GDPand employment and the effectiveness of the economic system (productivity anddecoupling from the United States) Wealth and income redistribution hasintensified within Europe Of secondary significance are the direct costs to theprivate sector, mainly resulting from the Greek PSI and the Cypriot Bail-in Thus,contrary to popular belief, the transfer of rescue funds from the center to theperiphery has not so far led to capital losses

The large-scale (5.4 % of EU GDP up until 2011) State Aid injections by theEuropean Commission to the banking sector as a whole are of particular impor-tance Moreover, the risk of incurring losses has grown because of conditions such

as bail-out programs, Emergency Liquidity Assistance (ELA) and the Target2interbank payment system

The image that emerges points to the conclusion that the political maneuversundertaken to date have transferred much of the crisis costs to the future Hence, toassess the size of the crisis, its continuing evolution will play a significant role Ifthe collapse of the Eurozone is avoided then the direct costs, although still being thelargest in postwar history, will be manageable and recognized as costs of the past.Should default occur, however, then the costs will surpass any rational assessment

P.E Petrakis et al., European Economics and Politics in the Midst of the Crisis,

DOI 10.1007/978-3-642-41344-5_3, # Springer-Verlag Berlin Heidelberg 2013 21

3.1 The Costs of the Great Recession

The economic crisis of 2008–2012 undoubtedly had significant economic and socialcosts: however, these costs are difficult to quantify In our assessment we use:(a) loss in the income and total output, and (b) cost of the possible breach of debt-repayment obligation that bondholders will be called on to pay (sovereigns andbanks) Furthermore, we include two figures that are influenced by the Europeancrisis: credits from inter-European transactions (Target2); and the funding of periph-eral countries by the European Central Bank (Emergency Liquidity Assistance,ELA) These two figures portray logical possible costs, and the risk of increasedfuture costs Finally, by including the decrease in labor productivity, we can present

an integrated medium-term growth potential representation of the consequences andthe cost of a large crisis Oulton and Barriel (2013) found that such a crisis reducesthe short-run growth rate of labor productivity by between 0.6 % and 0.7 % per year,and the long-run level by between 0.84 % and 1.1 % It also reduces the long-runlevel of capital per worker by an average of approximately 1 %

The European financial crisis of 2008 is the largest crisis in recent history,comparable only to that of 1929 As there are data available on the EuropeanUnion and the Eurozone from that period, we cannot make historical financialcomparisons Although severe, the crisis faced by the economy during 2008–2011was not as grave as the Great Depression “Half a Great Depression” is howKrugman (2009) put it; however, we use the term Great Depression here (Almunia

et al.2010) as it applies globally to all basic economic variables, such as worldindustrial production and world trade (Eichengreen and O’Rourke2010)

If we accept that the Great European Recession diverted from the projected term growth tendency (Fig 3.1), then the figure for the cost of the recession(2008–2014) for the EU-27 is valued at 1.3 tr (2012 prices) For the same time period,the cost of unemployment (i.e how many more unemployed people the crisis created)

long-in the EU-27 countries is estimated at 11 m people (2.2 m per year) The pertlong-inentquestion is on the analysis of the unemployment origins: i.e., whether they are of acyclical or a structural nature In other words, are the outcomes of the global recession,that started with the collapse of the economic activity, due to the European crisis, or dothey have a deeper, structural nature (e.g due to the eastward trend) that merely came

to the surface with the great recession? (C.A Pissarides October 2012, speech at theBritish Academy in London) As we can see a deep impact in the job market, this hasalso been attributed to the financial nature of the crisis (Boeri et al.2012)

It should be noted that the costs of the crisis may extend beyond 2014 Thiswould mean no immediate return to long-term growth, with the evolution curvehaving a permanently descending path

The main countries at the center of the crisis were those located at the periphery

of the Eurozone (Greece, Portugal, Spain, and Ireland) Income losses in Greece,Spain and Portugal together reached€100 bn1

during the period 2009–2012

1 This figure was estimated as the difference between the GDP for the years 2010–2012 and the respective one for the year 2009, at constant 2012 prices.

The exposure of the Eurozone banking systems to the debts of the peripheralcountries was significant France and Germany had the greatest exposure to Greeceand Spain (Fig.3.2) The breach of the borrowing countries’ obligations to repaydebts will have a direct impact on creditor countries and their banking system,which will incur big losses.

Crises-related recapitalization and impaired asset relief granted by the Eurostates to the financial sector by the end of 2011 stood at €31.7 bn The overallvolume of average outstanding guarantees, including new guarantees and liquiditymeasures, amounted to€682.9 bn, representing 5.4 % of the EU GDP (State AidScoreboard, European Commission (21 December 2012))

Looking at the Greek case, the losses incurred by the international financial(banking and insurance) system from the EU debt crisis to date (early 2013),amount to approximately€105 bn for the first stage (PSI – March 2012), and toapproximately€21 bn for the second stage (December 2012) of the debt decrease

In relation to Cyprus: private losses reached€5.8 bn because of the savings haircut(March 2013)

A significant contribution shaping the cost of the Great Recession are the out programs (Table3.1) for Greece, Ireland and Portugal, to the extent they includethe immediate transfer of resources From a loan resources perspective the follow-ing are important: (a) the interest rate and the grace period, and (b) whether suchloan resources can be converted to losses

bail-The only figure, however, that can be officially converted to losses to date byEuropean officials is part of the support program for Greece (IMF estimate€50–60bn) Nevertheless, significant losses will be recognized in the future (2014–2016)

0.06 0.07 0.08 0.09 0.1 0.11

Fig 3.1 The cost of the crisis: EU-27 projected GDP (in 2012 prices) and unemployment rates: actual, and under the assumptions of a “no crisis” scenario (Source: AMECO database and CEPII Projections Note: “No crisis” scenario GDP is estimated by using CEPII long-term projections for the European Economy (yearly growth rate of 1.5 %) “No crisis” unemployment rates are estimated by using the 2001–2008 average reduction rate of 2.5 % per annum)

Spain Italy Switzerland Netherlands US UK Portugal Germany France

programs to the member

states of the European

Union, by origin of funds

Source: European Commission

a A loan from the reserve funds of the domestic insurance system is also included in the sum of the financial assistance to Ireland

b Estonia had an internal devaluation program, without seeking recourse to external funding

c A loan from the Scandinavian countries, the World Bank and the European Bank for Reconstruction and Development is also included in the sum of the financial assistance to Latvia

d A loan from the World Bank, the European Investment Bank and the European Bank for Reconstruction and Development is also included in the sum of the financial assistance to Romania

e A loan from the World Bank is also included in the sum of the financial assistance to Hungary

There are two further figures linked to a possible loss risk at a European level,but they do not constitute literal losses The first refers to the accumulation ofcredits attained through the Target2 real-time gross settlement system, whereby thecredits extended by Central European countries to the countries with deficits aregrowing These creditor country credits reached€800 bn in 2012: this is recognized

as
€800 bn toward creditor countries (Fig.3.3)

This tendency towards Target2 balance growth was reversed in 2012 and 2013,

as a result of (a) changing peripheral country deficits, and (b) the movement ofcapital from Southern to Northern Europe because of lack of trust in southernbanking systems

The second figure relates to funding by the ECB to European periphery debtorcountries (Fig.3.4) In February 2012 this reached: Greece€80 bn; Spain €317 bn;Italy€270 bn; and Portugal €50 bn In reality, the ELA constituted a bail-out tool,despite it being of a short-term nature

Under normal conditions Target2 and ECB debtor country funding should not beincluded in the cost of the European crisis, but only in the risks it created.Otherwise, they will be converted to losses only in the cases of cessation ofpayments and de-structuring of the Eurozone

In addition to significant costs and risks, the Great Recession period of 2008–2012had important redistribution effects Such effects had both international andnational dimensions

Internationally, we compare the global evolution of the GDP per capita ofEurozone debtor countries (Austria, Estonia, France, Greece, Ireland, Italy,Portugal, Slovakia, Slovenia, and Spain) with creditor countries (Belgium, Finland,Germany, Luxembourg, and The Netherlands), as well as specific Southern

Fig 3.3 Estimate of the balances of the Eurozone countries in the Target2 real-time gross settlement system (in bn of euros) (Source: National Central Banks)

European countries (Greece, Spain, and Portugal) with specific Northern Europeancountries (Germany, The Netherlands, and Finland) (Fig.3.5) There is no surprise

in what these comparisons reveal The GDP per capita at constant prices isconsistently lower in Southern European countries than in Northern Europeancountries This also applies to debtor countries in relation to creditor countries.The creditor countries are distinguished by lower Gini index (measuring incomeinequality) values than debtor countries, and hence have higher equal distributions

of income Debtor countries have higher levels of income inequality, and from thisperspective France looks more like a creditor country than a debtor country(Fig.3.6)

The Gini index has values of between 0.24 and 0.36 for most European, andother developed, countries In the United States, the index values average over0.40,2showing high inequality levels The global Gini index has been calculated at

a value of between 0.56 and 0.66.3

Nationally, the distribution of wealth across a country can be measured by means

of comparing the median to the mean wealth (De Grauwe and Ji2013) The greaterthe difference between the two figures, the higher the level of unequal distributionwithin that country: this seems to be the case in Germany The mean Germanhousehold wealth is four times that of the median, whereas for other countrieswithin the Eurozone it is somewhere between 1.5 and 2 As such, wealth inGermany is particularly unevenly distributed, a fact which the Gini index doesnot depict

When we make comparisons among countries, we see that the crisis aggravatedthe uneven distribution of income The uneven income distribution in debtor

Fig 3.4 Estimate of the funding to European banks by National Central Banks (ELA balances) (in bn of euros) (Source: UniCredit (2012))

3 United Nations Development Program.

countries was decreasing before 2007: after 2008 it increased steadily On thecontrary, the uneven income distribution in creditor countries systematicallydecreased after 2007 (Fig 3.7) A similar pattern emerges when the data fromSouthern European countries are compared to those from Northern Europeancountries.

The clearly observable conclusion is that the 2008–2012 crisis widened unevenincome distribution, both within stricken economies and between strickeneconomies compared with those of Northern Europe These findings lead to twofurther observations concerning income and product distribution, both withinindividual economies and among Eurozone economies The first observationconcerns the de-structuring of social cohesion and the increased number of peopleclose to bankruptcy or social rejection (because of non-receipt of social welfare) inthe European Union

This number has increased by 2.5 % during the period 2008–2011, reaching atotal of almost 117 m people For the period 2009–2011, the number of people

Debtor / Creditor South / North

Fig 3.5 Comparison of the GDP per capita (at constant prices) of debtor countries to that of creditor countries, and of the countries of Southern Europe in relation to the countries of Northern Europe (Source: AMECO)

considered as being at particularly adverse states of deprivation increased byapproximately 5 %, reaching almost 42 m When figures are released for 2012,

we expect these numbers to be further worsened as Eurozone economies generallyshrank in that year We foresee further increases for the year 2013, when many ofthe Eurozone economies will remain sunk in recession

The second observation concerns the “middle class” and the fact that it is beingpushed towards lower income scales Jaimovich and Siu (2012) consider that alimitation of the middle class does not come about through a slow, evolutionaryprocess, but occurs abruptly and within a limited period of time, particularly incases of economic recession The reasons for such a pushback of the middle classinclude increased taxation, decreased employment and the introduction of flexibleforms of employment

What is characteristic of the crisis is the decrease in percentages of totalemployment and the shift to more flexible forms of employment since 2009 This

is directly linked to the 2008 crisis and the structural changes it created in the jobmarket

We attempted to assess the evolution of the relative position of the middle class

as a result of the crisis We examined two economies, Germany and Greece thatwere at opposite (positive–negative) ends of the crisis scale for the period2007–2011 We measured the percentage of the population with an annual income

of less than€20,000 In Germany this percentage is systematically decreasing, inGreece it has increased vertically since the implementation of austerity measures.Furthermore, we measured the percentage of the population with an incomeexceeding€40,000 Since 2013, this has decreased in both Germany and Greece.The conclusion is clear: the German middle class has widened (because thepopulation with incomes of less than€20,000 decreased while those with an income

of over €40,000 also decreased) (Fig 3.8), whereas in Greece it has shrunk(Fig.3.9)

Nevertheless, the compensation of the labor coefficient (apart from the tural sector) as a percentage of income follows a steadily declining trajectory after

Creditor countries Debtor countries

Fig 3.7 Average Gini income value index (weighted per population of each country) for the creditor and the debtor countries (Source: Eurostat [SILC] and own calculations)

the 1970s – at least in developed economies When the Great Recession started, theangle of decline became worse However, such compensations are not homogenous.The distinction between specialized and unskilled employment, as well as thepercentage composition of these two coefficients, influences the observed tendency.Hence, there are indications that percentage of specialized employment seems tohave better prospects Ultimately, the employment share is decreasing because thecompensation is increasing at a slower rate than productivity An alternativeviewpoint is that employment compensation is decreased at a faster pace than theproductivity decrease This tendency was observed throughout 1980s and the1990s However, it has intensified over the last decade for four reasons: (a) thedecreased the negotiation potential of the workforce, (b) globalization, and thetransfer of employment activities further to the east, (c) improved informationtechnologies leading to capital efficiency and (d) increasing financialization,which has two important effects on labor bargaining positions: (d.1) firms havegained more options for investing and (d.2) it has empowered shareholders relative

to workers, by placing additional constraints on firms (Stockhammer2004,2010).Moreover, because of the evolutionary nature of the economic cycle of the GreatRecession and of the asynchronous development of production, employmentsalaries and productivity, the employment share is decreased in conjunction with

a rapid growth in unemployment

Europe had been investigating the dislocation of the job market as a means ofincreasing productivity since the 1970s This strategy was implemented as onemeasure for confronting the excessive debt crisis of 2008 It resulted in theworsening of participation in the job market, because of the further weakening ofthe workforce’s negotiation potential

Poor employment figures have both economic and political consequences Theeconomic consequences include the accumulation of capital, the total demandcomposition, and the ability to collect tax revenues Whirl is triggered at a politicallevel, strengthening the anti-systemic forces This process is mainly evident inCentral, Eastern and South-Eastern European countries

Fig 3.8 Percentage of the German population with an income of less than €20,000 (left axis) and more than €40,000 (right axis) (Source: Eurostat [SILC] and own calculations)

Constructively, we can ascertain that the Great Recession has exacerbatedinequality, which leads to economic instability (Stiglitz2012).

In addition to redistribution consequences, the Great Recession of 2008–2012 gaverise to new situations, whose significance and effects will be triggered in themedium-term future and will influence the European evolution These are: (a) therelative position of the European recovery in relation to the United States and(b) the de-structuring forces wielded against European cohesion

The first of these two points relates to the issue of the European economy’sgrowth and dynamism in relation to that of the United States and is based on asimple observation The real growth rate paths of the United States and Europediverge for the first time in the 2000s Prior to this they had evolved in an almostsynchronized manner (Fig.3.10)

This change has significant consequences on the evolution of the unemploymentpercentage, as can be seen in Fig.3.11

These observations have wider repercussions They suggest that the underlyingreasons behind the crisis in these two regions have a degree of variety or, at least,have different consequences for coincidental or institutional reasons

Reinhart and Rogoff (2008) clearly showed that systemic financial crises acrossadvanced economies had far more serious economic consequences than normalrecessions, and, as far as the United States is concerned, this present crisis is the firstsystemic crisis since the Great Depression Therefore, the process of recovery from

a severe financial crisis is more protracted than in the case of a normal recession(Reinhart and Rogoff2012) Their conclusion is clearly that recovery is on hold inthe United States Can we infer that the difference in the European response to thecrisis was because of the severe European banking problem? The answer is most

Fig 3.9 Percentage of the Greek population with an income of less than €20,000 (left axis) and more than €40,000 (right axis) (Source: Eurostat [SILC] and own calculations)

likely yes, but it requires further research for this to be rigorously established Forthe time being, we retain the general conclusion that we should expect a longerEuropean comeback lag.

The general idea that the United States and Europe have parted economiccompany extends to the balance of payment to GDP ratios, and government debt

to GDP ratios Most importantly, European States GDP dispersion is rising in directcontrast to the situation in the United States, where it is dropping (Manasse2013).Manasse (2013) concludes that the Eurozone policy response to the crisis “is notonly imparting a recessionary impact on the Eurozone, but it is also aggravating the-original sin- of the euro: asymmetry” Consequently, “the longer-term prospects forthe survival of the euro not only are not improving, they are actually getting worse”

References

Almunia M, Benetrix A, Eichengreen B, O’Rourke HK, Rua G (2010) From great depression to great credit crisis: similarities, differences and lessons Econ Policy CEPR CES MSH 25:219–265, 04

Fig 3.10 Change in the actual GDP of the United States and the Eurozone (Source: IMF, WEO database Note: 2006 ¼ 100)

Fig 3.11 Evolution of the unemployment percentage in the United States and the Eurozone (Source: IMF, WEO database)

Boeri T, Garibaldi P, Moen ER (2012) The labor market consequences of adverse financial shocks, IZA discussion papers 6826 Institute for the Study of Labor (IZA)

De Grauwe P, Ji Y (2013) Are Germans really poorer than Spaniards, Italians and Greeks? VoxEu org, 16 Apr

Eichengreen B, O’Rourke K (2010) A tale of two depressions: what do the new data tell us? February 2010 update VoxEU.org, 8 Mar

Jaimovich N, Siu HE (2012) The trend is the cycle: job polarization and jobless recoveries, NBER working papers 18334 National Bureau of Economic Research

Krugman P (2009) The great recession versus the great depression, 20 Mar http://krugman.blogs nytimes.com/2009/03/20/the-great-recession-versus-the-great-depression/

Manasse P (2013) Eurozone crisis: it ain’t over yet VoxEU.org, 17 Jan

Oulton N, Barriel MS (2013) Long and short – term effects of the financial crisis on labour productivity, capital and output, Working paper Bank of England

Reinhart CM, Rogoff KS (2008) Is the 2007 US subprime crisis so different? An, international historical comparison Am Econ Rev 98(2):339–344

Reinhart CM, Rogoff KS (2012) 5 years after crisis, still no normal recovery Bloomberg View, 3 Apr 2012

Stiglitz J (2012) The price of inequality Project syndicate, 5 Jun 2012

Stockhammer E (2004) Financialisation and the slowdown of accumulation Cambridge Journal of Economics 28(5):719–741

Stockhammer E (2010) Financialization and the global economy Working papers wp240, Political Economy Research Institute, University of Massachusetts at Amherst

Part II The Structural Elements of the Crisis