Over the past three years, the euro area has been in a state of financial crisis. Recessions have afflicted states across the region, and on June 25, Cyprus and Spain became the latest members of the euro area to request an EU bailout, joining Greece, Ireland, and Portugal. EU ministers have been unsuccessful in securing sustained economic growth and reining in national budgets - moves necessary to ensure the Euro's survival. This is the first in a three-part spotlight series on the fallout from the euro area financial crisis.
Austerity Policies in Europe
Europe has reached a juncture where the future of austerity policies is unclear. Austerity measures have diminished economic growth and increased unemployment levels. The spring elections in France and Greece underscored a growing popular rejection of EU-mandated austerity measures. In a paradigm shift during the June 29 EU summit, newly elected French President Francois Hollande championed increased government investment in social welfare, funded by higher taxes, as the best course of action to reinvigorate euro area economies, as opposed to the policies of his predecessor Nicolas Sarkozy. However, with financially stable European states funding the bailouts and insisting on austerity, it is unclear if the anti-austerity movement will gain sufficient traction for a dual approach to stimulate economic growth along with austerity measures.
iJET uses various indices and indicators to monitor the state of European economies. These include bond yields, capital flows, credit ratings, unemployment rates, and budget deficit levels.
Bond Yields: A yield rate of seven percent on 10-year government bonds is generally considered unsustainable and is recognized by economists as an indicator that a country will soon be forced out of the bond market and have to request bailout loans. Low yield rates typically indicate that a country is viewed as financially stable and relatively risk free.
Capital Flows: Capital flows into or out of a country indicate the confidence level in a country's economic potential. An economy that investors believe is on a downward trend will lose capital at faster rate than one which is seen as stable or growing.
Credit Ratings: Credit rating agencies have been re-evaluating the credit ratings of various European banks and governments. Changes to credit ratings generally correlate to the ability an entity will have to be able to repay its debts and avoid default. Nearly all European banks and states have experienced rating cuts due to their exposure to the crisis.
Unemployment Rates: The unemployment rate of a country is one measurement of the effect that a recession has on a population, and can be used as a predictor for the level of unrest in a country. Unemployment is, however, a lagging indicator - there is a lag between when revenues rise and hiring increases. The stated unemployment rate may be much lower than the actual unemployment rate of a country. Eurostat, the EU's statistical office, measures the unemployment figure as unemployed individuals 15 to 74 who have looked for work in the last four weeks. Individuals who are underemployed or have stopped looking for work are not represented in the official unemployment rate. Unemployment among younger generations is generally higher than the average unemployment rate among the older population. As both unemployment figures rise, demonstrations become more common.
Deficit Levels: Euro area lenders are demanding governments reduce budget deficits to below three percent of GDP by 2013. Slashing the budget to reach this threshold often includes cuts to public sector salaries, reduction of welfare benefits, and tax hikes. These moves are unpopular and have in many cases led to anti-austerity protests.
Much of Cyprus's economy is based upon financial and business services, and its exposure to Greek debt has caused severe losses. In 2011, Cyprus received a loan worth EUR 2.5 billion (USD 3.0 billon) from Russia. On June 25, Cyprus, the current holder of the EU Presidency, requested an EU bailout loan - the fifth country to do so - worth an estimated EUR 10 billion (USD 12.2 billion) to recapitalize its struggling banks. The country's request for a parallel loan from Russia worth EUR 5 billion (USD 6.1 billion) has drawn criticism from EU members. Cyprus's 10-percent corporate tax rate, a draw for many businesses, will likely be raised as a condition of receiving a bailout. The recently requested bailout should shore up Cyprus's struggling banks, but economic contraction is expected to continue through 2013.
Greece has an economy that has been in recession for five consecutive years and an unemployment rate of 22.5 percent. Bailout loans from the EU have led to severe austerity measures, including layoffs and salary cuts to the public sector, cuts to social welfare programs, and tax increases. The recession has caused tax revenues to fall, hindering the government's ability to reduce the budget deficit. Greece also has a chronic problem with tax evasion; a report released on June 17 revealed that Greek citizens earn on average 1.92 times more than they report to the government, a figure that amounts to about half of the pre-crisis Greek budget deficit. Fears of a Greek exit from the euro area led to large capital flows out of Greece in the days leading up to the June 17 elections, but these fears were allayed when the election resulted in a pro-bailout coalition government. The coalition promised to renegotiate terms of the bailout with EU lenders to lessen the strain on the Greek economy through extending bailout mandated timetables for deficit reduction and reducing the implementation of austerity policies. Economic hardship and austerity cuts have led to near-perpetual demonstrations. Anarchist groups have carried out a rising number of attacks, such as the June 29 arson attack against Microsoft's Greek headquarters in Athens. Greece will be forced to deal with harsh austerity, a contracting GDP, and large degrees of social unrest over the long term. Political instability is likely to ensue as well if the government cannot successfully renegotiate the terms of Greece's bailout.
Ireland is on track for a recovery after receiving an EU bailout in 2010. Ireland returned to the bond market on July 5, holding is first debt auction in two years. Revised figures released on July 12 revealed that the country avoided recession in 2011, and GDP is predicted to rise slightly, by 0.5 percent, in 2012. Austerity policies, including increased taxes and decreased public salaries and pensions, have been unpopular and sparked protests nationwide. However, violent social unrest has been rare despite an unemployment rate currently at 14.6 percent. On July 17, instead of paying down government debt as originally intended, Ireland announced it would invest EUR 2.25 billion (USD 2.75 billion) in infrastructure projects, possibly indicating a more substantial move away from austerity policies. Reforms successfully implemented under austerity will likely lead to the Irish economy gathering strength over the next few years, despite economic weakness in the euro area.
Portugal has been mired in recession for over a year, and the government expects a negative growth rate of 3.3 percent in 2012. The 2011 EU bailout package, worth EUR 78 billion (USD 95 billion) has ensured that Portugal will be able to pay its debts through 2012, but ten-year government bond yields have remained unsustainable at higher than 10 percent for more than a year. Much of Portugal's debt is financed by Spanish banks, making Spain particularly vulnerable to Portuguese decline. Austerity policies have cut social welfare programs and public salaries, resulting in large scale labor actions and popular protests across the country. Portugal's economy is expected to continue to contract in 2012, but weak growth is expected to resume in 2013.
The collapse of the Spanish housing market in 2008 exposed Spanish banks to high levels of bad mortgage debt and greatly weakened the Spanish economy. Spain was forced to request an EU loan on June 25 of up to 100 EUR billion (USD 121 billion) to recapitalize its banks as economic conditions have continued to worsen. Spanish bond yield rates have topped seven percent and make its current situation unsustainable. Deeply unpopular austerity measures have been implemented. Unemployment levels at 24.5 percent and youth unemployment at 48 percent have led to one of the highest rates of social and labor unrest in Europe. Further economic contraction is likely through 2013 and violent social and labor unrest will probably not de-escalate soon, but reforms and austerity policies are likely to fuel growth in 2014 if kept in place. The EU loan to recapitalize Spain's banks has alleviated some of the pressure on the Spanish government and may prevent the need for a large EU bailout package for Spain.
High Risk Countries
Italy's economy has been struggling to sustain growth since the early 2000s. The 2008 financial crisis exposed the fragility of the Italian economy. Uncertainty surrounding Italy's economy has led many investors to stay away from government debt auctions, causing 10-year government bonds to rise above the unsustainable seven percent yield rate at times. Since becoming the Italian Prime Minster in November 2011, Mario Monti has sought to address structural weaknesses in the Italian economy by seeking to reform tax policy and cut public sector costs. Italy faces similar challenges to tax collection as Greece, but to a lesser extent. Italians have not responded favorably to rising taxes and decreasing state benefits. Many trade unions, as well as significant other segments of the population, have participated in frequent protests. Anarchist groups have been active in the past year, carrying out bombings and arson attacks against government offices. On May 13, members of an anarchist group shot the executive of a nuclear company in the knee, in an attack reminiscent of those carried out by the Italian Red Brigades in the 1970s. If Italy is able to continue the implementation of Monti's austerity policies and structural reform, Italy will likely avoid seeking financial assistance from the EU in the near term. If elections in April 2013 turn against Monti and lead to a reversal of his reforms, a bailout will be much more likely.
French President Francois Hollande's victory during June 17 presidential elections has been seen as a rejection of austerity policies by the French voters. Hollande campaigned with the promise of increasing taxes to fund government spending on the public sector and social welfare programs. However, Hollande's stated goals are unlikely to lift the economy, as higher taxes on an already struggling private sector will do little to decrease an unemployment rate that remains above 10 percent and boost the predicted GDP growth rate of 0.3 percent for 2012. Despite the country's exposure to the wider European financial crisis, France is seen as financially stable, as indicated by negative yields being paid on France's short term bonds at its July 9 debt auction. Hollande's election may have implications for the future of euro area policies. His support for Italy and Spain at the June 28-29 was likely instrumental in convincing German Chancellor Angela Merkel to agree to allow the EU to directly recapitalize banks without adding further sovereign debt or imposing austerity measures. France will likely continue to avoid the worst repercussions of the euro area crisis and experience limited economic growth.
Germany has been able to weather the financial crisis better than other states due to a strong export economy and labor, public sector, and social welfare reforms carried out in the early 2000s. German GDP grew by three percent in 2011, but is predicted to grow by only one percent in 2012. Data released on June 2 revealed that Germany's exports shrank by 1.7 percent as global markets showed signs of weakening, indicating a potential slowdown in the German economy. Nevertheless, Germany's finances remain in a relatively strong position, and the country currently has little risk of sliding into a fiscal crisis. Germany's bonds have the lowest yields in Europe, indicating Germany is viewed by investors as the safest location in which to invest. On the international scene, Germany has been the most vocal proponent of austerity policies in the euro area and has insisted on stronger regulations and more international oversight on European banks and national budgets. While German growth has been slowed by the crisis, the country's economy will maintain its position as the strongest in the euro area.
While not a member of the euro area, the UK's economy is closely tied to that of the euro area through financial and export markets. The British Pound continues to strengthen against the Euro as the crisis continues. However, this has made the UK's goods and services relatively expensive, sliding the UK into recession since October 2011. The IMF forecasts that the UK's GDP will continue to stagnate, as growth will only be 0.2 percent for 2012. The economic downturn has led to falling tax revenues and high unemployment, expected to rise to nine percent by the end of 2012. The government has responded to reduced revenue by implementing austerity measures aimed at lowering the budget deficit to below 3 percent, including cutting 490,000 public sector jobs, average departmental budget cuts of 19 percent, and raising the retirement age from 65 to 66. Austerity is very unpopular nationally, and has triggered a series of strikes by various trade unions and social unrest, such as the Occupy protests that occurred in January in London. The UK's ties to the euro area will continue to limit its potential for growth, but the UK will likely resume moderate economic growth going forward from 2012.
The euro area faces many challenges that must be overcome before financial stability can be restored. EU summits have largely resulted in stopgap measures, while needed currency reforms fail to gain traction. Austerity policies have, as yet, proven ineffective in remedying the financial ailments of struggling states. While anti-austerity arguments have gained traction recently, it is still unclear how much Germany and other financially stable countries will be willing to alter their positions to accommodate struggling governments.
In order for the fundamental structural issues of the euro area crisis to be addressed, the member-states must move toward a monetary union with central authority over financial policy. Uneven development in labor has distorted competitiveness, and asymmetry between monetary and fiscal policies has led to inflexibility in dealing with the economic flux. A concern over the loss of sovereignty has made many countries reluctant to move toward a functioning union. The inability of EU countries to reach an agreement on economic reforms will likely lead to further stopgap measures that avert crises in the 11th hour but do little to improve the long term stability of the euro area. The emerging London InterBank Offered Rate (LIBOR) scandal has further revealed the need for increased central regulation, as the manipulation of interest rates between banks likely skimmed vast sums of money from investors.
As economies in Europe continue to stagnate and austerity policies are used to close budget deficits, unemployment is likely to rise as social welfare benefits fall. This will lead to continued social and labor unrest in euro area countries. Protracted or worsening recessions in individual countries could potentially lead to an increased frequency and violence of demonstrations. Anarchist movements, such as those in Italy and Greece, could grow and spread to additional countries as anti-capitalist rhetoric gains hold among increasingly disaffected populations, possibly leading to an increased protests and general unrest.