Posted in Finance Articles, Total Reads: 3460
, Published on 20 February 2012
A lot has been said and studied about the European Crisis, its genesis and its implications. Most of these theories revolve around an origin which is focused on the US subprime crisis and its subsequent ripple effect in Greece and other countries in the EU in terms of fiscal deficit. It is based on these theories that most of the relief packages are based. In fact a closer look at the scene in Europe will reveal that the continent has now pinned its hope entirely on the shoulders of Germany. This clearly goes on to show a great bit of altruism on part of Germany for the greater good of the Union.
However, some economists have a totally different take on the issue. For example British economist Martin Wolf is of the opinion that the looming crisis is basically a balance of payments problem rather than a fiscal problem. Many economists like him are also of the opinion that the major reason for this problem is that the absence of a fiscal and financial integration on the currency Union called Eurozone.
To draw an analogy nearer to home imagine trade of goods and services happening between companies in two Indian States: say Maharashtra and Andhra Pradesh. Now imagine that there is a great imbalance in trade between these two states with the balance tipped heavily in favor of Maharashtra meaning that Maharashtra now has a trade surplus and AP a trade deficit. But mind you, this deficit is in the same currency and happens to occur in the fiscal Union of India which is financially integrated. As a result, these deficits go unnoticed and the worst possible consequence for AP would be seeking help from the Union government which will then allocate adequate resources to the state. Now imagine the same state of affairs between Portugal and Germany, with the balances tipped heavily in favor of Germany. Even though the situation seems similar on the surface the major differentiator is the fact that Eurozone is only a monetary Union which in essence means that there is no central body which would take care of the deficits of any member of the union for free.
There is ample evidence in form of data which point in the direction of the above hypothesis. Germany and France have been trying very hard on their part to approve more finance for the PIIGS from the ECB based on the assumption that fiscal misconduct is the origin of the crisis. However there is data that suggests otherwise.
For example if we look at the fiscal deficit of 8 member of the Eurozone we get the following picture:
Fiscal Deficit as % of GDP, Source: Eurostat database
According to the Maastricht Treaty (which formed the basis of the formation of the Eurozone), the ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. A closer look at the data which has is a segregated average of the period 97-99, 00-07 and 08-10, will show that most of the countries in the Eurozone don’t fit the bill.
Next let’s look at the public debt scenario.
Public Debt as a % of GDP, Source: Eurostat database
Some Eurozone members like Ireland, Austria, and Estonia had better public debt position as compared to Germany. In fact if we look at the German story pre 2008 it seems rather vulnerable in context of both fiscal deficit and public debt. However the tables turned post crisis and Ireland piled on huge public debts.
Finally, let’s look at the balance of payment figures to understand if the trend throws any surprise at us.
Balance of Payments (US $ millions), Source: OECD database
Clearly enough, the BoP for Germany improved tremendously whereas that of the other Eurozone members took a severe blow.If we try to understand this from the perspective of the Eurozone it becomes clear. Once the Eurozone was formed, it was relatively cheaper for members of the Eurozone to engage in bilateral trade with Germany and France. But all these countries shared the same currency with Germany now. Just as they drag the euro down, Germany pulls it up (with its industrial and technological might). So while Germany’s exports are cheaper than they should be, those of southern Europe (PIIGS) are more expensive.
The euro is thus making those countries less competitive and less able to grow. This brings us to the point where it becomes clear that the current Eurozone crisis is not a crisis of debt, deficit, but something more basic – growth. The smaller economies present in the Eurozone have to compete with the bigger, dominant economies; excluding them from the Eurozone will drastically drop the growth rate. And if these troubled economies do not grow, they won’t be able to sustain any of the “help packages” that they are being offered.