One State, One World

Coping With Crisis

The recent European Debt Crisis has exposed economic divisions among the countries using the euro.

word debt being erased

Photo: Alan Cleaver (Flickr)

The debt crisis has spurred debates about who should pay for future bailouts, exposing sharp divisions between economically strong and weak EU countries.

The recent European debt crisis has exposed economic divisions among the countries using the euro.

Although some countries recovered from the 2008 recession, some smaller countries have not. Greece, Ireland and Portugal all received financial bailouts from the EU, prompting questions about who should pay for future bailouts.

The Promise Of The Euro Zone

When the euro was created in 1999, it was seen as ushering a new age of European integration, as eleven countries would be using the same currency, making it easier for transactions to move across borders.

In the past decade, the euro has grown to seventeen members, but the euro has also exposed the economic divisions among countries using the euro.

Since the global recession in 2008, many European countries (typically in northern Europe) have experienced recoveries, while others (primarily located in southern Europe) have not seen their economies return to prosperity.

For instance, the German economy grew at its fastest rate since Reunification in 1989 between April and June 2010. However, Greece has not experienced economic growth since 2007.

One Size Fits…

The euro has actually helped exacerbate this problem, as it is difficult for the EU to implement “one size fits all” policies for seventeen different countries. Like the Federal Reserve System in the US, the European Central Bank (ECB) is responsible for controlling monetary policy for the entire Euro zone.

For instance, the European Central Bank increased interest rates in 2009 because Germany (which is the largest European economy) was growing, while Greece (which only accounts for 2 percent of the EU economy) was not.

The United States suffers from this problem as well, as American states grow at different rates as well. However, the U.S. Federal budget helps smooth out these bumps, but the EU cannot help member states in the same way.

While it was not apparent until recently, the euro created a second problem for Europe. After countries adopted the euro, the interest rate that national governments paid fell dramatically as investors thought that many countries were now safer places to invest.

EU countries seemed like a safe investment because to join the euro, governments had to agree to the Growth and Stability Pact stating that they would keep their budget deficits below 3 percent of GDP every year.

In addition, the EU had a “no bailout” clause, meaning that if one country could not pay its bills, the others would not step in and help them. Unfortunately, the rules of the Growth and Stability Pact were not enforced, and borrowing in some European countries soared now that they had access to cheap credit.

When the recession began, many governments had to borrow more as tax revenues decreased while government spending grew due to increasing unemployment and demands on social spending.

EU Says Yes To Bailouts

In 2010, investors started to realize that not all Euro zone countries’ finances were the same. Greece was the first to see the interest rates that it had to pay on government debt increase to levels that it could no longer afford and received a €110 billion (about $154 billion) bailout from the EU, the European Central Bank, and International Monetary Fund in May 2010.

Everyone hoped that this would calm the markets and Greece would be able borrow money again internationally in a few years. However, Greece was followed by bailouts for Ireland in November 2010 and Portugal in April 2011.

These three countries are all small and account for only about 5 percent of the total EU economy, but the fear is that investors will start to panic and focus on two of the largest EU countries—Spain and Italy. While the EU and others have been able to attempt to rescue Greece, Ireland, and Portugal, it would be very difficult to bailout Spain or Italy.

Voters in many richer European countries might be willing to loan some money to small economies, but the cost of supporting Spain or Italy would probably be too much and a Spanish or Italian default could potentially lead to the breakup  of the Euro zone.

A major crisis in the Euro zone would directly affect the US and Indiana. The transatlantic economic ties are among the strongest in the world, and economic problems in Europe would mean less European investment in the US and fewer American exports to Europe.

Indiana does not have very strong economic ties with Portugal or Greece, but Ireland, Italy, and especially Spain are major economic partners for the state.

Indiana is potentially exposed to the European Debt Crisis, although to date exports to the Eurozone have continued to grow despite the situation in Europe.

Learn More

This episode of One State One World is produced in partnership with the EU Center at Indiana University.

Read more about the European Union on the EU Center’s blog, Across the Pond.

For continuing coverage, the BBC and The Economist both have excellent sections devoted to the crisis.