PIIGS: Europe’s crisis,
options and the
potential consequences
Employment, Business Development and
Policy in the EU – Semester 1
By: Timothy Charlton
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1
Introduction
The nature of today’s global economy is such that what may be fair and true one day may be
inaccurate and outdated the next. As such any attempt to explain and outline the current economic
crisis faced by the world in early 2012 can provide only a snapshot in time. This requires readers and
academics to consult further papers and have a strong grasp of the situation at time of reading as
well of that at time of its writing.
During 2007/08 the world found itself thrown into the worst economic crisis since the so-called
Great Depression of the 1930s (Yurtsever, 2011). Four years on we are still deep in the throes of this
crisis worldwide, and nowhere is this more obvious than the European Union. The post-war era
signifies the time in which international trade became globalisation, laying the way for relationships
such as the European Union (Peng, 2011, p. 11). Since this crisis we have seen many of the
downsides of integration. Looking at the PIIGS (Portugal, Italy, Ireland, Greece and Spain), with a
particular focus on the Sovereign debt crisis we can see many of the issues faced, possible options
and consequences of these crises for the EU.
What is the EU?
The EU is currently amidst its largest crisis since its inception. Built on the basis of a peaceful
Western Europe after WWII, and designed to strengthen their position as an anti-cold war area, its
origins can be traced back to 1950 when France and West-Germany met to discuss pooling national
resources (Europa, 2009). This initial unification of Western Europe was designed to allow more
free and regular trade in Europe (Europa, 2009). The European integration project has undergone
many changes, and pseudonyms, to become the European Union of 27 countries (EU27). In 1992
the Maastricht treaty introduced the European Union of twelve, which in 1995 grew to fifteen, in
2004 to 25 and finally in 2007 the EU27. 1992 also saw the establishment of the Economic and
Monetary Union. The EU’s 27 members are not all full members of all European integration but
rather some have opted out, for example the United Kingdom and the Euro.
What is the Eurozone?
Since the inception of European Integration the concept of a need or desire for economic, fiscal and
monetary union has been present. This came to fruition partly by the creation of an Economic and
Monetary union in 1992; it was seven years later that the Euro came about. Adopted by eleven
countries it began in 1999 by locking exchange rates on member currencies to match the Euro, and
in 2002 the Euro currency came in to circulation (GoCurrency.com, 2005). The, now seventeen
country, single currency is controlled by the European Central Bank, which is in charge of Monetary
policy for the union (European Commission, 2011)but also by the central banks of those member
countries who still control fiscal policy.
The Global Crisis
Beginning in the summer of 2007 the first wave of the economic crisis was the collapse of the supprime mortgage market in the USA. In a similar way to the dotcom bubble in the early 2000s the
bubble burst around the second hand derivatives markets exposing trillions of dollars to the world
market and rendering these almost worthless. This effectively led to a devaluing of banks’ assets
and put a great deal of pressure on their balance sheets. The bank BNP Paribas were the first to act
upon this, ceasing to act with several major hedge funds dealing primarily in US mortgage debt, but
it soon became clear that these were in no way restricted solely to the US (Elliot, 2011). As a result
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of the increasing globalisation since the Second World War, and the interdependence which this
breeds, institutions around the globe owned derivatives linked to mortgages in all parts of the world.
This first wave of crisis was very much a crisis of trust as nobody knew each other’s exposure or risk
sending inter-bank lending to an all-time low (The Financial Times, 2012).
It was not until over a year later that the full force of this crisis was to be recognised. On 15th
September 2008 the US government allowed the investment giant Lehmann brothers to go
bankrupt. Until this point it had been assumed that central governments would take the necessary
steps to ensure that banks were not allowed to fail (Elliot, 2011). Although significant in its own
right it was the suggestion that banks were no longer untouchable but could in fact be allowed to
fail, albeit in a managed way a with huge ramifications. This resulted in an overestimation of the risk
involved in many major banks, resulting in governments having to intervene to ensure they did not
collapse as international and inter-institutional trust fell even further. Although central
governments around the western world acted in time to save the majority of its banks the global
economy was already in self-destruct mode (Wolf, 2011). As banks continued to be propped up,
government debt escalated, trust became almost non-existent and the crisis became truly global.
Why the EU?
In the globalised world the European Union is a major player. Represented in both the G8 and G20
groups of prosperous economic nations independently and also by four member states it has the
highest GDP (adjusted for Purchasing Power Parity (PPP) ) of any single market (The Guardian, 2011).
This means that the European Union was one of the most intertwined economies in the world.
When this is added to by the diversity of countries in the Single European Market (SEM) and their
relative positions it left the EU in a very complex and exposed position. This concept of a diverse
range of countries operating in the SEM can be seen by a disparity between the financial and trade
situations of different member states (European Commission, 2010). The EU being managed
predominantly by France and Germany who hold the most power resulted in the needs and interests
of some member states being ignored.
The EU is exposed to economic activity both positive and negative. All countries within the EU
suffered when the global economic crisis hit although to different degrees. Many of the countries
which we have witnessed falling the hardest are those which joined the EU after its inception and
often those who it is debated as to their suitability. The crisis in the EU was made worse by the
presence of the Euro. Within the seventeen-state Eurozone and the EU-27 trade was reduced as
governments and companies made economy savings. This meant that despite the freedom of trade
and movement across the EU countries fell into recession and experienced deflation.
The Euro Crisis
The Euro, or European Sovereign Debt, crisis is one of the most serious and dangerous ramifications
of the global economic crisis of 2008/9. The problems faced are not new. At the height of the global
crisis in 2009 Iceland’s banking sector collapsed, carrying with it assets outstripping GDP eight-fold
(The Eonomist, 2009). Now we see a not dissimilar situation in a number of members of the
Eurozone. the main evidence, although not all, centres around PIIGS. It is true to say that each of
these countries has a problem, some a crisis but these are very different to one another.
There are certain things, of course which these have in common; they are all full members of the
Euro and EMU. This, it is clear, can in times of financial difficulty present major problems for
countries who are already vulnerable. By joining the Euro countries hoped to gain; stability, security
and trade benefits, however they had to sacrifice control, in particular of monetary policy. They
were also largely in a poor economic state prior to the economic crisis, but due to the
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unprecedented trust, or risk, of banks and countries backed by over-inflated credit rating by the
worlds credit agencies, were still able to gain credit. Another factor contributing to this is that they
did not enter the crisis with strong growth and productivity but struggling to recover from recession
in the late 1990s.
The woes each of these countries faced, and face, are different, yet overlap. Firstly, national debt, in
2010 the national debt of both Italy and Greece sat at almost 120% of GDP, and counting, whilst
Spain’s reaches only 64%. Italy and Portugal had struggled to return to growth in the early 2000s as
they suffered from higher wage costs but lower productivity. Italy and Greece struggle collecting
taxes. Italy, Greece and Spain all have populations where between seventeen and twenty-percent
are over 65, representing a large ageing or retired workforce (Central Intelligence Agency, 2011).
Ireland faced crisis when trade and banking reduced, its economy’s dependence on exports and its
banking sector ran it in to trouble. Whatever the causes may be each of these countries face a great
deal of issues and due to the high levels of integration threatens not only themselves, but the EU as
a whole.
The Consequences
In May 2010 Germany’s Chancellor Angela Merkel said
“The euro … is in danger. If we don’t deal with this danger, then the consequences in Europe are
incalculable, and the consequences beyond Europe are incalculable too . . . because if the euro fails,
then Europe fails. (Issing, 2011)
It is of course an extreme view which Angela Merkel takes, however it shows the potential for
destruction which is represented by the debt crisis in the EU. The United Kingdom have already
made contingency plans for if the Eurozone were to fail and potentially taking with it the European
Union. Germany and France, the two largest economies in the EU have invested huge amounts of
money in order to prop up failing Eurozone countries, predominantly Greece (Chibber, 2011). So it is
clear that countries are taking the risk of a default and collapse seriously and would have global
ramifications. According to Swiss-based Bank for International Settlements in 2010 France and
Germany had $911bn and $704bn, respectively, worth of exposure to PIIGS countries in their
banking sectors. In addition to EU debts the US also has $187bn in exposed debt (Asymptotix, 2010).
It is believed that if one of PIIGS countries was allowed to fail then there would not be enough
capital to repay these debts. This would wipe billions of euros off the balance sheets of the
respective nations, in turn causing their debt burdens to spiral, and probably dragging down large
parts of Europe’s main financial sectors (MSN Money, 2011).
There are of course a number of different scenarios which could play out in order to bring about an
end to the situation the European Union faces. Firstly, and most drastically, one, or more, of the
countries could be allowed to default on their public debt. This is most likely in the case of Greece
who faces the highest debt burden; a default would mean that Greece accepts that it cannot meet
the repayments required by their creditors. This could either be a full default whereby the country is
effectively declared bankrupt and cannot pay any of its loans or, more probably, a managed or
partial default. In the case of the latter a mediator, probably the EU would intervene to repay as
many debts as possible, probably prioritising those involved in previous bail-outs: the IMF, ECB and
the European Union (BBC News , 2011; MSN Money, 2011). This would have drastic consequences
for those countries whose commercial banking sectors hold the most Greek debt, as this would be
no longer valid.
Secondly, and more probable, is that the EU will act upon the agreement reached in December 2011
to strengthen the EFSF (European Financial Stability Facility) using this, along with the IMF as a
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vehicle to channel money into struggling economies (Bloomberg, 2011). This would mean that PIIGS
would be able to avoid a default as loans from stronger economies would enable them to keep up
debt repayments (The Economist, 2010). However this plan relies on growth in the struggling
economies to enable them to repay all debts in the future without assistance. Although this
currently looks like the most likely solution to the problems the German led bail-out appears to be
stalling. Since the decision was made and approved at the end of 2011 there has been very little
action, and Germany appears to be attempting a waiting game (Bloomberg, 2011). This conclusion
of a European Central Bank co-ordinated bail out of struggling economies has already been proven
successful in a number of PIIGS. In late 2010 Ireland received an IMF/EU bailout after its banking
system collapsed; this helped prevent Ireland defaulting on loans and brought their economy back
from the brink, however this was not without cost. Ireland has been shut out from international
markets since accepting the bailout (The Guardian, 2012) and has had its credit rating cut by
Standard & Poor 5 times since 2009 (BBC, 2011). In Italy a partial bailout was given from the
Eurozone, amidst fears that Italy was too big an economy to bail out, or to let fail, and it still faces
grave economic and political challenges and ended 2011 seeking further assistance (The Telegraph,
2011).
Similarities are drawn to previous national defaults, that of Russia in 1998 and Argentina in 2001,
however the consequences of just one of PIIGS defaulting would be far greater. Greece alone has
over $500bn in public debt compared to $79 and $82 in Argentina and Russia at time of default
(MSN Money, 2011). The other major difference here is that they were not a part of the biggest
economic integration project in history, the EU. One view held by economists is that United States
of America was better placed to deal with it due to the full integration of semi-autonomous states
and the existence of the Federal bank. This leads to the suggestion that the EU would have coped
better, and be more stable, if they were a United States of Europe (Altman, 2011) and that
integration of fully autonomous states is the worst of both worlds.
There is talk of a break-up of the Euro, into countries or blocs, but this would plunge the countries
within the EU, who rely on the high levels of integration in the area for trade and prosperity, deep in
to recession. Those countries in the centre, France and Germany would most likely become inward
looking, or at least restrict trade to each other and perhaps Belgium, whilst those on the periphery;
the newest members and PIIGS would most likely be doomed to deep recession and poverty (The
Economist, 2011). It seems clear however that Germany has decided that the Euro will remain, and
countries will continued to be bailed our when required, and their economic strength may well carry
this through.
Conclusion
There are two real options, neither of which is ideal and both result in an increased amount of
national debt across the EU and Eurozone. One is likely to pull down the system which created it but
the other may save it, just. But either way to leave the crisis to its own devices would be
catastrophic. There is no shortage of commentary on the global and Eurozone crisis, and no lack of
theories on the best way to solve the issues we face. Across Europe governments are clashing with
opposition over the best way to handle the crisis showing that this is a political as well as economic
crisis (Wolf, 2011).
Ultimately it can be seen that the Euro and the European Monetary Union (EMU) was destined to
experience difficulties. With huge disparities between member states in terms of types and
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strengths of economies having a single monetary policy for all was not fit to cope with difficulties
and changes. Theory states that for successful monetary union countries need to be at similar
economic maturity and stability this is not the case (Mundell, 1961). Ultimately as integration an
exchange rate control policy even if it were to fail all would not be lost. Early exchange rate controls
such as the Gold Standard were hampered by big global events such as the First World War, and in
the case of the EMU the global crisis may have been that event. However if the Euro and Europe can
ride out the storm then it paves the way for a more integrated, stronger EU future. (Issing, 2011).
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