Eurozone’s fiscally troubled
economies, known as the “PIIGS” (Portugal, Ireland, Italy, Greece and Spain) have
triggered a severe crisis of confidence. 
The advent of the global financial crisis coupled with Greece’s public
debt admissionin October 2009 sparked dismay throughglobal markets as the full extent
of Eurozonedebt levels were unveiled.  According
to the Economist, Greece’s budget deficit reached 15.4%,Ireland’s was 14.3%,
Spain 11.2%, Italy 5.3% and Portugal at 9.3% of GDP in 2009. The European Union
(EU) has rescued Greece and Ireland, and most recently Portugal has admitted
its need for a similar rescue loan. Perhaps other wrecked countries will need
to be helped at a later date. All three countries, Greece, Ireland and Portugal
are economically small; “Greece the biggest, makes up only around 2.5% of
euro-area GDP.”  However, Portugal’s
recent capitulation to EU authority has awakened fears that the debt contagion
could spread to Spain, making the debt crisis far more serious. These preceding
events and the scope of Spain’s own debt have raised shiver and panic in markets.

This policy brief will attempt to
ascertain the origins of the crisis, enumerate European and international
responses, draw attention to possible alternatives to implemented policies, and
finally explore the broader implications for Europe, the United States and the
rest of the world.

I. Origins
of Crisis

The
global financial crisis led to the deterioration of government budgets and
finances as nations utilized public expenditures to provide stability and stimulus. Reacting in a similar manner,
Eurozone nations faced their own strand of fiscal distress due to heavy
borrowing practices, property bubbles and living above their means. The
accessibility to easy credit led to an overreliance on external credit sources
to fund domestic debt.  Additionally, the
commercial and financial interdependence Europe developed with foreign nations
made it more vulnerable to economic volatility; resulting in a domino effect
when crisis occurs in other parts of the world.

Acknowledging the inherent
hazards and risks of crises emerging due to the common currency; the EU
established the Stability and Growth Pact in 1997 that set a budget deficit
ceiling of 3% of GDP and external debt ceiling of 60% of GDP. The pact sought
to ensure member states maintained budget discipline in order to diminish
systemic risk and encourage monetary stability. In addition, the pact required
greater coordination of monetary and economic policies from members of the
monetary union, lowering a degree of national sovereignty and clout for certain
member states.

 Greece

Before the spread of the global
financial crisis, Greece borrowed heavily from abroad to fund its large budget
and current account deficit. The roots of Greece’s fiscal calamity lie in
prolonged deficit spending, economic mismanagement, government misreporting,
and tax evasion. When pressed on where Greece had gone wrong, Prime Minister George
Papandreou answered: “Corruption, cronyism, clientalistic politics; a lot of
money was wasted basically through these types of practices.”

Beginning with the adoption of
the Euro in 2001, Greece’s budget deficit averaged 5% per year until 2008,
compared to a Eurozone average of 2% and its current account deficits averaged
9% per year, compared to a Eurozone average of 1%. In 2009, Greece’s budget
deficit was estimated to have been 13.6% of GDP. However, a reevaluation of
Greece’s balance sheets in the latter part of 2009 revealed Greece’s budget
deficit was in reality closer to 15.4% of GDP. 

Soon afterwards Greece committed
itself to a drastic austerity program in order to avoid a default but later
accepted €110 billion ($155 billion) in financial assistance from the EU and
IMF in May of 2010.

Ireland

Once hailed as
the “Celtic Tiger,” Ireland’s economy performed exceptionally well due to a
successful financial services industry and robust property market. Yet, this
reliance on the construction and financial sectors coupled with the arrival of
the global financial crisis caused a deflation in its domestic property bubble
and hurt households, banks and the government.
The Irish republic became the first Eurozone country to fall into
recession in 2008.  Over 2008-2009 its
output decreased by 10%, and unemployment increased from 4.5% in 2007 to nearly
13% in March 2010.  When the crisis hit
in 2009, general government deficit was estimated at 14.5% percent of GDP. Unlike
Greece, Ireland’s fiscal shortfall was incurred due to the escalating cost of
propping up its undercapitalized banks.
In response, the Irish government implemented a series of consolidation
measures to help contain the deficit below 12% in 2010.

In late November of 2010, Ireland
formally sought support from the IMF and EU, and agreed to an €80 billion
bailout that required the drafting of a new budget. Ireland’s new budget is a
four-year plan that slashes $20 billion via spending cuts and new taxes; these
cuts include extensive unemployment benefits and welfare payment deductions.

 Portugal

Portugal’s adoption of the euro
originally resulted in an economic boom, yet increased its susceptibility to
the banking system’s volatile performance. The global financial crisis
worsened these pre-existing and homegrown problems. After Ireland’s bailout,
speculation quickly arose that Portugal would require a bailout as it shared
some of the symptoms of Greece and Ireland. The government’s repeated fiscal
adjustments became increasingly difficult as they were met with strong political
opposition. Moreover, on March 23^rd, Portugal’s Prime Minister Jose Socrates resigned
after failing to win support for the fourth austerity package in a year.
Markets responded by slashing Portugal’s credit rating to near-junk status on
March 29th, 2011 while ten-year bond yields rose above 8%.

On April 6^th,
Portugal’s prime minister admitted that his country needed a rescue loan from
the EU. The government has yet defined the amount or conditions of this aid.
Portugal now joins Greece and Ireland in the Eurozone’s sovereign-debt crisis.
Portugal’s public debt levels are significantly lower than Greece, and its
banking industry is comparatively more stable than that of Ireland. Rescue
funds are enough to cope with Portugal’s situation, the fear however is that confidence
in neighboring Spain will be shaken.

 Spain

After 15 years of strong growth
led by a housing boom, Spain was hit hard by the global financial crisis.  Its output fell sharply driven by sharp
declines in investment, exports, and private consumption, while weaker imports
and rising government demand provided some offset.  Moreover, Spain’s unemployment rate
skyrocketed, reaching 20%.  The
government deficit declined from a surplus of 2 % of GDP in 2007 to a deficit
of 11.2% of GDP in 2009, “due to the large stimulus and evaporating cyclical
and one-off revenues.”

Spain shares several of the
weaknesses of the three fallen economies. The country has lost its
competitiveness, and it has large current account deficit similar to Greece and
Portugal. Spanish bond yields are narrowing, and are continuing to fall as of
April 6^th 2011. Prime Minister Jose Luis Rodriguez Zapatero’s recent
decision not to seek re-election will likely add greater uncertainty to Spain’s
already dubious fiscal future.

Italy

Confidence, trade and credit were
quickly shaken due to the global financial crisis in Italy and
a global reduction in demand reduced Italy’s exports, contracting Italy’s
private consumption, and output.  The
country’s unemployment rate continues to be the lowest among the PIIGS nations.
However, fear of unfavorable market reactions has limited Italy’s ability to
use fiscal policy to stimulate its economy. The overall public debt increased
to about 122.14% of GDP by 2010.

II.  Responses

As the financial crisis in Europe
intensified, countries within Europe disengaged themselves from each nation’s
problems and focused on their own economic hardships.  However, as time went by and crises worsen,
it was clear that the effects of the economic meltdown would create contagion
and spill over the rest of Europe. The European financial crisis is very unique
due to the diversity of countries, policies, culture, and financial systems
involved.  Therefore, a harmonized
approach cannot be prescribed unlike the United States. “In the United States,
we were talking about the potential default of banks, that there were certain
banks that were “too big to fail.” In Europe, they’re now talking about the potential
default of countries: “countries that are too big to fail.”

Europe unlike any other part of
the world encompasses numerous nations that differ in many aspects, and that
entered the financial crisis in different stages. Realizing that country
containment was no longer an option the European Union and the European Central
Bank started seeking measures to address the European financial crisis.

Burgeoning public and investor
woe eventually forced EU ministers to enact a €110 billion ($147 billion)
rescue package for Greece on May 2nd of 2010. The package set out to prevent
Greece from defaulting and to halt the spread of the crisis to other peripheral
countries. Set as a precondition for the loan, Greece agreed to implement
austerity measures worth 13% of GDP. This controversial condition was met with
swift and violent criticism from many Greek citizens.

Shorty thereafter, the EU created
the European Financial Stability Facility (EFSF) to safeguard against a wider
crisis. The EFSF was created to preserve financial stability and assistance to
member nations if necessary. This mechanism provides over €750 billion for
member states in extraordinary and difficult circumstances beyond member
states’ control.

Consequently, the EU has
committed itself to accelerating structural reforms, strengthening fiscal
discipline, and establishing a more effective and permanent crisis resolution
framework. According to the Organization for Economic Cooperation and
Development, “The short-term challenges to European policymakers are magnified
by the need to press ahead with the implementation of structural reforms that
will help to prevent future financial crises, enhance resilience to adverse
economic shocks and improve both longer term growth prospects and the long-term
sustainability of the public finances, in the context of ageing populations.” The
proposed European Economic Recovery Plan “combines short-term measures with an
acceleration of structural reforms as set out in the Lisbon strategy country
specific recommendations.” This plan is a response to the crisis and it aims
to: stimulate demand and boost consumer confidence; lessen the human cost of
the economic downturn and its impact on the most vulnerable and help Europe to
prepare to take advantage when growth returns.

As diversified as nations in the
Europe are so are the reactions from the people.  For example, “social unrest had been more
limited in Spain than in Greece or Ireland.” 
However, the cuts on public spending have resulted in Spain suffering
more social unrest.  In Greece,
protesting workers continue to pour in the streets demanding the exit of
international intervention.  Moreover,
while the PIIGS were the most affected during the crisis protests can be seen
all over Europe from France, to Bulgaria and all in between. 

Nonetheless, according to
populations in those countries that maintained their financial stability (such
as Poland) or survived the crisis fairly well, the demands and economic
hardships of others should not be their country’s burden.  At the ordinary citizen level most believe (this
view is particularly popular in Germany) that they should not have to help
other countries who got themselves into trouble by living above their
means.  Still politicians realize that as
in the U.S. when President Clinton was under pressure during the Mexican peso
crisis it is probably wiser and cheaper to help the PIIGS now than later.

 III.  Possible Alternatives and Solutions

Apart from the official responses
taken by the EU, IMF, and European Central Bank, a number of different and
unique alternatives persist for Greece, Ireland, Portugal and other PIIGS
nations to ameliorate their debt issues.

 Debt
Restructuring

Upon the IMF’s approval of a bailout
loan to Greece, Prime Minister Papandreou expressed his view that debt
restructuring was not an option. Papandreou stated that austerity
measures would be enough to cut down the deficit and that debt restructuring
would be disastrous to Greece’s banking system, adversely affecting Greek
families in the process. European officials have long insisted Eurozone nations
can recover without restructuring and such measure would damage banks across
Europe and create panic in the markets. Yet, aside from Papandreou and the EU‘s
assurances, the final result of Greece’s austerity measures and those of
Portugal and Ireland remain uncertain. 
In the event that implemented austerity measures embraced by the IMF and
EU do not result in the desired consequences, the debt crisis could continue to
spillover and spread its contagion across other debt-ridden nations.  While debt restructuring presents its own
caveats, it remains to be a viable option to many European nations who continue
to express fears of a possible default.

Furthermore, a recent article
published by the German business daily Financial
Times Deutschland has stated the EU has “lost faith in Greece” and its
ability to service its debt. Moreover, Deutschland
claims representatives of several euro zone governments have
stated restructuring could no longer be ruled out.

Implementation
of an Innovative Fiscal Strategy mirroring the Osborne Plan of Britain

            Following the example of other European nations,
Britain is also implementing its own set of austerity measures, led by the
George Osborne, the Chancellor of the Exchequer, to cut government debt.  Despite popular disapproval, officials have
decided to enact these measures due to fear that growing debt could cause
foreign countries and investors to lose confidence in the British economy. The
Osborne plan includes extensive spending cuts and significant reform of welfare
programs.  Tenants of the plan include
new limits on benefits for the poor, increase of the retirement age for
millions, rise in college tuition rates and transportation fees, and reduction
in government employees. Although many acknowledge that women and the poor will
be the most negatively impacted by welfare cuts, in October 2010, public polls
reported that over 58 percent of British voters supported the proposed cuts.  Chancellor Osborne has recently reaffirmed
the necessity of fiscal austerity citing Portugal’s predicament as a
vindication of Britain’s fiscal readjustment.

Use
of Foreign Investment and Stimulus to Improve their Economic Standing

An additional alternative for the
PIIGS to overcome the present debt crisis is to look at other economically
dominant nations for economic support. 
During a visit to Europe last fall, Chinese primer Wen Jiabao announced
his support towards Greece, the EU and its currency. Wen reinforced this support
by announcing the creation of a $5 billion fund to assist Greece’s shipping
industry. China also promised to invest in Greek bonds as soon as they became
available to the market. Wen added, “China will undertake a great effort to
support euro-zone countries and Greece to overcome the crisis.” However, such
arrangement does not come without a price or a degree of quid pro quo.  China has expressed its commitment to the
Eurozone recovery, while simultaneously advocating for a relaxing of EU
restrictions on high-tech exports. China may also be using this crisis as a
means to deflect international criticism of its trade policies and its
reluctance to appreciate the Yuan.

 Exit
from the European Monetary Union

            Exit from the European Monetary Union (EMU) remains
to be a possible but extremely unlikely option. Germany at one point threatened
to kick-out fiscally irresponsible countries that were failing to follow EMU
guidelines. Although the forced or voluntary exit of a nation within the EMU is
illegal, such exit has been touted by some politicians and economists as a
better alternative to the prevalent austerity strategy. Because PIIGS nations
could potentially drag down the entire Eurozone, exit from the EMU may be
welcomed by other member states as means to halt further damage to the
union.  Exit from the EMU would require
departing nations to issue their own national currency at great expense and
economic uncertainty. On the other hand, exit from the EMU would allow highly
indebted nations to exercise their own monetary policy. Through currency
devaluation these nations could assuage fiscal austerity measures and stimulate
the economy through more price competitive exports.

 IV.             
Broader
Implications

The PIIGS crisis has consequently
raised fears and quandaries about the possible negative implications it poses
to the world economy, Europe and the United States.  The crisis could have potentially dire
economic crisis consequences for the world already in the midst of a severe
economic downturn.  Doubts have arisen over
the integrity of the European Union and its currency.  In the case of the United States, the PIIGS
crisis could potentially slowdown U.S. economic recovery in the
short-term.  In the long-term, the PIIGS
crisis provides a stern warning to Unites States in regards to its fiscal
policies, and has led to increased discussion of a similar debt crisis erupting
in the future.

Remedies implemented by the EU
and IMF were able to abate investor and public woes by a degree. Yet even after
the rescue and the creation of the stability facility, doubts persisted over
the conclusiveness of the crisis and if the responses were enough to avoid
further calamity.  Public financing from
the EU and IMF might “paper over” the debt crisis, but it will not resolve the
crisis comprehensively. Doubts lingered, but between May and October it seemed
the worst of the crisis had passed, and Europe was on its way to fragile
comeback, and then in November came the problems of Ireland.The acquiescence of
Ireland sparked discussions over the finality of the debt crisis and animated
reservations over the EU’s long-term future. Undergoing a political crisis and
increasing difficulties to finance its debt, Portugal applied to the EU for
assistance on April 6. Portugal’s call for help has fueled escalating
speculation that Spain will need a rescue similar to that of Ireland, Greece
and Portugal to complement their implemented austerity measures.

The ongoing crisis has also led
to a reevaluation of the EU and IMF’s bailout strategy for insolvent nations,
and has prompted calls for an alternative approach through debt restructuring. Serious
questions remain over the future of this EU and the forte of its responses to
the crisis.  Certain analysts have
suggested that these rescues only provide a short-term fix to the PIIGS
nations’ woes.  Moreover, the rescues
fail to address the fundamental problems of the PIIGS economies and the
inherent flaws of the Euro currency.  EU
officials, analysts and investors are beginning to gain recognition of the
long-term nature of the crisis and the host of new questions and ramifications
it presents for the EU and world markets. Currently, individual member nations
lack control over the Euro currency, a vital tool necessary for economic recovery
after the financial crisis. That inability has prompted questions over the
framework of the EU, its durability and the willingness of European citizens to
undergo harsh austerity and institutional changes as a price for defending the
common currency.

The
Integrity of the European Union

The PIIGS crisis has elucidated
the vulnerability and shortcomings of the EU as a congruous confederation. Before
the establishment of the Euro, reservations over its long-term durability were
ample. Robert Mundell and Milton Friedman both claimed the EU lacked the
necessary conditions for a single currency to work adequately. While EU
integration removed legal barriers to the movement of labor thus creating a
single labor market.  This single market
lacked the necessary wage flexibility and labor-market mobility due to deep
linguistic and cultural differences to make the Euro work more effectively. Few
believe the EMU will disintegrate completely and that the Euro will be dropped
as a currency. Yet, all policy makers must recognize that to ensure the EMU
remains viable; significant reform in its structure and policies are essential.
Moreover, questions remain over the fundamental convergence necessary for a
more integrated Europe and if member nations are willing to forgo sovereignty
to ensure fiscal discipline and stability on a regional level.

In the wake of the crisis,
financial analyst Simon Johnson asserted a lingering flaw of the European
Commission is its inability to address problems until they become crises.
Johnson claims it is then when the EU can come together to develop solutions.
If so, the question now is how can the EU succeed in the long-term if it does
not have the capacity to address problems early? Furthermore, who’s to say the
EU will not face a future crisis or problem until it’s too late? What happens
to the EU then?

 The
U.S. Economy

            If market and investment
confidence continues to diminish towards the EU, the Euro will likely diminish
in value. Euro depreciation would potentially allay U.S. economic recovery by
lowering U.S. exports towards and increasing imports from the EU.  As a result, the U.S. trade deficit will
increase, undermining President Obama’s export initiative to double U.S.
exports.

            On the other hand, Europe’s economic
flux, risk, and higher prices combined with lower interest rates in the U.S.
could signal greater investment and a reallocation of capital towards the U.S.
economy and its real estate sector.

 A
U.S. Debt Crisis?

            The United States’ current fiscal
trajectory is becoming increasingly worrisome and unsustainable in the long
term. The IMF recently noted U.S. debt could surpass 100% of GDP as early as
2015.  The IMF also noted the U.S. will
need to reduce its structural deficit by 12% of GDP, a figure higher than
Greece’s deficit reduction target of 9% of GDP. In May of 2010, Mervyn King,
governor of the Bank of England stated publicly that the U.S. shares many of
the same fiscal problems and risks inflicting Europe.

 However, the severity felt in the
Greek, Irish and Portuguese debt crisis is unlikely to be experienced in the
United States. The U.S. holds the advantage of the dollar acting as the primary
reserve currency, a tool that can be used to ameliorate the severity of a
possible debt crisis.

In an effort to address the U.S.’
fiscal situation and achieve fiscal sustainability, President Obama created the
National Commission on Fiscal Responsibility and Reform in February of 2010.
The commission’s newly published recommendations include an overall tax ceiling
of 21% of GDP, federal spending limited to 22% of the economy, reform of the
tax code and gradual deductions in total federal health spending.
Comprehensively, the plan aims to reduce the deficit by $4 trillion dollars
over the next decade through spending cuts and tax reform. Commission co-chair
Erskine Bowles compared U.S. budgetary trends to a cancer “that will destroy
our country from within” if not addressed.

By

Erika
Beltran

Lazaro Sandoval

Sodgerel Ulziikhutag

Temuun Zorigt

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