The European sovereign debt crisis, which made it difficult or impossible for some countries in the euro area to repay or re-finance their government debt without the assistance of third parties (Haidar, Jamal Ibrahim, 2012), had already badly hurt the economies in “PIIGS”, Portugal, Ireland, Italy, Greece and Spain. This financial contagion continues to spread throughout the euro area, and becomes a dangerous threat not only to European economy, but also to global economy.Although a commonly accepted view is that the hidden budget deficit in Greece is the beginning of the European sovereign debt crisis, the real causes of this economic crisis can be various. To reveal the whole event, a comprehensive review of the background is necessary. Background On 1 November 1993, the Maastricht Treaty formally came into force, and the European Union was formally established.
Afterward, the euro convergence criteria were created. The European Union member states have to meet the criteria before they enter the European Economic and Monetary Union, and use the euro as their common currency.Admittance to the eurozone brought great benefits to the member states. For those countries whose economies are not strong enough, the common currency prevented the individual economies of the euro-area countries to devalue their currency to make their exports cheaper, which gain them better trade balances. In addition, the member states would be able to borrow the low interest rate loans to improve their domestic economies. After 1999, the global economy had a rapid growth because of the high-speed development of developing countries.
The developing economies covered over 30 percent of the global trade (United Nations, 2012). The savings from those countries make the global savings available for investment have a significant increase. This gave investors a lot of temptation to use these money. The lenders use these savings to make high return investments, and the borrowers use what they borrow to make higher return investments, generating bubble after bubble over the world. In 2007, these bubbles burst. Subprime mortgage crisis caused global recession, prompting the hidden risk under the huge debt come to light.
The countries in euro area have to spend a lot to keep their economies stable, which makes them have heavy debt burdens. In addition, some countries did not firmly practice the agreed standard, and had little control over their budget deficits. Fact The European sovereign debt crisis firstly impacted the Greece, and gradually became the crisis of the whole euro area. The most affected countries are Portugal, Ireland, Italy, Greece, and Spain. The similar situation happened in these countries.
The credit ratings of those countries fell rapidly, some even were downgraded to junk status, which makes them hardly to borrow low interest loan. The government had to request bailout loan to stabilize its public finances, and took measures to improve the State's financial situation. In addition, the austerity measures leads to an increasing unemployment rate and social unrest. Their GDP grew slowly while the debt soared, making their debt to GDP exceed far more than 60 percent - the convergence criteria maximum.
Analysis How did those countries get that place?Five separate but interrelated reasons are the origin. Unsustainable debt level. Since subprime mortgage crisis burst, the global economy began entering to a downturn. The governments in euro areas had to spend largely on its public finances to support its financial environment.
As a result, the debt of those countries soared to a high level. 12 of the 17 members of euro area had debt-to-GDP ratios that are over 60 percent. As Appendix Table 1 shows, the ratios in Portugal, Ireland, Italy, Greece, and Spain constantly boosted after 2007.This led to higher borrowing cost for their future requirements. The lack of common fiscal policies. The common currency brought the members to a situation that they no longer had control over their currency, meaning they cannot adjust their monetary policies to solve their dilemma.
Specifically, they cannot devalue their currency to gain the export advantages as what they did before. In addition, without common fiscal policies, the countries tend to over rely on the adjustment of fiscal policies to solve their problems, leading bigger budget deficits. The terrible internal economies control.The countries in euro area, especially Portugal, Ireland, Italy, Greece, and Spain lost their control over the domestic financial situation. Specifically, Greece had long standing financial problems.
The government spent largely on the social welfare, and had a great number of public servants who had extremely generous wage and pension benefits. Besides, the government had little control over its budget deficit, leading a long standing financial budget overrun. In Ireland, the estate bubble greatly destroyed government tax income and consumption power of public.Portugal’s lasting recruitment policies led to a great number of redundant public servants. The Italian economy suffered from the high unemployment rate and high tax rate, and had a slow growth in recent years. Trade imbalances.
Appendix Table 2 shows that from 1999 to 2007, German unit labor costs fell by five percent, while these costs rose by 20 percent in Greece, 41 percent in Ireland, 19 percent in Italy, 22 percent in Portugal and 28 percent in Spain. These competitiveness gaps offered Germany a huge advantage in the trade, making it a better public debt and financial deficit relative to GDP than others.As appendix table 3 shows, in this period, Germany always kept a large current account surplus, while Portugal, Ireland, Italy, Greece, and Spain struggled with their current account deficits. The Greek current account deficit even reached 15 percent relative to GDP.
Confidence loss. Prior to the crisis, Sovereign bonds were held by the banks as assets against losses on the loan. However, after the crisis burst, the bonds from weaker economies were downgraded, which means the bonds lost their value and became riskier. The default risk make investors tend to safer options, such as German federal government bonds.
And the fact that Greece cannot afford its debt worsened the situation, and made a vicious circle. Impact The European sovereign debt crisis had great impacts over the world, especially the European, and not only on the economy, but also on the politics. Europe, as a huge market, had great consumption power. However, because of European sovereign debt crisis, this power suffered a reduction. The direct result is less import, which means its long standing trade partner, such as USA and China, will have decreases on their exports to Europe.
This will cause the global economy to slow down.In addition, for those banks which held the debt of the affected countries like Greece, they had great losses due to the fallen value of the bonds. This had already disturbed their normal financial activities. If the crisis gets worse, the banking system in euro will face a huge crash. Many affected countries took austerity measures to reduce their deficit, leading to a higher unemployment rate, slow economy growth, and social unrest. Besides, the government of the affected countries all had some transition.
Portugal, Ireland, Italy, Greece, and Spain all changed their prime ministers.
