The global financial crisis, and the chaos in the eurozone in particular, has been a hot topic for economists and international finance experts. Here experts from the School of Business and Economics, Emanuel - Oliveira and Howard Qi, share their insights on the collapse and the future of economic unions like the EU.
Spain, alongside Portugal, Italy, Ireland, and especially Greece, has faced a storm of criticism from other eurozone nations about their budget and spending policies. yet, several economists have warned since the inception of the euro experiment, dating back several decades (see the timeline), that having a common currency without enforced rules for budgets would lead to disaster. Cheap, accessible credit dried up almost overnight, and these nations, with high levels of spending, suddenly had bills they could not pay. International bodies agreed to a bailout, but at the cost of austerity, a policy where public spending is drastically reduced with a commensurate reduction in services and public support. Some nations have had more success with this approach than others. Here we look at the perspective of Michigan Tech faculty in the School of Business and Economics as well as finance experts from around the world.
The Road to Recovery?
In March, the Dow Jones Industrial Average finally crawled back above the previous high water mark set in 2008, marking—statistically, at least—the end of the long road to recovery from the global economic crisis. Five long years of shuffling, restructuring, bailing out, and bankruptcy have led to upheaval, change, and questions. The collapse of the American housing market draws parallels to other burst bubbles.
“We are certainly better off than a couple of years ago,” says Emanuel Oliveira, senior lecturer in economics at Tech. “But besides the known economic problems that society still has to deal with, recent events make one wonder which other bills the taxpayer has yet to pay and if we are heading to a lost decade similar to what Japan experienced when its housing market collapsed in the early 1990s.”
Nations faced the choice between austerity and an attempt at stimulus. “They are indeed two inseparable sides of the issue and neither is a good answer in my view,” says Howard Qi, associate professor of finance at Tech. “The solution lies somewhere in between. Neither stimulus nor austerity is enough to manage this situation.”
Despite valid arguments on both sides of this debate, Oliveira favors stimulus policies during severe recessions in order to prevent socioeconomic Armageddon/chaos such as the one seen these days on European streets. Oliveira stated he was “incredulous at the magnitude of the financial meltdown and flabbergasted by the learning opportunity.” The results of the various government policies will be studied closely for years to come.
In Spain, where a construction boom fueled by cheap credit resulted in ballooning debt, the credit crunch hit very hard, with unemployment skyrocketing and public projects left unfinished. There were few spending limits on regional governments, so a race to construct cultural and sporting landmarks was well underway. This lack of fiscal discipline has hit the central Spanish government very hard, with multiple bailouts of the country’s financial sector the only thing standing between them and default.
And here is the microcosm for what has happened to the European economy: just like Spain, where budgets were handled regionally but the ability to borrow and sustain debt was national, for European nations, they have control over their budgets, expenditures, and debt, but cannot manipulate currencies to ease financial pressures.
In the Financial Times, Antonio Garcia Pascual, the chief southern European economist at Barclays, says, “In terms of financial stress, one could say that Spain has touched the bottom... but in terms of growth and economic activity there is still no light at the end of the tunnel.”
Spain is following a pattern of austerity to make up budget shortfalls caused by an economy that is still contracting, though this is perpetuating itself because consumers have less to spend, causing a further slowdown in the economy.
“What I find quite surprising is that most countries around the world are implementing stimulus whereas the European Union is mainly implementing austerity,” Oliveira says. “Even more astonishing is that peripheral EU countries persist in implementing such policies despite experiencing significant socioeconomic turmoil such as severe unemployment rates, decreases in real GDP per capita, heavily discounted privatizations of public assets, the rise of violent extremist groups (e.g. neo-Nazis in Greece), criminality, suicides, nationwide street protests, strikes... Such problems are reminiscent of the interwar period."
Small Economy, Big Issues
Greece has been the face of the eurozone’s struggles with the global economic crisis. Writing in Foreign Policy, John Sfakianakis runs through some of the numbers that tell the story of hardship in Greece. While he points out that the government deficit has been cut more than half in just four years, 2013 is the sixth year of depression for the nation. Comparing the situation to the Great Depression in the United States, he notes that, “Although the United States’ depression saw GDP decline 27 percent, it lasted for only four years (1929 to 1933) and the country returned to its pre-Depression GDP by 1937, surpassing it the year after. This kind of recovery will almost certainly not happen in Greece before 2020.” Wages are down more than 30 percent, unemployment over 25 percent, and expectations for quality of life and income are in free-fall.
Greek veterinary student Evi Poulopoulou, speaking to satellite network Al Jazeera, put it more succinctly: “No one from the middle class can live happily.” Charis Mertis, a Greek architecture student, goes further, claiming that, “Austerity measures have led to students in primary school fainting from hunger.”
In the United States, one of the key tools available to the Fed was the ability to adjust the value of the dollar. The core of the crisis in Europe lies in the fact that individual nations did not have this option. The 17-member eurozone shares a common currency, but does not share common budgets. This means that these economies, while working together in a free trade zone, did not all have the same strengths and weaknesses, and the central bank’s ability to assist one ailing economy would have a detrimental effect on another.
Economics and Political Power
The nation most at odds with the situation in Greece is Germany, which in early 2012 proposed that the Greek government be replaced by a European commissioner. The logic was that, as Europe already controls the Greek national currency, should they not also control levels of taxation and spending to get the nation and the eurozone through this crisis?
According to Reuters, news of this proposal hit Greece “like a hurricane.” The rift that has formed between two nations with deep ties—one in ten Greeks has lived, worked, or studied in Germany, while German tourists hail Greece as a top destination. In addition, cultural differences have strained that relationship beyond the breaking point.
There is a cold economic logic to the proposal. “Germany’s proposal makes sense from Germany’s perspective,” says Qi. “It does not make sense from Greece’s perspective because of sovereignty concerns and the harsh standard of living” that would result. Perhaps unsurprisingly, the move failed.
Germany’s economy depends on exports, and 40 percent of those exports go to the rest of the European Union. Without those exports, Germany would be plunged into a recession or depression. It is in Germany’s interests to keep spending levels up in neighboring nations to maintain demand.
For a small economy like Greece, devaluing the drachma would have been a tool to relieve the economic crisis. As it stands, however, that tool is unavailable to Greek economists and politicians so long as they are a member of the eurozone.
Lessons to be Learned
The important lesson in this drama, still unfolding, is that economic integration can only be as successful as political integration. Our economy is undoubtedly globalized, but currencies and central bank decisions are still national and regional. Nations and regions forging closer ties would be well-advised to remember that their political integration needs to match their economic integration in order for the economy to be as flexible as it needs to be. For the system to work in Europe, “Budgets and tax collection must be matched,” says Qi. “This requires the economic and political systems to be consistent, which might be achieved in two ways: the EU countries could become more independent or more integrated. The status quo is what causes the problem.”
Oliveira agrees on the need for change, but points out that now is the time to alleviate socioeconomic turmoil, not to implement further austerity with the pretense of fostering political union. The outcome might end up being exactly the opposite — as daily news from Europe clearly shows: “The least disruptive solution to this dilemma is to make such reforms in times of abundance, not during a severe recession,” Oliveira says.
The choices left—austerity or debt-fueled stimulus spending—are uncertain, leading to dueling notions on what needs to be done. The lessons learned from this crisis will sculpt the next economic and political unions. The United States may also react to the process, in the halls of power, in boardrooms, and on the streets, as these economies all try to climb the ladder once again.
The debt crisis in the eurozone has raised strong questions about sharing a currency across a number of nations. Yet, our global economy is more and more integrated, with nations and major city-regions forming a global economic network; a global currency would not be outside the realm of possibility, so the eurozone crisis is a lesson for a potential monetary future. Should we adopt a global currency?
1. Dean Johnson: James and Dolores Trethewey Professor
Let's look at economic history for an answer. A global currency would, in essence, be a global Gold Standard. Under a gold standard, each currency was worth a certain amount of gold. As such, there was a fixed exchange rate between currencies and, de facto, there was a global currency - gold. The US abandoned the gold standard, primarily, because it gave the government little flexibility to employ monetary policy to counteract shocks to the economy. Economic history has shown that inflation may be tempered under a gold standard, but economic output is subject to much greater variability.
2. Cody Renard: Student
A global currency will lead to the loss of free monetary policy for independent nations throughout the world. Monetary policy for a particular currency is controlled by the central bank of that independent region or nation, and is a key tool in adjusting interest rates in order for independent nations to adjust to economic recessions and expansions. With a common global currency and monetary policy, independent nations will no longer have the authority to control their individual monetary policy. This could cause drastic economic effects in some nations. Even as the world economy is at an integrated scale never seen before, a global currency should not be adopted because there are too many economic discrepancies between independent nations to create a functional global currency.
3. Emanuel Oliveira: Senior Lecturer in Economics
If “money is power” then the adoption of a global currency is quite difficult to implement as it would decrease the geopolitical influence of national central banks and their affiliates. Impossible? No. Seventeen European countries did it and the euro has been in circulation since 2002. The main advantage of a single currency would be lower transaction costs, whereas the disadvantage would be the impossibility of using monetary policy to address country-specific recessions (as the eurozone now knows). Another issue of concern would be who would manage such global currency? China? USA? An unbreakable and permanent code for money creation like the one used in Bitcoins could potentially be the solution. No particular country would run it. It runs itself. As long as the incumbents do not stop adoption, then we are already on our way to a single global currency.
4. Becky LaFrancois: Assistant Professor in Economics
A single global currency would reduce transactions costs and eliminate exchange rate risk faced by global firms and consumers, increasing the efficiency of markets. However, a single currency would also inhibit effective central banking targeted at controlling interest rates and inflation within a particular economy. Although economies across the world today are more interconnected than in the past, it is too soon to act as if there is only one global economy.
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