Background
As most of us have already know, the UK (well, 51.89% of them) has voted to leave the European Union (EU). This unprecedented move seems also to drag down the promise of the EU, which is to bring stability and prosperity that Europe have never seen before should Europe is closely integrated. But how could EU so wrong that some British have chosen to withdraw from EU?
Initially, all things went well after the initial creation of the EU by twelve European countries, including the British, in 1993 and introduction of common monetary system which placed most of EU members under the authority of European Central Bank (ECB) complete with the common Euro currency. It went so well that almost all EU’s initial members enjoyed a 50% economic growth from 1993 to 2007. However, the good times ended abruptly when the 2008 Global Financial Crisis occurred. Although most of EU members experienced negative growth rate during 2008-2009, the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain) are the hardest hit countries. They were hit so hard that they were unable to repay their government debts and to bail out their nearly-collapsed banks, triggering the ongoing European Sovereign Debt Crisis.
In response to the crisis, the EU imposed strict austerity measures on the crisis-affected countries which were not welcomed by some people in the respective countries. This culminated in “Grexit”, a possibility of Greek’s exit from the the Eurozone[1] in 2015. Although the Grexit did not happen, it did increase the Eurosceptic perception of some people inside the EU. This view was later fueled up by the recent European Migrant Crisis that divided the EU between those who welcome and who do not welcome refugees. Since than, it seems that the European “Union” was not “united” at all. Adding the fact that some people believes that the EU has killed some British industries, this prompt the British government to conduct the ill-fated referendum. Thus, the writer will try to economically explain the correlation between some fundamental mistakes of the EU and its current situation..
The EU, ECB, and Euro were not without flaws since its creation. First, many academicians have warned if a monetary union was not accompanied by a fiscal union, the policy will not work as well as expected. Second, the promise of achieving common prosperity in a strong and united Europe had provided a false sense of security for some weaker European economies. These countries thought that being a member of EU means that they could hid the weaknesses of their economies and took cover behind stronger European economies. In case of they were getting caught, they believed that a united Europe will come to save the day. This may lead some countries to lose the incentives to fix the flaws in their economies by their own.
A clear example of this case is Greece. By having joined the EU and used the Euro, the idea that Europe will backup Greece if something goes wrong were prevalent among Greeks themselves in the good old days. Within the false sense of security, the Greek government has done very little in fixing their problematic and idle tax system, which has proven to be a fatal mistake later when the crisis struck Greece in 2008. Furthermore, should a fiscal union had been implemented before, it would force the Greeks to fix their taxation system and may reduce the severity of the crisis.
Inappropriate Common Interest Rate
As the central bank of the Eurozone, the ECB is responsible for maintaining price stability by using monetary policies. One of the monetary policies that ECB uses is setting up a common interest rate, meaning that a same interest rate applies to all 19 countries inside the Eurozone, regardless whether it actually fits the respective country or not. Theoretically, high interest rate only suited the countries that are looking towards economic stability while low interest rate only suited countries that are searching for economic growth.
During 2003 and 2004, when two Eurozone’s largest economies, which are Germany and France, experience a slowdown in their economic growth, the ECB responded with lowering the already low interest rate. On one hand, the measure has helped Germany and France to regained a faster pace of economic growth while on the other hand, this has sparked weaker and unstable Eurozone economies such as Spain, Portugal, and Greece to embark on a shopping bonanza fueled by borrowed money. This causes an economic bubble[2] in their economies and when the bubble bursts, they cannot repay the debts. Thus, it could be said that common interest rate is unsuitable.
When the Economic Bubble Bursts
With the foundation of the economic integration is somehow problematic, the question is not will a crisis occurs but when the crisis will occur. In this case, it happened in 2009. Knowing that a high possibility of default and collapse of financial institutions existed in PIIGS countries, the ECB was quick to the rescue by a series of financial supports through European Stability Mechanism/European Financial Stability Facility (ESM/EFSF).
However, the ESM/EFSF is not free. In order to get the needed bailouts, the ECB requested the respective countries to accept reform packages that contain strict austerity measures, decided by none other than the ECB itself. Although the measures are negotiable, it did not help very much to avoid a massive cut on state pension funds and some subsidies, a raise on taxes, privatization of state-owned enterprises, and the sale of national assets. In the case of Greece, whose amount of government debt are the highest among the five countries mentioned before, not only the government put Athens’ airport up for sale, they also enforced a limit on cash withdrawal from banks of 60 Euros a week and other cash transactions needs to be approved by the government for a period of time. These measures were proved to be unpopular for majority of the people, causing a change in the political climate in PIIGS countries.
Actually, Greece and other countries did not have to experience the severe austerity measures. All that those countries need to do, if we put in a simple way, is just to devalue their currency. By lowering the value of the currency to a right number, their exports could be competitive because the products’ price will be cheap, allowing them to get competitive advantage among competitors. With the advantage in hand, the needed cash will soon be flowing to the state budget and then, starts to repay the debts.
However, such thing would never happen in the all the mentioned countries considering the fact that those countries are just a part of Eurozone. Because they use the common Euro, they cannot devalue Euro as much as they need. Devaluing Euro is solely the decision of the ECB. It is because the ECB want to keep Eurozone’s inflation rate under 3% per year, since an inflation that is higher than 3% might destabilize two Eurozone’s economic powerhouses, which are Germany and France – a risk that is too heavy for ECB to carry.[3]
Although the discussion may be far from over and there are other factors as well, this might be enough to show some pitfalls inside the EU system itself, which could be partly blamed for the current situation of the EU.
First things first, a monetary union would look like a joke if it is does not followed by a fiscal union as well. It is like giving someone a pen without the ink inside. Second, the EU need to stop turning a blind eye of the differences that exists in standards between more advanced countries and the less advanced countries. Tough common standard and its strict implementation need to be enforce in order to make a union works. Third, it is also not too wise to implement a common interest rate when in the same time there are countries who look more to growth and there are countries who eyed more on stability. If the EU did not address this issues as soon as possible, sooner or later, the EU itself might be doomed.
By: Marcel S. Kriekhoff | Staff Divisi Kajian | Ilmu Ekonomi 2015
[1] Eurozone is a group of 19 EU members that uses Euro as their currency. It also important to note that being a member of the EU doesn’t necessarily means being a member of the Eurozone although it is legally binding to be the member of the Eurozone once a country join the EU.
[2] Economic Bubble is a rapid economy growth that may be cause by an excessive monetary policy, such as an extremely low interest rate, that might increase the demand for assets and made them being traded in a price that is much higher that the assets’ intrinsic value.
[3] Although devaluation could increase the competitiveness of a country, it also leads to inflation (an increase in overall price level) and this will create economic instability in a country with strong economy (in this case, France and Germany). According to Forbes, it is proven that a country with strong economy slipped in high inflation rate. Of course, the EU would not like to see Germany’s and France’s economy but this hurts weaker economies such as PIIGS countries.
Feldstein, Martin. (2010). The Euro’s Fundamental Flaws. Washington, DC: The International Economy
Louzek, M. (2015). Eurozone Crisis. Prague Economic Papers, 24(1), 88-104.
BBC Documentary: The Great Euro Crisis. (2002)
http://www.investopedia.com/terms/b/bubble.asp
http://econ.economicshelp.org/2008/04/problem-with-euro.html
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