What actually happened? A brief look at the Global Financial Crisis.

How did the global financial crisis result in large government sector cuts?

The events of 2007 are very well documented. There has been a plethora of texts published, journal articles, books, magazine articles etc. dedicated to covering the horrific downturn of several leading financial markets in 2007. The crash ensured that several billions worth of Sterling, Dollars, Yen and so on were given to numerous financial institutions that were deemed “too big to fail.” The term “too big to fail” is theoretically questionable to say the least, a point I shall discuss further as this piece develops. The significance of the bailout funds were the fact that they were generated from taxes. What was clear however about the government bailouts, particularly in the UK, was the fact that institutions such as Northern Rock (now Virgin Money) and RBS would have collapsed had the government chosen to ignore their pleas and let them fail. It is worth remembering that between 1995-2006 a period of unfettered market capitalism allowed substantial financial products to penetrate several economies. A brand new phenomenon that several households had very little exposure nor knowledge too. It would become clear in the years to follow that this imperfect information would have devastating effects on the entire global economy. This period where credit was “pumped” into the economy was truly unique.

Stock crash

Austerity policies have been discussed in some depth on this blog, my pieces here and here are pieces I wrote, I attempt to ask certain questions about government policy and question the notion that government policy could actually be having an adverse effect on the UK economy. The UK (much like the rest of the areas affected heavily by the global banking crash) have adopted a set of rigid public sector cuts, designed to reduce the large dependency on government for goods and services and also because the current government deem the current debt-to-GDP too high. (86%)

If one were to assess austerity in the UK so far could anyone deem the set of policies a success? Of course, the government intends for their policies to have much longer effects, a legacy effect if you will, but that should not come at the peril of current generations, for governments should dictate policy for both now and the future. Moreover, economists such as Stiglitz, Krugman, Solow, Diamond, Sharpe, Skidelsky and several others all warned against excessive fiscal cuts. There is no empirical evidence of any large economy cutting its way to prosperity. Yet what could easily be described as a gamble or the set of ideologically driven policies have ensured that in the UK and much of the developed world have had their economies remain flat since 2011, having slumped from 2009-2011.

In 2009 the rhetoric around fiscal policy changed. If you go back to Tony Blair’s premiership I do not remember anybody on either side of the House quibbling about government spending, in fact the opposite. The then Shadow Chancellor of the Exchequer George Osborne stated that he would match Labour’s spending. Spending he would later tirade about once he became Chancellor. Moreover, Labour made several economic mistakes one of them was the heavy deregulation of the financial markets that actually allowed a steady and then volatile flow of cheap and available credit to flood the economy. Too many people binged on cheap and available credit and several institutions capitalised on this and were making substantial profits as a result. Making profits is part of our societal fabric and that is not my issue, but in the business world, if a firm does not make profit, eventually that business is driven out and replaced by one that will. This to me that is the essence of capitalism. Why then was RBS, Northern Rock or Lloyds bailed out? Okay, anybody with an account with those firms would have lost their money, which is very unfortunate, but in a market economy, an economy In which proponents of free-market capitalism constantly bombard against government interference, where more than happy to accept taxpayers money. Some clarity would be great because these are the same institutions that support, lobby and advocate for laissez faire policies yet accept the ultimate form of government intervention. This anomaly still baffles me and it is unfortunate that we are still paying the heavy price for the actions of a few financial institutions. Moreover it was the substantial bank bailouts, not excessive government expenditure that caused such a sharp rise in the high levels of public sector debt. Debt that is being tackled with austerity policies. Nothing should ever be “too big to fail” because that is the antithesis of a competitive free market, the kind of market that is encouraged in the UK. The government should have let the failing banks fail so other banks could learn that reckless and irrational behaviour should not be tolerated. It would have been a message of biblical proportions. Without bailing the banks out we would not need austerity and six years and more of lost or flat output. It appears that policy has not favoured the majority of the population who are still readjusting to the large structural changes that have taken place since 2009. The graph below is an economic outlook for the UK and makes for miserable reading.

My main qualm lies with blaming government spending. I have maintained from the outset that some government cuts are good, just like in a household or with your personal consumption; you assess what you are spending and cut what is not required. Fair enough. The extent at which the government in the UK and in several nations in the Euro Zone has undertaken huge public sector cuts and perhaps more importantly, the rate at which they have penetrated society is likely to have long lasting negative effects. So far they have proved highly ineffective in producing genuine economic growth as the graph above displays. It should be noted that anything above zero is “growth,” however, in reality people need what I call tangible growth. If more buildings go up, more roads are finished, more bridges and so on are completed then people up and down the nation will actually see growth for themselves. Obviously all those examples require large labour input. We have not had enough of that in the UK. Those examples also highlight investment and investment has what we call in economics a multiplier effect. Simply put, the government spends £1, that £1 generates more that the initial £1 invested say another £1, then the additional £1 can be reinvested on top of the original £1, so the good or service can generate a much higher multiplier, say £3 in the future. What is important is that it comes from the initial £1 investment. This period (2007-period day) of flat economic activity has needed and needs fiscal investment.

Even with an extremely accommodative monetary policy in the sense that the interest rate has been 0.5% since March 2009 the government’s reluctance to deviate away from an ineffective set of policies is detrimental to the economy. Now is as good a time than ever to undergo strategic and logical investment programmes. Instead, the large public sector cuts have actually been damaging to the government’s deficit reduction plan because unemployment is rising, therefore, transfer payments in the form of Job Seekers Allowances and Unemployment benefits have increased. If the government were to run public sector cuts with substantial investment programmes and run them simultaneously, shifting resources away from areas deemed to be wasting government funds and invest in areas with high returns this would be a better set of policies. Instead, we just have the negativity associated with public sector cuts, which has made the private sector less responsive as a result of the lack of economic activity and weak demand from majority of the public.

It is impossible to cut your way out of a recession; nations need to invest wisely in order to grow. America pulled itself out of recession because their production levels in the late 1930s and early 1940s substantially boosted their economy. The point is, they invested. There was an economic crash and the government invested. The New Deal (America’s recovery plan) took several years to have a noticeable effect on the economy, but it was investment that helped aid their recovery.

The government’s gamble still has not paid off and the UK does not appear to be changing any time soon. Governments need to spend in order to get a return. Without it, our economy shall remain sluggish for some time and this is a direct result of the aftermath of the global banking crisis, not excessive government expenditure.

Read of the Week

This is an excellent piece relating prostitution and the public sector cuts. This blog is intended to highlight how significant economics and economic decision making is and how it affects every aspect of society. Thus, no part of society is exempt.

http://blogs.independent.co.uk/2013/05/01/prostitutes-and-the-recession-how-david-cameron%E2%80%99s-cuts-are-affecting-british-women/

Do right wing parties become more popular during economic downturns?

Golden Dawn: Their sharp rise has occurred during the worst economic crisis since The Great Depression

Clearly the global economy is disarray. Several large economies around the world have still not resumed their pre crisis levels of output and that does not appear to be changing anytime soon. This has several consequences, unemployment across the world, especially in Europe is high, people have less disposable income so spending levels are lower and there seems to be rising support for right wing politics. This has led me to ask a question: do right wing political parties become more popular during periods of economic upheaval? My answer is yes.

Economic stagnation or downturns are periods in which more people lose their homes, credit is harder to obtain, several businesses close down, unemployment & underemployment rise and disposable income is reduced. They occur during an economic upturn, however, the positivity during an upturn far outweighs the negativity, so the effects are minimalized. So if we take the UK for example and we look back during Tony Blair’s premiership, the economy was booming during most of his time, with exception to the downturn of the early 2000s, (dot com bubble) post 2002 the economy is performing well. At the time Britain was pro E.U. and pro immigration and a lot people were contempt to allow migrant workers to come to Britain. Nobody can escape the UKIP hysteria; they were often ridiculed as just another political party whose views on immigration and E.U. membership were extreme. Now Nigel Farage has David Cameron looking over his shoulder. The progress UKIP have made since the credit crunch has been nothing short of remarkable. In this age where the main political parties have lost connection with several disillusioned members of the public, UKIP represent boldness and consistency. But their views are more acceptable during a time of economic disarray. They are saying nothing different from ten years ago, they were anti-E.U. then and they are now. They were anti-immigration then and they are now. And migrant workers coming into Britain is not a recent phenomenon, yet there surge in popularity has transformed them from just another political party comprising of disgruntled former Tories into a real pain to the three main political parties. Moreover, their MEP seat looks secure and a recent YouGov opinion poll shows that public opinion is on their side and politically, immigration is such a contentious issue, politicians know they must tread carefully around it, often lacking the boldness UKIP has, hence there surge in popularity.

UKIP leading the way according to poll                                                     YouGov

 This surge has stemmed from the fact that the large public sector cuts have affected millions of people. This is on the back of the huge bank bailouts ordered under Gordon Brown for several failing banks and the fact that the large public sector deficit does not appear to be reducing. Economically the UK has a long way to go. It certainly has a huge effect on people’s lives, their mood, thoughts and actions. People think differently during recessions and downturns and this is reflected on the political landscape. Politics provides the avenue in which any citizen can protest against political actions and clearly people are speaking out against the way society is today. And this is because the economy is in such a dire situation.

 Last year in France, François Hollande won the general election. By defeating Nicolas Sarkozy he was elected President. One could suggest that many French voted out of protest in order to remove Sarkozy due to the problems in the economy. The French had similar concerns to the British, mainly regarding its economic woes and social problems based around immigration. Moreover the real story of this election was Marine Le Pen, leader of the far-right group Front National (National Front.) Of the 35,883,209 who voted, the Front National received 6,421,426 of the votes. So 18% of the votes went to a far-right political party. Thus the Front National came third overall. Again, their clear policies struck a cord with over six million people and this was their best election result to date.

The Euro Zone has come close to collapse and nowhere has that been more apparent than in Greece. Greece has always had high levels of public expenditure and around 10% unemployed for the last ten years, so this has added to the high national debt. Who should be blamed is not the issue at hand? If anyone should take responsibility it is the Greek politicians, for overseeing the mess and allowing public finances to spiral out of control. in the midst of this the far-right party Golden Dawn has had a huge impact on Greek politics, their surge in popularity certainly provide and sometimes channels the energy the recession has created. Their anti-immigration policies, much like Front National and UKIP have resonated with people and have provided them with the platform in which they hope to gain considerable election success.

If we look at the UK again, much of what the BNP said about immigration is not that different from what UKIP opine. Where they are on the political spectrum is different fair enough, but in terms of both being anti-immigration they are virtually the same. Yet the BNP was close to bankruptcy and UKIP appear to be going from strength to strength. Times have certainly changed. In an economic downturn people may have less patience for issues such as immigration, social housing and the provision of social services such as education and health care. This is usually because tax receipts have shrunk as a result of higher levels of unemployment, public sector cuts and less activity in the economy as a whole. So people may feel that domestic policy ought to prioritise its national citizens before seeing to the needs of others. What does not garner the same emotion from public attention are the benefits immigrants usually bring to communities. Ethnic minorities make up 6.24% of the Greek population. This figure has been growing steadily, but up until 2005, Golden Dawn were not the force they are now. The Greek economy has rotted since and the popularity of not just Golden Dawn, but right wing politics, especially in smaller parties, has gathered loyal cult followings, what they hope is that it manifests into tangible political success. They are at the very least making their bigger counterparts take notice, especially at local elections.

Personally, I think UKIP and the surge in popularity in far-right political parties highlight the sad state of politics in the UK and the rest of Europe today. However, I genuinely believe in freedom of political expression. For me UKIP provide more problems than solutions because they are virtually a one-policy party and I am yet to be convinced what they would do if the UK were to leave the E.U. In the case of the Front National in France, Le Pen was recently voted the most popular French female politician so she does not look to be losing any momentum.

I am confident that if the global economy was in a better state, more people had jobs and more money in their pocket then I can’t see where the far-right could get their impetus. Blaming immigrants for instance is a weak and flawed argument for the UK at least. There is no doubt that immigrants reduce the cost of labour, but the problems in the UK are more complex than blaming one group. Maybe the UK has got too many immigrants, but what I am certain of is this issue is not a simple case of close the borders and the problems will disappear. I would personally like to see the same energy exerted towards tax avoidance from large multinationals because that could potentially recoup billions in tax revenue.

How UKIP and other right wing parties perform in the next series of elections should be interesting, if the economy is still as sluggish as it is now, I predict well, and if the recovery is looking strong then I don’t think they’ll do that well. My only hope is that the economy starts to show real signs of growth and it will be interesting to see how the right reacts to that.

Beer Tax

 

This is an interesting analogy from Dr. David Kamerschen. It relates to progressive taxation. It is certainly worth a read. Dr. Kamerschen certainly presents a strong argument. Although, it could be suggested that it is a little simplistic in places, nevertheless, a compelling read.

Suppose that every day, ten men go out for beer and the bill for all ten comes to £100…
If they paid their bill the way we pay our taxes, it would go something like this…

The first four men (the poorest) would pay nothing.
The fifth would pay £1.
The sixth would pay £3.
The seventh would pay £7..
The eighth would pay £12.
The ninth would pay £18.
The tenth man (the richest) would pay £59.

So, that’s what they decided to do..

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve ball.

“Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily beer by £20”. Drinks for the ten men would now cost just £80.

The group still wanted to pay their bill the way we pay our taxes.

So the first four men were unaffected.

They would still drink for free. But what about the other six men?
The paying customers?

How could they divide the £20 windfall so that everyone would get his fair share?

They realised that £20 divided by six is £3.33. But if they
subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer.

So, the bar owner suggested that it would be fair to reduce each man’s bill by a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.

And so the fifth man, like the first four, now paid nothing (100% saving).

The sixth now paid £2 instead of £3 (33% saving).

The seventh now paid £5 instead of £7 (28% saving).
The eighth now paid £9 instead of £12 (25% saving).

The ninth now paid £14 instead of £18 (22% saving).

The tenth now paid £49 instead of £59 (16% saving).

Each of the six was better off than before. And the first four continued to drink for free. But, once outside the bar, the men began to compare their savings.

“I only got a pound out of the £20 saving,” declared the sixth man.

He pointed to the tenth man,”but he got £10!”

“Yeah, that’s right,” exclaimed the fifth man. “I only saved a pound too. It’s unfair that he got ten times more benefit than me!”

“That’s true!” shouted the seventh man. “Why should he get £10 back, when I got only £2? The wealthy get all the breaks!”

“Wait a minute,” yelled the first four men in unison, “we didn’t get anything at all. This new tax system exploits the poor!”

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn’t show up for drinks, so the nine sat down and had their beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and government ministers, is how our tax system works.

The people who already pay the highest taxes will naturally get the most benefit from a tax reduction.

Tax them too much, attack them for being wealthy, and they just may not show up anymore.

In fact, they might start drinking overseas, where the atmosphere is somewhat friendlier.

For those who understand, no explanation is needed.
For those who do not understand, no explanation is possible

David R. Kamerschen, Ph.D.

Professor of Economics.

 

Read of the week

This is an excellent piece from today’s Guardian. It relates to spending levels in football. On one hand you have Bourssia Dortmund, a club that epitomise Germany in terms of values, work ethic and productivity. (If I were a betting man I would place some money on them reaching this years final.) And on the other hand Spanish side Malaga, who, despite some excellent performances this season have been in hot water with UEFA for financial irregularities. Both go head in tonight’s Champions League. The article

Personally, whilst I love football, I cannot help but think that it is losing some quality. The influx of foreign owners on European football have inflated transfer fees which has not only increased pressure on football clubs to become profitable. Inflated prices thus have an affect on every club and it is near impossible to not participate. Clubs like Newcastle have invested in excellent scouting and are able to find quality players like Yohann Cabaye, Moussa Sissoko and the like and sell them on for large fees. Moreover, Dortmund are a breath of fresh air because the current German champions have spent, but not on the levels of Malaga, PSG, Manchester City, Liverpool and other clubs with foreign owners and are both profitable off the pitch and excellent on it. UEFA’s toothless Financial Fair Play regulations  have yet to have much of an impact on football. They need to enforce these regulations to ensure that football does not continue to spiral out of control and the inflated market reduces.

http://www.guardian.co.uk/commentisfree/2013/apr/03/borussia-dortmund-malaga-political-football-austerity

Good Read

This relates to my piece on footballer’s wages. Interesting piece.

http://www.bbc.co.uk/sport/0/football/21790728

Are footballers paid too much money?

Eto’o who playes for Anzhi in the Russian Premier league is currently the highest paid footballer in the world with a reported salary of £17million per annum

Footballers wages are subject to heavy scrutiny, especially wages that are paid to footballers that play in the Barclays Premier League and other top leagues such as the Bundesliga (Germany) or La Liga (Spain). Globally, high end professional footballers are paid millions of pounds in wages and many of them receive many forms of extra income, in the form of endorsements and other ventures they may operate.

The reason why their wages subject to much debate is because several people, including past footballers such as Gary Linker, feel that wages are simply too high. They believe that footballers get paid too much money. The question is; are footballers paid too much? In short, no.

Manchester United, this week became the highest valued sports team in the world, valued by Forbes magazine at $3bn (£1.4). If you consider how much revenue that all top football clubs generate in revenue from all avenues, merchandise sales, season ticket sales, television rights, transfers out and so on, these institutions generate millions in revenue. So wages fall into proportion with revenues. A top player at club will be paid more than his peers because his labour is deemed more valuable to his employer. This is often the case in workplaces around the world; wages indicate labour contribution. Moreover, if a top player is being paid >£100,000 per week, it is still insignificant when you consider how much these clubs generate. Furthermore, if you look at the lower divisions, this wage model is place, but wages are significantly less, although it is the same profession, clubs in League 2 do not generate hundreds of millions in revenue, so wages are once again in proportion to club size and revenue generated.

One cannot escape the fact that we are living in times of economic woes, where jobs are increasingly difficult to obtain, so the subject of footballer’s wages is more potent at the moment. However, the more abundant your set of skills, the less you will receive in wages. Hence low skilled jobs are paid accordingly, high skilled jobs treated in the same manner. There are few people in the world that can produce what Leo Messi or Luis Suarez or any top professional can. Their skills are scarce; hence the willingness of football clubs to pay for their respective talents. So when you consider the skills that top footballers have, not many in society can do what they do. I know this may seem difficult to comprehend, especially after watching a lot of ordinary Premier League teams, but even those mediocre players are in a position where (all good fortune aside because this is certainly a factor) their skills are still scarce, even if it may not appear to be the case.

Football is also an extremely short career, when you consider that the current government is looking to increase the working age to sixty-eight and a footballer is considered at veteran at thirty five, it does put into perspective just how short many footballers careers are. From the model professionals, players like Paul Scholes, Jamie Carragher and Ryan Giggs, players who take pride in staying fit and looking to get the most out of the profession, the mean age for retirement in football is 35. This means for around seventeen (from the first professional contract) years’ footballers receive a salary. Seventeen years to be paid potentially millions should be enough to last a lifetime. However, this is clearly subjective, the fact is it is a short career, many players choose to leave football, some stay within, neither are as lucrative. If you were to stretch footballers wages over the span of the average working person, so from eighteen to sixty five, some forty-seven years, then their wages would probably seem a lot less crude and I personally feel they would be treated in a completely different light.

At times, footballers wages do seem like too much, but one must remember that as so long as people keep demanding football, attending games, paying for Sky Sports, buying merchandise and so on, football clubs will continue to generate millions. As so long as clubs generate millions, they’re main staff members will receive their proportionate share.

Government Debt and the effects on UK Unemployment.

There has been no secret of the coalition’s economic policies. That has been to reduce the deficit, i.e. the amount of money the government looses each year. The government has also aimed to reduce the burden of high levels of government debt. How it implements these policies has a drastic effect on the UK economy and in particular, unemployment.

Clintons are one of many well known brands to feel the strain of these tough economic times

Government debt management affects all aspects of the economy. The substantial reductions in government spending have led to several members of the population forced to find alternative employment. George Osborne was confident that the private sector would compensate for the jobs lost through the government policies. It is therefore vital to analyse how government debt management has affected the rate of unemployment. UK unemployment is currently 2.53 million, which is 7.9% of the population, which has fallen from the previous is sixteen year high. Last year unemployment peaked at 8.4%. This was an increase by 118,000 from September to November 2011 and a further 28,000 from November to January 2012. Clearly the government’s policies have not had the desired effect.

OECD Economic Outlook 2011

Above is a graphical depiction of the rise in unemployment from 2008, with both jobs losses in the public and private sector also depicted. Despite the claim in the November 2010 Budget, Osborne claimed that the private sector would compensate for the jobs lost in the public sector, the evidence is clearly contrasting to the government’s claim.  The Chancellor claimed,

“Public-sector job creation would far outweigh the job losses in the public-sector.”

Unemployment in the UK continues to rise to record levels and the jobs being lost in the public sector are a direct result of government policy. When The Chancellor made the premature assumption that the private sector would compensate for the jobs lost through the public sector it may have highlighted an inadequacy in government policy. High and rising levels of unemployment is detrimental for economic growth because it places a financial strain on those working as transfer payments such as Job Seekers Allowance (JSA) and benefits. The number of individuals claiming JSA has risen by 28,000 from November 2011 to January 2012. With further increases expected for the rest of 2012 and 2013.  Moreover, there has been an increase in part-time employment as jobseekers have been desperate to earn some income, but it is proving insufficient to make a substantial difference in terms of contributing towards substantial economic growth.

In addition, the higher than target inflation, those in work will have less disposable income and the government will have to increase transfer payments out to those affected by unemployment. Secondly, tax revenue will also decrease simply because less people are in work, the government must therefore create employment in order to raise taxes so it can finance expenditure that can later contribute to economic growth.

Unemployment is therefore the greatest challenge facing the UK economy because it does not appear to declining. By making such large expenditure cuts, the government may have undermined any recovery effort and may find it very difficult to reduces its debt obligations. The most effective method to reducing government debt is establishing sustained economic growth, however, sustained economic growth in the UK is some considerable way away. Although the UK economy is no longer in recession, rising unemployment will continue to place a severe burden on those in work due to the inflationary and tax restraints already in place, with lower disposable income, growth is likely to remain very low. Moreover, the method in which the government has chosen to reduce its debt may have exacerbated the problem because of the sharp rise in structural unemployment.

The Writing On The Wall: Eurozone fail to take decisive action

Eurozone leaders tacit failure to take prompt action leaves Eurozone a long way from recovery.

The current eurozone crisis is not going to end any time soon. Despite Mario Draghi’s so-called “ice-cream,” a pledge by the European Central Bank (ECB) to intervene in the European bond market, the optimism was brief and the current crisis remains more potent than ever. What is most striking  are some of the parallels between the current eurozone crisis and the European Monetary System (EMS) crisis of 1992-1993 and more importantly, the inability of European ministers to act effectively on past mistakes.

Many Greeks and Spaniards have stoned police cars and set fire to shops to protest budget cuts, to little avail. Hitherto, the EMS crisis, although in hindsight is not of the same magnitude, relatively speaking, there are many mistakes that have been repeated during the current crisis. Interest rate harmonization across the entire euro-zone clearly does not work due to the structural imbalances of the Northern, wealthier states and the Southern, poorer states. Similarly, when the UK wanted to reduce interest rates during the 1992-1993 EMS crisis, they were prohibited, due to the dominance of the German economy (sound familiar ?) and when they maintained high interest rates due to several factors, including the reunification of East and West Germany it had a detrimental affect on the British economy. Moreover, this imbalance of economic performance requires a significantly tighter fiscal framework that will complement the monetary framework already in place, without this, the crisis will not be solved and this increases the possibility of another crisis reoccurring in the future. Furthermore, had Greek, Spanish, Irish, Italian and most European nations adopted a much stricter fiscal framework, then the problems of today would be severely reduced.

This has been the hallmark of the eurozone, austerity is the bitter medicine for over indulgence on cheap credit

It should be noted that the legal framework was already in place to circumvent nations from binging on cheap and available credit, but this has proven to be nothing more than hollow rhetoric. The ECB’s decision however to act as lender of last resort should provide the framework for the fiscal unity that the euro-zone has required since its inception. Monetary unity alone is not sufficient, both fiscal and monetary unity is required to harmonize the euro-zone. Nevertheless, by accepting the stringent fiscal reform package, the indebted nations will be relinquishing national sovereignty, which is a consequence of the over indulgence of available credit. Undoubtedly, these are the very beginnings of the proposed reforms and many citizens in the heavily indebted countries may not have the patience to wait until these reforms manifest into tangible results. This transition period marks a significant time for the euro-zone and many nations may feel time is running out. The Stability and Growth Pact was intended to penalize nations with a debt-to-GDP ratio greater than 60%. Clearly, the intentions were correct, but the implementation or rather, the lack of demonstrates the incapability of euro-zone leaders to take decisive action.

The intentions of the SGP were understandable; any union that would amalgamate several contrasting economies needed a stringent fiscal framework in order for it to function appropriately. If we analyse the current euro-zone crisis, the authenticity of the SGP is in question because strict sanctions were to be imposed on any nation who did not adhere to the ‘strict’ conditions set by the EU. If this were the case then several nations including Germany, Italy and Greece in particular would have been punished appropriately for their fiscal mismanagement. Former UK Prime Minister John Major suggests that:

“Southern states over indulged on low interest-rates and racked up debts. When Germany and France over-stepped the criteria without any penalty by the commission, the criteria became toothless.” 

It is fair to suggest with hindsight that sanctions on nations who had failed to abide by the framework set by the EMU would have almost minimalized the severe economic damage that has beset the euro-zone today. Had sanctions been imposed some ten years ago, or even five, then the severe problems that appear only to be appearing now could have been dealt with then.

Nations were meant to be punished if government debt-to-GDP exceeded 60%.

With regards to the realization of the EMU, the SGP was implemented in 1997, two years before the data range in the graph. Despite a prerequisite of national debt being less than 60% of GDP levels, the graph above highlights the inability of euro-zone members failing to deal with nations not following the fiscal framework. This tacit failure to impose sanctions on members allowed certain members continue to let national debt to grow until it became an apparent and uncontrollable problem, hence, the systemic failure of the system itself. Clive Cook of Bloomberg is one of several commentators who have critical views on not only the SGP, but of EU governance in general.

“Remember the EU’s vaunted Stability and Growth Pact of 1997, which supposedly put limits on public borrowing — and which Germany, by the way, violated? The same syndrome is evident today. Write a new rule now, worry about enforcing it later. This has been the hallmark of EU governance.”

Moreover, this has been a consistent theme that has underpinned EU and euro-zone governance (or lack of). Despite apparent mechanisms being in place to prevent severe economic shocks, euro-zone nations appear to have repeated some of the same systemic errors, the only difference with the EMS crisis of 1992 and the current crisis is the severity, the current crisis however appears to be of a much greater proportion, with the lasting effects significantly greater.

Clearly, the current economic crisis that is crippling the euro-zone could have been prevented if decisive action was taken to punish nations who did not adhere to the ‘strict’ rules set out in the SGP. Retrospective analysis does little to compensate the fact that the damage as a result of this failure has been catastrophic. There is no easy remedy; the euro-zone must comply with the reform package set out by the ECB in order to have the fiscal harmonization so desperately required in order to achieve the goal of a single currency. Without both monetary and fiscal unity, this crisis will occur in the future, and the consequences far worse, something that seems too difficult to comprehend at this moment in time.