A European Winter
The last couple of years have been tumultuous for the global economy. Unfortunately, the policies that were adopted to fight that crisis are now creating bigger problems

Post World War 2, the world saw some major changes, both political and economical. Previously, most of the world was ruled by the major European powers. Asia, Africa and much of Latin America were properties of the major European countries and served as the backyards for their economies, providing resources and wealth to fuel their development. Post World War 2, Europe, despite being devastated by the war, retained its technological and industrial superiority and remained an important part of the developed world, even though the mantle of being the core of the global economy passed on to USA. Trade became the new medium of exchange, with the developed world providing industrial manufactured products to the world, while the rest provided primary commodities like agro-products, mineral ores and other raw materials etc.

Over the years, the development of the erstwhile colonies meant that many of these European countries were losing their competitive edge. The emergence of Japan in the late 70s and 80s, the South East Asian countries during the 90s, and China and India in the new millennium, shifted the scales as is quite well known. Consequently, growth of many of the erstwhile developed economies started to hit a plateau. In the face of this challenge, many MNCs based in the developed world started shifting their activities to the cheaper developing economies. Business Process Outsourcing, disintegrated manufacturing models, etc. are some of the most common happenings that we have witnessed and benefited hugely.

In this new age with such economic dynamics, the developed countries retained their edge by maintaining control over two major factors; technology and finance. The current age is called the age of finance, as finance capital emerged as the strongest economic entity dictating much of everything. While the USA was the core of the global economy, Europe was struggling to retain its strength. The development of the European Union - the eurozone - as one economic entity, and the development of a single currency euro were all attempts to make a Europe a economy as large and rich as the USA. Europe has also been following a model of welfare state, where the state finances a large part of the social benefits that the people enjoy. Despite the advent of a free-market paradigm in economic discourse, much of the old welfare state principles still existed much strongly in Europe till date.

Fast forward to the present, when finance capital got out of control and shot itself in the foot. The problem that emerged in the USA was soon transmitted to Europe as it did to the rest of the world. The immediate response to the financial crisis was bailouts and stimulus packages to maintain financing in the absence of private capital. According to a calculation made by the McKinsey Global Institute, as a result of a combination of these two policies, the total amount of debt incurred by governments across the world rose by a staggering $25 trillion to $41.1 trillion over the decade ending 2010.

As described in the previous article on credit ratings, higher debts immediately lower credit ratings. Usually, a Government raises debt by issuing public bonds. Government bonds historically have been regarded as the safest form of asset holding, as a government never defaults on its debts. Much of the large banks and financial institutions park their assets in government bonds. Another concern is that higher borrowing can also lead to the devaluation of the currencies such that the values of the bond assets fall.

In the case of Europe, the concern had some specific factors. The attempt to shift to just one currency (the euro) across countries was still in an experimental stage. There has hardly been a smooth transition with bigger economies like Germany being reluctant to trade their currency at the same price as the currencies of weaker economies, say the lira of Italy. The euro as a currency was on very shaky grounds when the crisis hit. One major problem in the case of such a unified currency is that unlike individual currencies, the government does not have control over the quantity of currency, or its value. Thus, the case of European governments raising public debt in euro was very different from the US raising public debt in dollars, as the latter has full control over the currency whereas Estonia, Italy or Greece do not.

Take the case of Greece. Greece had a public debt which was 152% of its national GDP. With such a huge debt threatening to destabilise the economy, Greece had no option but to approach the European Union for help as it depended on the latter for the euro. Countries like Germany were highly critical of Greece; they blamed Greece for weakening the value of the currency which would adversely affect their economy as well. While in the case of Greece (and Italy which now has a debt of 102% of its GDP) much of the debt was historical as the government was highly dependent on debts to run the economy, the debt problems of Spain and Ireland were results of bailing out finance capital. Thus, suddenly, Europe is now facing a situation similar to what happened in South East Asia during the 1997 crisis. Such a ‘contagion’ effect is spreading across all the European countries. Even the big guns like Germany and France are not quite healthy either.

The immediate corollary to higher public debt was a cut back on government welfare spending so that the government had greater revenue to service the debts. The arguments for austerity measures have been gaining momentum on both sides of the Atlantic. However, as the experiences of Greece amply pointed out, such austerity measures are disastrous. The European economies need fiscal deficits to maintain their economic growth. Any cut down in government welfare spending is bound to have high inflationary pressures as prices of basic social facilities, goods and services rise. This then results in lower demand in the economy as the population is forced to cut down on their consumption. There can be no economic growth if there is no demand in the economy. For developing countries that are export dependant for growth, a cut down on domestic consumption can release greater resources for export such that the demand of some external market can still trigger growth. However, given that Europe had lost much of its global competitiveness in the recent past, such an exit route does not exist for these European countries.

As growth slows down, government revenues also fall, debt to GDP ratio rises and the government’s ability to repay its debt is further lowered. This thus generates a vicious cycle and Europe seems to be digging itself deeper and deeper in this vortex. The only solution to this problem is bolstering growth through fiscal deficits as only growth can solve debt repayments in the long run. However, in the short run, such moves will lower the asset values of the public bonds which private finance today holds as assets. It is because of this short term interests that finance capital is so strongly opposed to public debt/ fiscal deficits.

Thus, the current situation is a fallout of the crisis brought about by private finance. Unbridled speculation resulted in a crisis in the financial sector, which first sought to be bailed out by governments. Both a lack of capital and a reduction in government spending are resulting in spiralling prices and global inflation is spreading, creating greater woes for the common man.