After a sense of calm had finally emerged in the eurozone since last summer, panic has erupted once again. Cyprus’s long awaited bailout was carried out with little thought of the consequences, both short term and long. The initial decision to place a one off tax on all depositors in Cypriot banks, both over and under €100,000, was always going to lead to public uproar and a bank run. The second bailout decision was slightly better, only affecting those with over €100,000 in their banks accounts and winding down one of Cyprus’s biggest banks, the Laiki bank, while switching accounts to the Bank of Cyprus. But the damage had already been done; the government now has to enforce capital controls to keep money in the country, while the public won’t forget how close it came to them losing chunks of their bank balance. It has almost certainly ruined one of Cyprus’s biggest sources of income as an offshore financial haven, with the conditions of the bailout most likely requiring reforms of the country’s economy. Then there is the tourism sector (another big market) which will be hit, as foreigners won’t want to risk getting caught in the middle of another financial crisis. Worst of all, this will not be the end of it; the economy is set to retract by 5% in the more positive estimates and another bailout will need to be negotiated.
Cyprus’s Debt-to-GDP ratio could overtake Greece in the future by some estimates. Found at http://trueeconomics.blogspot.co.uk/2013/03/2432013-are-cypriot-debt-dynamics-worse.html
Yet this is not the biggest worry for the European Union. Cyprus accounts for a tiny 0.2% of Eurozone GDP, its bailout at €10 billion is minuscule compared to the €246 billion needed to bailout Greece. If the economy crashed and defaulted on its debt, it would hardly tear the European Union apart. The bigger repercussions of this debacle are that the EU looks as divided as ever. The capital controls being placed on the Cypriot economy are not supposed to be possible in the EU – they are the first case of it since its creation. They are supposed to be short term, but then the same was said about Iceland 4 years ago.
Cyprus’s Bailout is tiny compared to the other EU Bailouts. Found at http://www.economist.com/blogs/graphicdetail/2013/03/daily-chart-18
Even more worrying is that the much heralded banking union that the EU nations announced last year now seems less likely. The European Central Bank was set to bail out troubled banks directly, thereby cutting off the self-defeating link between weak banks and weak governments. But to some member countries that seemed too much like gifting money without conditions that have so far been ever present within bailouts e.g. reforms to the economy. Cyprus was the big test, to see if the ECB would directly fund the failing banks of the island, but disappointingly this was not to be the case. A banking union would have showed a more unified EU, with member countries prepared to provide assistance to troubled states. It could have possibly paved the way for joint government bonds, stopping the inconsistent borrowing costs that have spread throughout the eurozone. In reality the EU members have been diverging for awhile, amplifying the problems of the union.
Looking across the region, this isn’t the only sign of a gap emerging between EU states. Tensions are rising within the union, with the periphery nations growing resentful over the austerity policies being enforced onto their economies, while the central nations are becoming frustrated at having to rescue the weaker nations from their own mistakes. This is showing in the form of protest votes. Greece had a near miss in their latest election, where a party campaigning on leaving the euro ran the victors close. Italy went a step further, with the 5 Star Movement (a protest party lead by an ex-comedian) caused a political gridlock in the March elections which has yet to be resolved. This was helped by the far right being led by Silvio Berlusconi, a controversial billionaire who campaigned on ending the EU austerity in Italy. In Germany, Angela Merkel will soon face her own elections, where her popularity will be tested by opponents who will campaign against the continued funding of the EU by the German tax payers.
Beppe Grillo has captured votes for his 5 star movement party by campaigning for a referendum on EU membership.
Then there is France, a country somehow caught in the middle. The nation is central to the EU, its partnership with Germany gives the union its clout and its leadership with Angela Merkel helped lead Europe through the financial crisis in 2008/2009. But Francois Hollande won his presidency by promising policies like the 75% tax on millionaires and the lowering of the retirement age, while he has backed the periphery economies in talks against austerity (to the annoyance of Angela Merkel). The French economy is in desperate need of reform and cuts however. The budget deficit is set to go over the set target of 3% of GDP, public spending is the highest in the EU at 57% of GDP and while Germany’s economy has become more competitive over the last decade, France’s has been left unproductive in the global economy. President Hollande is now set to implement the austerity measures he never mentioned during his campaign and has since seen his popularity plunge to the lowest since the firth republic began.
Showing the high public expenditure of France compared with similar sized countries.
The contradictory aims of the different members are leaving the big decisions unmade. The lessons of the past bailouts are not being learnt; there is still no definite lender of the last resort, no banking union, no talks of the possibility of sharing out some of the debt across the union to help member states recover. Austerity is needed, but so are some pro-growth policies and just demanding more and more cuts from the bailed out countries is not going to get the right results. The EU budget could be restructured to help improve spending on much needed areas like infrastructure and reduce spending on subsidies like French Farming and the rebates that go to countries like Britain.
Britain is another obstacle awaiting the EU in the future. The government is set to hold a referendum after 2015 (if it wins) on its EU membership and if the union is still facing the problems it is today, it is not inconceivable that the nation could leave the club. The public are already frustrated at the European laws they have to abide by and the levels of immigration that arrive to their shores. Losing Britain would be a deep blow to the union, both as the third largest economy and as a good balance to Germany’s motives. But the growing popularity of the UKIP party, again campaigning on an exit from the EU, shows the split that is appearing between member states.
Together the EU is the biggest economic zone in the world, one which can rival the economies of the USA and China. Divided it is a bunch of quarrelling nations that can’t agree on the best policies to move forward. Right now the latter is a more poignant picture of the EU, with GDP retracting by 0.3% in 2012 and unemployment reaching a new high of 12%. Europe needs to integrate further both politically and economically if it’s reverse this slump. A move towards a banking union would be a good start, while sharing the debt burden of its weakest members would go a long way to restoring stability to an economic zone that has struggled with such a concept.
A divided Europe is a weaker Europe, let’s just hope it doesn’t take its members too long to remember this.