Economic Interests

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Archive for the tag “EU”

The next EU Bailout?


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The Euro Crisis has died down in 2013 after a turbulent 2012. This was not because of a lack of effort by Europe’s trouble makers; Italy ground to a halt when trying to decide a government, while Cyrpus were the latest government to need a bailout. Yet the cost of borrowing for many EU countries has been decreasing gradually regardless. This has mainly been down to the statement made last year by the head of the European Central Bank to “do whatever it takes” to save the euro, hinting at the bank finally becoming a lender of last resort to the rest of the eurozone.

But tricky times lie ahead for Europe. The Euro area declined on averaged by 1% in the first quarter of the year and unemployment has reached a record 12.1%. Protests and riots have been more common in recent years (with even Sweden now experiencing public unrest) leading to many extreme parties getting more public attention, campaigning largely on their respective countries leaving the EU.

So a big question remains; who will be the next country to request a bailout?

One likely candidate is Slovenia. With a budget deficit over 5% of their GDP, their finances are in disarray. The economy retracted by over 15% in 2008/09 and is not set to return to growth until at least 2015. The largely state owned banking sector, saddled with debt, has grown to 140% of GDP, with an estimated 20% of loans considered non-performing (extremely late repayments). The public debt is still rather low at around 60% of GDP compared to much of Europe, but the interest levels Slovenia have to pay for borrowing are rather high at near 6%, if that rises much higher in the coming months they may lose access to the international markets and require external help (i.e. a bailout). Much of Slovenia’s problems come down to the credit crunch, where easy credit fuelled a construction boom similar to that in Spain that promptly burst. Another problem was the size of the state, which kept a tight grip on the bigger markets, crowding out private competition and stopping innovation. With the government now employing austerity measures, the growth of these industries have stalled, with potential buyers now a lot harder to find in a recession hit EU.

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Slovenia’s prime minister has announced a brave rejection of any bailout talks, instead talking of important reforms to the banking sector (a creation of a bad bank for the worst debts) and budget balancing austerity measures including: cuts to school subsidies, a recent 5% cut in nominal public sector wages and a new higher marginal personal income tax. Their crisis resembles more Ireland’s than Cyprus and some strong leadership is giving the country a fighting chance of avoiding an international bailout.

So if not Slovenia, who then?

Two countries that resemble Cyprus (the latest bailout victim) more closely are Malta and Luxembourg. Both are small countries with massively outsized banking sectors. Malta’s banking sector is nearly 800% of its GDP making it impossible for the government to bailout out the sector by itself if needed, while the government already has high public debt of around 70% of GDP. But Malta has relatively low unemployment and a controllable budget. Its banking sector is rather different in nature to Cyprus’s as well; instead of two big local banks full of dodgy russian money and heavily exposed to the volatile Greek economy, Malta banks are actually subsidiaries of foreign banks, with high capital ratios and profits. Luxembourg also has a large banking sector, roughly 23 times its GDP. But once again the banks are large foreign owned, differentiating it from Cyprus. The economy is also very strong; experiencing low growth in 2012 when the surrounding countries were in deep recession, holding low public debt and unemployment and possessing one of the large current account surpluses in the region. If that weren’t enough, the small country has the highest GDP per capita ratio in Europe, meaning its people enjoy a very high standard of living. Both countries are over reliant upon their financial sectors and are very exposed to shocks in the market, but neither are realistically on the brink of a bailout.

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Rather more worryingly, a much bigger economy is at risk, one which has already had to accept a bailout for its banking sector. Spain withdrew around €40 billion from European Stability Mechanism to help recapitalize their banks (a EU organism set up to offer up to €100 billion in bailout funds to member states). Yet many believe this wasn’t enough and that problems remain in the troubled Spanish banking system. Spain has had to nationalise one of its largest banks Bankia, while most others have had to make large cuts to their balance sheets. If this wasn’t enough, the economy is in serious trouble. Spaniards are seeing a deep decline in their national output, likely to fall for an eighth consecutive quarter and unlikely to see growth until after 2015. Unemployment is at a record high of 27% of the population, nearly 60% for the young. The budget remains heavily unbalanced, with a deficit of 7% of GDP, leaving public debt high (though not as high as private debt). A construction crash has lost many young spaniard an entry into the work force and has caused a lot of bad debts in the banking sector. When times were bad for the EU, Spain and Italy have faced some of the highest borrowing costs. Many see Spain as the weakest member of the big club, and any serious bailout of the economy would cause massive fractures in the EU and could possibly cause a domino effect on the likes of Italy and so forth. Fortunately, the political scene is stable, with the government in power for the foreseeable future and elected on a mandate of budget balancing and reform. Such reforms and austerity are already under way, with labours cost having dropped in contrast to rises in Frances and Germanys and a 4% drop having been achieved in the budget deficit since 2009. Progress is being made, but it needs a stable environment and a strong recovery in europe wide demand for Spain to really recover and see of the need for a bailout. That is a big ask in a continent that has become synonymous with the word crisis. A bailout for Spain is largely not talked of, precisely because of the implications it could have for the future of the EU. Yet it probably remains more likely than a bailout for Luxembourg and Malta.

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The reality is that many member states could require a bailout if matters turned for the worst, with Portugal another possibility after the rejection of austerity measures by the national courts. The lack of a proper system in place and the reluctance by the ECB to really put its money wheres it mouth is, means rich and stable countries like Germany will continue to fund the mistakes of poorer economies. A more united Europe could solve this, with the spreading of some of the debt between the member states an attractive idea, ending the vicious circle of national debts being inflated by bailouts and increasing the need for further bailouts. Politically it remains a tough sell, especially for Germany, but it would also show a strong and united Europe, something most national leaders would secretly like to see.

Slovenia are the strongest possibility for a next bailout, with markets lacking confidence in the economy and increasing the costs of borrowing to perhaps unstable levels. But a spreading of at least some of the debt  through Euro Bonds could greatly decrease the need for this guessing game.

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Is the EU being dragged apart?


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.

Joining the Club


At the end of this year, immigration restrictions within Europe are set to relax, spiking fears in Britain that a mass influx of poor immigrants will arrive from the likes of Romania and Bulgaria. Britain has form, with similar circumstances in 2004 leading to a flood of Polish Citizens arriving in the country, to the point where Polish is now the second most spoken language in the country. This situation has lead to a growth in the popularity of UKIP, who campaign on restricting immigration and leaving the EU. Semi-Success in a by-election in Eastleigh, while rather meaningless in the grand scheme of things, has proved both their popularity gain and the unrest of the public. But are these fears well founded?

UKIP take advantage of public discontent.

Unhelpfully, there isn’t really any respected statistics on how many immigrants are set to hit the shores of the UK, while the government underestimated the numbers in 2004 and are wary to make the same mistake twice (with up to 13,000 projected a year but over quarter of a million arriving after the first couple of years) . A general estimate is that immigration from Romania and Bulgaria could rise to 50,000 a year for the next few years.

But why choose Britain? The economy is spluttering along, the government is implementing tough austerity measures and the public already has a negative view of immigrants. In fact the government has been advertising this in the home nations, even going to the lengths of trashing Britain’s weather. Yet Britain remains an attractive location, with low unemployment when compared to the rest of Europe, a language spoke across the continent and a welfare system made famous by its generosity.

Unemployment figures as of April 2012. 

However if the public is expecting a repeat of 2004, they will be mistaken. The factors are different now. Britain was one of the fastest growing economies on the continent back then and importantly was one of the few large economies to fully open their borders at the time. Now Both Romanians and Bulgarians have a much wider choice in where they can travel, meaning the immigration figures should be split between the different countries. In fact, Germany in an economic sense is a lot more attractive; they have more impressive employment figures and a more stable society (whereas Britain has suffered from riots in recent history). Additionally, while their movement has been restricted, its hasn’t been completely stalled, so many Romanians for example have already emigrated, while countries like Spain had already allowed unrestricted immigration prior to this.

So while there will be an increase, it might not be as inflated as many are projecting. Either way, there will be more immigrants taking our jobs many will say. But that view is clearly wrong; many immigrants are either highly skilled and genuinely add something to the economy, or they are willing to do the low paid jobs many Britons would turn their nose up at e.g. picking vegetables.  In fact, while locals grumble about the polish “invasion”, a reputation has spread of polish immigrants being hard workers, a term that isn’t coined so easily with British workers.

But there are inevitably those that move into the country to take advantage of a welfare system that has seen benefits grow faster than average wage. This is the worst case scenario, with immigrants draining the system and sending money out of the country to families back home. But this is more rare than many think; labour participation is on average higher for immigrants than in the general population, while those that wished to move to Britain for such reasons could have already done so – the limitations have applied only to the labour market. In total, when comparing what immigrants have contributed with their costs since 2004 in the top eight European countries, immigrants have had positive effects on the country’s finances.

Welfare cuts are being implemented now to help tighten the budget.

If this wasn’t enough, the current government’s policies have not made the country very open or attractive to possible immigrants. The welfare state is being cut drastically; with benefit growth no longer being tied to inflation and a cap being introduced on entitlements to any family up to the average salary in the UK. While immigration in general is being clamped down on, with the government sticking to a target to reduce total immigration to fewer than 100,000 by 2015. David Cameron has gone about this by making it harder to obtain visas, which has unfairly fallen upon students, the sort of immigration that the country wants, young and skilled. But it has helped encourage an anti-immigration vibe in the public, where polls have shown a majority of the public wanting near zero immigration. Not that this would have an effect on immigrants from Europe anyway, unless the government was to radically defy EU law and start denying visas to such citizens.

Growth in student immigration has been a strength of Britain’s. 

So what will happen come the end of this year is still up to debate. The UK is no longer the only club in town and once you get in the locals aren’t very friendly. But then the minimum wage is fives that of Romania’s, which could be the equivalent of five more drinks…

Was the Euro Doomed from the Start? (Essay from my graduation year of university last year)


The European Union (EU), an economic union between 27 member states in Europe, has recently suffered its first serious setback since its creation, termed as the “Euro Crisis”. Various members of the eurozone have been found to have serious debt problems which have affected the rest of the EU as they all share a single currency, the euro. But as Verhofstadt (2011), the former Belgian prime minister said “A state can exist without a currency, but a currency cannot exist without a state”. In this essay, I will discuss whether the euro was in fact doomed from the start from structural and unforeseen problems. First a short history of the euro will fill in any background information for this essay. Then the problems that will be considered are; the monetary policy problems, fiscal policy problems, a lack of preparation for any crisis, the lack of a real political union and a lack of equality throughout the EU. I will also explain reasons why the EU has been beneficial to its members including; the growth experienced before the crisis and the safety net the EU provided for the now failing economies in eurozone. The Mundell Fleming model will also be used to help show the different effects of both fiscal and monetary policies.

The euro first came into existence in 1999, though the physical representation of the money wasn’t fully circulated until 2002. Important institutions for the EU are; the European Commission, the European Council, the Court of Justice of the EU and the European Central Bank which decide important decisions within the EU like legislation, European law and interest rates for the eurozone. Entry into the EU was regulated by the Maastricht treaty which stated any nation that wished to enter must pass certain fiscal criteria; inflation must not be 1.5% higher than the average of the three best performers, the budget deficit must not exceed 3% of GDP, government debt to GDP ratio must not rise above 60%, long term interest rates could not be 2% higher than the three lowest members and the applicant should have mirrored the domestic currency to the euro for two years without devaluating currency. Greece famously did not originally meet these criteria and weren’t allowed to join until later on, while the UK and Denmark decided against adopting the euro currency. In 2004, the eurozone expanded to include smaller nations like Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia and then in 2007 Bulgaria and Romania. Out of these nations only Slovenia, Cyprus, Malta, Slovakia and Estonia adopted the euro currency, while the other nations faced difficulties adjusting. Then in 2007/2008 there was a global financial crisis that pushed the eurozone into its first official recession in the third quarter of 2008, experiencing negative growth in the second, third and fourth quarters of 2008 and then into the first quarter of 2009. Greece suffered a crisis in confidence as international creditors started to doubt their ability to repay the huge debts they had acquired; with the debt to GDP ratio at a staggering 159% of GDP. This meant the eurozone countries along with the IMF had to bail out the country for the first time in May 2010, totalling €110 billion. This was followed by a second bailout this year of another €130 billion to help the country finance itself, while other countries like Ireland have also had to be bailed out. This has lead to a new European Fiscal Compact to be created that enforces nations to adhere to fiscal stability. This states that national budgets must either be in balance or surplus, otherwise punishments of fines of 0.1% of GDP and the loss of some of the countries fiscal sovereignty can be used.

The first fundamental problem with the euro was that it was expected a single monetary policy for all the countries would work. The monetary policy, which controls the supply of money into a country by targeting interest rates, is controlled by the European Central Bank (ECB) in the eurozone. This means every country in the eurozone has to operate under the same interest rates, despite the massive differences between the economies of the central countries (Germany, France) and the periphery countries (Greece, Spain). Andre Szasz, a retired Dutch central banker, supports this argument, suggesting it was a mistake to have “a monetary policy of one size fits all” as interest rates will be “too low” for some countries and “too high” for others.  This makes sense, as a country like Germany which produces a lot would be inclined to target low interest rates while a country like Greece which doesn’t produce enough would have higher interest rates. This led to the periphery states like Spain, Portugal and Greece being able to exploit the low interest rates that would not have been possible without being part of the euro. These low interest rates meant poorer countries could borrow money easily from international investors, not a big problem by itself, but when mixed with low productivity it encouraged nations to spend more money than they were making. This has lead to these nations building up vast amounts of debt that they cannot realistically pay back and with the financial crisis making credit scarce, these countries are finding it hard to obtain the loans they once found easy, with Portugal, Ireland and Greece being given junk credit status by credit rating agencies. This mass borrowing by the periphery nations (and Ireland) was good news for the central countries, especially Germany, as it meant new possible customers for their exports financed using money loaned from the richer nations like Germany: A vicious cycle. Zemanek (2010) supports this stating “Germany has experienced rising trade surpluses against the euro area countries starting from 2002 up to the recent crisis… other countries have large current account deficits, thereby accumulating increasing stocks of international debt”.

Bayumi and Eichengreen (1992) argued that the European monetary union could not be an optimum currency union. An optimum currency union is a region where a single currency would maximise economic efficiency, satisfying the criteria of; labour mobility, capital mobility, price and wage flexibility, fiscal transfers and similar business cycles. It is argued that the eurozone does not have price and wage flexibility, fiscal transfers or labour flexibility. Issing (2000) supported the lack of this last quality, arguing “dangers can be identified relatively easily. The most obvious one is the lack of flexibility in the labour union… this poses an almost lethal threat to monetary union”. A single monetary policy also meant individual countries couldn’t de-value their currency by printing. When the financial crisis hit, countries like the UK and USA were able to devalue their currency by printing more money, this helps boost exports and stop imports and can be an important tool in restructuring a countries economy. But countries like Greece and Portugal within the EU don’t have that option and therefore the only way to restructure their economy is through internal austerity; cutting wages and spending.  The Federal Union (2011) wrote “British government borrowing grew from 29.7% of GDP in 2002 to 36.5% in 2008… Since August 2007, the pound has lost 20 percent of its value against the euro”  showing the UK was fiscally irresponsible as well, but that they had the ability to de-value their currency and boost exports and therefore not have to adhere to severe austerity policies like their EU counterparts.

The second fundamental problem of the euro was the fiscal policy of the EU. In contrast to the monetary policy of the EU, each nation has a separate fiscal policy which leaves a very mixed economic structure for the EU. The fiscal policy refers to the government expenditure (e.g. new roads) and the collection of revenue (taxes) which affects the economy of the country. White (2011) suggested that it was “impossible to completely separate fiscal policy from monetary policy as central banks can prop up government bond prices by monetising debt” meaning the central banks of countries can buy up the debt of the country (though it is illegal to directly buy the debt, it can easily be bypassed) to help increase the supply of money, therefore affecting the monetary policy.

The Mundell-Fleming model (an adaptation on the IS-LM model) helps shows the relationship between a country’s interest rates, output and nominal exchange rates. The model argues that a country cannot simultaneously achieve a fixed exchange rate, free capital movement and an independent monetary policy. The EU for example has flexible exchange rates and instead decides to target interest rates and free capital movement. The model shows; the IS curve: Output = Consumption + Investment + Government Spending + Net Exports, the LM curve: Money supply/Price = Liquidity preference (Interest rates, Output) and the Balance of Payments curve: Current accounts (Net Exports) + Capital accounts (Cash Flow). The EU uses flexible exchange rates, which means the European Central Bank allows exchange rates to be determined by market forces alone. With flexible exchanges rates, the central bank can increase the supply of money to try and boost the economy (Monetary change). This causes the LM curve to shift to the right, thereby increasing output and lowering the domestic interest rate in comparison to the global interest rate. This depreciates the local currency, making local goods more attractive and thereby increasing net exports. Increasing net exports shifts the IS curve to the right as well, up until the point where the balance of payment is equal again and the domestic exchange rate equals the global interest rate. But while this returns to normal, the GDP increases once again, meaning any increase in the money supply doesn’t have an effect on interest rates in the long term, but does increase the GDP of the country and vice versa for a decrease in the supply of money. The European Central Bank increases money supply through Quantitative easing, where it prints more euros for all the countries to help boost the economies that are underperforming. Too much quantitative easing can be bad for the economy, leading to a poorer standard of living, bad reputation with foreign markets and even the risk of hyperinflation, while the ECB has to try and balance out whether quantitative easing would benefit all the countries in the eurozone. Another option with flexible exchange rates is to increase government spending (fiscal change), this causes the IS curve shifts to the right, causing an increase in GDP and in the domestic interest rates compared to global interest rates. This leads to the currency appreciating, making foreign goods more appealing and decreasing net exports. This shifts the IS curve back to its original position where domestic interest rates are equal to global interest rates and has no impact on the LM curve. This means if there is perfect capital mobility, then an increase in government spending has no impact on GDP and vice versa with cuts in spending. This shows that both the fiscal and monetary policy are integrated and cannot just be separated like the EU have tried to do with the euro.

A fiscal change with floating exchange rates graph shows what happens when government spending is increased (or taxes are decreased). A monetary expansion with floating exchange rates shows what happens when the supply of money is increased.

The EU also had to make an assumption that with interest rates fixed and a single currency, each country would be fiscally responsible. That assumption was proven badly wrong, as a lot of countries used low interest rates to borrow irresponsibly without having the output to support such loans and built up uncontrollable amounts of debt. Marian Tupy (Legatum Institute) argued that “Greece’s membership in the eurozone allowed the Greek government to borrow at lower interest rates, and thereby enabled its overspending” showing the allure the EU created for poorer nations to borrow beyond their means.  A new fiscal compact has recently been agreed between the countries in Europe (as described previously), with the UK and Czech Republic notably opting out of the treaty, which has the aim of stopping states running huge debts. This new fiscal compact shows an original problem with the structure of the EU, that regulation of fiscal activity in the eurozone was too relaxed. Dominguez (2006) came to this conclusion in her paper, writing “In 2000, one year after the euro was launched, five of the eleven countries in the eurozone were in violation of the public debt rule”, she then added “In 2005, the three largest eurozone economies – France, Germany and Italy – were out of compliance with both the budget deficit and public debt rules”.

Another fundamental problem with the euro was that it seemed totally unprepared for a crisis. As the Economist captured perfectly “the designers of the good ship euro wanted to create the greatest liner of the age. But as everybody knows, it was fit only for fair-weather sailing, with an anarchic crew and no life boats”. The European central banks main purpose was to keep inflation low, not deal with any potential credit problems which it had neither the financial nor political power to accomplish.  David Cameron (British Prime Minister) argued that successful currency unions have a lender of last resort, fiscal transfers, collective debt, economic integration and flexibility to deal with shocks, suggesting “currently it’s not that the eurozone doesn’t have all of these, it’s that it doesn’t have any of these”. Looking at the EU structure, it is easy to see what he is saying; countries are unable to transfer funds to struggling regions (e.g. Germany couldn’t transfer funds to Greece), debt is split unequally between different countries despite all using the same monetary policy, economies are kept largely separate with trade barriers still existing and there is absolutely no flexibility to deal with shocks as the financial crisis showed. Stelzer (2012) wrote ”Nor does Europe have a seamless method of transferring income from flush to stricken areas. America does: cash flows automatically to troubled states with falling tax receipts and rising welfare costs, from states doing better” which shows the one reason how America have been able to bounce back faster than the eurozone, because they have been able to transfer funds to poorer regions and have spread the debt collectively over all the states. But the most important of these factors is arguably having a lender of last resort, some sort of institution that can bail out the government if they can’t pay its debt. The USA has this in the form of the Federal Reserve, which can provide funds for any of the states if they require it. One of the main problems of the euro crisis was a lack of liquidity; this should have been the role of the European Central Bank as a lender of last resort. Instead the EU had a rule of no bail outs, relying on markets to keep a government from acting fiscally irresponsible, which has now backfired as the EU has hurriedly created a rescue fund to help solve a liquidity time bomb. The rescue fund created has little use however as it is massively underfunded, unable to bail-out a country the size of Italy for example. Without the ability to bail out countries, the EU could break up, a topic politically avoided. Ulrike Guerat of the European Council on foreign relations expresses fear in his paper that rather like the Soviet Union, the EU would go down quickly if the euro started to break up, showing a general worry that if a country like Greece (in the worst condition in the eurozone) defaults on its debt and leaves the euro, it could have a domino effect on the rest of the EU, with Portugal and Ireland very vulnerable to any shocks in the market.

An additional structural problem with the euro was that there wasn’t a political union. George Soros (2011) stated “the euro is a flawed construct “by which he meant the euro needed a stronger political union behind it. He then went on to suggest a single-pan European Union welfare state would allow for the creation of one fiscal and monetary policy for all of Europe. The EU faces constant bickering from different members over different policies, and struggles to achieve a united front at times. One such example was with foreign policy, where the UK and France agreed to intervene in the conflict in Libya, while Germany decided against joining in, showing that a conflict in interests can divide the eurozone. The United States of America is a good body to compare the European Union to as it shows the difference of being united politically. The Economist supports this argument, stating “America created political union followed by a fiscal union. But Europe is doing things backwards, creating the euro in hope of fostering political union”. EU policy has long been seen as being dominated by the central nations, with Germany suggested as having a lot of sway in the decision making process. This has stemmed from EU policy benefitting Germany before the crisis; as a weak currency meant they could export their goods more easily and low inflation was suggested to be focused on strongly because of German fear of hyperinflation, indeed the European Central Bank’s main policy is to control inflation.  This has been resented by the periphery nations which feel they are not represented in EU policies. The EU parliament has long been an institution with little power, with the economist describing it well, suggesting they measure “themselves against America’s congress without having its means” meaning that unlike Congress, they have little sway in uniting different countries inside the eurozone and although it can decide how to spend the EU money, it cannot dictate how it is raised. The EU parliament gained mores powers in 2009 after the Lisbon Treaty to monitor national budgets but any decisions have to be debated between two other bodies; the European Commission and the Council of Ministers while all the major topics like education and health are decided by national governments. This sort of system keeps the different nations separate and makes decision making a long and tedious process. The German Chancellor, Angela Merkel, has spoken of a potential “political union” for the EU with a strong parliament, showing the lack of one originally has been realised as a mistake by the leading figures of the EU.

The final structural problem found with the euro was the lack of equality throughout the EU. There is a vast difference between the economies of the central nations and the economies of the periphery nations. Germany has been a highly competitive saving nation since the euro’s creation whiles the “PIIGS” countries (Portugal, Italy, Ireland, Greece and Spain) were the complete opposite; uncompetitive in production and too reliant on credit to finance themselves. This meant the capital flowing into these countries created a wage boom which saw wage growth rise above productivity growth, while Germany’s wage growth remained moderate meaning they could remain competitive over their rivals. A rigid labour market meant that when the financial crisis hit, real wages couldn’t adjust quickly enough in the periphery states, which coupled with an inability to devalue their currency led to a deep recession for these countries. Rogoff (2012) argued that the lack of labour mobility in the euro was a big problem, suggesting “if intra-eurozone mobility were anything like Mundell’s ideal, today we would not be seeing 25% unemployment in Spain while Germany’s unemployment rate is below 7%” meaning the eurozone is not one of Mundell’s optimal currency areas. Zemanek (2010) produced some facts, saying “while Germany and Austria broadly kept unit labour costs at the level of 1999. In Iceland, Portugal, Spain, Greece, Italy and the Netherlands unit labour costs have increased significantly – by up to 30% compared with 1999” showing how competitive Germany had become compared with most other countries. This inequality throughout the eurozone has destabilised the EU, leading to hugely contrasting current accounts; with Germany having a big surplus and Greece having a large deficit.

We can use the idea of an optimal allocation to show the problems with inequality in the eurozone. An allocation (consumption of an individual in an economy) is only an optimal allocation if it is both efficient and equitable. We can judge efficiency by using the idea of Pareto efficiency: that no-one can be better off without making another individual worse off. A lot of allocations can be pareto efficient but still be unfair however, for example if one person has 7 apples and another 3 this would be considered pareto efficient. To make the allocation equitable, it needs to maximise social welfare (benefit society). A good model to show this is the Utilitarian model, which shows an economy of two individuals, where a UPF curve shows the pareto efficient utilities of both consumers and the social welfare function curve shows the point on the previous curve where the allocation is both pareto efficient and equitable. In the case of the EU, the redistribution of endowments in the market is the responsibility of the EU government and they haven’t done this effectively, as the imbalances between different countries shows. Germany is highly productive, export more than they import and have high employment, this is in contrast with Greece where they import more than they export, have high unemployment and have low productivity. The EU needs to fix these sorts of problems, where jobs are available in some areas of the eurozone and non-existent in others. They could do this by producing more public sector jobs in areas that have low unemployment or improving infrastructure to attract private industry, but this will be hard as countries in the eurozone still have individual governments (not in the EU’s power) and political mistrust between countries will interfere in the sharing of resources e.g. Germany are unlikely to agree with strengthening their rivals in the market. A more unified European Union, as discussed in earlier points, in the shape of a real political union could help different countries become more equal in the EU.

Map showing the different debt to GDP ratios of the countries in the eurozone. This shows the contrasting levels of debt in the eurozone; with Greece, Italy, Portugal and Ireland in much worse positions than France and Germany. This inequality is bad for the EU and a collective measure of the debt would help sort out these issues. (Economist, 2011).

However, it cannot be said that the euro was all bad. Most of the countries that joined the EU experienced big growth in the period up to the crisis. Yannos Papantoniou (2011) found that in the years 1999-2008 compared to 1989-1998, the eurozone countries experienced; 1% lower unemployment, 1.1% lower inflation and GDP growth of at least 5% each year (excluding 2003). The periphery nations like Spain and Greece experienced big economic growth (with Greece growing larger than the eurozone in 2003) which has seen their standard of living for their people improve greatly. During this period life was good for those nations, despite it being financed by debt, and their business sectors and infrastructure were upgraded in the process.  Having the same currency also meant countries could trade with each other much easier without the need for different exchange rates. The euro has benefited businesses in Germany and France (whose main customers were in Europe) and tourism for countries like Greece and Spain (whose economies rely on this sector) as there were no longer any transaction costs for each country and made prices in each country relatively equal and transparent. Also it is comparable to look at Iceland who possesses a single currency and has had troubles with volatile exchange rates due to changes in the market. This shows the problems that each country could still be facing if they hadn’t been part of the euro; highly vulnerable to any changes in the world market like rises in oil prices or commodity prices. Papantoniou (2011) supports this stating “the growth of output seems to have been stabilised in the euro area since the end of the 1990’s. Although the eurozone has not been the only area enjoying this decline in volatility of output growth, the convergence of economic policies of the eurozone countries coupled with a steady monetary policy of the ECB in its response to major events, such as the global economic downturn in the early 2000’s”. By employing data over 1982-2002, De Sousa and Lochard (2005) found that the euro has raised flows of foreign direct investment within the euro area by 62%.

Another benefit of the euro has been the safety net that each nation in the eurozone now possesses. Since the euro crisis, Greece and Ireland have had to be bailed out by the EU and IMF, this wouldn’t have happened had they not been part of this union that they can fall back on. The EU can’t afford to let any nation default as it could trigger a domino effect, so all the countries in the eurozone will continue to help bailout any countries in need to stop another crisis. Also, though countries like the UK do have the option of de-valuing their currency that members of the euro don’t have, it does have negative effects. The Federal Union website supports this stating “devaluation leads to reduced living standards, higher inflation and creditors deprived of full repayments abroad” with the last factor leading to countries losing their credible reputation with foreign investors. White (2011) reiterated this stating “For the citizens of an open economy who want to enjoy cross-border trade and investment, and want to have a trustworthy currency, the option of their central bank to devalue carries a near zero or even negative value, while the benefits of membership in a common currency area are important and positive”. He went on to suggest “The euro has so far held its value better than the drachma or the lira or the peseta used to” meaning the countries in the eurozone could have been much worse off had they not shared a currency and seen their economies lose their value. Tilford (2012) suggests that the EU compares favourably with its rivals, stating “Eurozone members as a whole … have a lower budget deficit than the US and the United Kingdom, and a similar level of public debt. Unlike the US and the UK, the eurozone in aggregate is running a current-account surplus” though the problem is whether to perceive the EU as a single organism or a host of multiple countries. The economist also found that “Prior to the crisis, Italy’s government was running a primary surplus and bringing down its debt-to-GDP ratio. So long as markets were prepared to finance Italy’s old debt at low rates, it was in good shape. Now, of course, markets aren’t prepared to do that” showing not all the nations now in trouble were spending outrageously, it’s just that once markets were spooked it effected some fragile economies in the eurozone like Italy. The European Central Bank also managed to keep its inflation rates at low levels throughout the euro (at around 2%), an important step in making sure a problem of hyperinflation didn’t spread through the eurozone.

In conclusion, the euro has some fundamental problems that need to be solved if it is to survive. The first two problems are interlinked, as the EU cannot have one monetary policy and multiple fiscal policies. The EU will need to either centralise the fiscal policy of the eurozone, giving more power to the EU parliament over taxes/government spending or give up some of its power over monetary policy and allow countries to print their own euros with some sort of maximum limit in place. The first choice seems the most likely as the EU continues along a current path of greater unification (bailing out countries to keep the EU in existence) and this could result in Eurobonds, as a way of reducing borrowing costs for each country and creating a safer asset for the EU. The current structure of the EU has political fractures between different governments, as countries fight for their own interests, this will need to be sorted by giving more power to the EU parliament and getting rid of current trade barriers between nations. The vast inequality will need to be treated too, as contrasting statistics between central and periphery states (budget deficits, current accounts) will continue to split the EU. A solution could be to have a system like that in USA where the richer states can transfer funds to the poorer states; this is basically in use now in the eurozone as countries like Germany and France are being forced to bail-out their neighbours. The last fundamental problem of having no preparation for a crisis is already being resolved, as the recent Euro Crisis has caused countries to stop either living fiscally irresponsibly (Greece) or to stop relying on certain  markets (Spain too reliant on construction market). There is also more regulation over fiscal activity and bank credit, which was badly missing from the original set up and encouraged nations to live beyond their means. The euro did allow growth in poorer regions of Europe, but this was financed by easy debt. While the safety net it now provides relies on the belief that the countries footing the bill will continue to decide the costs of bail outs outweigh the costs of a breakup of the euro. Instead there should already be a lender of last resort set up, the European Central Bank for instance, which can help out any country and already have been financed by years of savings from each country. These points add up to suggest the euro was in fact doomed from the start due to innate problems in its structure and the only way it can survive in its current form will be through reforms in its monetary and fiscal policy and its political unity.

Daily chart: The maths behind the madness | The Economist


Daily chart: The maths behind the madness | The Economist.

A great graph by the economist showing the different debt levels of countries and what the IMF is predicting in the next few years.

At the centre of it all


HQ of the EU in Brussels.

The Euro crisis ceases to go away, after protests erupted last week in Spain and Greece over tough austerity measures. This followed a relatively calm period in the storm; as Germany’s constitutional court ratified the ESM bailout fund, Holland elected pro-euro parties and Mario Draghi announced that the ECB would buy unlimited bonds from weak euro economies. But despite this the EU is continuing to do badly, with an estimated decline of 0.5% of GDP across the region and unemployment averaging at 11.3% of the population.

In the middle of all this stands Belgium, at the centre of the EU. The country shares its capital city, Brussels, with the rest of the European Union and is the location to many of Europe’s governing bodies. The country understandably supports the EU strongly, with calls for deeper integration and more centralized power. But is the country setting the right example for the other periphery economies?

Mario Draghi’s promises won’t keep the peace for long. 

This year GDP is only expected to rise by a miniscule 0.1%, hardly an improvement for a country that was expecting to be in the middle of a recovery by now. The country also boasts a budget deficit of 3.4% of GDP, not as high as the likes of Spain or Britain (6.8% and 8.4% respectively) but not quite as low as the likes of Germany (0.3%) or even Italy (2.8%). Alongside this the countries debt to GDP ratio is near 100%, a statistic more representing of the unstable southern economies than the prudent northern economies. For a country that sits in the heart of the EU, it would be expected that they would have better finances than that, especially if they are calling for fiscal decisions to be made by a more centralised EU. The interest rates on the 10-year bond yields of a country are always a good way to measure how confident the international markets are with that nation, Belgium’s are at 2.58%, roughly in between the low rates of Germany and Britain (under 2%) and the high rates of Spain and Italy (above 5%). This paints the picture of an economy that is distinctly average, not in danger of being pulled into the current crisis’s of Spain and Italy, but behind the leading economies like Germany and Poland. More importantly, the volume of exports has decreased this year, with the current account swinging from a surplus into a deficit of 0.2% of GDP. This is a bad sign for an open economy that has famously relied on trade in the recent past, with rising production costs and more of an emphasis towards the service sector helping to lower the exports of the country.

A graph at The Economist shows the forecast current account for Belgium swinging into a deficit. 

But there are mitigating circumstances and Belgium as a whole is not doing too badly. When you consider that Belgium is a country reliant on trade to the rest of Europe, then small growth is to be expected when other euro economies are implementing austerity measures. The budget deficit is also only just above the agreed limit for eurozone economies and the government is clearly implementing austerity measures itself so as not to ensure it loses control of its finances. They approved a €11.3 billion package of cuts at the end of last year, rose the retirement age of its people and have already dropped the deficit from the 3.8% level it was at in 2011. The country boasts a lot of positives as well; an excellent infrastructure, strong trade links and high skilled workers. In fact, Belgium is one of the few countries to have higher economic activity than they did back in 2008 at the height of the crisis.

This graph shows that Belgium were ranked 20th in the world for infrastructure in 2011. 

The real problem lies in the future of Belgium. As long as the eurozone crisis rattles on, Belgium cannot legitimately expect to recover from its deep recession years. Were the likes of Greece to default on their debts, Belgium would be highly susceptible to a possible domino effect as markets got spooked and banks runs started occurring in the weaker economies. The country was already downgraded last year by the much feared credit agencies and the estimated growth in the next few years does not generate much enthusiasm with just 0.8% growth next year and 1.3% the following year, notwithstanding any setbacks in the global economy. The downgrade occurred largely because of the forced bailout of Dexia (a Belgium bank), where the Belgium government had to buy their division of the bank for €4 billion and help secure 60.5% of their state guarantees, this following a previous bailout of the bank back in 2008. This was a drain on the states resources and shone a light on the countries worryingly fragile banking system, where another large bank Fortis (the 20th largest business in the world according to revenues in 2007) fell apart after the financial crisis and was sold off in parts. The weakness in the banking sector is systematic of the rest of Europe, as weak banks now have to be re-capitalised by their governments, in deep contrast to their American counter parts who had to go through strict stress tests to ensure they were strong enough to compete in the market. This could be an expensive problem for Belgium to fix and set back their recovery even more. In fact, a survey carried out by Deloitte found that the percentage of CFO’s that believed the economy would recover by the end of the year fell from 60% in March to 20% in June, while 25% believed it wouldn’t recover until after 2014.

The above table found in the Wall Street Journal shows Dexia’s exposure to the fragile economies of the EU, a worrying trend in Belgium banks. 

So while other struggling euro economies are trying to build back up lost competitiveness or pay back uncontrollable debts, Belgium is waiting for these countries to pick up and consequently for trade to begin flowing again at pre-crisis levels (as three quarters of its trade is with Europe). With its fortunes so closely tied to the rest of Europe, Belgium will hope its calls for tighter integration start to pick up momentum.

Is a Brixit possible?


Britain has always been the odd one out within the EU; declining to adopt the euro, going against general European opinion in “liberating” Iraq and generally having a poor reputation with the rest of Europeans. More recently David Cameron vetoed the European Fiscal Compact last year (tightening fiscal rules for countries in the EU) while Britain’s foreign secretary was excluded from a group of eleven European foreign ministers in trying to come up with a solution for the Euro crisis over the last year. Furthermore, Britain is also very hard to fit into the general pattern that has emerged in Europe, that of prudent northern nations and reckless southern nations. The likes of Germany and Holland lived within their means and are now footing the bill for the likes of Greece and Portugal that are drowning in their own debt and cut off from the international markets.

Britain would be considered one of the Northern nations geographically, but has finances more like those of Spain (another troubled country). For example, a high budget deficit to GDP ratio of 8.3% resembles Spain’s slightly lower ratio of 6.8% rather than Germany, who boast a far lower deficit to GDP ratio of 0.3%. But while Spain are facing talks of a bailout and bond yields near the levels of those that had to be bailed out (5.9% on ten year bonds), Britain are comfortably paying extremely low yields on their 10 year bonds, at 1.86% recently. Some argue this is because Britain holds the confidence of the international markets, as it still holds its AAA credit status, had a budget deficit reduction plan (albeit rather unsuccessful so far) and importantly has its own currency – allowing it to depreciate externally.

A graph showing the difference in the UK and Spain’s 10 year bond yields. 

But just because Britain’s position within the EU is hard to place, it doesn’t mean they should leave, so next we will look at the positives and negatives for staying in the EU. A big positive is that the UK is part of the world’s largest single market, with free trade within the EU boosting the UK’s exports and imports (with protectionism not allowed). For example, 51% of the UK’s exports are to the rest of the EU, accounting for around £200 billion. Another benefit is the free movement of labour within in the EU, which has seen 3.5 million jobs created that are directly or indirectly linked to the EU. This also works the other way as Britons are allowed to move freely to different countries to find work. Both these measures help in cutting the regulation for firms and individuals as well, that for too long strangled the opportunities for business between different countries in Europe. For example the 27 different currencies made trade between multiple countries much more complicated and created instability as currencies could appreciate or depreciate too readily. Lastly investment is a bonus, as the UK is a good entry into the rest of the EU market for foreign firms, with the UK receiving £28 billion in 2009 from FDI. That is not to mention the increased togetherness of Europe now, with war highly unlikely and diplomatic relations at an all time high. But eurosceptic’s will argue differently, pointing to the current-account deficit of £33 billion in the first quarter of this year (a deficit to GDP ratio of 2.1%)) and the ever increasing contributions to the euro budget that outweigh, some think, the benefits that Britain receives.

UK FDI inflows in 2010 near $50 billion. 

I would argue that being part of the EU has benefited Britain over the years, but that the real question is whether they should leave now? Britain is facing the costs of helping to bail out countries that have struggled to depreciate while being part of the euro, a currency that Britain doesn’t actually use. These bailouts have stemmed from a euro crisis, which is having a clear negative effect on Britain’s exports, investments and confidence. A full scale break-up of the EU would have dire consequences on Britain, as the nation’s banks are heavily linked with the rest of Europe and could conceivably collapse as part of a domino effect.

Showing the exposure of UK’s banks to the Eurozone. 

Even considering that the EU doesn’t implode and instead moves towards further integration, is that where Britain wants to head towards? The country is already an outsider for having a separate currency; any further integration would surely lead to the adoption of the euro. It would also mean more loss of sovereign powers, as budgets would be decided in Brussels, debts spread across the whole union and credit transferred across countries to those nations that need it most (as what happens with the USA and its states). A country already angry at the loss of sovereign powers to the European High Court would be very reluctant to transfer even more control to central Europe. Another problem of further integration is that many believe this could only happen by shrinking the union itself. If so, the dropping of some unwanted countries would reduce the markets open to Britain substantially, reducing the benefits (more trade) of the single market and making the idea of staying in the EU more unattractive.

The nation’s future with the EU is clearly in doubt, with both possible outcomes leading to a big change in the relationship the country shares with the rest of Europe. For years it has gained all the benefits of being partly integrated and now it is facing all the problems. A referendum seems unlikely in the near future, as the public’s views is tainted with all the current media storm about the euro crisis, while the government would do better than to revolve the next election on whether the country stays in the EU.

So for now Britain will remain on the sidelines, as Europe moves towards an uncertain future, but sooner or later the nation will have to make a choice.

No tenemos dinero… Beneath the glamour Spanish football is going broke | Just Football


No tenemos dinero… Beneath the glamour Spanish football is going broke | Just Football.

New article up on Just Football by me, on Spanish Football and the economic problems the country is experiencing. Click on the link to have a read 🙂

Why there’s more in Draghi’s may-day speech than markets realise | Economics Intelligence


Why there’s more in Draghi’s may-day speech than markets realise | Economics Intelligence.

 

Great piece on what Draghi really said.

Cyprus’s Choice: A Failing EU Or Corrupt Kremlin?


The pillars of Cyprus’s economy could be crumbling.

A small country that sometimes slips under the radar is now facing serious problems. Cyprus’s economy is intertwined with that of Greece and the country is now in need of a bailout. But while the other countries in the eurozone have been acquiring these funds from the EU, Cyprus has been taking from the hand of Russia. Last year Russia issued a €2.5 billion emergency loan to help out the country and is now rumoured to provide another loan of €5 billion. This would account for a quarter of Cyprus’s GDP and will help save its troubled banks, which are heavily exposed to the messy Greek banking system. It has been estimated that if Greece were to exit from the euro, the Cypriot banks would require a capital increase of around €9 billion or in other terms 50% of their GDP.  In total the Cypriot banks owe around €152 billion, roughly eight times the country’s GDP, and this will need to be brought down over time.

Cyprus is in a tough situation as it can no longer borrow freely from the markets after it was given “junk” credit status, with long term government bond yields currently at 7%.  This means the island now relies on loans from either the EU or Russia, but which is the better option?

Most would probably argue the EU is the safer option, and makes more sense as Cyprus is part of the eurozone. But the government is wary of the tight austerity measures the EU have placed on the other members that have asked for bailouts, something a Russian loan does not include. The country would almost certainly be forced to lose its low corporation tax, currently at 10% (compared to the UK’s at 24%) which has helped Cyprus become a tax haven for companies. So the country could turn to Russia again, with the Russians having a vested interest in the safety of the Cypriot economy. A lot of Russian money is currently in the tax haven that is Cyprus, while newly found natural gas resources have been found off the south coast, an appealing thought for Russian companies. But this only masks the real problems; Cyprus cannot avoid the economic reforms that the EU proposes forever. Taking a Russian loan just prolongs the process of returning to the markets, it’s not like Russia will provide loans every year for Cyprus to run its country.

2010 levels of Corporation tax in the EU. Cyprus possess one of the lowest tax levels. 

The country has other problems to deal with as well. The economy is expected to decline by around 1% this year after slow growth of just 0.5% last year. The slow growth was partly explained by the Evangelos Florakis naval base explosion, which was reported to have cost the country up to €3 billion (17% of GDP). Unemployment in the country remains high at around 10% and youth unemployment even higher at near 30% of the population, a worrying statistic for a country so small. On top of this the Cypriot government had to cut their budget by €120 million to get its deficit under its intended target of 2.5% of GDP, which have seen cuts in public worker salaries and an increase in the VAT. This is to help tackle the huge debt the country possesses, currently over 70% of GDP. This isn’t to mention the divide that runs through the island, separating Greek-Cypriots and Turkish-Cypriots, which disrupts the country’s economy. Talks have been ongoing but a lack of compromise from Turkey means tensions are as high as ever.

The no-mans land separating Northern and Southern Cyprus.  

Things aren’t all gloomy for the country however. They remain part of the EU, which still largely benefits them more than it hinders them. Without such protection, their currency could have proved very volatile to changes in the market, while the EU will continue to offer help to the county accepted or not. The fears of the country’s economy imploding are also not as dangerous as some would think, the costs sound high, but with a bailout fund of nearly €500 billion, the EU could afford to rescue such a small economy.  The real danger is that whatever causes Cyprus’s economy to fail (e.g. Greek exit) might cause a country like Spain or Italy to fall, which would crash the whole European market. In these circumstances Cyprus could be forgotten in all the uproar and its people left in a country with no working economy. Such a nightmare scenario remains rare, with the hopes that Angela Merkel and the other European leaders will finally agree on a path out of these worrying times.

Can the major leaders of Europe agree a solution?

For Cyprus, the big question right now is whether they should borrow from Russia or the EU. One promises short-term relief while the other would help concentrate the government on fixing the economy. Let’s hope the Cyprian government makes the right choice, but something tells me the Russian money will win out for now.

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