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The Financial Crisis and the European Union

Dr. Marek Wroblewski (University of Wroclaw, Poland) Visiting International Fellow at the Alworth Institute has contributed this web log on financial crises. He writes: It is general knowledge that there is a financial crisis not only in the United States but also amongst European economies and in the world more generally. It would be hard to miss such significant news. But what is a financial crisis? How is it experienced, in the various countries of the European Union (EU), and what are its consequences?

A financial crisis is a significant event or circumstance that hinders the routine functioning of financial markets. Financial markets help distribute financial resources to, amongst other things, investment projects. Crisis events may appear in various forms and affect different segments of the market. A financial crisis may be experienced in a variety of ways: as a dramatic fall in the external value of a currency; a breakdown in the banking sector; a crisis in the stock market; a debt crisis. A crisis in one area may have a consequence in another. This may be considered normal since financial markets and processes permeate all aspects of the national and international economy. The very nature of this part of the economic system facilitates a speedy transmission of market information from one country to another. This makes contemporary international economic relations particularly susceptible to financial crises. Their highly destructive implications place a heavy burden on the global economy as a whole.

The financial crisis as experienced in the countries of the EU is highly complex. The financial crisis has impacted all European financial markets. Stock markets have experienced dramatic falls in stock values. Capital markets have been disrupted. The operation of a number of significant financial institutions has been hindered by the lack of liquidity and some banks have been threatened with bankruptcy, leading to special action by the financial authorities. Building sectors, construction and property have encountered problems but only the UK has experienced losses in value in the private housing market that are equivalent to losses in the United States. The consequences of all of this taken together have been felt in the real, as opposed to the monetary, economy. The impact has been significant.

The present economic breakdown in Europe is possibly the most serious economic crisis since the end of the Second World War. Highly destructive effects of the crisis with more expected to come have already been experienced. Industrial production in the EU taken as a whole fell in 2008 by 11.5% (EUROSTAT estimate). GDP in the same period fell by 1.3%. The deterioration in members states has varied with dramatic declines in GDP having been seen in Estonia (-21%), Spain (-19.5%) and Sweden (-18.5%) and less dramatic outcomes experienced in Germany (-2.1%), France (-1.2%) and Italy (-1.8%). During 2008 however the most recent members of the EU maintained slow growth. Since then most of the Central European economies have experienced significant problems as the impact of the financial crisis has come to be felt in Hungry and, given the financial interrelationships, also in Austria. Unemployment grew overall by 1.2%. This overall figures masks significant problems in Spain. Germany is the biggest European economy and if the situation in Germany continues to deteriorate with the further loss of international and regional export markets, further problems will be experienced. European countries outside the EU, particularly Russia and the Ukraine, have also felt the negative consequence s of the financial crisis.

Most European countries are attempting to muffle the impact of the recession. The really significant measures are taken by national governments and these are of an internal and independent nature. Most government expenditures to counter-act the recession are focused on infrastructural projects and to support banks and other financial institutions. There is a problem in that increased government expenditure results in increased government deficits unless fiscal policy is also tightened. Benefits through expenditure must be set against the loss of consumer spending through tightened taxation. Countries in the Euro-zone are constrained to keep any deficit within prescribed limits and this in itself, in principle, imposes a form of financial discipline not applicable, for example, to the UK. Fiscal tightening is, as of this week, now also part of the UK’s approach. The concern is to avoid future inflation. The European Central Bank has acted to reduce interest rates and is prepared to take further action should this be required. It is worth noting that amongst economists, there is no settled view as to the effectiveness or otherwise of the package of measures that have been put in place.

With respect to the EU as a whole, the commission has accepted a stimulus plan but this is, when compared to actions by national governments, relatively modest (amounting to US$ 5 billion). Energy-saving investment projects and rural development projects are targeted. The EU has also accepted a US$50 billion aid package for new member states and has allocated funding to strengthen the International Monetary Fund. Such actions will have potentially beneficial consequences for some Central European economies such as Hungry. The development of a European Institution concerned with financial supervision to help prevent future de-stabilizing bubbles is under investigation.

One clear point of principle has emerged from the otherwise unsatisfactory, and indeed politically disputatious, process of finding a unified and coordinated approach to the various crises. Essentially countries have made their own responses that relate to their self-interest as interpreted by the politicians. The European Commission has made it clear that the Single Market is not to be sacrificed to economic expediency. France, for example, had tried to impose protectionist conditions on any state-aid to industrial firms such as car makers. This is a significant point of principle. There will be further strains to encounter particularly if new members in Central Europe continue to experience long-term problems when the crisis has passed elsewhere.