Thursday, April 9, 2009

Difficulties Facing European Economies

The current economic crisis is often seen as an Anglo Saxon crisis. Originating in America and affecting the UK the most. Many European leaders (Germany and France) felt (hoped) they would be relatively insulated from the crisis because of their relatively lower exposure to the banking crisis and slumping housing markets. However, data suggests that the recession is hitting all economies - even those without the same exposure to volatile housing markets.

Problems Facing Europe

  • Slump in Global Trade. The EU has become increasingly reliant on world trade. The global downturn has seen a sharp fall in exports; this has particularly affected Germany. In February Germany saw industrial production fall a record 2.9 percent. In Italy it was -3.5%
  • Unemployment. Already high, EU unemployment is likely to keep rising. Spain, which has a forecast of GDP growth of -3%, could see unemployment touch 19% by 2010.
  • The Euro has Proved Strong. The strength of the Euro is a mixed blessing. On the one hand it insulates countries from an Icelandic style meltdown. On the other hand many Eurozone countries are suffering from a strong Euro. This is especially the case for fringe Eurozone members like Greece and Spain - where rising wages have made their exports very uncompetitive.
  • Housing Market Slumps. Whilst the US and UK have witnessed spectacular housing slumps, unfortunately it could be much worse for countries like Ireland and Spain. Both economies became reliant on a construction boom that has switched to a slump. Combined with excess supply, bubble prices, and a shortage of banking credit, house prices could fall significantly creating many problems for economy - see problems of falling house prices.
  • Lack of Flexibility. The Euro provides currency stability. That is desirable in the present situation. But, unfortunately, it limits the response of European countries to the crisis.
  1. Firstly, it removes option of depreciation to improve competitiveness (surely Greece and Spain would like to devalue, like the UK has benefitted)
  2. Secondly, the ECB are more conservative in cutting interest rates and adopting unorthodox measures such as quantitative easing.
  3. Thirdly, EU countries have proved more reluctant to pursue expansionary fiscal policy - either because of large public sector debt (e.g. Italy over 100% of GDP) or a fiscal conservatism and concern over borrowing too much.
  • Eastern Europe. Many eastern European countries are facing even more serious problems. e.g. Ukraine's national debt has been labelled highly risky. There is pressure for the EU to bailout their eastern neighbours - or even admit them into the Euro. But, both policies would place a strain on the Eurozone which faces enough of its own problems.

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