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European Union-Crises of Confidence

By | on November 4, 2016 | 0 Comment

britishAfter the end of the 2nd WW, Europe became the world’s 2nd most prosperous region after the USA mainly due to America’s generosity in the form of the Marshall Plan and the military protection it provided under NATO. Although Washington Consensus provided an ideal financial and economic environment for the developed and the developing countries alike to expand their economies, it was a shot in the arm for Europe. Starting from a strong base, European countries were able to benefit most from this congenial environment. Lastly, one of the main reasons for its phenomenal success was the creation of an increasingly integrated and dynamic trade and economic union among its largest states-the European Union.

However, after more than three decades of its existence as a powerful economic block, EU is facing an existentialist threat. The house that visionary leaders built in the aftermath of world war 2 is in the midst of major and multiple crises. Falling rates of growth, rising unemployment, external threats and increasing frustration among the masses about the state of affairs in their respective countries are swinging the public opinion to the left and even far right.  While British people have voted to leave EU, questions are increasingly raised in the other member countries about the advantages of the European Union. There is also a growing distance with the US on security policies, especially relations with a resurgent Russia and a rising China.

Causes of the Crisis

The crises European Union is facing are neither new nor are entirely due to exogenous factors. These are the combined result of demographic changes, foreign policy decisions made and socioeconomic policies pursued by the EU member countries during the last several decades. Some of the structural reasons for the crises can be traced to the following;

Demographic Transition: Europe’s population has been declining over a period of time for various reasons-economic prosperity, social welfare state, women empowerment, religious skepticism and breaking family ties are some of the reasons for this decline. Ratio of the young who contribute more to the economy and demand less is decreasing while those of the aged who are spending less and demanding more on their healthcare is increasing. Consequently, there is a secular decline in the indigenous aggregate demand on the one hand, there is increased healthcare expenditure on the other.

Unnecessary Expansion: Idea of creating a United Europe started with the conquest of Charlemagne, promoted by the Holy Roman Empire and eschewed by Napoleon and Hitler. Despite centuries of efforts Europe could not be untied. Post war European leaders tried to do in a few decades what their predecessors could not do in centuries. Small countries like Greece, Spain and Portugal embraced the European Community as the avenue to prosperity and NATO as the guarantor of their security.

Bigger countries used it for expanding their markets. Collapse of the Soviet Union brought East Germany, Poland, Hungary, Czechoslovakia, Latvia, Lithuania and Estonia into the European Union. The fragmenting Yugoslav states followed. Bailing out these too many poor, underdeveloped countries in such a short time was too much for EU; it not only stretched the limits of the bigger partners, it resulted in creating an unmanageable European Empire which is falling apart at the seams.

Immigration: It is affecting the EU in diverse ways. With few exceptions, UK being one of them, Europe’s failure to fully integrate its immigrant populations had already resulted in their self-alienation, social marginalization and economic deprivation. Suspicion of and discrimination against Muslim communities increased after series of terrorist attacks. Arrival of hundreds and thousands of refugees fleeing conflicts in the Middle East and Africa — conflicts largely created by the Western-aided overthrow of authoritarian regimes, has further worsened the situation.

In the backdrop of rising joblessness, strict rules on immigration are hindering to fill the labour shortages in critical areas; the manufacturing costs are increasing making European goods and services non-competitive, forcing the European businessmen to invest in Asia, further compounding the crises

Deindustrialization: Europe has been witnessing a gradual deindustrialization for the last several decades due to internal and external reasons. Like any mature economy, it has seen rapid expansion of its service sector with resultant shrinking of its industrial sector. While inadequate investment in R&D has resulted in less than satisfactory growth in science and technology, strict rules on immigration are creating labour shortages in critical areas as well as increasing the costs of doing business. Consequently, European goods and services are becoming increasingly noncompetitive, forcing the European businessmen to invest in Asia, further compounding the crises.

At the same time, former developing countries are catching up with the West producing high tech goods at lower costs which has not only reduced the chances of western exports but also giving them tough competition even within EU. If China is becoming expensive because of its increasing labor costs and appreciating currency, others are taking its place. Policy of zero rate of interest in the hope of reviving the economy is not working, as there is less borrowing by the private sector because of overall recession.

Creation of Single Market did provide a greater market but the increasing costs of production have precluded any possibility of its reversing the deindustrializing. Excessive employment protection legislation and reduced competition in the goods markets have further complicated the situation. The enormous costs of maintaining a welfare state is now adversely affecting the economic health of most of the countries

Euro Zoning: Paradoxically, the most crucial reason for the present crises is the creation of Euro because of its structural contradictions and implementation flaws. Creation of the Single Market did enable the lower-wage countries to grow through trade and investment flows. However, with the launch of the single currency, the advantage of the ‘poorer’, peripheral members of the Union was significantly neutralized. The more efficient countries, especially Germany, became the dominant producers and exporters, within and from the EU. Growth in the poorer member countries was maintained by the extension of credits. With basic necessities met, the money flowed mostly into non-productive sectors, like real estate and stock markets, creating ‘bubbles’ which burst once the contagion of the US sub-prime bubble collapse spread to Europe in 2008-9. Now the weak members despite their financial frugalness is creating pockets of permanent underclass in a prosperous Europe. Probably European countries were trying to do too much in too short period of time without sacrificing their sovereignty—the first casualty of any such endeavor.

Economic Policies: The situation became irreversible due to certain policies of the EU. Not taxing the agriculture, rather granting them huge subsidies, under taxing some lucrative sectors, and proverbial loop holes which produce scope for tax avoidance are resulting in less than potential revenue collection. Recession has already reduced the taxation base while mismanagement of tax collection is also denting the kitty. On the other hand, the state expenditure on welfare and wars have bankrupted the states resulting in infrastructure decay. Similarly, the monetary policy of zero rate of interest in the hope of reviving the economy is not working, as there is less borrowing by the private sector because of overall recession. It is only helping the governments borrow money at dirt-cheap rates and inflate the debt profile.

Foreign Policy Decisions: Europe has unfortunately no foreign policy; all its foreign policy decisions are merely an extension of American strategic thinking. Consequently, Europe has started a new confrontation with a resurgent Russia with whom several members have strong economic relations. The confrontation was the consequence of the American strategic push to extend NATO influence ever closer to the borders of Russia, in its soft belly of Ukraine. At the same time, Libyan fiasco alerted Russia and China to flock to the support of Bashar ul Assad of Syria, leading to civil war without end in a region which is almost a soft belly of Europe. Besides losing Crimea forever, Europe is now not only facing the challenges of terrorism and mass scale inflow of civil war migrants but also bearing the brunt of the economic fallout from the reciprocal sanctions, interruptions of Russian gas supplies, and lost contracts. At the same time, Europe’s old security fears have been revived by Russian air and naval patrols along NATO’s edge. The Baltic states are near panic. Unlike the past, Europe and NATO are ill prepared to confront a newly muscular Russia. The US, preoccupied with the Middle East and a rapidly rising China, is unlikely to deploy the large numbers of troops it had in Europe during the Cold War.

Global Recession: The Global Financial Crisis of 2007-2009 have left deep scars on many economies and are still shaking the world economy. The response of the Eurozone countries was reactive and inadequate, revealing the structural weaknesses of the region. Eurozone governments had to abruptly reverse their fiscal stimulus when massive public debt of Greece prompted it to default in 2012. Fearing a Domino Effect, Portugal, Spain, Ireland, and Cyprus were bailed out by an EU-backed fund and the IMF.

Since March 2015, the ECB has resorted to Quantitative Easing (QE) which has no doubt contributed to pushing down long-term interest rates. However, it has had a modest impact on private investment; rather it has eroded the profit margins of Euro banks. Lower bank profitability prompts bank to avoid riskier deals; it may have a negative impact on the supply of loans which can have an adverse effect on growth and investment in real projects. Several experts claim that this excess of liquidity is actually fuelling a rise in asset prices.

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