Mathew Higgins and Thomas Klitgaard explore the impact of heavy borrowing by countries within the Eurozone area before 2010. The authors observe that majority of the countries are suffering from a debt crisis. In this context, it is evident that a debt crisis is preceded by a loss of investor confidence. In most cases, private investors disregard lending services to debt-ridden countries. To understand the circumstances of European countries with a debt-crisis, the authors explain the causes and challenges associated with the same.
From the article, the sovereign debt crisis started before 2010 and still ongoing in several countries within the Eurozone area. Countries such as Greece, Ireland, and Portugal are known for the debt crisis prompting an intervention from the International Monetary Fund (IMF) and the European Union (Higgins and Thomas 1).
The authors explain the sovereign debt crisis in the Eurozone area by associating the same with continued foreign borrowing. The emergence of the European Economic and Monetary Union was a major factor that led to heavy borrowing from foreign investors. Interestingly, countries such as Greece and Portugal did not suffer from the debt crisis during the late 1990s. The article identifies low-interest rates as a factor that led to increased use of foreign capital in supporting domestic consumption. In this context, the periphery countries such as Greece failed to focus on productivity-enhancing investments.
By focusing on Greece, the authors highlight the large current account deficits that persisted for many years. In any case, Greece was embroiled in a vicious cycle of fiscal austerity measures to counter the continuous credit risks. In addition, the country’s economic position before 2010 was characterized by a frail fiscal deficit, low tax revenues, a housing boom, and ailing bank sectors. In this context, it is difficult to determine whether Greece and other European periphery countries will manage to restore private investment inflows and markets in the future.
The authors’ explanation about borrowing and lending by countries within the euro area suggests that Greece had already experienced saving imbalances prior to 2007. In fact, this is evidenced by a deficit of 10% to 15% of the GDP by the end of the same year. The creation of a common currency especially through the European Union was detrimental to Greece. Apparently, Greece was used to high inflation that is critical to the devaluation of currencies. Devaluation of the Greece’s currency resulted in lower interest rates for borrowed money. Although such a strategy was meant to encourage foreign investors, it resulted in increased current account deficits. From this perspective, the strategy discouraged foreign investors from establishing operations in Greece. From an economic perspective, high current account deficits are detrimental to a country’s credit worthiness.
According to a saving-investment matrix, the risks associated with a current account deficit depend on higher investment or reduced savings. In the case of Greece, the current account deficit developed as a result of reduced savings. Consequently, this resulted in increased domestic consumption and potential debt crisis. Before the emergence of the global financial crisis in 2008, Greece’s savings had reduced by 8% of GDP in the previous year.
Another strategy of understanding the economic situation in Greece is the analysis of private consumption spending. However, this is only applicable for the country’s real estate investments. Apparently, the consumption spending on private real estate investments increased rapidly between 2003 and 2008 before the decline in subsequent years.
Moreover, the authors explain the increased household debt ratio as a key indicator of the deteriorating economic situation in Greece. For example, the household debt ratio for Greece has increased from 26% to 75% between 1999 and 2007 (Higgins and Thomas 5).
Greece’s competitiveness in external markets is decimal compared to other countries within the European Union. The unit labor cost in Greece has increased by about 15%, therefore, lack of competitiveness. In addition, the country’s lack of competitiveness is caused by a slow growth in exports. Since the inclusion of Greece in the Eurozone area, the country’s lack of competitiveness is attributed to the new trade regulations within the European Union’s trading block.
A comparison of Greece with other European periphery countries such as Spain, Portugal and Ireland reveals that IMF and other Eurozone establishments are critical to reviving the country’s economy.
The immediate response by the Eurozone countries and the IMF was bail Greece from the debt crisis. The gradual process of ensuring that Greece improves competitiveness has been promoted through a weak exchange rate. In addition, the IMF has advocated the abolition of strict regulations against foreign investors. The idea is to improve productivity among the country’s manufacturers and foreign investors. The Eurozone countries through the ECB control saving imbalances from the member states. In this context, the ECB has assumed the mandate of regulating operations of the central banks. The Eurosystem ensures that the country’s saving imbalances are regulated using other central banks within the Eurozone. For example, the country’s central bank can transfer functions to a similar financial institution within the European Union.
Work Cited
Higgins, Matthew and Thomas Klitgaard. “Saving imbalances and the euro area sovereign debt crisis.” Current Issues in Economics and Finance 17.5 (2011). Print.