Southern Europe and the Financial Earthquake

Coping with the First Phase of the International Crisis

Susannah Verney, Anna Bosco, Marina Costa Lobo

• Publisher: Taylor & Francis
• Year: 2016
• Print ISBN: 9781138803107
• eBook ISBN: 9781317622352
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

Following the outbreak of the international financial crisis, Southern Europe became an epicentre of economic instability and international concern. The prospect of a sovereign debt default in the eurozone's 'flaky fringe' sent shock waves through the European and global economies. Examining the crucial initial phase, when the financial crisis was just beginning to spill over into the real economy, the volume surveys the impact of the September 2008 Lehman Brothers' collapse across the EU's southern periphery. The six South European eurozone members – Italy, Greece, Spain, Portugal, Cyprus and Malta – are viewed in comparative perspective with EU candidate state and non-eurozone member, Turkey. In an era before the spectacular EU/IMF bailouts, the picture that emerges is one of national differentiation, illuminating these countries' different starting points and varying policy responses in the face of the gathering financial storm.

This book was published as a special issue of South European Society and Politics.

Flaky Fringe? Southern Europe Facing the Financial Crisis

Susannah Verney

The introduction to this special issue notes how the financial crisis has revived long-held concerns about the potential impact of Southern Europe on the economic cohesion of the European Union and the eurozone. The article outlines the brief of the special issue (geographical scope, time period covered) and suggests that expectations of a South European eurozone withdrawal are unrealistic.

The international financial crisis has acted with the destructive power of an earthquake. In mere months, it has transformed the landscape as supposedly solid edifices have swayed and cracked. The seismic shocks have triggered an economic crisis, whose depth and duration analysts can only begin to guess at. Already the first phase has seen significant effects, not only in international trade and investment, but also rippling out to such diverse fields as government spending, migration flows and holiday habits. While the full picture of its long-term effects is not yet discernible, the crisis seems likely to impact on multiple aspects of social and political life. The emergence of new economic winners and losers has the potential to alter social relations and affect patterns of political representation. Already there appears to be the beginning of ideational change, with a challenging of ideas and assumptions which have previously influenced public policy.

Thus, for scholars of contemporary Southern Europe, as for other regions of the world, the crisis and its consequences have already become a factor that cannot be ignored in our research, regardless of our specific individual fields of study. While the crisis is clearly important for Southern Europe, the latter also has a special significance for students of the crisis, especially in Europe. Within the European Union, as the financial storm clouds began to gather, the potential weakness of Europe’s south rapidly emerged as a focus of concern. This reflected what has been described in the Financial Times as ‘a real and sensitive issue within the Union: the fear that it is economically and politically divided between a northern hard core and a flaky southern fringe’ (Rachman 2009).

It was in the 1970s, when Greece, Portugal and Spain applied in turn for admission to the then European Community, that such concerns first surfaced. The admission of a group of less developed economies with weak state structures was viewed as a potential threat to the pace and cohesion of the economic integration process. In a decade when the global ‘North–South’ divide had become a highly salient international issue,¹ it appeared that the fault line between developed North and developing South was about to be reproduced within the EC, with existing member states Ireland and Italy also potential members of the less developed group. It was at this time that the idea of a ‘two-speed community’, in which integration would advance at a faster rate among those able to maintain the pace, was first proposed as a way of resolving this problem.

In the late 1980s, following the EC’s Mediterranean Enlargement, the presence of a group of less developed states within an EC already embarking on economic deepening led to the formulation of a Community cohesion policy to reduce the internal development gap. Then, in the early 1990s, the advent of Economic and Monetary Union once again highlighted the ‘Southern Question’ on the Community agenda. Under the programme for EMU, two-speed economic integration became a realistic prospect. Historical experience, particularly of the notoriously unstable Greek drachma and Italian lira, led to fears that South European participation in the new European currency could fatally weaken it. But with the tough criteria formulated at Maastricht for entry to the third stage of EMU, it appeared that the euro would be launched without Europe’s South. At that time, the countries of what has subsequently become known as ‘Old Southern Europe’ (Greece, Portugal, Italy and Spain) were so far from meeting the criteria concerning national debt, budget deficit, inflation, interest rates and currency stability that it seemed impossible they could do this by the end of the decade.

However, during the course of the 1990s, the Southern Four confounded all expectations. Following the implementation of strict economic stabilisation programmes, Italy, Spain and Portugal all qualified as founder members of the third stage of EMU in 1999 and were joined by Greece in 2001. As a result, in all four, as in the other eight original eurozone members, the euro became legal tender on 1 January 2002. Instead it was three northern member-states, the UK, Denmark and Sweden, which remained outside the eurozone, in their case by choice and not by exclusion.

The South European success story was comparatively short lived. The image of South European reform received a significant blow in 2004, when a survey of public finances by the incoming Greek government suggested that the country’s eurozone admission had been achieved by some particularly creative accounting, which had been more extensively employed than in the case of other eurozone entrants. Meanwhile, for the Southern Four, eurozone entry had weakened the incentive to continue the fiscal discipline of the 1990s, as the financial markets tended to assess the level of risk of public debt in all the eurozone countries as almost identical, disregarding national differences with regard to the health of public finances or economic competitiveness.

Analysts assessing the long-term sustainability of the euro continued to regard the South European presence as a source of vulnerability. Such fears were enhanced in 2005 when Northern League members of the Italian government suggested Italy should leave the euro. In his 2006 working paper entitled Will the Eurozone Crack?, Simon Tilford of the London-based think tank, the Centre for Economic Reform, suggested that Italy was the EMU member state ‘most likely to trigger a crisis’, with a ‘40 per cent probability’ that Italy would leave the eurozone and the Italian situation already at ‘five minutes to midnight’ (Tilford 2006, pp. 1, 46, 41). His scenario was based on financial markets finally responding to Italy’s declining competitiveness by raising the cost of Italian public borrowing, thus eliminating what had until then been one of the major advantages of EMU membership. Given that it was no longer possible to use currency fluctuations to enhance competitiveness as so often in the past, Tilford surmised that Italian political elites and public opinion would turn against the euro. He suggested that other South European countries would then be forced to follow Italy out of the eurozone in order to be able to compete with it (Tilford 2006, pp. 1, 47).

In response, Wolfgang Munchau in the Financial Times suggested that Spain was more likely to leave the eurozone than Italy. Although identifying a different chief suspect, his analysis maintained the spotlight on Southern Europe. However, reflecting a more generally held view that the costs of eurozone withdrawal would be too high to offer a realistic option, Munchau concluded that the chances of either country voluntarily exiting the eurozone were ‘still small’ (Munchau 2006).

With the development of the international financial crisis from 2007 and its deepening in autumn 2008, fears of a eurozone breakup became common currency in the international press (e.g. Spiegel 2009). The ‘Italian question’ resurfaced (e.g. Evans-Pritchard 2008; Codogno 2008) but was soon overshadowed by the fallout from the bursting of the Spanish housing bubble and what Charles Grant (2009) described as the need to ‘beware of Greeks bearing debts’.

The market for government bonds had responded to the crisis by displaying widely varying levels of confidence in bond issues by different eurozone governments, resulting in sharply differentiated national borrowing costs. The worst affected were the group dubbed by The Economist (2009) as ‘the profligate five’, consisting of the Old Southern Four plus Ireland. In January 2009, their poor fiscal positions resulted in Greece, Spain and Portugal having their international credit ratings downgraded.² The debate on the eurozone’s southern Achilles heel thus refocused from the possibility of a voluntary eurozone departure to the prospect of a South European debt default. Even a year earlier, such a prospect had seemed ‘inconceivable’ (Tilford 2009b).

Whether or not accompanied by eurozone withdrawal, a member-state default would be deeply damaging to the credibility of the euro as a whole. The result was a fierce debate in the early weeks of 2009 about whether the eurozone should ‘bail out’ an ailing eurozone member, thus overturning a basic rule of the single currency. This was accompanied by some speculation, even in the habitually eurosceptic Economist (2009), that the flaws revealed by South European weakness might encourage deeper integration to protect the euro, although this did not appear the most likely prospect (e.g. Tilford 2009b).

Southern Europe has thus been central to European concerns in the midst of the crisis. The focus has once again been on ‘old’ Southern Europe, this time with particular emphasis on Greece and Spain. However, in covering the crisis, South European Society and Politics, in accordance with the journal’s usual practice, has also included the three states of ‘new Southern Europe’. This allows an examination of the major EU candidate state, Turkey, which is not a eurozone member, as well as of the small island economies of Cyprus and Malta, both of which joined the EU in 2004 and the eurozone in 2008. In the case of Cyprus, the area in the north which is not under the control of the government is also outside the eurozone and has a special economic dependence on Turkey. This special issue therefore includes three large, two medium and two very small countries, while at the same time covering six eurozone economies and two non-eurozone cases.

This special issue began life as a contribution to the journal’s South European Atlas section of short, informative articles on topical issues. Thanks to the enthusiasm of the contributors and the significance of the topics addressed, it rapidly outgrew its original brief and developed into a fully fledged special issue. However, while the issue has expanded in size and scope, its aims remain modest: they are, quite simply, to survey the impact of the crisis and the policy response to it in each of the South European countries during the crucial first phase, while leaving a more ambitious and far-reaching assessment for later. For the purposes of this special issue, the first phase is interpreted as the months immediately following the deepening of the international financial crisis in September 2008 up to late February/early March 2009 when the final versions of the articles were delivered.

The country cases collected here clearly present a picture of national differentiation. Each economy faced the crisis from a different starting-point. For example, Spain and Greece both experienced high growth rates in the years preceding the crisis while Italy and Portugal were already in a phase of low growth. Government responses to the crisis also present a picture of variation. Nevertheless, it might be useful to summarise a few general points.

Southern Europe’s problems in the financial crisis did not originate within the indigenous banking sector. By international standards, South European banks had relatively low exposure to toxic assets. This was a direct result of the lesser degree of internationalisation and development of the national banking systems which, as several of our authors point out, paradoxically proved an advantage in the crisis. Thus, Southern Europe was not Iceland and there were no spectacular Southern bank failures or rescues.

However, this lesser exposure of the national financial sectors could not insulate Europe’s South against the global shock. In Old Southern Europe particularly, heavy public indebtedness left our states vulnerable to the financial storm, as the new nervousness of the international money markets resulted in soaring borrowing costs which plunged public finances into crisis. Meanwhile, as elsewhere, the mutual loss of confidence among credit institutions led to reduced credit flow, causing the financial crisis to spill over into the real economy.

In some cases (e.g. Spain), the international crisis aggravated an economic contraction that was already under way, while in others (e.g. Malta) the latter seems to have been rather the product of external shocks. For old Southern Europe especially, the international crisis has highlighted existing problems of competitiveness. A common feature of all our South European countries concerns the important economic role of tourism, a sector which has already proved particularly vulnerable in the crisis. As several of our authors note, the deleterious impact in this sector has been aggravated in the case of our eurozone members by the strong euro. Meanwhile, in coping with the crisis, there have been some common elements, such as increased state guarantees for bank deposits, but essentially each national government has followed its own route. For example, the increase in infrastructure spending noted in the case of the government of the Republic of Cyprus is an option which has been explicitly rejected by Greece.

Finally, while South European difficulties in the midst of the crisis raised expectations in some quarters that ‘the Greeks would smash the crockery and march out of the eurozone’ (Rachman 2009), our examination of the South European cases shows such an assessment to be wildly unrealistic. It ignores the immense significance which eurozone entry played in South European politics as a major national goal and achievement. Particularly in Old Southern Europe, meeting the Maastricht criteria was seen as proving that the Southern poor relations could match their northern partners and attain a place at the centre of the European integration process. Eurozone withdrawal, negating their national success stories, would entail a major loss of national status with serious negative consequences, not only in the practical realities of day-to-day EU politics, but also at the symbolic level of national identity.

While Nobel Prize winner Paul Krugman, writing in the New York Times in January 2009, suggested that ‘in Spain’s case (and Italy’s, and Ireland’s, and Greece’s), the euro may well be making things worse’ (Krugman 2009), our authors indicate that during the first phase of the crisis this view was not widely shared within the South European eurozone members. On the contrary, the initial impression is that the crisis, and especially the travails of those European countries outside the eurozone, has had a positive influence on public attitudes towards the euro. The latter, a popular prospect during the 1990s in South European states with weak national currencies, as a post-2002 reality acquired a more negative image due to its association with price inflation. In contrast, during the first phase of the crisis, the euro was seen as offering protection against the currency speculation and even more onerous credit terms that South European countries might otherwise have faced.

Clearly, this special issue cannot offer the last word on the subject of Southern Europe and the crisis. Inevitably, a project of this nature entails a number of dangers, given that its subject ...

Table of contents

• Cover
• Half Title
• Series
• Title Page
• Copyright
• Contents
• Citation Information
• Notes on Contributors
• 1. Flaky Fringe? Southern Europe Facing the Financial Crisis
• 2. The Response to the Global Financial Turmoil in Italy: ‘A Financial System that Does Not Speak English’
• 3. After the Fiesta: The Spanish Economy Meets the Global Financial Crisis
• 4. The Return of the Greek Patient: Greece and the 2008 Global Financial Crisis
• 5. Back to External Pressure: Policy Responses to the Financial Crisis in Portugal
• 6. Wobbling but Still on its Feet: The Turkish Economy in the Global Financial Crisis
• 7. Cyprus in the Global Financial Crisis: How Lack of Banking Sophistication Proved an Advantage
• Postscript March 2014
• 8. Malta’s Open Economy: Weathering the Recessional Storm?
• Index