Background to the crisis

The main factors leading to the finan cial crisis of 2007–8, as it played out in the European Union, are summar ized in Figure 2.1. In the early 2000s, the European Union and the United States exper i enced strong economic growth, much of it as a consequence of increases in private debt fuelled by high levels of foreign invest ment, easy access to credit and low interest rates (European Economic Advisory Group 2012). Rapid growth led to arti fi cially high wages and prices in some parts of the European Union, partic u larly in coun tries on the peri phery, which in turn contrib uted to signi fic ant imbal ances within the Eurozone in

18 Economic Crisis, Health Systems and Health in Europe

terms of compet it ive ness. In countries that had joined the Eurozone, these imbal ances could no longer be addressed through changes in exchange rates.

Low interest rates and high levels of foreign invest ment also led to increased demand for housing and prop erty, pushing up prop erty prices. Because invest ment in prop erty appeared to be finan cially secure, finan cial insti tu tions began to offer invest ment instru ments backed up by mort gage values. After housing market bubbles in the United States and several European coun tries peaked around 2006, and prop erty prices began to fall, finan cial insti tu tions and others exposed to mort gage- backed secur it ies lost consid er able wealth.

Many finan cial insti tu tions did not have enough assets to cope with such large losses, creat ing a crisis in liquid ity and trust – a major trigger of the finan cial crisis.

As finan cial insti tu tions became tech nic ally bank rupt, govern ments respon-ded by guar an tee ing bank depos its and backing strug gling finan cial sector compan ies. This in turn led to signi fic ant increases in public debt. With economic growth no longer a given, investors ques tioned the ability of some govern ments to service their debts. What had started as a finan cial crisis now began to look like a public expendit ure crisis and, in some coun tries, a sover eign debt crisis.

Before the crisis, trends in public debt and in the fiscal situ ation more gener ally varied signi fic antly across coun tries in Europe. Countries like Greece and Italy had high levels of public debt relat ive to the size of their econom ies, while Portugal had amassed defi cits since the 1970s. In contrast, coun tries like Iceland, Ireland and Spain were in surplus from 2003 to 2008.

Yet these coun tries also faced sharp increases in the cost of borrow ing in the Figure 2.1 Causes of the finan cial crisis in the European Union

Source: Authors.

years after the finan cial crisis, as levels of public debt rose rapidly. In Ireland, the sheer size of the govern ment guar an tee of private debt placed the country in a diffi cult finan cial situ ation. The differ ence between private and public debt became largely irrel ev ant; any worsen ing in the situ ation of the finan cial markets directly affected govern ment finances; equally, any threat to the govern ment’s ability to service its debt had consequences for the solvency of the finan cial system.

For coun tries in the Eurozone, exit from the Euro was quickly ruled out on the grounds that the economic and polit ical shock would be too great. The only option avail able to Ireland, Portugal, Greece and (later) Cyprus was to ask for inter na tional finan cial assist ance from the International Monetary Fund (IMF), the European Central Bank and the European Commission (Table 2.1). The economic adjust ment programmes (EAPs) agreed with the Troika (as the three insti tu tions came to be known) required ‘auster ity’ – a sharp down ward fiscal adjust ment in public spend ing relat ive to reven ues – and a range of market- oriented reforms. The agree ment for Greece included an expli cit commit ment to cut public spend ing on health by a signi fic ant amount. However, many coun-tries without Troika- determ ined EAPs followed the same approach, often in response to pres sure to meet EU fiscal rules on deficit and debt levels. Lower public spend ing and higher taxes contrib uted further to reduced consumer demand, which had already fallen due to the drying up of credit, leading to a

Table 2.1 EU coun tries receiv ing inter na tional finan cial assist ance since the onset of the crisis

Country Years Type of assist ance Amount

Hungary 2008–10 Multilateral finan cial assist ance (EU, IMF) €14.2 billion Latvia 2008–12 Multilateral finan cial assist ance (EBRD, EU,

IMF, World Bank, bilat er als) €4.5 billion Romania 2009–15 Multilateral finan cial assist ance (EIB, EBRD,

EU, IMF, World Bank, bilat er als) €20 billion Greece 2010–16 EU–IMF EAP to support macroe co nomic

adjust ment €237.5 billion

Ireland 2010–13 EU–IMF EAP to support macroe co nomic

adjust ment and banking sector restruc tur ing €67.5 billion Portugal 2011–14 EU–IMF EAP to support macroe co nomic

adjust ment and banking sector restruc tur ing €78 billion Spain 2012–13 European Stability Mechanism to recap it al ize the

banking sector €41.3 billion

Cyprus 2013–16 EU–IMF EAP to support macroe co nomic

adjust ment and banking sector restruc tur ing €10 billion Source: European Commission (2014).

Note: EAP = economic adjust ment programme; EBRD = European Bank for Reconstruction and Development; EIB = European Investment Bank; EU = European Union; IMF = International Monetary Fund.

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rapid rise in unem ploy ment, a drop in living stand ards and negat ive economic growth. By this time, what started out as a finan cial crisis had turned into an economic crisis.

There has been consid er able debate, in the current crisis, about the effect ive-ness of auster ity in helping to restore a country to fiscal and economic health.

Research on the impact of auster ity on economic growth is incon clus ive (Alesina and Ardagna 2010; Guajardo et al. 2011). Some argue that spend ing cuts have stifled growth by dampen ing demand in the economy. The IMF, for example, in review ing its strategy towards Greece, noted that it had made over- optim istic assump tions about how demand would develop in the face of large public spend ing cuts (IMF 2013). The IMF has also found that stronger planned fiscal consol id a tion in Europe was asso ci ated with lower economic growth than expec ted, espe cially early on in the crisis (Blanchard and Leigh 2013).

Others argue that the contro versy is more one of degree than of overall strategy, and that the real issue is whether fiscal adjust ment should be pursued more or less rapidly.

Three points emerge from this simpli fied analysis. First, it was not only irre-spons ible fiscal policies that resul ted in crisis, but also inad equate economic and regu lat ory policies. Second, policy responses played a crit ical role both in address ing and escal at ing the crisis. For example, govern ment guar an tees of very high levels of private debt in response to the initial finan cial crisis made a sover eign debt crisis more likely. In turn, sharp reduc tions in public spend ing in response to high levels of public debt and high borrow ing costs have facil it ated economic crisis in some coun tries. This is partic u larly evident in the case of unem ploy ment, as the next section shows. Third, the degree to which coun tries have been affected by the crisis in its various forms has differed markedly across Europe. Some coun tries barely felt its effects. For others, the effects have been far- reach ing and are likely to be felt for years to come. In the follow-ing sections we try, where possible, to differ en ti ate coun tries based on the nature and magnitude of the crisis they faced, although this is not always straight for ward (Keegan et al. 2013).