Cause and Effect in European Politics and Law

Can the Council for Mutual Economic Assistance be a solution?

Adelina Marini, May 30, 2010

You have for friends a family in which the woman has a reduced ability to work, due to illness, and the man has not graduated university and suffers from gambling. This family has two children and a constant lack of money. They attempted to take a loan, covered by their apartment but the relatives of the family rescued them because they could now allow them be left in the street. They constantly ask for loans - for many years. The husband does nothing to increase the family's incomes and the wife, in spite of her wish, cannot work.

After many years no one wants to give this family a loan because people know that they will never see their money back - it will either be spent in a bingo game or would be "eaten". What should this family do?

This situation is quite similar to countries like Greece, Spain, Italy and others that suffer from a constantly falling competitiveness (meaning they have nothing to offer to other states to buy from them), from "the lazy philosophy" in the labour market and from heavy indebtedness. All this is additionally fed up by the nervousness of global markets which react sharply to each news about the situation in those countries.

And while it is still not certain whether all rescue efforts for Greece calm the markets, now we have Spain headed toward the fate of its akin southern economy. Only a month after the Standard & Poor's rating agency downgraded Spain's rating, on Friday another rating factor in the world's economy (Fitch) did the same. The reason for the agency's decision was that Spain's economic recovery is sluggish, a not very successful process of rescuing savings banks is going on which makes the government's forecasts more optimistic than reality allows.

Rating agencies' behaviour and their significant influence on international markets has been a subject of serious debates ever since the peak of the global financial and economic crisis. Most political leaders in the world expressed disagreement with the way the rating agencies work and vowed for more control. The issue of rating agencies, however, is quite similar to the one which is the first - the egg or the hen - or which is the primary reason for the Greek crash for example? Is it the piling of debt for years, combined with dropping competitiveness or is it rating agencies' and investors' behaviour?

And what exactly are the rating agencies? In a very simple analysis CNN explains that their purpose is to provide an independent assessment of companies, states or financial products' capability to pay off their debts or investments. The assessments vary from the highest AAA to the lowest - D. Investors all over the world need their analysis in order to decide where to bet their money in the markets. The main agencies are three and all are American - Standard & Poor's, Moody's and Fitch.

And here's the logic in Fitch's assessment, quoted by the BBC: "The economic adjustment process will be more difficult and prolonged than for other economies with AAA rated sovereign governments, which is why the agency has downgraded Spain's rating to AA+". It also warns that the lack of flexibility in the labour market and the restructuring of regional and local savings banks will influence the speed of adjustment, especially after the property boom.

The issue here is that many of the 45 savings banks operating in Spain have struggled after investing heavily in the property sector, causing a boom in construction before its collapse following the financial crisis. Now these banks have to deal with debts worth 445 bn euros, according to the Goldman Sachs.

Separately, Spain has an enormous problem with unemployment - 20%. The fiscal deficit was 11.2% for 2009 and the debt to GDP ratio exceeds 100%, while the requirement of the Stability and Growth Pact is 60%. It is the debt however that is making the boat rock.

A little after the EU approved a rescue mechanism for Greece, the European leaders started to work out another mechanism in order to insure against the "Greek contagion" which might infect Spain, Portugal, Ireland, Italy and others. After the decision of a second rating agency to downgrade Spain's rating the question not whether but when Spain will ask for assistance is being raised. The problem here is that this will additionally shake the positions of the euro and the confidence in the European single currency. The internal tension in the euro area will increase which would probably lead to a series of smaller or bigger "explosions".

In the end of the day, everything is reduced to the initial conclusion about confidence. If we go back to the example of the family in the beginning of the article - a lot more efforts will be necessary to make lenders and investors believe that they can invest or lend because they see that things are going up. Regretfully this scenario is less probable because the countries with troubles have already entered the vicious circle - they need trust in order to get money to realise the necessary measures but no one wants to lend because of the lack of trust. The situation gets further complicated because of the lack of trust within the eurozone itself.

What is the solution? Given that the problematic countries suffer from low productivity and competitiveness, they need to find a way to stimulate interest in their production. One of the ways is restructuring the economy, aimed at finding that sector which can deliver incomes and be attractive for investments, by being in the same time safe from ballooning as happened with the housing sector. The problem with this way is that it takes years which will make a country ask for loans and stay in the vicious circle.

If the European Union was the former Council for Mutual Economic Assistance (in which all former communist countries were members), the problem would have been easy to solve - production will be allocated among countries and the rest will be obliged to buy it. But as the EU is not CMEA, it has to find its own formula for economic integration. Thanks to the crisis there is almost no one who still thinks that it is possible for an economic and monetary union to exist only based on a single currency. In the same time, some countries' resistance continues to be strong.

But this, however, would mean only one thing - a growing gap between strong developed countries and the weak ones, when the first would have to choose between paying the debts of the latter or break away in a Super League. This is hardly the future the EU is looking for and which could be of any benefit for the European citizens. After all, we all remember the sad end of the CMEA, caused exactly by division (between the countries) and isolation (from the rest of the world).