Photo Gallery: Southern Europe Stuck in Economic Doldrums


Downward Spiral Southern Europe Remains Stuck in Crisis

For years, EU leaders have been trying to put a stop to the debt crisis that has been tearing apart Southern Europe. They have made little progress. Is it time for a change in strategy? By SPIEGEL Staff

Spanish top models strutted on the stage to the sounds of flamenco music. They were wearing tightly fitting clothes made by their country's most famous designers and presenting plates of bold tapas creations by Spanish chefs.

Staged in the middle of the European Parliament in June, the show represented a rebirth of sorts. "We have something to offer to the world. We are not just a land of crisis," said Foreign Minister José Manuel García-Margallo. And he hopes to use the blend of fashion show and cooking event to present the Spanish brand name, the "Marca España", to the world. It comes with a promotional video proclaiming that Spain has the "world's best bank," the largest number of installed solar panels of any country across the globe and a big heart. The Iberians, the video notes, are also unbeatable when it comes to the number of organ donors.

But will that be enough to lead Spain and the rest of Southern Europe out of the current crisis? There is plenty of room for doubt on that score.

Aside from the lender praised in the video, Banco Santander, Spain has a weak savings bank sector with an uncertain future, all efforts to rehabilitate it notwithstanding. And despite the many reforms, government debt and unemployment are still on the rise in Spain, while the economy remains stuck in recession. And Spain remains one of the more hopeful of Europe's many troubled economies.

The sovereign debt crisis has been eating its way through the Continent for the last four years, despite the various remedies prescribed by crisis managers in Brussels and Berlin, and at the European Central Bank (ECB) in Frankfurt. The situation in the euro zone eased somewhat after ECB President Mario Draghi's announcement last summer that he intended to do everything possible to preserve the euro. But it is now becoming clear how deceptive this period of calm was. Since US Federal Reserve Chairman Ben Bernanke announced his aim to gradually pump less money into the financial markets, interest rates have gone up considerably in both the United States and Europe.


Graphic Gallery: The Euro Crisis Refuses to Let Go


With the sedative effect of cheap money now diminishing, it is becoming clear what risks still lurk in Europe's debt-ridden economies, and that many problems remain unsolved. Sovereign debt is rising rapidly, not just in Spain, but also in Greece, Italy and Portugal, despite austerity policies and impressive reform efforts. The countries have significantly reduced spending in response to pressure from the so-called troika, consisting of the European Commission, the ECB and the International Monetary Fund (IMF). But the recession has led to a concurrent decline in revenues. In addition, devastatingly high unemployment  has led to higher government spending.

'Those Who Exit Will Lose Out'

It has created a vicious downward spiral. And economists have been left to argue over whether and how the countries in question might be able to emerge from it.

Hans-Werner Sinn, head of the Munich-based IFO Institute for Economic Research, favors a temporary withdrawal from the common currency area by crisis-ridden countries. Their products have become so expensive that it is impossible for them to compete within the monetary union, Sinn argues. After exiting the euro zone, the countries could devalue their new currencies, making imports more expensive and reducing the price of exports. It would be a drastic treatment, but in the end, at least according to theory, the patient would return to health and could even re-enter the monetary union later.

Thomas Straubhaar, head of the Hamburg Institute of International Economics (HWWI), calls such talk "cynical" and has made clear that he does not see "devaluation as a cure-all." In what areas, he asks, is Greece supposed to become competitive ? Besides tourism and a few agricultural products, he says, the country has little to offer.

"Those who exit will lose out," says Straubhaar, which is why no country will voluntarily leave the monetary union. Straubhaar believes that establishing and developing adequate economic structures is much easier within a common currency area such as the euro zone.

But those efforts have made very little headway so far, and many politicians and economists in the troubled countries believe that this is the result of strict austerity policies, for which they hold German Chancellor Angela Merkel largely responsible.

'Weak Economic Situation'

"Portugal has done a large share of the dirty work, and yet it still has high debt levels and high unemployment," says Pedro Santa Clara, a professor at the Nova School of Business & Economics in Lisbon. "There is only one solution to our problems: growth and investment." Portuguese Economy Minister Álvaro Santos Pereira also wants to see new ideas in crisis management. "Europe has to find its way back to growth and establish confidence to stimulate consumption and investment," says Pereira.

But the German government is determined to stay the current course. "The weak economic situation in the euro zone is no reason to deviate from the dual strategy of ongoing fiscal consolidation combined with structural reforms," reads an internal document from the German Finance Ministry, which argues that the present strategy has been successful .

According to the document, the structural deficit in the euro zone has been reduced by more than half since 2009, and unit labor costs, a key indicator of competitiveness, have "declined significantly." The ongoing weak growth in the common currency zone is an "expression of a deep-seated adjustment process that the euro zone is currently undergoing, and is by no means solely attributable to budget consolidation." This development is "conducive to growth in the medium term." The paper warns sharply against curbing "the necessary adjustment process," saying that a departure from the current austerity policy would "jeopardize the positive development of the last few months."

Klaus Regling, head of the European Stability Mechanism (ESM), comes to Schäuble's defense. "The euro program countries are experiencing what IMF program countries like Brazil, South Korea and Turkey experienced a few years ago." Those affected, says Regling, should consider that these countries are now growing at impressive rates, thanks to structural reform and patience.

Persistent Unemployment

At last week's European Union summit, Merkel also reined in every initiative to quickly free up more money for economic stimulus programs. "First we have to develop a common understanding of what is important for growth," Merkel said. She told fellow European leaders that she wanted to see a more in-depth debate at the next summit in October. Everyone wants growth, but some of her counterparts believe that ramping up government spending is enough to achieve growth targets, Merkel scoffed after the meeting.

The basic elements of agreements between the European Commission and individual EU countries are to be established in December, at which point a sort of solidarity fund will exist among the individual euro-zone member-states. Under Merkel's plan, more money will only be provided in return for reforms that are legally binding and subject to fixed agreements. In Brussels, the chancellor steadfastly refused to even discuss concrete amounts before such agreements are reached.

At the summit, the European leaders did approve €6 billion ($7.8 billion) in new spending to fight youth unemployment and facilitate lending to smaller companies. But this does little to change the underlying problems. A few additional billions are not enough to fix the crisis in the labor market and the financial sector, the recession and political paralysis in a few Southern Europe countries.

The Job Plight

In a sports arena in the northern Tuscan city of Prato, normally a venue for indoor soccer matches or fly fishermen displaying their casting skills, 700 young people from all over Italy recently competed for a very special prize: a job.

Some had come from as far away as Sicily to take the initial test, which consisted of answering 30 difficult questions, to enter the final round. The winner of that round will receive a position as librarian in the nearby town of Poggio a Caiano, population 10,000. It's a 26-hour-a-week position, and the after-tax pay is €900 a month.

Jobs have become rare in Italy, especially for young people. Nationwide, some 40.5 percent of Italians under 25 are unemployed, while in the south the number jumps to 50 percent. Those who do have jobs usually have only limited contracts.

The situation is even worse in neighboring Southern European countries. Unemployment in the under-25 age group tops 50 percent in Spain and Greece and is at 42.5 percent in Portugal. While politicians in Germany somewhat dismissively explain away these devastating numbers, arguing that the economies on Europe's southern edge are just not competitive and need to become cheaper, the southern countries disagree.

"It is part of Spain's character that we work longer than in most European countries," Foreign Minister García-Margallo said on the sidelines of the European Parliament fashion show. And, as Paloma López, in charge of labor policy for the CCOO trade union, points out: "60 percent of Spaniards earn less than €1,000 a month."

In addition, unit labor costs have declined and current account deficits have become smaller in Spain and other countries in recent years. But for skeptics, what some tout as a reform-policy success story is nothing more than a statistical phenomenon. After all, they argue, unproductive jobs are lost in a crisis. From a mathematical standpoint, the productivity of the remaining jobs is bound to increase.

Unskilled and Out of Work

The real problems lie in the way the economy is structured. In the years before the crisis, low interest rates led to growth, especially in the construction sector. "During the real estate boom, many young people discontinued their education and training programs and went into the construction industry, usually with fixed-term employment contracts," says Federico Steinberg, a professor at Real Instituto Elcano in Madrid. These people are now unskilled and out of work.

Nevertheless, Fernando Jiménez Latorre, state secretary for business affairs in Spain, is convinced that labor market reforms are working. "Spain is becoming more flexible," he says. "In the future, 1 percent growth will likely be sufficient to create new jobs."

But where will this growth come from? "Spain has a very restrictive and, therefore, not very business-friendly budget policy. This is good for increasing competitiveness but, when combined with only a moderately expansive monetary policy and a strong euro, it's choking the Spanish economy," concludes economist Steinberg.

The Recession

Signs on the Praça dos Restauradores in Lisbon read "Basta de Exploração," or "stop the exploitation." It's the slogan Portugal's two largest trade unions are using in their call for a general strike. And while European leaders meeting in Brussels last week celebrated their €6 billion commitment to reducing youth unemployment, trams and buses were idle in downtown Lisbon, where thousands protested against the austerity policy imposed by the troika.

Although the Portuguese government is backing the austerity policy, Lisbon is now openly demanding support from Brussels and Berlin in return. "Growth is impossible without solid government finances," says Economy Minister Pereira. "But without growth, it's very difficult to balance the budget."

The minister can cite the most recent IMF diagnosis. "The solid social and political consensus that to date has buttressed strong program implementation has weakened significantly," reads an IMF report released in June. "Economic recovery is also proving elusive." The report notes that the troika program lacks additional instruments to improve competitiveness in the short term, which is why the decline in demand will continue and cannot be offset by more exports.

Increasingly Frustrated

Spain, Greece and Italy are all in a similar position. People in all of these countries are increasingly frustrated over the fact that their sacrifices are ineffective because of the lack of growth. "We need Europe's cooperation to overcome the crisis," says Spanish State Secretary Latorre.

At least €60 billion would be necessary to overcome the current weak growth in Europe, says Guntram Wolff, director of Bruegel, an influential think tank based in Brussels. Wolff believes that stronger domestic demand would also be helpful in Germany. He wants to see the public sector finally invest more in the future, such as for R&D and daycare centers. "A boom would be good for Germany -- and for Southern Europe," says Wolff, which is why he is calling for a change to the German debt limit that would allow for deficit spending to pay for government expenditures once again.

But Brussels and Berlin rebuff such arguments. German Commissioner Günther Oettinger opposes additional economic stimulus programs. "The EU is incurring about €500 billion in new debt this year. Should we now make that €800 billion or €1 trillion?" he asks.

The Banking Crisis

Politicians from the euro-zone member states haven't been as self-congratulatory as they were at last week's Brussels summit in a long time. They agreed on key elements of a European banking union, which provides for joint supervision of the industry and rules for the winding down of ailing lenders.

"We are moving away from taxpayers constantly having to answer for the banks," Merkel crowed. Spanish Economy Minister Luis de Guindos called the agreement an "important step," while politicians in crisis-ridden Ireland even described it as a milestone.

The only problem is that every politician in the euro zone expects something different from the banking union, which is why each one is pleased about something else and the important questions remain unanswered.

Countries suffering most from the crisis hope that the European Stability Mechanism, the euro-zone bailout fund, will share more of the burden for ailing banks in the future. Germany, though, would rather see each individual country continue to be primarily answerable for its own ailing banks. Everyone, of course, wants to see creditors and taxpayers pay for losses in the future -- but they don't want to scare off investors.

In fact, though, it is still unclear  who will bear which burdens in the future and who will be responsible for re-supplying struggling banks with urgently needed capital. And that uncertainty means that Europe's zombie banks will continue to inhibit the economic recovery.

Loan Defaults

The lenders' financial difficulties are exacerbating the credit crunch. Banks have been issuing fewer loans in Southern European countries for years, and when they do lend money, it's at higher interest rates than competitors in Germany. In 2012, the volume of credit declined by almost €50 billion in Italy alone.

One reason is that the recession is plunging companies and households into bankruptcy. The resulting loan defaults are tearing new holes into bank balance sheets. In response, lenders are showing a preference for holding onto their money. The problem is especially dire among small and mid-sized companies, which account for more than 90 percent of all jobs in countries like Portugal.

When the banks are asked why they are so reluctant to lend, the competitiveness of Southern European economies is not their top concern. Rather, according to a study by the Association for Financial Markets in Europe (AFME), banks are influenced by a general sense of insecurity over the future of the euro zone and a lack of confidence in the economy. As such, attempts to address the credit crunch in Southern Europe with the help of development banks, like Germany's KfW or the European Investment Bank, are likely to be of only limited use.

Instead, Italy, Spain, Greece and co. are depending on help from the European Central Bank (ECB). "The ECB can play an important role in overcoming the credit crunch, as can the European Investment Bank," says Portuguese Economy Minister Pereira.

The ECB had hinted at the possibility of indirectly buying up corporate bonds. But because such a step is highly controversial within the central bank, ECB President Draghi abandoned the plan. Instead, he is now calling on lawmakers to finally get serious about reforms.

Overwhelmed Politicians

The mood was explosive when Greek Prime Minister Antonis Samaras recently ordered the closure of public broadcaster ERT. The state-owned media empire was a "symbol of waste and corruption," he said bluntly.

His accusation was not inaccurate. But the prime minister's summary act triggered a wave of outrage that almost brought down the entire government. After all, it was the political class itself that was primarily behind cronyism at the broadcaster. After several difficult crisis meetings, Samaras managed to avert the collapse of his coalition. A number of Greece's euro-zone partners breathed a sigh of relief; Samaras is viewed as the first truly reliable reform partner in Greece. The conservative premier has even surpassed a few fiscal goals. For instance, the government now spends 30 percent less than in 2009, and the budget deficit is predicted to be just under 4 percent of GDP this year, bringing it relatively close to European targets. The deficit was still 15.6 percent of GDP in 2009.

The problem, however, is that as soon as it's time to fight cronyism and corruption, and streamline the completely bloated and frustratingly inefficient government apparatus, even the Samaras regime begins dragging its feet in pursuit of the troika targets.

The precipitous closing of the government broadcaster, with its 2,600 employees, was not a kneejerk reaction by a politician tired of corruption. It was an act of desperation. Samaras had promised the troika that he would dismiss 2,000 government employees by this summer. But the minister charged with making the cuts had dragged his feet on compiling the necessary list.

He probably could have come up with a large percentage of the 2,000 slated job cuts if he had simply addressed suspected cases of corruption and fraud in government agencies and public companies and sanctioned the offenders accordingly. In fact, a list of some 2,300 cases had existed since February.

Currently Pending

Such instances are sometimes exasperating for troika envoys, as well as for those in Greece who would like to see the country fundamentally restructured. The entire country is like a construction site. When it comes to the fight against tax evasion, investigators are making little headway in part because many offenders went out of business long ago or have disappeared. Government agencies are overwhelmed by the task of determining which culprits are even capable of paying their fines. Furthermore, the judiciary is so inefficient that it is often pointless to take a case to the courts, where 150,000 tax disputes are currently pending.

It is thus not surprising that attracting investors to the country has proven difficult and the privatization of government assets has slowed down. Still, financing gaps are the result. Athens has already received more than €200 billion in aid money -- yet it may need more. An additional €5 to €8 billion might be necessary next year.

Reform efforts have also slowed in Italy, even though Prime Minister Enrico Letta unveiled another legal package a few days ago. But economists aren't convinced that the changes will ever be implemented.

Letta's predecessor Mario Monti, who managed to maneuver the country away from the precipice Silvio Berlusconi had created, was a miracle worker to be sure and was able to calm the markets. But he did little to fix Italy's structural shortcomings. They include, in addition to an oppressive tax burden, a bloated, incapable bureaucracy, which obstructs or smothers virtually any economic activity; an inefficient judiciary, which scares away potential investors; and poor infrastructure, including potholed streets, a failure-prone energy supply, trains that are constantly late, aging communication networks and a depressingly low educational level.

Reforms Must Continue

According to Clemens Fuest, president of the Center for European Economic Research (ZEW), respected economists believe that Italy's debt-to-GDP ratio "will inevitably continue to rise."

Economists are also skeptical about Portugal's chances of reducing to a sustainable level its sovereign debt level of more than 120 percent of GDP. And in the case of Greece, another debt haircut seems unavoidable after Germans vote this autumn.

Chancellor Merkel and the troika will have little choice but to change their strategy. So far, they have emphasized austerity measures and increasing competitiveness in the crisis-ridden countries. This may work in the long term, but they need more support until then.

Economist Steinberg criticizes lawmakers involved in efforts to save the euro for applying the same economic model to all countries and trying to create small, strongly exported-oriented economies. "Merkel's strategy could work if all euro-zone countries would export to China." But, he adds, the majority of trade takes place within the euro zone. "In other words, there have to be countries here that consume and import."

SPIEGEL reporters have spent extensive time in Southern Europe in recent weeks to study the various problems faced by Greece, Spain, Italy and Portugal. Their stories will appear over the course of the next four weeks.

The quartet of countries, they have realized, all share one thing in common: A shift in the mood is needed so that companies will be willing to invest and consumers will be willing to consume once again. Economic stimulus programs can help, but they can't produce miracles. And, as painful as they are, the reforms must continue.

In the long run, a monetary union with so many differences in cost and economic structures cannot survive.


Translated from the German by Christopher Sultan
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