What has Affected the European Economy in the Last Decade?

The European economy has had its fair share of ups and downs in the last 10 years. The recurring economic crises that plagued the European economy for a decade finally seemed to let up in 2016.

According to data released by the EU, the economy of its member countries, which use the euro as their domestic currency, improved 0.6% in the first quarter of 2016, as compared to the previous quarter. This caused the annual GDP to touch 2.2%, slightly higher than the record GDP reached at the start of 2008.

The economic crisis may be over for now, but there are still some after-effects that Europe’s core economy continues to experience. Several events from the last decade have played key roles in determining the fate of the European economy.

1. The Lehman Brothers Crisis

US investment bank, Lehman Brothers, filed for bankruptcy on September 15, 2008. At the time of its collapse, the bank had assets worth $639 billion and debt amounting to $619 billion. This was a highly critical event, the ripple effects of which were experienced by economies all over the world.

What made this bankruptcy filing such a huge crisis was that the assets possessed by the bank were much more than other large bankrupt companies, such as WorldCom and Enron. Lehman Brothers was the fourth largest investment bank in the US in 2008, with a global workforce of 25,000 employees.

The Lehman Brothers collapse made the effects of the 2008 market crash even worse and removed around $10 trillion worth of market capitalisation from the world’s equity markets. This caused major damage to the European and other world economies.

Reason for the Collapse

The Lehman Brothers’ downfall was brought about by the subprime mortgage financial crisis in the United States, the effects of which echoed throughout the global markets in 2008. During the US housing bubble of 2003-04, the bank acquired five mortgage lenders. These included Aurora Loan Services and BNC Mortgage, which were subprime lenders.

At first, the decision seemed wise since the Lehman Brothers’ real estate business drove revenues up from 2004 to 2007. The investment firm also reported a 10% increase in securitised mortgages from 2006. There was unprecedented growth, with net income of $4.2 billion on revenues of $19.3 billion.

But the credit crisis of August 2007 turned the entire market on its head. Due to the failure of two Bear Stearns hedge funds, the investment bank’s stock price plummeted. As a result, the company had to close down its BNC unit. This was possibly the first nail in the Lehman Brothers’ coffin.

2. The European Debt Crisis

Also known as the European Sovereign Debt crisis, this was a multi-year debt crisis that started at the end of 2009. This was a period filled with collapsing financial institutions, a rise in bond yield spreads and high debt in many European countries.

A number of Eurozone members were unable to repay their debts or bailout over-indebted banks, without the help of other member countries, the IMF or the European Central Bank. The European countries that faced this situation included Ireland, Cyprus, Portugal and Spain. The crisis reached its peak between 2010 and 2012.

Contributing Factors

The collapse of Iceland’s banking system marked the start of the debt crisis. It then spread to Portugal, Italy, Ireland, Greece and Spain.

The factors that contributed to its repeated occurrence were the financial crisis of 2007-08, the great recession of 2008-2012 and the crash of the real estate market. Apart from this, fiscal policies related to government expenditure and revenue were also involved.

Direct Impacts and Remedial Measures

Due to the recurrence of the Sovereign Debt crisis, there was a feeling of mistrust and fear of excessive debt among lenders. As a result, they demanded higher interest rates from Eurozone states in 2010.

Some of the more affected countries, such as Greece, increased taxes and put austerity measures in place. This increased social disturbance and led to a further decline in people’s confidence in their leaders.

In addition, many countries had their debt downgraded to junk by credit rating agencies, increasing fears in investors’ minds. To address the growing concerns, 17 Eurozone members voted to establish the European Financial Stability Facility (EFSF) in 2010. This was followed by the EU collectively creating the European Financial Stabilisation Mechanism (EFSM) in 2011.

3. The Brexit Referendum

Since the historic referendum of 2016, where Britain voted to exit the EU, there has been a lot of talk about its impact on the European economy. The immediate impact was seen in the decline of the value of the pound sterling to its lowest since 1985, following the Brexit decision.

According to the Bank of England, the UK economy is 2% smaller than it would have been if the vote had gone the other way. The output lost since the referendum result has been around $1 billion per week.

This damage has occurred despite no changes being made to the trading regulations between the EU and Britain so far.

The Road Ahead for European Economy

Due to the furor over the Brexit decision, many other important issues have been put on the back burner by the EU. Going forward, the biggest problem for the EU will be its rapidly ageing economic model. Unlike the US, which currently has innovative companies such as Google, Facebook and Amazon, Europe’s economy seems like a distant memory of a bygone golden era.

There are no European companies engaged in emerging technologies and this can pose a serious threat from the accelerating world economies. For instance, China is taking giant strides in Artificial Intelligence and Machine Learning. This is one of the reasons why US President Donald Trump considers China a target, rather than Europe.

The introduction of the euro as a unified currency has not paid the dividends that were predicted 30 years ago. The latest reports on the health of the Eurozone economy show weak growth. Italy is experiencing its fifth recession in the last 20 years, while the export-dominated economy of Germany is being affected by a global slowdown.

The Eurozone is expected to grow by a meagre 0.2% in the first three months of 2019, which is the same as the last three months of 2018. These issues need to be taken into consideration while framing new policies in order to ensure growth for the European economy.

What has Affected the European Economy in the Last Decade?

1. The Lehman Brothers Crisis

Reason for the Collapse

2. The European Debt Crisis

Contributing Factors

Direct Impacts and Remedial Measures

3. The Brexit Referendum

The Road Ahead for European Economy

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