Key Summary:
• Europe takes 50% of UK exports and the crisis affecting the eurozone impacts the UK market
• The rush of borrowing by some eurozone countries at the inception of the euro forced them to issue government bonds and, more recently, the borrowing of ECB loans, which some countries are struggling to pay back
• Labour costs affecting these countries has risen to a level that makes them uncompetitive in the global market, making the paying back of loans even harder
• The options available to avert more crises in the eurozone are long-term and painful for its countries to absorb
It's difficult to ignore the eurozone crisis, such is the weight of its media coverage. But it's also easy to think: "That's Europe, that's nothing to do with us in the UK." With commentators also explaining the growing significance of emerging market nations, just how important is the eurozone to the contemporary British economy?
The answer is simple. Europe takes more than 50% of UK exports and so any financial crisis in Europe is bound to affect commercial business within the UK.
How did we get here?
When governments borrow money they issue a bond which is purchased by commercial banks or institutions such as pension funds. This means that they are borrowing for a fixed term at an agreed rate, undertaking to return the cash at a predetermined point in the future.
Among the large borrowers in the contemporary eurozone market are:
• Spain
• Portugal
• Greece
These are regular names in eurozone crisis media reports.
When the EU countries entered into the euro currency, it was agreed the new European Central Bank would set monetary policy for these members. This was good news for the weaker nations because having the support of their stronger partners meant they could borrow money at much more favourable rates than before.
Helped by this cheap credit, countries like Greece, who had an Olympic Games to support, started a rush of borrowing by issuing a great quantity of government bonds.
Money out but no tax in
In Greece, much of the borrowed cash went on public sector wage rises, but without any tax increases to compensate. Debt totals rose alarmingly, and the facts speak for themselves:
• Britain's debt is around 63% of gross domestic product
• Italy and Greece owe 120% and 160% respectively
Labour costs rose alarmingly for these nations with high debt/GDP scores. Whereas German productivity has been steady for more than 10 years compared to the weaker nations – thereby reducing its unit labour costs by 3% — Greece has faced a 61% increase in its labour costs.
This has made goods produced by the nation extremely uncompetitive compared with Germany. Before the introduction of the euro, Greece could have just de-valued the Drachma until parity was reached, but now, because they are tied into the euro, Greece no longer has that flexibility.
Competitiveness grows the market
Germany's competitiveness is also allowing them to grow their economy through trade with the increasingly important and cash-rich emerging market nations. This is not open to uncompetitive eurozone countries, as their cost of goods is too high. Instead, they rely on their traditional trading markets, many of whom are similarly struggling with recession forecasts and austerity measures.
Stopgap liquidity
To help a country like Greece to recover, the European Central Bank has poured almost a trillion euros in to the European Banks. And while this is helping to plug the gap at the moment, it is becoming increasingly likely that some eurozone countries will be unable to pay back the money they have borrowed.
This would mean that any contracts placed with members of the eurozone would be at risk – they would not be able to pay for goods or services or to borrow from their banks to do so.
Some business sectors are suffering more than others from public expenditure cuts and austerity measures. For instance, pharmaceutical companies and suppliers of medical equipment are finding long delays in receiving payment for medicines and other products delivered to state-run health services.
Three options
There are various options for addressing the eurozone crisis.
• Inject enough cash into the affected countries to stabilise their economy
• Support those countries as they go through painful and highly unpopular austerity measures to get them back to being competitive
• Accept some countries withdrawing from the euro
It is worth making contingency plans for these scenarios and being aware of what business with Europe might be like under these options. Forewarned is forearmed.
Trevor Williams on the eurozone climate
Although most forecasts for this year show the UK and US in growth, the European Central Bank is suggesting that the eurozone will contract by about a quarter of 1%. With the UK reliant on Europe for 50% of its exports, this contraction affects us all.
Confidence
A loss of business and consumer confidence has meant businesses are saving rather than investing. Households are also saving rather than spending. In that environment, it's hard to engineer a recovery and explains why there has been a relapse back into recession.
Competitiveness
In order to achieve recovery, it is absolutely vital for economies to take action to ensure they are competitive. This is not only on the global stage but against countries they are locked into monetary union with.
The reality is that some eurozone countries have remained uncompetitive with high wage levels and low productivity holding back their chances of recovery.
Silver lining
Although some eurozone nations have grabbed headlines for their struggles with austerity measures, many of the companies across Europe have taken a lot of action to put their balance sheets back in order. As a result, they have better financial positions, and stronger cashflows, than suggested by their national performance. When enough of these companies believe a recovery is likely, so they'll have the ability and desire to invest in capital – and in people.
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