Debt Crisis in Europe and the Limits of National Power in the Face of a Global Challenge

by
Kostas Kourtikakis  European Euros
Lecturer & Research Assistant Professor
Department of Political Science
University of Illinois at Urbana-Champaign
The European debt crisis has been at the top of the news in the United States and around the world since it fist broke out in 2009.  Citizens and businesses have been watching with great concern and fascination as this seemingly endless drama is escalating before their eyes.  What is not visible to the naked eye, however, is the deep change this crisis highlights in the ability of governments to pursue their preferred policies in a globalized economy.  This essay explores the nature and roots of this important change.The first signs of trouble appeared in Greece, a small European economy, which became unable to service its debt and therefore received international financial support in 2010.  Soon the crisis spread to other European countries, and it was not long before Ireland and Portugal also had to receive international assistance loans in order to support their troubled budgets.  With time, the economic health of large European countries such as Italy, France and, even Germany, was also at stake.  At an alarming rate, governments of small and big countries alike find themselves in an untenable position, as interest rates on their debts rise sharply and their borrowing costs increase exponentially.  Today we talk about a pan-European crisis, with potentially grave implications for the world economy.  The United States, the world’s largest economy and Europe’s biggest economic partner, is not immune to this crisis either.

What is more surprising than the speed by which the crisis spreads is the inability of political leaders in Europe and beyond to take measures that will either stop it or at the very least slow it down.  This inability definitely does not stem from a lack of effort.  The leaders of the Eurozone, the currency union that includes the countries in the eye of the storm, have announced several rounds of measures with the intention of assuring markets and making their union more resilient against the current economic turbulence.  In addition, the members of G20, a grouping of powerful world economies, have also tried to weigh in and suggest solutions.  And yet, with every set of new measures or recommendations announced to halt it, the debt crisis seems to come back with a vengeance.

To make matters worse, popular discontent is also on the rise.  One can detect two main trends, both of which are related to the distribution of economic resources.  On the one hand, citizens in economically robust countries object to the disposal of funds for assistance loans to economies in trouble.  German and Finnish citizens have expressed very vocal opposition to the “bailout” of Greece, for example.  On the other hand, the governments of all the countries that have already seen their borrowing costs rise or anticipate they will, have been undertaking painful austerity measures, which reduce household incomes dramatically and lead to significant social tensions.  Demonstrations and riots in Greece, Spain, Portugal, and most recently in Britain, are all examples of this trend.

The rapid spread of the debt crisis, the inability of political leaders to solve it, and the emergence of significant social instability are three distinct phenomena, which even the casual observer can link to each other.  But what are the underlying conditions that make these phenomena so intertwined?  And why do they reinforce each other, leading to a continuous deterioration of the crisis?  The answer to these questions is that we live in a world where economic processes are increasingly global, while political decision-making is fragmented into separate national arenas.  As a result, economic problems can easily spread across countries almost automatically, while the political solutions to these problems must still be negotiated among governments that answer to different national constituencies.

In the European debt crisis, one could identify international banking institutions and rating agencies as examples of economic actors that are involved in truly global processes.  These two types of institutions are entangled in a continuous cycle of mutually dependent decisions.  When a rating agency signals that a bond becomes a risky investment, banks will only agree to buy it at a higher interest rate.  But this rate hike will increase the cost of borrowing for the government that issues the bond, and it may compromise that government’s ability to pay back its loans.  This development will fuel additional concerns among rating agencies, which may lead to more rate increases, thus further compromising the country’s ability to borrow.  The ease and speed of transmitting information and making international transactions across borders in today’s world means that large amounts of money can move easily away from the bonds of a particular government, leaving it strapped for cash.

The news of a suddenly inflated Greek budget deficit is the event that triggered this automatic process that has engulfed all of Europe.  Because Greece is a member of the Eurozone, banks and rating agencies were concerned that the roots of the Greek problem lie in the design of the currency union and raised red flags about other countries as well, causing their borrowing costs to rise and the problem to spread.  Clearly then, this is a problem that many countries are confronting at the same time, and coordinated action is necessary to assuage market concerns.

But European governments have struggled unsuccessfully to coordinate a response.  Originally they even failed to realize the transnational nature of the problem, thinking that it affects only certain economies.  Since the full extent of the problem became known, however, conflicting national priorities and conditions have made finding a common solution elusive.  What is an acceptable response for Germany is not necessarily welcome in France, Italy or Greece.  Yet, because of the rapid spread of market uncertainty, governments are under immense pressure to bridge deep differences in very little time.  The resulting measures are therefore often a sloppy compromise, rather than an effective solution to the problem.  This makes international banks and rating agencies get even more suspicious and therefore the debt crisis continues to spiral downward.

At the same time, citizens see their countries and communities in trouble, and naturally expect their governments to come up with solutions.  But the complexities of international finance are far removed from most citizens’ daily lives.  In the absence of sufficient explanations from their leaders about the true global nature of the problem, they demand national solutions to what they perceive as their own nation’s problem.  Constituencies become thus more sensitive, which exacerbates the problem even more:  as democratically elected political leaders try to satisfy their enraged citizens, national positions harden and diverge during government negotiations for a coordinated solution, making international synchronized action even more difficult.

Granted, this crisis is, to an extent, a peculiar European phenomenon because there is no other currency union like the Eurozone.  But if we take a step back and look beyond the details of these specific events, we will find a problem that is deeply engrained in transnational processes.  As such, it requires an equally transnational remedy.  In the absence of a global government, coordination through international institutions seems like the only solution.  The difficulties faced by European governments today, even after 60 years of close integration, are therefore particularly indicative of the loss of control faced by governments in dealing with global crises, precisely because both leaders’ and citizens’ perceptions are still informed by a national mindset.

Recommended readings:
Martin Heipertz and Amy Verdun, Ruling Europe: the Politics of the Stability and Growth Pact, Cambridge University Press, 2010
Saskia Sassen, Losing Control: Sovereignty in an Age of Globalization, Columbia University Press, 1996

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