Personal Loans

Earlier this year, the EU and the International Monetary Fund (IMF) organised a e110 billion (R1.04 trillion) bailout for Greece. This week, Ireland has accepted around e90bn to help save it from bankruptcy. What does this mean and what implications does it have for Europe? |||

Earlier this year, the EU and the International Monetary Fund (IMF) organised a e110 billion (R1.04 trillion) bailout for Greece. This week, Ireland has accepted around e90bn to help save it from bankruptcy. What does this mean and what implications does it have for Europe?

As a result of the Greek crisis and the fear of a continuing recession across Europe, the EU has set up two funds, contributed to by the 16 euro zone countries, to support EU member economies in danger of going bankrupt. EU countries, such as Ireland, can also source funds from elsewhere, as they are doing with the IMF and through bilateral arrangements with the UK and Sweden.

Countries go bankrupt when their budget deficit (difference between spending and earning) is too high, leaving them with insufficient funds to manage their economies, as in the case of Ireland.

After initially saying that it would not need a bailout, Ireland accepted separate offers from the UK, the IMF, Sweden and the EU funding programmes.

Ireland remains a major importer of UK products; on average, every Irish citizen spends approximately £3 600 (R40 000) on British goods every year. Were the Irish economy to crash, this would have severely negative effects on the British industry and economy.

But the effect is larger than this.

As the EU has agreed to perfect mobility of labour across borders and a common currency, the collapse of one of its members is indirectly carried by the more successful members. If one country’s economy collapses, businesses fail and unemployment rises. In terms of currencies, failing EU countries are less desirable places to invest, which makes the euro less attractive. This depreciates the euro and affects the economy of all EU states, even the successful ones.

But what are the consequences of these bailouts or loans? The borrowers need to repay the loans, so they need to raise the money to do so, which often results in them raising taxes.

In Ireland’s case, this would be especially damaging as its low company taxes make it attractive for international business. The expense of the loan will put massive pressure on its government spending policy and will make its future cost of borrowing even higher.

The lenders, on the other hand, sit with a catch-22 situation. They can’t allow member states to collapse, but bailing them out requires raising and spending huge funds of their own. Even if they will be repaid, this still imposes huge costs upon their own spending and economic policies.

The bigger worry is how long this strategy can continue. Bailout funds are limited and Spain, Portugal and Italy are all sitting with dangerously high budget deficits. If one of them was to require a bailout, similar to that of Greece or Ireland, there may not be enough money available to help the others. Were their economies to collapse, the knock-on effects on the whole EU economy could make the current bailout policies completely ineffective.

Since the EU is one of South Africa’s major export markets (valued at more than e22bn a year), every South African should be concerned about the success of the EU. A collapse of its economies would cause significant collapse of businesses within South Africa.

Pierre Heistein is the convenor of the UCT Applied Economics for Smart Decision Making course, which starts in March. The course is presented by GetSmarter, www.getsmarter.co.za.

View full post on All Stories