By Elisabeth Krecké
In a Nutshell
- Gloomy times lie ahead with war, debt, inflation, refugees, energy woes
- Europe is running out of monetary and fiscal options to help citizens
- The race to avert climate change may bring more economic stagnation
A cascade of crises started in 2008 when the near-collapse of the international banking sector took the world by surprise. The ensuing financial crisis1 was followed by years of economic recession on both sides of the Atlantic.
In 2012, a European sovereign debt and trust crisis almost brought down the entire eurozone and its common currency.
In 2014, Russia invaded Ukraine’s Crimean Peninsula and instigated a war in the nation’s eastern Donbas region.
In 2015, the European Union had to cope with the worst refugee crisis since World War II, many fleeing the Syrian civil war.
In 2020, in response to the global Covid-19 pandemic, worldwide lockdowns led to the deepest economic contraction in modern history.
Just when there seemed to be a glimpse of light at the end of the tunnel, on February 24, 2022, Russia launched a full-scale invasion of Ukraine, raising the specter of a third world war amid nuclear threats by Russian President Vladimir Putin.
A new refugee flow, even larger than the last one, is now overwhelming Europe as an estimated 5 million Ukrainians have fled abroad, most to Poland and other EU member countries.
Additionally, since 2021, a global energy crisis has been looming amid soaring inflation. It is obviously exacerbated by international sanctions against Russia, as well as the necessity for European countries to wean themselves off Russian gas2 and oil imports.
Thus, the recent geopolitical evolution augurs another gloomy decade for the EU – the decade precisely that was supposed to be the world’s last chance for reversing climate change, dubbed the biggest crisis of all.
The societal impacts of these global crises are broad-ranging and long-lasting. The scars left on economies and populations are investigated, almost in real time, by academics, in international organizations and the media.
Reports explore how crises affect people’s health3, including mental condition, social development and relationships, average life expectancy and fertility. They argue that chronic economic gloom produces unemployment, worsens poverty, limits children’s access to high-quality education, and fosters anxiety and depression. Low-income individuals, as well as women and young generations, are usually the ones who pay the highest toll.
Moreover, when people suffer, they tend to blame those in charge.4 Crises can erode trust in government and lead to political polarization and the rise of populism. In this light, the 2016 Brexit vote is broadly viewed as the most consequential expression of British citizens’ loss of confidence in the EU and its institutions.
The most considerable social damage of crises typically evoked by sociologists and other social scientists is rising inequality. Undeniably, crises, whatever their nature, produce both winners and losers. The recent pandemic is a good example. It caused a great deal of suffering and loss, but many, at the same time, benefited from the mandatory lockdowns and generous government support. For instance, many employees saw their work-life balance improve due to teleworking. EU households globally saved more money than ever because they were forced to reduce consumption.
Above all, the massive fiscal and monetary stimulus implemented by governments and the European Central Bank (ECB) pushed up asset prices, such as those of stock and real estate, to record levels. In several member states, the wealth of property and financial asset owners increased significantly during the pandemic. A housing affordability crisis is growing acute, especially in nations like Luxembourg and the Netherlands, and others where wealth gaps have been widening drastically.
Even ECB executive board member Isabel Schnabel,5 responsible for the institution’s asset purchase programs since early 2020, is exasperated about this unintended and, in her own words, unjust, side effect of an emergency monetary policy she had helped to put in place.
In economic science, the term “social cost” has a different and narrower meaning than in most other social sciences. Mainstream economists define social cost, quite austerely, as the sum of private and external costs. Private costs are the costs arising from a transaction between market participants. External costs or externalities, for their part, are costs imposed on third parties who bear the consequences of a transaction in which they are not involved. That means they are neither compensated for negative externalities nor charged for positive externalities.
An oft-cited example of negative external costs is pollution. Traditionally, economists maintained that the polluter must compensate the residents who suffer the effects of polluting activity. In 1960, British economist Ronald Coase challenged that policy recommendation. In his trailblazing study “The Problem of Social Cost,” he called for an arrangement that minimizes social cost. This outcome can be achieved either through private negotiation among concerned parties or, if transaction costs are high, through the intervention of a judge.
For Professor Coase, everyone involved in harm over the use of resources is responsible, to some extent, for the existence of the problem and hence for resolving it. In the pollution example, residents harmed by the pollution may also be consumers of the polluters’ goods or even work for the polluter. If the polluter is forced out of business through prohibitive fines and punitive taxes, society at large might suffer more than by accepting some degree of pollution.
Of course, each situation is different. By affirming that the optimal solution is the one that minimizes social costs rather than the one that punishes the party that caused the damage, Mr. Coase put an economic argument of social efficiency before the legal principle of causation.
His article, published in the iconic Journal of Law and Economics, became one of the most cited contributions to modern welfare economics. It gave rise to a variety of interpretations to which Nobel Prize winner Mr. Coase did not always adhere.
Bailing out bad banks
Can looking through the Coasian lens help us uncover a rationale behind the overall pragmatic handling of the recent crises in advanced economies?
At the root of the 2008 global financial crisis was a subprime mortgage crisis, which had started a year earlier in the United States after a housing bubble burst. The events exposed that slipshod and even fraudulent practices had become a common feature of the banking sector, not only in America, but worldwide.
What was the policymakers’ choice here? Making pay those who, through their irresponsible behavior, had caused the disaster? The problem was that many of the incriminated financial institutions were deemed too big to fail. The financial tsunami triggered by the bankruptcy of a prominent American investment bank, Lehman Brothers, gave policymakers a glimpse of what might happen if they let entire networks of banks and businesses fail.
Policymakers were clearly eager to minimize the damage to society. It appeared unthinkable to them to let honest companies’ financial reserves and people’s lifetime savings go down the tubes. They saw no option other than bailing out, with taxpayer money, hundreds of leading banks7 that had contributed to the disaster.
Efficiency versus fairness
In the U. S., the government bought failing banks’ toxic assets and equity under the so-called Troubled Asset Relief Program.8 Almost no conditions were attached to this form of bailout. Helping distressed banks survive – not customers – was the priority. The fate of the six million American households that lost their homes to foreclosure was simply considered acceptable. As for the rescued banks, they were allowed to continue some of their dubious practices and even distributed bonuses and gifts to their top executives.
In Europe, too, ailing systemic banks received vast state aid.9 However, the rescue came with stringent obligations. Not only were banks required to reimburse a large part of the public funds they received, but they also had to comply with a slew of new regulatory obligations in terms of capital requirements, stress testing and reporting. They had to start by cleaning up their balance sheets by getting rid of their nonperforming loans.
Since 2014, the Single Supervisory Mechanism, which grants the ECB the leading supervisory role over EU banks, has ruled over the European banking sector with an iron fist. That same year, the Bank Recovery and Resolution Directive (BRRD) was adopted, stipulating that in case of bank failure, the costs are to be imposed on the bank’s shareholders and customers for deposits above 100,000 euros. The rationale behind the BRRD and its bail-in principle is that taxpayers should not pay for damages caused by irresponsible bank behavior next time.
A similar back-and-forth between a logic of social efficiency and preoccupations with fairness could be observed during the handling of the Greek sovereign debt crisis. At first, policymakers were reluctant to bail out Greece, but they finally did it out of fear that Athens’ default would cause tremendous damage to the euro area. As a counterpart, they forced a punitive austerity program on the country they accused of having fraudulently misreported economic statistics for years. In hindsight, the harsh treatment by the European troika of the Greek population pushed to the brink of a humanitarian crisis is seen as a policy error of
By 2020, the European economy was recovering with the support of ultra-cheap money generously flowing from the ECB. The monetary authority had grown used to treating the economy as if it was in permanent crisis mode, even when it was not anymore.
And then, the coronavirus crisis hit, forcing governments to trigger an unprecedented recession by shutting down economic and social activity to prevent the collapse of overwhelmed health systems.
Between 2020 and 2022, governments responded with massive fiscal and monetary stimulus,10 giving the impression that the priority was not just to provide temporary emergency relief but to push for a fundamental paradigm shift in social policy. It was a transformative moment, financed through cheap credit.
Until less than a year ago, elite economists fostered the illusion of a free lunch11 by telling us that there is hardly any chance of high inflation soon and that, for a host of reasons, mounting public and private debt were not troublesome.12
It was all too good to be true, of course. With rising inflation came the reminder that the only free cheese is in the mousetrap.
Inflation rates are already approaching double digits in some EU countries, even before calculating the effects of the Russia-Ukraine war on energy prices.
Surging energy and transport costs have started to force factories all over Europe to stop production.13 This will lead to further bottlenecks in a global economy already full of them.14 The financial stress will inevitably drain savings. Moreover, the promised transition to green and energy-independent economies will make life unaffordable for an increasing number of citizens struggling with debt and taxes.
Stagflation, an unhealthy mix of high inflation and chronically low growth, may loom, presaging a scenario in which monetary and fiscal policies may be of limited help.
For the next major global crisis, the paternalist welfare state might no longer be there to ease our pain. Eventually, it may not have many options left other than to appeal to our guilt over our carbon footprints to nudge us into accepting the idea of economic stagnation.
This article was first published in GIS on May 4, 2022 https://www.gisreportsonline.com/r/europe-economy-crises/
About the Author
Elisabeth Krecké is an independent, Luxembourg-based economist, as well as a former policy advisor and university professor. She focuses on the economics and regulation.
Professor Krecké was a professor of economics at the University of Aix Marseille (1994-2004 and 2007-2014) and at the University of Science and Technology of Lille (2004-2007). Her academic research focuses mainly on the methods of the economics of law, an interdisciplinary field devoted to the study of legal and regulatory decision-making in a variety of domains, as well as the efficiency (or impact assessment) of laws, government policies and institutional frameworks.
- Is there a future for the EU’s banking union? https://www.gisreportsonline.com/r/eu-banking-union/ 21, September 2021
- How Europe Hopes to Wean Itself From Russian Natural Gas https://www.wsj.com/articles/how – europe – hopes-to-wean-itself-from-russian-natural-gas-11647163803 The Wall Street Journal 13, March 2022
- COVID-19 and Society: Shaping the COVID Decade https://www.thebritishacademy.ac.uk/projects/covid-decade/
- The Social and Political Costs of the Financial Crisis, 10 Years Later
https://hbr.org/2018/09/the-social-and-political-costs-of-the-financial-crisis-10-years-later Harvard Business Review 25, September 2016
- Monetary policy and inequality https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp211109_2~cca25b0a68.en.html
- European Central Bank 9, November 2021
Bailed out banks https://money.cnn.com/news/specials/storysupplement/bankbailout/ CNN Money
- Troubled Asset Relief Program (TARP) https://www.investopedia.com/terms/t/troubled-asset-relief-program-tarp.asp Investopedia 29, September 2020
- FACTBOX-What has happened to more than 30 bailed-out European banks. https://www.reuters.com/article/europe-banks-bailouts-idUKL5N10W0XJ20150821 Reuters 21, August 2015
- Recovery economics: Optimism or overheating? https://www.gisreportsonline.com/r/economic-overheating/ 15, June 2021
- The future of public debt https://www.gisreportsonline.com/r/future-public-debt/ 21, July 2020
https://www.piie.com/system/files/documents/wp19-4.pdf Public Debt and Low Interest Rates February 2019
- European Industry Starts Shutting Down as Energy Prices Soar https://www.bloomberg.com/news/articles/2022-03-09/european-industry-starts-shutting-down-as-energy-prices-soar Bloomberg 9, March 2022
- Surging Energy Prices Close U.K. Factories, Another Bottleneck in a World Full of Them https://www.wsj.com/articles/surging-energy-prices-close-u-k-factories-another-bottleneck-in-a-world-full-of-them-11631792586 The Wall Street Journal 16, September 2021