“Can PIGS Keep Flying High?”: Portugal, Ireland, Italy, Greece and Spain Look to Get Back on Track after the Financial Crisis

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PIIGS-euroEuropean economies were also hard hit by the financial crisis in 2008.  But the effects of the crisis were especially profound in certain European countries with substantial fiscal issues due to the disappearance of credit markets that fueled speculative booms in their respective local economies.  These countries, known as the PIIGS are made up of Portugal, Ireland, Italy, Greece and Spain.  This group of five countries experienced well publicized bouts of high unemployment and significant social upheaval as a result.

Former PIGS member Ireland (originally the fifth country of what was known as the PIIGS) began preparations to exit the bailout program earlier in December, albeit without a credit line.  Any precautionary credit line would have to meet approval from the European Union, the European Central Bank and the International Monetary Fund.

Wealthier countries such as Germany and France are concerned about their own long term fiscal prospects, especially after bailing out the PIIGS at the cost of higher taxes and especially with lower projections for GDP growth in the Eurozone in 2014.  After battling a double-dip recession in 2011-2012, growth in the Eurozone is poised to decrease by 0.4% in 2013 but will squeak out a feeble 1.1% increase in GDP in 2014, according to a European Commission report released in November.

Aside from the economic costs, there are political costs that are associated with a bailout. In Finland for example, parliamentary approval is required to participate in EU bailouts. The Finance Minister and Prime Minister of Finland called for harsher measures in the case of Portugal and significant opposition against bailouts for Greece and Ireland.  With Finnish support essential for any future bailout effort (bailouts in EU require unanimous approval); this certainly worries Germany and France, the two strongest EU members and the two countries that shouldered a large portion of the bailout effort.

Drawing the Lines

A European Commission report noted that the three Baltic States, Latvia and Lithuania outside the euro zone and Estonia already inside will be the three fastest-growing countries in the Eurozone. The main catalyst behind the Euro area’s 2014 recovery will be a combination of German economic growth along with a modest increase in growth coming out of Italy and Spain.

Many observers are starting to observe a two-way feeling of “bailout remorse”; countries that receive a bailout find that strings attached to bailout monies are tantamount to iron chains, giving rise to resentment of Franco-German economic domination, while taxpayers in wealthier countries will find themselves subject to higher taxes and a feeling of their own kind of resentment of supporting states that cannot effectively organize their fiscal affairs.

The PIGS also face the conundrum of drawing a “line in the sand” in the face of resolving their respective fiscal issues; while increasing taxes on wealthier citizens and cutting back services provides a fix in the short term, additional reform in both taxation and fiscal structures is sorely needed if a long-term fix has any chance of working.

There are some highlights that may point to a more positive outlook. In 2013 the stock market indexes of the PIGS outperformed other, more established European equity indexes such as the FTSE 100 and the DAX 40 (Eurozone economic powerhouse Germany’s stock index based in Frankfurt).  In addition, credit markets have become kinder to the PIGS; the Irish Government floated a €5 billion debt offering for its benchmark 10-year sovereign debt in March, the first time since September 2010.  The oversubscribed offering of marked Ireland’s reentry into the credit market; the issue was oversubscribed by 400% while yielding 4.25%.

While the Irish debt issuance seems like a step in the right direction, little is discussed of how Ireland’s credit worthiness comes at the cost of increased austerity measures.  While this helps the overall economy long term, the short term is painful in terms of unemployment and higher interest rates in the future.  Critics point out that while the economy of Ireland has improved, growth in both employment and wages have simply not been able to justify the increased credit worthiness of Irish bonds.

But more importantly, it may set a dangerous precedent that the PIIGS, as well as Germany and France, are looking to avoid. In the past, distressed nations would devalue their currencies. Fiscal manipulation is long prized by central banks and legislatures alike for its power to boost competitiveness and economic growth rates along with tax revenues.  In this case any devaluation for Portugal, Ireland, Italy, Greece and Spain would be the opposite; it would be disruptive to the Eurozone.  For Germany and France, it may also conjure long-feared realizations about “how much is too much” when it comes to propping up weaker EU members.

As the European Central Bank can always choose to devalue the Euro, the involvement of using tax policy to ultimately manipulate a weaker currency would make exports more attractive overseas.  But the Eurozone has the issue of balancing cheap exports along with allowing wages to climb faster than economic efficiency, especially in the PIIGS. As a result, exports were increasingly outclassed on foreign markets and a consequence was a surge in deficits and unemployment.  A deficit of greater than 5% of national income often spells economic trouble; at the start of the financial crisis in 2008, Greece, Spain and Portugal had deficits in excess of 10%.

In order to sustain such a pace of spending, it would mean that the wages and productivity of Greek workers would have to be on par with their German counterparts, which led to Greece’s financial turmoil. Bailing out the PIIGS meant that Germany leveraged itself into a situation where it should not be devaluing the Euro; but in 2007, Germany lifted its VAT rate from 16% to 19% while lowering income taxes, depriving itself of significant revenue.  One major worry among economists is how the impact of a regressive tax such as a VAT will affect those with lower incomes.  Although these difficulties are not insurmountable, they are very difficult since policymakers and central bankers will have to walk a politically unfavorable tightrope of across the board tax increases.

When combined with an anticipated increase in interest rates in both the U.S. and Europe, it is easy to see that 2013 and 2014 will be kind to the PIIGS but a lack of structural reform can still lead to negative growth and higher unemployment long term.