Economics of the European Union

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ECONOMICS OF THE EUROPEAN UNION: UNRAVEL OR UNITE BY VICTORIA BARNETTE A Thesis Submitted to the Division of Social Sciences New College of Florida In partial fulfillment of the requirements for the degree Bachelor of Arts Under the sponsorship of Professor Richard Coe Sarasota, Florida September, 2011

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Table of Contents Abstract...............................................................................................................................iv Chapter I. Introduction.........................................................................................................1 Chapter II. Clarification of Macroeconomic Methods.........................................................4 A. Macroeconomic Indicators..................................................................................4 B. Economics of Shocks..........................................................................................9 C. Currency Competition.......................................................................................16 D. Monetary Integration.........................................................................................20 E. Snapshot of the United States...........................................................................22 Chapter III. Snapshot of the European Union....................................................................26 A. Contemporary History.......................................................................................27 B. The Roots..........................................................................................................30 1. Germany.......................................................................................................30 2. France..........................................................................................................32 3. The Netherlands...........................................................................................34 4. The United Kingdom...................................................................................36 5. Denmark......................................................................................................38 6. Belgium.......................................................................................................40 7. Sweden.........................................................................................................42 8. Austria.........................................................................................................44 9. Czech Republic ...........................................................................................46 10. Luxembourg...............................................................................................48 11. Slovenia......................................................................................................50 12. Finland.......................................................................................................52 ii

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C. The Branches.....................................................................................................53 1. Ireland..........................................................................................................54 2. Greece..........................................................................................................56 3. Portugal........................................................................................................58 4. Spain............................................................................................................60 5. Italy..............................................................................................................62 6. Baltic States.................................................................................................64 i. Estonia.............................................................................................64 ii. Latvia...............................................................................................66 iii. Lithuania.........................................................................................69 7. Bulgaria.......................................................................................................71 8. Romania.......................................................................................................73 9. Poland..........................................................................................................75 10. Hungary......................................................................................................77 11. Slovakia......................................................................................................79 12. Cyprus........................................................................................................82 13. Malta..........................................................................................................84 Chapter IV. Analysis of European Economic Crisis August 2011.....................................86 A. Greece in Crisis.................................................................................................88 B. Ireland in Crisis.................................................................................................92 C. Spain, Portugal, and Italy in Crises...................................................................98 1. Portugal..................................................................................................98 2. Spain and Italy......................................................................................100 D. Problems of the Root, core economies............................................................102 Chapter V. Conclusion.....................................................................................................105 Bibliography.....................................................................................................................110 iii

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ECONOMICS OF THE EUROPEAN UNION: UNRAVEL OR UNITE Victoria Barnette New College of Florida, 2011 ABSTRACT This work provides an up-to-date analysis of the current economic environment in the United States and Europe in order to evaluate whether the current European economic crisis will unravel the Euro Zone, as failing economies remove the euro as their national currency. The work concludes that unless the European Union garners the political will to earnestly investigate each economy's financial and banking systems, restructure and recapitalize bad loans and banks, and agree on common fiscal policy the Euro Zone will unravel as it is today. In the first chapter of the body of the work, context is given by explaining macroeconomic indicators, the economics of shocks, monetary integration, and currency competition. This well help the reader understand the analysis and conclusions. Also, an economic snapshot of the United States is provided as an example. The second chapter surveys the economic landscape of Europe by presenting and analyzing the major macroeconomic indicators of each member state in snapshots. The third chapter analyzes the current economic crises in Greece, Ireland, Portugal, Italy, and Spain as well as discussing problems facing Germany, France, and the United Kingdom. The last chapter concludes by providing a possible future scenario in which Greece defaults on its debt and possible solutions. In order for Europe to maintain economic prosperity, the European Union must politically and fiscally unite so member governments may sustain effective control over economic and policy instruments under a fixed exchange rate system with small, open economies. Professor Richard Coe Division of Social Sciences iv

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Chapter I. Introduction "The downgrade," S&P said, "reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics." -Standard and Poor's "The downgrade" is Standard and Poor's choice to downgrade the United States from an AAA credit rating to an AA+. This is the first time that the World's largest national economy has had its credit score downgraded. Currently, Lichtenstein has a better credit rating than the US and New Zealand is the only country other than the US that has an AA+ rating from S&P and an Aaa grade from Moody's 1 Since the global economic downturn in 2008, the United States and Europe have been struggling to recover 2 Financial crises have placed tremendous pressure on governments that are having trouble expanding their economies while staving off financial contagion. The reduction in US credit rating exposes one part of the interconnected web of problems brewing within our global financial system. Another major part of this disease is currently being exposed in Europe. So far, Greece, Ireland, and Portugal have accepted bail out packages from the EU and IMF in order to escape the extent of the financial and debt crises. The idea of kicking the can down the road can only get you so far, that is, having a richer country pay off the debt of a poorer country means that eventually there will be no economies left to bail out those 1 1 Paletta, Damian and Matt Phillips, "S&P Strips U.S. of Top Credit Rating," The Wall Street Journal August 6, 2011. 2 "Recession 2011: US crisis may hit exports and capital flows: Rangarajan," The Economic Time s, August 8, 2011.

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that need loans. Furthermore, strangling the other economies with interest and loan payments while riding your people to bail out the others will lead to dissolution of the Euro Zone as it is today. The countries at the root, core of the Euro Zone and Union, Germany, France, and the United Kingdom must be steadfast and stick to ruthless truth telling in order for the European Union to achieve economic prosperity. Complete economic integration will be necessary to increase the likelihood that officials of Europe will be honest with their people, the banks with their governments, and the debtors with their creditors. This concerns more than just Europe, many of our business relationships and investments lie in Europe or come from Europe. Furthermore, Europe is the birthplace of western culture and the economy of Europe is the largest on earth, representing one-third of the world's wealth. Much of this is the result of the EU, European Union, composed of 27 European states, the largest single economic area in the world. There are 16 EU states that share the Euro as a common currency, making up the Euro Zone, five of them rank in the top ten largest national economies in the world. We can see that the economic health of the EU is significant in determining the health of the global economy. This paper provides an up-to-date analysis of the current economic environment in the United States and Europe in order to evaluate whether the current European economic crisis will unravel the Euro Zone, as failing economies remove the euro as their national currency. The paper concludes that unless the European Union garners the political will to earnestly investigate each economy's financial and banking systems, restructure and recapitalize bad loans and banks, and agree on common fiscal policy the 2

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Euro Zone will unravel as it is today. In the first chapter of the body of the work, context is given by explaining macroeconomic indicators and definitions to help the reader grasp the depicted economic landscape provided by economic snapshots in second chapter. Also, a snapshot of the United States is provided as an example. The second chapter continues where the first left off, painting a portrait of the economic landscape of Europe by presenting and analyzing the major macroeconomic indicators of each member state. The third chapter analyzes the current economic crises in Greece, Ireland, Portugal, Italy, and Spain as well as discussing problems facing Germany, France, and the United Kingdom. The paper concludes by summarizing findings in the analysis as well as providing a possible future scenario for Europe if Greece should default on its debt and the possibility of further integration to save the European Union. 3

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Chapter II. Clarification of Macroeconomic Methods This chapter provides the reader with necessary background information to help make sense of the methods utilized in this work, i.e. the economic snapshots and analysis of the current European Crisis. The end of the chapter contains an example, the United States economic snapshot, in order to give the reader a taste of what is to come and to provide context to the European snapshot and analysis. The first section of this chapter defines and explains the basic macroeconomic indicators that make up the economic snapshots of the countries. The second part of the chapter deals with the stages of monetary integration and the effects of currency competition. Finally, the last section of Chapter 2 is designed to clarify the economics behind the analysis of the current economic crisis in Europe, including effectiveness of monetary and fiscal policy, exchange rates, bond markets, etc. A. Macroeconomic Indicators Firstly, an economic snapshot is a portrait of the current economic environment of a country. The snapshot is made up of historical, economic, and political data of the recent past of the country, and compares it to current data, providing a brief analysis. In order to understand the snapshot, one must define the macroeconomic indicators that compose it. Macroeconomics is the study of major economics indicators, totals, or aggregates 3 An aggregate is a total expressing an economic magnitude of the economy 4 3 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 3.

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as a whole. More specifically, aggregates or indicators are data that help determine the economic well-being of a people in an economy, e.g. inflation, unemployment, GDP, account balances, interest rates, productivity, wages, and real GDP growth influence individual's standard of living and quality of experience in different ways. The first and most basic indicator is the Gross Domestic Product of a country or GDP, and is defined as the total final product and includes all currently produced goods and services that are sold through the market but are not resold. The GDP or national income is that which is currently produced, thus excluding used items and transfer payments. A transfer payment is any transaction in which money is transferred without any accompanying good or service in return. GDP is composed of consumption (C), investment (I), government spending (G), and exports minus imports, or net exports (NX): Y = C + I + G + NX (1) Consumption expenditures are purchases of goods and services by households for their own use. Final goods that are consumed by firms instead of sold are private investment, they add to the nation's stock of income-yielding physical assets or that replaces old, worn-out physical assets. There are two types of private investment, inventory and fixed. Inventory investment includes all changed in the stock of raw materials, parts, and finished goods held by business. Fixed investment includes all goods purchased by business that are in addition to inventory and includes structures and equipment. Exports are goods produced within one country and shipped to another, while imports are goofs consumed within one country but produced in another; net exports and net foreign 5

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investment are both equal to exports minus imports 4 Private saving is the part of personal income that is neither consumed nor paid out in taxes. The introduction of government spending, taxation, and the foreign sector to the macroeconomic analysis requires the use of the magic equation. The magic equation states that private saving plus net tax revenue must by definition equal the sum of private domestic investment, government spending on goods and services, and net exports: S + T = I + G + NX (2) Since income is equal to expenditure, the portion of income not consumed (saving plus net taxes) must be equal to the nonconsumption portion of expenditure on final product (investment plus government spending plus net exports) 5 In other words, the leakages out of the income available for consumption goods, saving plus tax revenue, must be exactly balanced by injections of nonconsumption spending or investment, government spending, and net exports. The magic equation expresses how the funds from a government surplus are used and how a government finances a budget deficit. Arranging equation (2) above to show the uses of a government budget surplus: T G = (I +NX) S (3) 6 4 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 26-32. 5 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 35.

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If the left side of the equation, taxes collected by government subtracted from government spending, is positive, the government is running a budget surplus. The right side of the equation expresses the balance between investment and net exports (total investment both domestic and foreign) and private savings and its relation to budget surplus or deficit. That is, a budget surplus allows private saving to decline without any need for a decline in total investment. Also, a budget surplus stimulates domestic investment and foreign investment, even reducing dependency on foreign borrowing 6 If the government is running a deficit, the left side of the equation is negative. This forces domestic investment to shrink, or private saving to rise. However, if private saving does not change, avoiding a decline in domestic investment means borrowing more from foreigners (even more imports than exports) or declining to lend to foreigners. Inflation is a sustained upward movement in the aggregate price level that is shared by the majority of products in the market, the rate of inflation is the rate of increase in the economy's average price level expressed in percentages. The unemployment rate is the ratio of the number of people unemployed to the total number of people employed and unemployed individual. An individual is unemployed if he is jobless and actively seeking work or is on temporary layoff. The Gini index is a number that measures the degree of inequality in the distribution of income in a given society; the lower the Gini index the more equal a country's income distribution, the higher the index, the greater the difference between the rich and the poor in a country 7 Productivity is the 7 6 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 35. 7 Central Intelligence Agency's "The World Factbook," last modified late 2010, accessed July 2011, https:// www.cia.gov/library/publications/the-world-factbook

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average output per hour of work that a nation produces in total goods and services, $55 per worker-hour in the United States in 2008 8 9 The faster the growth of productivity, the easier it is for a member of the society to improve her standard of living; zero productivity growth requires that a society substitute goods or services for other goods or services making it harder of members of the society to obtain goods or services without sacrifice 10 The economic fluctuations expressed by aggregates or indicators like unemployment and inflation can be represented as cycles of periods of economic prosperity and hardship. These business cycles consist of expansion occurring at about the same time in many economic activities, followed by similarly general recessions and recoveries that merge into the expansion phase of the next cycle. There are times that the cycle deepens creating booms and busts that expand or contract the economy, respectively. The goal of macroeconomic analysis is understand causes of changed in important aggregates and to predict consequences of policy changes. The health of the economy is represented by these target variables or aggregates and the government manipulates policy instruments that influence target variables in order to improve the 8 8 According to Robert J. Gordon and Ian Dew-Becker, the EU-15 reached US productivity levels in 1995 but started to decline as they find a substantial trade-off between labor productivity and employment growth. Before 1995, labor was made expensive through higher taxes, tight regulations, and strong unions. Thus reducing labor demand, increasing unemployment but increasing the real wage and the average product of labor. After 1995, the process was reversed, lower taxes and looser regulations reduced the cost of labor, increasing employment per capita and slowing growth in labor productivity. The conclusion is that policy reforms in Europe may raise employment per capital but also reduce productivity. 9 Gordon, Robert J. and Ian Dew-Becker. "Europe's employment growth revived after 1995 while productivity growth slowed: Is it a coincidence?" VOX: Research-based policy analysis and commentary from leading economists. April 15, 2008 10 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 4.

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health of the economy 11 The main policy instruments employed by government are monetary policy and fiscal policy. Monetary policy influences target variables by changing the money supply, interest rate, or both. Fiscal policy influences target variables by manipulating government expenditures and tax rates. Macroeconomics is an international subject in that it deals with the global economy and the individual economies that make up the whole. Because of this, the analysis deals with open economies rather than closed economies. An open economy exports goods and services to other nations, imports from them, and has financial flows to and from foreign nations 12 B. Economics of Shocks This section looks at how real GDP is determined and how monetary and fiscal policy can be used to offset shocks that affect real GDP. A demand shock is a significant change in desired spending by consumers, business firms, the government, or foreigners. The demand that is changed is aggregate demand, or the total amount of desired spending expressed in current (nominal) dollars. Changes in consumer confidence, business optimism, government spending, and foreign events that influence exports and imports. Shocks to demand can change either real GDP, the price level (GDP deflator), or both. Aggregate supply, or the amount that firms are willing to produce at any given price level, shocks also influence real GDP and price levels. Changes in aggregate supply depends on costs of production for business firms, wages and prices. Since price level is 9 11 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 19. 12 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 22.

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assumed to be fixed in the short run, all changes in aggregate demand automatically cause changes in real GDP by the same amount in the same direction 13 The "Keynesian Cross" Model determines the equilibrium level of income in an economy so that there is no pressure on business firms to increase or reduce production and income. An economy is at equilibrium when planned expenditure (E) and total income (Y) are equal. The consumption function is: C = Ca + c (Y T) (4) the fixed amount is autonomous consumption and is independent on the level of income (Y). The marginal propensity to consume (c) is the dollar change in consumption expenditures per dollar change in disposable income. This extra element of induced consumption results in expenditure not always equaling that which is planned; if some expenditure is unplanned, business firms will adjust production until the unplanned component of expenditure is eliminated 14 A change in autonomous planned spending will cause a change in the equilibrium income. The multiplier is the ratio of the change in output to the change in autonomous planned spending that causes it. The marginal propensity to save also determines the multiplier. The marginal propensity to save is equivalent to one subtracted from the marginal propensity to consume. Shifts in planned spending have the following results: 10 13 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 59. 14 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 65.

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i. A $1 change in autonomous tax revenue changes planned autonomous expenditure by the marginal propensity to consume multiplied by $1 in the opposite direction ii. A $1 change in planned investment changes planned autonomous expenditure by $1 in the same direction. iii. A $1 change in government spending changes planned autonomous expenditure by $1 in the same direction iv. A $1 change in net exports changes planned autonomous expenditure by $1 in the same direction. v. A $1 change in autonomous consumption changes planned autonomous expenditure by $1 in the same direction. Monetary policy deals with interest rates to influence planned autonomous spending, increasing spending when interest rates are low and cutting spending when interest rates are high. Interest rates help build saving in the economy, rewarding those for abstaining from consumption for the future. Increases in interest rate increase the incentive to save and decrease borrowing. The Federal Reserve Board (the Fed) manipulates the interest rate in order to affect the cost of borrowed funds to private borrowers. Thus, planned autonomous spending depends on the interest rate, while real GDP and real income depend on planned autonomous spending. Thus, real GDP and income must depend on the interest rate. The IS curve is the schedule that identifies the combinations of income and the interest rate at which the commodity market is in equilibrium; i.e., everywhere along the IS curve the demand for commodities equals the supply. The missing relation between real income and interest rates is in the money market or the financial sector of the economy. 11

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Money is defined as a medium of exchange used for buying and selling goods and services; the supply of money consists of currency and transaction accounts, including checking accounts at banks and thrift institutions 15 The amount of money demanded by people in real terms depends on income and the interest rate. Real money balances account for the price level and demand for real money balances increases when real income increases. The higher the interest rate, the greater the reward for holding interesting-earning financial assets, less money is held. The supply of money depends on the Fed while real quantity of money demanded depends on income and interest rates. The LM curve is the schedule that identifies the combinations of income and interest rate at which they money market is in equilibrium; at each point on the curve, demand for money equals the supply of money 16 The IS-LM model uses the schedules to determines real income and interest rate; however, the exogenous variables that are not explained in the model include the two instruments of monetary policy. Expansionary monetary policy is one that has the effect of lowering interest rates and raising GDP. While contractionary monetary policy is one that has the effect of lowering GDP and raising interest rates. In order to connect the domestic economy to the rest of the world, macroeconomics is internationalized through the concepts of the current account and balance of payments. The current account records the nation's current international transactions, including exports and imports of goods and services, net income from abroad, and net unilateral transfer payments. The capital account records capital flows, 12 15 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 94. 16 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 100.

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or purchase and sales of foreign assets by domestic residents, and purchases and sales of domestic assets by foreign residents. A current account deficit must be financed by net borrowing from foreign firms, households, and governments or from foreign central banks. Thus, a country with a current account deficit must increase its indebtedness to foreigners in the private sector, foreign governments, and foreign central banks. A nation's net international investment position is the difference between all foreign assets owned by a nation's citizens and domestic assets owned by foreign citizens 17 The balance of payments is the record of a nation's international transactions, including credits and debits occurring from sales of exports and sales of assets and purchases of imports and purchases of assets, respectively 18 When the balance of payments is negative, as for the United States, if the current account is a larger negative number than positive value of the capital account. The international transactions are made with the national currencies of the nations involved in them and the assets are evaluated according to the value of the currency. The foreign exchange rate for a nation's currency is the amount of one nation's money that can be obtained in exchange for a unit of another nation's money. An increase in the value of one nation's currency relative to another nation's currency is appreciation, on the other hand, depreciation is a decline in the value of one nation's currency relative to another nation's currency. For example, when one dollar can purchase two euros one day, but only one euro the next, the dollar is said to depreciate relative to the euro. Demand for a nation's currency comes from a nation's exports, while supply is created by a 13 17 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 150. 18 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 148.

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nation's imports. Government manipulates exchange rates in order to control demand for exports, a cheaper national currency means more exports. For example, the European Central Bank (ECB) can purchase dollars in order to appreciate the dollar relative to the euro. The purchasing power parity theory holds that the prices of identical goods should be the same in all countries, differing only by the cost of transport and any import duties; therefore, differences in relative values of national currencies are taken into consideration when determining prices of identical goods. In a fixed exchange rate system the foreign exchange rate is fixed for long periods of time. Under this system, banks agree in advance to finance any surplus or deficit in the balance of payments by maintaining foreign exchange reserves in currency and gold. Foreign exchange reserves are government holdings of foreign money used under a fixed exchange rate system to respond to changed in the foreign demand for and supply of a particular nation's money. In the fixed exchange rate system a nation devalues or depreciates their currency when it runs out of foreign exchange reserves and revalues or raises the value of their currency relative to foreign money when its foreign exchange reserves become so excessive they cause domestic inflation 19 This is termed intervention and central banks of governments utilize intervention to prevent unwanted variations in the foreign exchange rate. The demand for currency of a nation stems from two sources: the desire to buy that nation's products and the desire to buy financial assets denominated in dollars; for example, bank deposits, nation's government bonds, and bonds issued by a nation's corporations. The relative attractiveness of the nation's 14 19 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 174.

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securities depends on the interest rate differential, or the average interest rate of the nation subtracted from the average interest rate of a foreign nation. With perfect capital mobility investors regard foreign financial assets as a perfect substitute for domestic assets, and when these investors respond without delay to an interest rate differential, shifting sufficient assets to eliminate that differential 20 Perfect capital mobility implies that domestic monetary and fiscal policy do not affect the domestic interest rate. Also, with fixed exchange rates, a stimulative monetary policy will not reduce the domestic interest rate, rather monetary policy causes a country to lose international reserves as the capital account in the balance of payments is throw into deficit. Monetary expansion occurs when the central bank raises the money supply, shifting the LM curve to the right, the result usually being a reduction in interest rate and stimulated spending. However, in a small open economy with perfect capital mobility, interest rate is fixed at the world level since a small open economy has no power to set its domestic interest rate at a level that differs from foreign interest rates. Thus, a drop in interest rate results in capital outflows and losses of international reserves because foreign assets are more attractive due to relatively higher interest rate. The central bank loses control of the money supply when the economy is a small open one and when capital is perfectly mobile. Thus, the monetary policy instrument is completely impotent when exchange rates are fixed 21 In a small open economy fiscal policy works in the opposite way of monetary policy. Increasing spending shifts the IS curve to the right, increasing the interest rate; under a fixed exchange rate system, central banks must allow the money supply to 15 20 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 182-183. 21 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 185.

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increase until the interest rate returns to its pre-increase level. Thus, fiscal policy is made very effective under a fixed exchange rate system with perfect capital mobility, basically forcing monetary policy to be accommodative, gaining control over it. Financial markets are the channels through which securities and financial instruments are directly bought and sold. Financial intermediaries are indirect channels, issuing liabilities in their own name. These intermediaries make loans to borrowers and obtain funds from savers by accepting deposits 22 Money market instruments are assets sold in financial markets and have short maturities, usually less than one year, small fluctuations in price, and minimal risk of default. On the other hand, capital market instruments have long maturities, may experience large fluctuations in price, and expose investors to greater risk of default. Thus, the role of financial intermediaries and markets is for savers to send funds to markets held as currency, deposits, money market instruments, stocks, or bonds. A bond, for example, is a debt security where the issuer owes the holders a debt and is obliged to pay interest to use or repay the principal at maturity, a later date. The interest is paid on the coupon, the coupon rate is the amount of interest paid per year expressed as a percentage of the face value of the bond. If the interest rate rises, the bond prices will fall, lowering the value of the investment. The opposite is true if the interest rate falls, bond prices will rise. C. Currency Competition 16 22 Robert J. Gordon, Macroeconomics (Boston: Pearson, 2009), 418.

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Transitioning to a single currency benefits international transactors since it eliminates the cost of acquiring information on current exchange rates and controls, the transaction cost of changing monies and of passing exchange controls, and exchange rate and convertibility risks, as well as the cost of hedging for these. A macroeconomic perspective of the costs of establishing a single currency is provided by the theory of optimum currency area. An optimum currency area or region is one where a single currency provides optimum economic output. The model of optimum currency with stationary expectations requires that four criteria be satisfied in order for a region to become an optimum currency area: labor mobility across the region; capital mobility, price and wage flexibility across the region; a risk sharing system that redistributes money to areas requiring development in order to increase both labor and capital mobility, as well as price and wage flexibility; members of the region have similar business cycles 23 Labor mobility is, in part, determined by the physical ability of workers to travel (visas, worker's rights, infrastructure), but also by the size of cultural barriers to free movement (including different languages and customs); institutional arrangements between members also influence labor mobility. Keynesian and modern classical perspectives that have contributed to the theory of optimum currency area agree that the cost of currency union is a positive function of the equilibrium real exchange rate changes that occur among member countries. From a Keynesian perspective the nominal exchange rate adjustment is a prerequisite for real 17 23 Vaubel, Roland, "Currency Competition and European Monetary Integration," The Economic Journa l 100 (Sept., 1990): 941.

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exchange rate adjustment and as an instrument of employment policy. On the other side, the classical economist is concerned about price destabilization that occurs when equilibrium real exchange rate cannot take the form of nominal exchange rate adjustment. Adjustment of the real exchange rate depends on the size and frequency of changes in demand and supply conditions among member countries and on the cost of alternative mechanisms of real adjustment to economic shocks (international labor mobility as an alternative). The variability of nominal exchange rates makes real exchange rates difficult to interpret but easy to measure. Both economic perspectives agree on real exchange rate criterion but disagree on other costs of currency union. For example, the Keynesian economist may advocate nominal exchange rate variation as a means of reconciling international differences between optimal inflation rates in a Phillips Curve framework; the modern classical economist might argue that nominal exchange rate flexibility increases competition among suppliers of money resulting in a lowered inflation rate. Currency competition lowers the inflation rate by two mechanisms 24 : exit' and voice'. Exit' is the shift of the demand for money from currencies that are expected to depreciate and considered risky, to currencies that are expected to appreciate and considered safe. Thus, inducing issuers of the riskier currency to correct their monetary policies or face a decline in their market share. Voice' is created by competition among monetary policies that enables voters in high-inflation countries to go to superior foreign central banks. That is, under flexible exchange rates, the price level reacts more quickly due to the immediate 18 24 Vaubel, Roland, "Currency Competition and European Monetary Integration," The Economic Journa l 100 (Sept., 1990): 942.

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depreciation of the domestic currency when facing currencies of competing central banks. A smaller currency area results in quicker rise of the price level and a higher chance of protests. Thus, the need to pursue an inflationary policy grows as the size of the currency area increases. Inflation rate increases due to currency unification, on average, also depend on the degree of currency competition from non-member countries. The author dives into a discovery procedure utilizing a microeconomic perspective in order to provide a reliable cost-benefit analysis of currency unification since there is no scientific procedure of determining whether countries should come together in a currency union. How efficient a currency union is depends on the size of information and transaction economies of scale in the use of money. If economies of scale are sufficiently large, money is rendered a natural monopoly good (asset). This would result in the destruction of currency competition and a single producer of money. Therefore, currency competition is the only operational way of determining efficiency of currency union. Exchange rate union is a less efficient means to currency unification since currency reform is a better option for most members than attempting to stabilize an inflated currency (Germany before the war). Maastricht criterion of inflation rate results in lower reference inflation rate as number of EU members increases. The inflation rate criterion is determined by averaging the three lowest inflation rates of current EU members plus 1.5 percentage points. Thus, adding members can only reduce the reference inflation rate but never increase it, making it more difficult for new members to comply to Maastricht criterion. Monte Carlo simulations suggest an average reduction of reference inflation rate of 0.15-0.2 percentage points caused by enlargement (15 to 27 19

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members). Considering those members with negative inflation rates had significant impact on the results 25 D. Monetary Integration Monetary or economic integration can be categorized into six stages: preferential trading area, free trade area, monetary union, common market (customs union), economic union (includes customs and monetary union), fiscal union (includes economic and monetary union), and complete economic integration. The first stage of integration introduces a trading bloc or preferential trade agreement (PTA) giving access to certain products from member economies through reduced tariffs. A PTA aims to be a Free trade area in accordance with the General Agreement on Tariffs and Trade. Thus, the second stage of integration is a Free trade area (FTA). This agreement is formed when at least two states partially or fully abolish custom tariffs on inner border. If economies within the union are competing with one another, a customs union allows each member economy to set import quotas with common external tariff 26 The fourth stage of economic integration is the establishment of a monetary union that introduces a shared currency. There are three types of monetary unions: informal, formal, and formal with common policy. An informal monetary union is one where states unilaterally adopt foreign currency. A formal union is one where the issuing authority of 20 25 Vaubel, Roland, "Currency Competition and European Monetary Integration," The Economic Journa l 100 (Sept., 1990): 945. 26 Vaubel, Roland, "Currency Competition and European Monetary Integration," The Economic Journa l 100 (Sept., 1990): 937.

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the foreign currency is in bilateral or multilateral agreement with the non-issuing member, often supplemented by currency peg regime that issues local currency. The next step or type is a formal union with common policy where multiple countries establish common monetary policy and issuing authority for common currency. The fifth stage involves a common market, comprised of each of the previous stages including freedom of movement of capital, labor, goods, and services. A single market further reduces barriers including physical, technical, and fiscal barriers like borders, standards, and taxes. Each member of the union attempts to remove barriers maximally in order to smooth the flow of movement of factors of production. Common political and economic policies, in combination with strong political will of members, improves the chances of establishing a single market. The European Economic Community was the first common market; the addition of a customs union made it an economic union. An economic union is a common market with a customs union where participants have common policies on product regulation, freedom of movement of labor, capital, goods, services and the same external trade policy. Finally, a fiscal union includes a shred fiscal and budgetary policy. Common institutions in member countries make decisions about taxes and budgets. There are no complete fiscal unions in existence; however, the European Union has limited fiscal power by controlling VAT (consumption tax) and external tariffs. The EU has fiscal strength, spending in the form of a budget of billions of euro. Advanced stages of integration generally include unification of economic policies (social welfare, tax, etc.), 21

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introduction of supranational bodies, reduction in remaining trade barriers, and a move towards political union. In order to understand the effects of integration on individual economies, the economic snapshots provided in the next chapter, and the analysis, the reader must be familiar with basic macroeconomic models and concepts. E. United States a Snapshot The United States economy is the largest national economy in the world, making up approximately one quarter of global GDP or $14.66 trillion 27 Considering purchasing power parity, the US produces $47,200 of GDP per person. GDP growth during the first quarter of 2011 was 2.3 percent, lower than the 2.8 percent growth experienced in 2010. The Economist predicts that GDP growth will be 2.5 percent in 2011 but will increase to 2.9 percent in 2012. Inflation was 3.6 percent by June 2011, up from 2.1 percent in the beginning of 2011. The highest 10 percent of households in income share 30 percent of household income or consumption, thus the Gini index is 45. Agriculture, industry, and services, make up 1.2 percent, 21.9 percent, and 76.9 percent of the economy, respectively. The unemployment rate was 9.1 percent as of May 2011, down from 9.7 percent in 2010. The labor force, including unemployed, numbers 154.9 million. The industrial production growth rate is 3.3 percent, main industries include: high-technology innovator, petroleum, steel, motor vehicles, aerospace, 22 27 Statistics utilized in snapshots are collected from the Central Intelligence Agency's "The World Factbook," and the "Economic Report of the President 2011," accessed July 25, 2011, https://www.cia.gov/ library/publications/the-world-factbook The CIA obtains data from over twenty US organizations including the Bureau of Labor Statistics, Bureau of the Census, and other public and private sources.

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telecommunications, chemicals, creative industries, electronics, food processing, consumer goods, lumber, mining, defense. The US exports $1.280 trillion to Canada, Mexico, China, and Japan. Capital goods make up 49 percent of exports, agriculture products, industrial supplies, and consumer goods the rest. On the other hand, imports are higher at $1.948 trillion, coming from China, Canada, Mexico, Japan, and Germany in the form of industrial supplies, 32.9 percent, capital goods, 30.4 percent, and consumer goods, 31.8 percent. The US produces 9.056 million bbl/day of oil while consuming 18.69 million bbl/day of oil; oil imports are 11.31 million bbl/day. Gross fixed Investment is 12.8 percent of GDP. The country's external debt is $14.39 trillion. The budget deficit is 9.1 percent of GDP in 2011. Public debt is 93 percent of GDP, at $14 trillion. US stock of direct foreign investment at home is $2.581 trillion and $3.597 trillion abroad. By the end of 2010 Reserves of foreign exchange and gold were $130.8 billion. From 1946 to 1973 the US economy grew by an average of 3.8 percent as real median household income increased by 55 percent or almost 2 percent per year. Since 1973, growth has been slower at 2.8 percent, with household incomes increasing only 10 percent. The longest periods of growth include the 1960s, the economy expanded by 53 percent, 5.1 percent per year), 1991 to 2000, 43 percent growth, 3.8 percent a year, and from 1982 to 1990, 37 percent growth or 4 percent per year. In 2008, a derivative market and subprime mortgage crisis and a declining dollar value brought down GDP by 4.1 percent. In order to help stabilize financial markets, Congress established the $700 billion Troubled Asset Relief Program (TARP) in October 23

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2008. These funds were used to purchase equity in US banks and industrial corporations. In January 2009 an additional bill providing $787 billion in fiscal stimulus to be used over 10 years was passed and signed. In July 2010, the DODD-FRANK Wall Street Reform and Consumer Protection Act was passed and designed to promote financial stability by protecting consumers from financial abuses, ending taxpayer bailouts of firms, dealing with large troubled banks, and improving accountability and transparency in the financial system. Particularly, the act required certain financial derivatives to be traded in markets that are subject to government regulation and oversight. In November 2010, the US Federal Reserve Bank announced the purchase of $600 billion worth of US government bonds by June 2011 in order to keep interest rates low and promote growth. Similar recessions took place in 1957, 1973 oil crisis, and 1981; GDP fell by 3.7 percent, 3.1 percent, and 2.9 percent, respectively. The US has had trade deficits since the oil crisis in 1973. However, it has maintained a surplus in its trade in services reaching $140 billion yearly in 2008. The debt in the economy has increased dramatically, household debt is $11 trillion, corporate debt is $9 trillion, mortgage debt is $15 trillion, as well as unfunded Medicare and Social Security liability. In 1980, US public debt was $909 billion, 33.3 percent of GDP. By 1990, the debt tripled to $3.2 trillion, 55.9 percent of GDP. In 2001, the debt was $5.7 trillion, making up a similar percentage of GDP as 1990s. The debt ceiling hit $14 trillion in 2010, and is expected to be 100 percent of GDP. Servicing the debt will cost over $700 billion a year in 2019, compared to $202 billion in 2009. According to US Treasury statistics, non-US citizens 24

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and institutions hold 44 percent of US public debt. China is the largest financier of US debt holding $801.5 billion in US treasury bonds. 25

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Chapter III. Snapshot of the European Union The EU economy is the largest in the world, generating $16.228 trillion in GDP per year and is maintaining real growth of 1.8 percent per year in 2010; GDP per capita (PPP) is $32,700 28 By the first quarter of 2011 GDP growth was 2.5 percent, the Economist expects GDP growth for the Euro area to be 2.9 percent in 2011 and 2.7 percent in 2012. Over 70 percent of GDP comes from services, 25 percent from industry. There are 225.3 million workers in the labor force; the unemployment rate is 9.9 percent in May 2011, up from 9.5 percent in 2010. The Gini index is 30.4, ranking 111 in the world. Investment in the economy is 18.6 percent of GDP. Inflation was 1.8 percent in 2010 and 2.7 percent in June 2011. The economies in the Euro zone of the EU use the euro as common currency, one euro purchases a little less than $1.50. The Industrial sector of the economy grows at 4.1 percent per year, producing metal products, petroleum, coal, cement, chemicals, pharmaceuticals, aerospace, rail transportation equipment, passenger and commercial vehicles, construction equipment, industrial equipment, shipbuilding, electrical power equipment, machine tools and automated manufacturing systems, electronics and telecommunications equipment, fishing, food, tourism. The EU produces 2.365 million bbl of oil per day, while consuming 13.63 million bbl/day. Thus, the economy imports 8.613 million bbl of oil per day. 26 28 S napshot statistics are gathered from the Central Intelligence Agency's "The World Factbook," last modified late 2010, accessed July 2011, https://www.cia.gov/library/publications/the-world-factbook

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The current account balance was $51.4 billion in 2010, with $1.952 trillion coming from exports and $1.69 trillion going to imports. In the first quarter of 2011, the current account deficit was $70.1 billion. Top exports include machinery, motor vehicles, aircraft, plastics, pharmaceutical and other chemicals, fuels, etc. Imports are similar to exports, machinery, vehicles, aircraft, plastics, crude oil, and chemicals. The external debt as of June 2010 was $13.72 trillion. The budget deficit of the Euro area is 4.3 percent in 2011. A. Contemporary History In an attempt to prevent further death and devastation in post world war Europe, the French Foreign Minister Robert Schuman put forth the idea of the eventual unification of all European countries into one supranational community 29 His proposal, which is most commonly known as the Schuman Declaration was met with little resistance and in 1951 France, West Germany, Italy, Belgium, the Netherlands and Luxembourg signed the Treaty of Paris. It established the European Coal and Steel Community that initially created a common market for coal and steel among the member states. He believed that this would prevent conflict between the rivaling nations of France and Germany, as both materials were necessary for the production of war munitions. The rewards reaped from the formation of the ECSC contributed to the decision to integrate other aspects of the member state's economies. This led to the 27 29 European Union, "The History of the European Union," http://europa.eu/about-eu/eu-history/ index_en.htm

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signing of the Treaty of Rome, which established the European Economic Community, and also the dissolution of trade barriers between the six countries. Further integration occurred in 1967 when the institutions of all three communities were officially combined into the European Community. This created a single European Commission and Council of Ministers as well as what is currently known as the European Parliament. Over the next two decades the number of member states in the EC increased to twelve with the addition of Denmark, Ireland and the United Kingdom in 1973, Greece in 1981, and Spain and Portugal in 1986. In 1992 the Treaty of Maastricht created the European Union that at the time stood alongside the European Community, as well as an economic and monetary union among the member states which would eventually lead to the use of a single currency, the euro. This treaty also developed the five main criteria required for member states to enter the third and final stage of the EMU and adopt the euro as their national currency. These criteria require that: 1) a member nation's inflation rate should be no greater than 1.5 percentage points above the average of the three member nation's with the lowest inflation rate throughout the previous year, 2) a country's budget deficit must be lower than three percent of GDP, 3) national debt should not surpass sixty percent of GDP (footnote, but a country can join if debt is falling steadily), 4) long-term interest rates must be no more than two percentage points higher than the rates of the three EU members with the least inflation throughout the previous year, and 5)the national currency's exchange rate must stay within certain margins of fluctuation for two years. 28

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In 1999, the euro was introduced into the money market and adopted by all EU nations except for the United Kingdom and Denmark, who were permitted to opt out, and Sweden, who had not yet met the criteria required to participate. Three years later, in 2002, residents of countries in the Euro zone began using the euro bank notes and coins that would soon be used by a large portion of Europe as Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia joined in 2004 and Bulgaria and Romania joined in 2007. Of these twelve countries only five have adopted the euro, but all are legally required to once they have satisfied the Maastricht Criteria. The European Union was affected by the global financial crisis but has bounced back far more quickly than expected with business investment increasing by approximately two percent in 2010. Unfortunately though, housing development and public investment are still below the desired levels. The recovery is expected to continue with the aid of strong corporate profits although there are still significant threats to growth, which include but are not limited to, increased official debts and deficits, aging populations and doubts concerning the sustainability of the European Monetary Union. In an attempt to quell the aforementioned doubts and prevent financial crises like that of Greece from occurring in other member states, the EU and IMF created a one trillion dollar bailout fund for any members in danger of default. Regrettably, this did not calm the fears that have devalued the euro in many countries. The European Union is attempting to remedy this issue and prevent further crises by developing of a permanent European Stabilization Mechanism that will safeguard financial stability in the euro zone. 29

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B. The Roots The following section contains snapshots of the economies of Europe that are considered to be more stable and healthy than the rest: Germany, France, the Netherlands, the UK, Denmark, Belgium, Austria, Sweden, Czech Republic, Luxembourg, Slovenia, and Finland. Therefore, they are referred to as the root, core economies; however, this is not completely accurate and the purposes of the division of the European economies in this chapter is more logistical than analytical. Later, in Chapter 4, the difference between the core and peripheral economies will be the heart of the analysis. 1. Germany The German economy is the fifth largest in the world in terms of purchasing power parity and is Europe's largest. GDP is $2.94 trillion (PPP) or $35,700 per person. Real growth rate of GDP was 5.1 percent in the first quarter of 2011, higher than the 3.5 percent posted in 2010 and -4.7 percent in 2009. The Economist predicts GDP growth to be 3.3 percent in 2011 and 2.1 percent in 2012. The inflation rate was 2.3 percent by June 2011, up from 1.1 percent in 2010 and 0.4 percent in 2009. The German labor force consists of 43.45 million people, 67.8 percent of whom are employed by the services sector, 29.7 percent by industry. The unemployment rate is seven precent in June 2011, slightly less than 7.4 percent in 2010 and 7.5 percent in 2009. The richest 10 percent of Germans share only 24 percent of income or consumption, the Gini index is 27. 30

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Germany invests 18 percent of GDP in gross fixed investment while stocking $1.057 trillion of direct foreign investment at home and $1.484 trillion abroad. Germany has $180.8 billion in foreign exchange and gold reserves. The external debt of the country is $4.713 trillion as of June 2010 while the public debt is 78.8 percent of GDP. The government's budget revenues are $1.396 trillion, while expenditures are $1.516 trillion; thus, the budget deficit was 3.61 percent of GDP in 2010. Germany is Europe's leading exporter with $1.337 trillion in exports, exporting machinery, vehicles, chemicals, and household equipment to France 10.2 percent, US 6.7 percent, Netherlands 6.7 percent, UK 6.6 percent, Italy 6.3 percent, Austria 6 percent, China 4.5 percent, and Switzerland 4.4 percent. Germany imports $1.12 trillion of machinery, vehicle, chemicals, foodstuffs, textiles, and metals from Netherlands 8.5 percent, China 8.2 percent, France 8.2 percent, US 5.9 percent, Italy 5.9 percent, UK 4.9 percent, Belgium 4.3 percent, Austria 4.3 percent, and Switzerland 4.2 percent. German industry grew by 7.5 percent by June 2011. The current account surplus was $191.9 billion in May 2011. The positive effects of reforms that addressed chronically high unemployment and low average growth are expected in the following years, with GDP forecast to grow this year at a real rate of 2.2 percent. Some of the recovery is due to rebounding manufacturing orders and exports. The budget deficit dropped to 1.7 percent in 2011, which had ballooned due to stimulus and stabilization efforts and tax cuts. Germany's constitution was amended in 2009 to limit the federal government to structural deficits of no more than 0.35 percent of GDP per annum as of 2016. 31

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2. France France is the most visited country in the world and has the third largest income in the world from tourism. France is transitioning from modern economy with extensive government ownership and intervention to one relying more on market mechanisms. Many of the large companies, banks, and insurers in France have been partially or fully privatized; the government has ceded stakes in firms such as Air France, Renault, Thales, and France Telecom. France has weathered the economic downturn better than most larger EU economies because of domestic consumer spending, a large public sector, and less exposure to the negative effects of changing global demand. French real GDP contracted by 2.5 percent in 2009 but recovered to 1.5 percent real GDP growth in 2010. GDP growth continued to increase to 2.2 percent by the first quarter of 2011. The Economist predicts that GDP growth will be 2.1 percent in 2011 and 1.7 percent in 2012. The inflation rate was 2.1 percent by June 2011, up from 1.5 percent in 2010 and 0.1 percent in 2009. The GDP is $2.145 trillion (PPP) or $33,100 per person. The labor force numbers 28.21 million, 71.8 percent of whom are employed by the services sector. Unemployment rate increased from 7.4 percent in 2008 to 9.5 percent in 2010 and remains at 9.5 percent. The richest 10 percent of households share 24.8 percent of the income or consumption and the Gini coefficient is 32.7. The industrial production growth rate was 2.6 percents by May 2011, down from 3.5 percent in 2010; the industrial sector consists of these industries: machinery, 32

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chemicals, automobiles, metallurgy, aircraft, electronics, textiles, food processing, and tourism. France produces 70,820 bbl/day of oil, consumes 1.875 million bbl/day of oil, and imports 2.386 million bbl/day of oil. France exports $508.7 billion of machinery and transportation equipment, aircraft, plastics, chemicals, pharmaceutical products, iron and steel, and beverages to Germany 15.88 percent, Italy 8.16 percent, Spain 7.8 percent, Belgium 7.44 percent, UK 7.04 percent, US 5.65 percent, and Netherlands 3.99 percent. French imports cost $577.7 billion consisting of machinery and equipment, vehicles, crude oil, aircraft, plastics, chemicals coming from Germany 19.41 percent, Belgium 11.61 percent, Italy 7.97 percent, Netherlands 7.15 percent, Spain 6.68 percent, UK 4.9 percent, US 4.72 percent, and China 4.44 percent. As of December 2009 France had $133.1 billion in foreign exchange and gold reserves. France has public debt equivalent to 83.5 percent of GDP. France's external debt is $4.698 trillion. Gross fixed investment is 19.9 percent of GDP. At home, France has $1.207 trillion in direct foreign investment, while abroad, it has $1.837 trillion of direct foreign investment, up from $1.711 trillion in December 2009. The current account deficit is $60.7 billion. The government of France has been pursuing aggressive stimulus and investment measures since the global economic downturn but at the cost of deteriorating public finances. The budget deficit increased from 3.4 percent of GDP in 2008 to 7.8 percent of GDP in 2010 and the public debt increased from 68 percent to 84 percent of GDP during the same period. Because of this, France is ceasing to provide stimulus measures, 33

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eliminating tax credits, and freezing most government spending. This should bring the budget deficit under the 3 percent euro-zone ceiling by 2013. The plan seems to be working since by the budget May 2011 the deficit dropped to 5.8 percent of GDP. 3. The Netherlands The economy of the Netherlands is known for is stability in industrial relations, a sizable current account surplus, moderate inflation and unemployment, and is an important transportation hub in Europe. The Dutch GDP is $676.9 billion or $40,300 per person (PPP). After 26 years of uninterrupted growth, the Dutch economy was hit hard by the global economic crisis due to its openness, dependence on foreign trade and financial services. Dutch GDP contracted by 3.9 percent in 2009 and exports dropped by almost 25 percent. However, the real growth rate of GDP in 2010 was 1.7 percent with an inflation rate of 1.1 percent. By the first quarter of 2011, GDP growth was 2.8 percent with 2.3 percent inflation. The Economist expects GDP growth to be 2.2 percent in 2011 and 1.8 percent in 2012. The labor force numbers 7.86 million with 5.0 percent unemployment in June 2011, down from 5.5 percent unemployment rate in 2010. Eighty percent of the labor force in occupied by the services sector. The richest 10 percent of households share 22.9 percent of the income or consumption; the Gini index is 30.9. Industrial production growth rate is 2.6 percent in May 2011, down from 3.2 percent in 2010; industrial production in Holland comes from agriculture industries, metal and engineering products, electrical machinery and equipment, chemicals, 34

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petroleum, construction, microelectronics, and fishing. Holland produces 57,190 bbl/day of oil while consuming 922,800 bbl/day. Thus, the Dutch import 2.426 million bbl/day of oil and export 1.66 million bbl/day of oil. Exports total $451.3 billion on machinery and equipment, chemicals, fuels, and foodstuffs to Germany 25.54 percent, Belgium 12.49 percent, France 9.27 percent, UK 8.17 percent, Italy 5.07 percent, and US 3.97 percent. Holland imports $408.4 billion in machinery and transport equipment, chemicals, fuels, foodstuffs, and clothing from Germany 17.16 percent, China 11.58 percent, Belgium 8.68 percent, US 7.77 percent, UK 5.72 percent, Russia 4.47 percent, and France 4.4 percent. The Netherlands maintains a current account surplus of $61.8 billion as of the first quarter of 2011, up from $46.69 billion in 2010 and $39.58 billion in 2009. The Dutch hold $39.61 billion in reserves of foreign exchange and gold with an external debt of $3.733 trillion as of December 2009. The stock of direct foreign investment at home is $687.8 billion and $950.8 billion abroad. The public debt is 64.6 percent of GDP, up from 60.9 percent of GDP in 2009. The government spends $399.3 billion and earns $356 billion. The government nationalized two banks and injected billions of dollars into a third bank to prevent further damage and risk. The result was a government budget deficit of nearly 4.6 percent of GDP in 2009 and 5.6 percent in 2010, very different from the surplus in budget of 0.7 percent of GDP in 2008. Today, the budget deficit is 3.8 percent of GDP, just above the EU requirement. The weight of unemployment on private consumption makes it more difficult to keep the budget deficit low while stimulating economic recovery. 35

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4. United Kingdom The UK is the third largest economy in Europe after Germany and France. The government has opened up the market, reducing public ownership and containing growth of social welfare programs. UK is a leading trading power and financial center; banking, insurance, and business services account for almost 77.1 percent of GDP. GDP in PPP is $2.173 trillion or $34,800 per person. The real growth rate of GDP was 1.6 percent in the first quarter of 2011, up from 1.3 percent in 2010, 4.9 percent in 2009, and -0.1 percent in 2008. The inflation rate was 4.2 percent in June 2011, up from 3.3 percent in 2010 and 2.2 percent in 2009. UK's industrial production growth rate was -0.8 percent by May 2011, opposed to the 1.9 percent expansion in industry last year; industries include: machine tools, electric power equipment, automation equipment, railroad equipment, shipbuilding, aircraft, motor vehicles and parts, electronics and communications equipment, metals, chemicals, coal, petroleum, paper and paper products, food processing, textiles, clothing, and other consumer goods. Electricity production is 368.6 billion kWh while consumption is 345.8 billion kWh. Oil production is 1.502 million bbl/day while consumption is 1.669 million bbl/day in 2009. UK exports 1.393 million bbl/day of oil and imports 1.491 million bbl/ day of oil in 2008. The country's total exports are $405.6 billion of manufactured goods, fuels, chemicals, beverages, and tobacco to US 14.71 percent, Germany 11.06 percent, France 8 percent, Netherlands 7.79 percent, Ireland 6.89 percent, Belgium 4.65 percent, and Spain 4 percent. In 2010, imports were $546.5 billion of manufactured goods, machinery, fuels, 36

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and foodstuffs from Germany 12.87 percent, US 9.74 percent, China 8.88 percent, Netherlands 6.94 percent, France 6.64 percent, Belgium 4.86 percent, Norway 4.84 percent, Ireland 4.01 percent, and Italy 3.99 percent. The current account deficit was $40.34 billion in 2010, up from $23.65 billion in 2009. In the first quarter of 2011, the current account deficit was $70.4 billion. UK's reserves of foreign exchange and gold were $66.72 billion in December 2009. The country invests 14.4 percent of GDP in fixed gross investment. The government spent $1.154 trillion and earned $926.7 billion in 2010. The public debt is 76.5 percent of GDP, up from 68.2 percent of GDP in 2009. The external debt was $8.981 trillion as of June 2010. England has $1.169 trillion of direct foreign investment at home and $1.705 trillion abroad. The labor force numbers 31.45 million and the unemployment rate is 7.7 percent in May 2011, slightly less than 7.9 percent in 2010 and slightly more than 7.6 percent in 2009. The highest 10 percent of household incomes share 28.5 percent of income or consumption; Gini index is 34. The 2008 global economic downturn hit UK particularly hard due to its dependence on the financial sector. This, combined with declining home prices and high consumer debt forced the economy into recession and pushed the government to implement stimulus measures and stabilized the financial markets by nationalizing parts of the banking system, cutting taxes, suspending public sector borrowing rules, and moving forward public spending on capital projects. The new government, faced with increasing public deficit and debt levels, initiated a five-year austerity program aiming to 37

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lower the budget deficit from over 11 percent of GDP in 2010 to almost 1 percent in five years. Today, the budget deficit is down to 9.1 percent. Although the UK is outside of the EMU, the Bank of England coordinates interest rate moves with the European Central Bank. In 2010, one pound was equivalent to 1.5654 US dollars; today, one pound buys $1.6129. 5. Denmark The Danish economy is a modern market economy that features a highly developed industry with world-leading firms in pharmaceuticals, maritime shipping and renewable energy, as well as a high-tech agricultural sector that employs 2.5 percent of the labor force. Denmark is a member of the EU and Danish policy, regulation, and legislation strictly conform to EU standards. Danes enjoy very high standard of living, in 2010 GDP per capita was $36,600 (PPP). GDP was $201.7 billion; real growth rate of GDP was positive in 2010, at 2.1 percent, for the first time since 2007. The inflation rate was 3.0 percent in June 2011, up from 2.6 percent 2010 and 1.3 percent in 2009. The Danish labor force numbered 2.82 million in 2010. 77.3 percent of workers are employed by services while 22.8 percent work in industry. The unemployment rate was 4.0 percent in May 2011, slightly lower than 4.2 percent in 2010 and 4.3 percent in 2009. In 2007, the richest 10 percent of households share 28.7 percent of income or consumption; the Gini index was 29. Danish industrial production expanded by 7.1 percent by May 2011 and 4.0 percent in 2010. Danish industries include: iron, steel, nonferrous metals, chemicals, 38

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food processing, machinery and transportation equipment, textiles and clothing, electronics, construction, furniture and other wood products, shipbuilding and refurbishment, windmills, pharmaceuticals, and medical equipment. From this industry Denmark produced 34.6 billion kWh of electricity in 2008 of which it exported 11.36 billion kWh. Denmark also produced more oil than it consumed in 2009, 262,100 bbl/ day produces compared to 166,500 bbl/day consumed. Thus, Denmark exported 268,500 bbl/day of oil in 2008. As of 2010, Denmark has 1.06 billion bbl in proved oil reserves. Natural gas is another resource that the Danes have in surplus, in 2009 they produced 8.398 billion cu m while only consuming 4.41 billion cu m; exporting 3.98 billion cu m of gas to trade partners Germany, Sweden, UK, US, Norway, Netherlands, and France. There are 61.3 billion cu m of natural gas reserves proven to exist in Denmark. The current account balance was $14.35 billion in 2010 and $14.0 billion by May 2011; both improving on $12.43 billion in 2009. Total exports were worth $99.37 billion 2010, up from $91.51 billion in 2009. Denmark made a modest recovery in 2010 partly due to increase government spending swinging the budget into deficit; for many years up to 2008 the Danes maintained a healthy budget surplus. In 2010, the government collected $160.3 billion in revenue while spending $175.9 billion, the budget deficit was between 4 and 5 percent in 2010. In 2011, the budget deficit dropped to 3.8 percent. The country's external debt is $559.5 billion in June 2010, down from $588.8 billion in December 2008. Denmark has $149.6 billion of direct foreign investment at home and $199.8 billion abroad. The 39

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Danes use the kroner as currency, one US dollar purchases 5.81 kroner today, 5.624 Danish kroner in 2010, 5.361 in 2009; in 2006 the dollar bought almost 6 kroner. The median age of the Danish people is almost 41 years. The population growth rate was 0.251 percent in 2011; there are 10.29 births per 1,000 people. 87.0 percent of the population is urbanized and there are only 2.41 migrants per 1,000 people. 17.6 percent of people are between ages 0 and 14, 65.3 percent of people are between 15 and 64 years of age, while 17.1 percent are 65 years of age and over. 6. Belgium The economy is modern and based on private enterprise. Belgium has also capitalized on its central location within Europe, constructing a highly developed transport network, as well as a solid industrial and commercial base. In 2010, GDP was $394.3 billion or $37,800 per person (PPP). The same year, GDP expanded by 2.1 percent compared to the 2.7 percent contraction in 2009 and only 0.8 percent growth in 2008. By the first quarter of 2011 real GDP growth increased to 3.0 percent. According to The Economist magazine, GDP growth will be 2.3 percent for the year of 2011 and 1.8 percent in 2012. The inflation rate was 3.7 percent by June 2011, up from 2.3 percent in 2010 and zero change in consumer prices in 2009. The unemployment rate increased to 8.5 percent in 2010, compared to 7.9 percent in 2009; but dropped again by May of this year to 7.3 percent. There are 5.02 million workers in the labor force, 73 percent of whom are employed by industry. In 2006, the richest 10 percent of household shared 28.4 percent of income or consumption; the Gini index was 28. 40

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The 2008 global economic downturn led to government bail-outs of financial firms in Belgium that led to budget deficits. The deficit decreased from 6 percent of GDP in 2009 to 4.8 percent of GDP in 2010 and to 3.8 percent of GDP in 2011; while public debt was 98.6 percent of GDP in 2010, up from 96.2 percent in 2009. The external debt was $1.241 trillion as of June 2010, down from $1.354 trillion in 2008. In 2010 Belgium had greater stock of direct foreign investment at home then abroad, $741.7 billion compared to $632.8 billion. Belgium has few natural resources, importing $281.7 billion in 2010 of raw materials, machinery and equipment, chemicals, raw diamonds, pharmaceuticals, foodstuffs, transportation equipment, and oil products. In 2010, the current account deficit was $1.129 billion, up from the surplus of $1.251 billion in 2009. By March 2011, the current account deficit was turned into a surplus of $2.7 billion. Belgium imported 16.87 billion cu m of natural gas and 1.12 million bbl/day of oil in the same year. Belgian industry contributed to GDP growth by expanding by 3.5 percent in 2011. Almost three-quarters of the country's trade is with other EU countries, almost 20 percent of exports went to Germany in 2010; Germany also exported 17.1 percent of Belgian imports, as did the Dutch. Belgium has $23.98 billion foreign exchange and gold reserves. The Belgian population numbered over 10 million in July 2011. The median age is 42.3 years with 15.9 percent of people between the ages of 0 and 14, 66.1 percent of people between ages 15 and 64, and 18 percent of people are 65 years and over. The population growth was only 0.071 percent in 2011 with only 10.06 births per 1,000 41

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people and 10.57 deaths per thousand; net migration rate was only 1.22 migrants per 1,000 people in 2011. Also, 97 percent of the total population is urbanized. 7. Sweden Sweden is one of Europe's most stable economies, achieving high standard of living with $39,100 GDP per capita (PPP) and relying on high-tech capitalism with a skilled labor force and extensive welfare benefits. The GDP was $354.7 billion in 2010 (PPP). In 2010, the inflation rate was 1.4 percent, up from -0.3 percent in 2009. Today, the inflation ration was 3.1 percent. The Swedes are not part of the EMU, turning down membership in 2003 concerned about impact on economy and sovereignty. The labor force numbered $4.93 million with 7.9 percent unemployment in 2011, down from 8.3 percent the previous year. The richest 10 percent of households share 22.2 percent of income or consumption; Gini index is 23. The government spent $236.6 billion in 2010 while making $230.1 billion in revenues. The public debt was 40.8 percent of GDP as 2010, down from 41.6 percent of GDP in 2009. Sweden's budget deficit in 2010 was less than half of EMU requirement. Privately owned firms account for 90 percent of industrial output with the engineering sector accounting for 50 percent of output and exports. The industrial growth rate was 13.4 percent by May 2011, 5.4 percent higher than the rate in 2010. Swedish industries include: iron and steel, precision equipment (bearing, radio and telephone parts, armaments), wood pulp and paper products, processed foods, and motor vehicles. Sweden produced almost 10 billion kWh of electricity more than it consumed 42

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in 2007. In 2008, Sweden exported almost 2 billion kWh of electricity more than it imported. In 2008, Sweden imported 589,900 bbl/day of oil in order to consume 328,100 bbl/day. The Swedes consumed $1.229 billion cu m of natural gas in 2009, of which all was imported. The Swedish economy is strongly based on foreign trade. A relatively low currency keeps Swedish export strong versus competitors; in 2010, 7.5077 Swedish kronor (SEK) was worth one US dollar; for the last five years the kronor has been between 6.4074 per dollar and 7.6529 per dollar. Exports and Imports were $162.6 billion and $158.6 billion, respectively. Sweden had a current account surplus of $21.68 billion in 2010. Exported commodities include: machinery 35 percent, motor vehicles, paper products, pulp and wood, iron and steel products, and chemicals; exports come from Norway 10.61 percent, Germany 10.2 percent, UK 7.45 percent, Denmark 7.35 percent, Finland 6.44 percent, US 6.36 percent, France 5.05 percent, and Netherlands 4.67 percent. A large fraction of Swedish imports are from Germany and are similar Swedish exports with the exception of foodstuffs and clothing. Sweden had $47.29 billion in reserves of foreign exchange and gold in December 2009 with an external debt of $853.3 billion as of June 2010. In December 2010 Swedish stock of direct foreign investment at home was $321.4 billion and $383.9 billion abroad. The current account surplus was $32.2 billion in the first quarter of 2011. After the economic downturn of 2008, the economy continued to contract, first by 0.6 percent then by 5.3 percent in 2009. The government implemented reform programs aimed at increasing employment, reducing welfare dependence, and streamlining state's 43

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role in the economy. The economy rebounded in 2010 with a real GDP growth rate of 5.5 percent due to strong exports and return to profitability in the banking sector. The expansion continues as Sweden's GDP growth was 6.4 percent in the first quarter of 2011. The Economist expects GDP to be 4.4 percent in 2011 and 3.0 percent in 2012. 8. Austria Austria's economy is a developed market economy whose people enjoy high standard of living; the economy is closely tied to the EU economies and Germany's in particular, in 2010 almost 45 percent of Austria's exports went to Germany. The economy features a large service sector, employing two-thirds of the labor force, a welldeveloped, growing industrial sector, and a highly developed agricultural sector. After solid growth for several years the global downturn in 2008 led to a brief recession; in 2009 GDP contracted by 3.9 percent but expanded by 2 percent in 2010 and 3.9 percent by the first quarter of 2011. The Economist predicts that GDP will be 2.7 percent for 2011 and 1.9 percent for 2012. In 2010, GDP (PPP) was $332 billion, $40,400 per capita. The inflation rate was 1.9 percent the same year, up from 0.5 percent in 2009. By June 2011 the economy continued to gain momentum reaching 3.3 percent inflation rate. After the implementation of stabilization measures, stimulus spending, and income tax reform used to give a boost to the economy, the budget deficit jumped from 3.5 percent of GDP in 2009 to 4.7 percent of GDP in 2010. The government manage to cut the budget deficit to 3.3 percent in 2011. Public debt also increased from 67.5 percent of GDP in 2009 to 70.4 percent of GDP in 2010. 44

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The Austrian labor force numbered 3.7 million in 2010; two-thirds of workers were employed by services in 2009, 27.5 percent worked in industry, and 5.5 percent in agriculture. The unemployment rate was 4.5 percent in 2010, down from 4.8 percent in 2009. In 2008, only six percent of the population was below the poverty line; the poorest ten percent of households shared four percent of household income or consumption; the Gini index was 26 in 2007. Much of Austria's GDP growth in 2011 and 2010 came from Industry, the industrial production growth rate was 9.7 percent and 7.0 percent, respectively. Austrian industries include construction, machinery, vehicles and parts, food, metals, chemicals, lumber and wood processing, paper and paperboard, communications equipment, and tourism. Austria produced more electricity than it consumed by over 3 billion kWh in 2009. However, Austria still imported 19.54 billion kWh of electricity while exporting 18.76 billion kWh. The country is not so lucky when it comes to natural resources, Austria imported 273,000 bbl/day of oil and 9.46 billion cu m of natural gas in 2009, ranking thirty-seventh and twenty-third in the World, respectively. In 2010, exports made $157.4 billion and imports cost $156 billion. Germany is Austria's greatest trading partner, thirty-one percent of exports go to Germany and fortyfive percent of imports are German. Austria had $21.89 billion in foreign exchange and gold reserves in 2010, up from $18.05 billion in 2009. The country has improved its external debt position by reducing debt from $864.2 billion in 2009 to $755 billion in 2010. Austria keeps net factor payments balanced by maintaining an equal amount of foreign direct investment at home and abroad, in 2010 there was $154 billion of FDI at 45

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home, in Austria, and abroad. In April 2011, the trade deficit on merchandise was $6.6 billion but in the first quarter of this year Austria had a $10.7 billion current account surplus. Austria's population numbered 8,217,280 in July 2011. The median age was 42 years with 14 percent of the population between ages 0-14, 67.7 percent of the population between ages 15-64, and 18.2 percent of people 65 years and over. The expansion of the population has almost ceased as the growth rate is 0.034 percent; there are 8.67 births and 10.14 deaths per thousand people. Fortunately, there are more immigrants than emigrants per thousand people since the net migration rate is 1.81 migrants per thousand. Sixtyeight percent of the people live in cities with 1.693 million living in the capital city of Vienna. Urban living is becoming increasingly popular as the annual rate of change of urbanization is 0.6 percent. 9. Czech Republic The Czech Republic joined the EU in 2004 and has a stable market economy that harmonized laws and regulations with those of the EU before joining. The global downturn hurt the economy since main export markets suffered but the conservative financial system remained relatively healthy. The GDP was $261.3 billion in 2010 or $25,600 per person (PPP). The real growth rate of GDP was 2.8 percent in the first quarter of 2011, up from 2.3 percent in 2010 and from the 4.1 percent contraction in 2009 and down from the 2.5 percent growth in 2008. The Economist predicts GDP growth to be 2.0 percent in 2011 and 2.9 percent in 2012. The inflation rate was 1.8 by June 2011, 46

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up from 1.5 percent in 2010 and 1.0 percent in 2009. The labor force numbered 5.37 million in 2010 with 7.1 percent unemployment, down from 8 percent in 2009. However, the unemployment rate jumped back up to 8.1 percent by June 2011. The Gini index was 26 in 2005. 58.3 percent of labor was employed by the service sector in 2009, 38.6 percent worked in industry. The Czech economy depends greatly on its neighbors demand for its exports, exporting 31.7 percent of its $116.5 billion worth of exports to Germany in 2010; other export partners include Slovakia, Poland, France, UK, Austria, and Italy. The Czech imported $109.2 billion in 2010, twenty-five percent coming from Germany and 12 percent from China. The current account deficit was $6.4 billion in the first quarter of 2011, up from $5.956 billion in 2010 and $2.146 billion in 2009. The Czech Republic produces more electricity than it consumes of which it exported 22.23 billion kWh in 2009. This, along with 219,900 bbl/day of oil and 9.683 billion cu m of natural gas imports, are used to fuel to industry which grew at 15.2 percent in 2011 and 15.9 percent in 2010, the seventh highest industrial production growth rate in the world. Czech industries include: motor vehicles, metallurgy, machinery and equipment, glass, and armaments. In 2010, the government made $77.9 billion and spent $87.87 billion; the budget deficit was 4.5 percent of GDP in 2011. The public debt increased from 32.5 percent in 2009 to 40 percent in 2010. The external debt was $86.79 billion as of December 2010, up from $86.55 billion the previous year. Gross fixed investment was 22.5 percent of GDP in 2010. The stock of direct foreign investment at home was $130.4 billion in 2010, 47

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up from $121.9 billion in 2009; abroad, the Czech have $14.67 billion in direct foreign investment. The koruny is the Czech currency; one US dollar bought 19.111 koruny in 2010, up from 17 in 2008 and down from 22.596 in 2006. The Czech population numbered 10,190,213 as of July 2011. The median age was 40.8 years with 13.5 percent of people between ages 0-14, 70.2 percent of people between ages 15-64, and 16.3 percent of the population 65 and above. The population growth rate has become negative, the population is contracting at 0.12 percent per year in 2011. There are only 8.7 births per 1,000 people and over 10 deaths per thousand. The country only nets less than one migrant per 1,000 people per year in 2011. Almost three-quarters of the population are urbanized, annual rate of change of urbanization is estimated at 0.3 percent for the 2010-15 period. 10. Luxembourg The economy is small and rich, benefiting significantly from its proximity to EU members Germany, France, and Belgium. Per capita, Luxembourg is the richest country in the EU and third in the World. Luxembourg depends on its industrial and financial sector to maintain solid growth, low inflation, and low unemployment. In 2010, the GDP was $41.09 billion or $82,600 per person (PPP). Almost ninety percent of GDP comes from services, the financial sector accounted for 28 percent of GDP in 2010; most banks are foreign owned with extensive foreign dealings. 48

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Similarly to its neighbors, Luxembourg's economy contracted in 2008 and again by 3.7 percent in 2009; the economy rebounded in 2010 with a 3.2 percent expansion and again by 4.8 percent in the first quarter of 2011. The Economist predicts GDP growth to be 5.3 percent in 2011 and 3.4 percent in 2012. However, the recovery came from an injection of capital into the banking sector after the global downturn resulting in a five percent government budget deficit in 2009; nonetheless, the deficit was reduced to below the 3.0 percent mark in 2010. In 2011, the budget deficit was down to 1.4 percent of GDP. The public debt was 16.2 percent of GDP in 2010, up from 14.6 percent of GDP in 2009. The external debt was $1.892 trillion as of June 2010, down from $2.02 trillion in December 2008. The labor force numbers only 206,600, the services sector employed 80.6 percent of workers. In 2010, the unemployment rate was 5.7 percent in May 2011, down from 5.5 percent in 2010 and equivalent to the rate in 2009. The inflation rate was 3.5 percent in June 2011, up from 2.1 percent in 2010 and 0.4 percent in 2009. The industrial production growth rate was negative at -0.5 percent, a stark difference from the 1.7 percent expansion in 2010 that was largely due to expansion in banking and financial services, information technology, and telecommunications. Luxembourg has a current account surplus of $4.5 billion in the first quarter of 2011, up from $3.396 billion in 2010 and $2.985 billion in 2009. The stock of direct foreign investment at home was $11.21 billion in December 2008. In 2010, total exports were $17.82 billion, up from $15.5 billion in 2009. 20.2 percent of all exports went to Germany, 16.3 percent to France, and 11.2 percent to Belgium. Imports were worth 49

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$23.67 billion in 2010, commodities include minerals, metals, foodstuffs, and quality consumer goods; 27.5 percent of imports are Belgian, 23.2 percent are German, and 18.5 percent are Chinese. Luxembourg had $810 million in reserves of foreign exchange and gold in December 2009. The population of Luxembourg numbered 503,302 in July 2011. The median age was 39.4 years with 18.2 percent of people between ages 0 and 14, 66.9 percent between ages 15 and 64, and almost 15 percent are 65 and over. The population is growing at 1.145 percent per year, the birth rate is 11.69 per thousand per year and 8.48 people die per thousand per year. The economy depends greatly on foreign and EU workers with its inherently small population, 60 percent of labor force comes from outside Luxembourg. Thus, the net migration rate is 8.24 migrants per thousand. 85 percent of the total population live in cities; the rate of urbanization is changing by 1.4 percent annually. 90,000 people live in the capital city of Luxembourg. 11. Slovenia Slovenia was the first country of the 2004 European Union entrants to adopt the euro in 2007. The economy stands out in the region as a model of economic stability and success. Slovenia's GDP was $56.58 billion in 2010 (PPP), with $28,200 GDP per person, the highest in Central Europe and similar to Italy and Spain. In 2009, the economy contracted by 8.1 percent and unemployment rate was 9.2 percent. The economy rebounded somewhat in 2010, real growth rate of GDP was 1.2 percent but unemployment rate increased to 10.6 percent. In the first quarter of this year, GDP 50

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growth was 2.0 percent but unemployment jumped to 11.6 percent. The Economist predicts GDP to grow at 2.1 percent this year and 2.2 percent in the next. The inflation rate was 1.3 percent in June 2011, down from 2.1 percent in 2010 and up from 0.9 percent in 2009. The labor force is small, numbering 930,000 in 2010. The richest 10 percent of households share 24.6 percent of income or consumption; the Gini index is 28.4. The government spent $25.53 billion in 2010 while earning $22.56 billion in revenues; the resulting budget deficit was 6.89 percent of GDP, more than double the required amount. Today, the budget deficit has been reduced to 5.1 percent of GDP. The public debt was 35.5 percent of GDP as of 2010, up from 31.3 percent of GDP. The external debt was $51.57 billion in June 2010, down almost $3 billion since December 2008. Slovenia's industrial production grew by 4.3 percent by April 2011, much better than the 1.0 percent growth experienced in 2010; a good sign considering 31 percent of GDP comes from industry and 35 percent of workers are employed by this sector. The country produces no oil and consumes only 60,000 bbl/day; however, consumption and importation of natural gas was 1.05 billion cu m in 2009. Slovenia exported $24.97 billion and imported $25.96 billion in 2010, resulting in a current account deficit of $598 million. Today, the current account deficit has been cut to $200 million. The country's main trading partners are Germany, Italy, Croatia, Austria, and France. It held $1.08 billion in foreign exchange and gold reserves as of December 2009. The stock of direct foreign investment at home was $15.73 billion and $9.001 billion abroad in 2010. 51

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Despite great economic success, Slovenia is lagging behind the region in foreign direct investment. Also, high taxes, an inflexible labor market, and loss of sales of legacy industries to competition in China and India have made it difficult for the Slovenian economy to rebound. 12. Finland The Finish economy is a highly industrialized, free-market economy with GDP per capital similar to that found in the Netherlands, Sweden, Austria, and Belgium. In 2010, GDP was $186 billion or $35,400 per person (PPP). The Finish economy suffered from the world slowdown in 2009, experiencing an 8.2 percent contraction. However, recovery of exports, household consumption, and domestic trade resulted in 3.1 real GDP growth in 2010. The Economist expects Finish GDP to expand by 3.4 percent in 2011 and 1.6 percent in 2012. The inflation rate was 3.5 percent in June 2011, up from 1.7 percent in 2010 and 1.6 percent in 2009. The labor force numbered 2.672 million 2010 with 8.4 percent unemployment, up from 8.2 percent in 2009. Almost one third of the population works in public services and almost twenty percent of laborers are employed by commerce. The Gini index was 26.8 in 2008. The industrial production growth rate was 5.1 percent in 2010; by May 2011, industrial production grew by 6.0 percent. Finish industries include metal and metal products, electronics, machinery and scientific instruments, shipbuilding, pulp and paper, foodstuffs, chemicals, textiles, and clothing. 52

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Exports account for over one third of GDP ($69.4 billion in 2010); Finland excels in high-tech exports and depends on raw materials, energy, and some components for manufactured goods ($64.96 billion in 2010). Forestry provides a secondary occupations for the rural population and is an important export earner. The current account surplus was $7.561 billion 2010, up from $3.343 billion in 2009. Russia, Germany, and Sweden are Finland's main trading partners. Finland has $9.6 billion of reserves of foreign exchange and gold, down from $11.46 billion in 2009. The external debt was $370.8 billion as of June 2010, up from $339.5 billion in 2008. The contraction in 2009 left a mark on government finances and the debt ratio. The budget deficit was 2.5 percent of GDP in 2010, public debt was 48.3 percent in the same year. The government received 51 percent of GDP in taxes and other revenues. Finland maintained a budget surplus for years before the current deficit and will likely return to balanced government finances but not without maintaining economic growth by addressing a rapidly aging population, decreasing productivity and competitiveness. C. The Branches The branches are the weaker economies of Europe, generally found on the periphery. These are the economies that are currently in economic trouble or might be in the future. The countries experiencing economic crisis are: Ireland, Greece, Portugal, Spain, and Italy. The other countries that make up this list have economies that are smaller or weaker than those of the Root and include: 53

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1. Ireland Ireland was part of the initial group of 12 EU nations that started circulating the Euro in 2002. Before the recession in 2008, Ireland experienced an average of 6 percent GDP growth during the period 1995-2007. Since the recession Ireland has struggled greatly, the economy has shrunk; GDP growth has been negative, hovering around negative one percent around 2010. However, in the first quarter of this year the economy rebounded some what with 0.1 percent GDP growth. The Economist expects GDP to be -0.2 percent for this year and 0.5 percent in 2012. Ireland produced $172.3 billion worth of goods and services (PPP) in 2010 or $37,300 per person, down from $41,700 in 2008. The services sector makes up 70 percent of GDP, the rest generating from industry. The labor force numbers 2.15 million and the unemployment rate is 14.2 percent in June 2011, up from13.7 percent in 2010 and 12.4 percent in 2009. The richest 10 percent of the population share 27.2 percent of household income or consumption, thus the Gini coefficient is 29.3. The inflation rate is negative 1.6 percent in 2011. The country invests 16.5 percent worth of GDP in gross fixed investment. The industrial production growth rate is 0.3 percent by May 2011, greatly reduced from five percent growth in 2012. Irish industries are: pharmaceuticals, chemicals, computer hardware and software, food products, beverages and brewing, and medical devices. Ireland produces no oil but consumes 160,900 bbl/day coming from imports. The country exports $115.7 billion of machinery and equipment, computers, chemicals, pharmaceutical, live animals, and animal products to US 20.52 percent, Belgium 17.78 54

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percent, UK 16.31 percent, Germany 5.66 percent, France 5.56 percent, and Span 4.19 percent. Ireland imports $70.36 billion of data processing equipment, other machinery and equipment, chemicals, petroleum, textiles, and clothing from UK 35.28 percent, US 16.87 percent, Germany 6.76 percent, Netherlands 5.86 percent, and France 4.76 percent. Ireland's current account balance is -$3.191 billion. Ireland has $2.104 billion of foreign exchange and gold with $2.253 trillion in external debt. The stock of direct foreign investment at home is $228 billion, while the stock of direct foreign investment abroad is $286.2 billion. The current account balance in the first quarter of 2011 was $1.6 billion. The recession of 2008 was due to the collapse of Irish domestic property and construction markets. Property prices increased more dramatically in Ireland than in any other developed economy, the average prices of houses have fallen by 50 percent since 2007. In response to the downturn, the government moved to guarantee all bank deposits, recapitalize the banking system, and establish partly public venture capital funds. In 2009, the National Asset Management Agency (NAMA) was established to acquire problem commercial property and development loans from Irish banks. The government was forced to cut budgets due to reduced revenues and a burgeoning budget deficit, including wage reductions for all public servants. Still, the budget deficit reached 32 percent of GDP in 2010 and in late 2010 the Cowen Government agreed to a $112 billion loan package from the EU and IMF to further capitalize the banking sector and prevent defaulting on debt. Public debt was 94.2 percent of GDP in 2010. The latest move to reduce the budget is a four-year austerity plan that will cut an additional $20 55

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billion from the budget. The measures are working some what, the budget deficit fell to 11.4 percent of GDP in 2011. 2. Greece Greece is a capitalist economy with a large public sector accounting for 40 percent of its GDP. Greece benefits significantly from EU aid; GDP in 2010 was $318.1 billion, 3.3 percent of which came from EU aid. The GDP per capita is $29,600, close to that of Italy. The Greek economy grew an average of 4 percent during the period 2003-2007. In 2008 the global economic downturn along with tightening credit condition and a growing budget deficit brought the economy into recession. The economy contracted by 2 percent in 2009 and 4.8 percent in 2010. The first quarter of this year was worse for Greece, GDP contracted by 5.5 percent. The Economist predicts GDP growth to end up being -4.5 percent in 2011 and -1.2 percent in 2012. The inflation rate was 3.3 percent in June 2011, down from 4.5 percent in 2010 and up from 1.2 percent in 2009. Greece was not able to meet the Growth and Stability Pact budget deficit criterion of 3 or less percent of GDP until 2007. In 2009, Greece's budget deficit reached 15.4 percent of GDP, then dropped to 9.4 percent in 2010. Today, the budget deficit is back up to 9.6 percent of GDP. Public debt in 2010 was 144 percent of GDP, up from 126.8 percent in 2009. The labor force numbered 5.05 million in 2010 with 15.8 percent unemployment in April 2011, increasing from 12 percent unemployment in 2010 and 9.4 percent in 2009. 12.4 percent of workers are employed by agriculture, 22.4 percent by 56

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industry, and 65.1 percent by the service sector. In 2009, twenty percent of the population was below the poverty line. The richest 10 percent of households share 26 percent of the income or consumption; the Gini index was 33 in 2005. The industrial production growth rate was 3.2 percent in 2010. However, this year, industry shrank by 10.0 percent by May 2010. Greek industries include tourism, food and tobacco processing, textiles, chemicals, metal products, mining, and petroleum. In 2007, Greece produced more electricity than it consumes by 500 million kWh. The economy consumes 414,400 bbl/day of oil and imports 520,900 bbl/day. In 2010, exports totaled $21.14 billion of food and beverages, manufactured goods, petroleum products, chemicals, and textiles. Greece's export partners are Germany 11.11 percent, Italy 11.05 percent, Cyprus 7.28 percent, Bulgaria 6.74 percent, US 4.95 percent, UK 4.4 percent, and Turkey 4.23 percent. Greece imported $44.9 billion in 2010 of machinery, transport equipment, fuels, and chemicals. The import partners are Germany 13.73 percent, Italy 12.71 percent, China 7.08 percent, France 6.1 percent, Netherlands 6.02 percent, South Korea 5.68 percent, Belgium 4.34 percent, and Spain 4.08 percent. Greece has $5.546 billion in reserves of foreign exchange and gold with an external debt of $532.9 billion. The stock of direct foreign investment at home in December 2010 was $48.1 billion and $38.66 billion abroad. The current account deficit was $28.5 billion as of April 2011. Greece's international debt rating dropped in late 2009 because of eroding public finances, inaccurate and misreported statistics, and consistent failure to follow through on reforms. Due to pressure from EU the government adopted austerity measures that 57

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include cutting government spending, reducing the size of the public sector, reforming the health care and pension systems, improving competitiveness by reforming labor and product markets, and decreasing tax evasion. Greek labor unions are striking over austerity measures and reforms making it more difficult for the government to move along with reforms. In April 2010 a leading credit agency assigned Greek debt the lowest possible credit rating. In May, the IMF and Euro zone governments provided $147 billion in loans so the country could repay debt to creditors. The government announced spending cuts and tax increases totaling $40 billion over three years. Greek was unable to reach its own set austerity measures, lenders are giving Greece more time to repay the loans by increasing tax collection, shoring up public enterprises, and reining in health spending. The Greek's responded once again by implementing structural reforms but investors question whether Greece can respond considering the unforgiving economic outlook. 3. Portugal Portugal was one of the first countries to launch the Euro in 1999. Following the currency switch, household debt expanded rapidly and Portugal's public deficit exceeded 3 percent GNP in 2001. Austerity measures were difficult to implement due to slow rate of growth. GDP was $247 billion or $23,000 per person in 2010(PPP). Per capita GDP rose from 51 percent of EU average to 78 percent in early 2002 and down to 72 percent in 2005. GDP shrunk by 0.6 percent in the first quarter of 2011, opposite the expansion of 1.3 percent in 2006. The inflation rate was 3.4 percent in June 2011, up from 1.1 percent 58

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in 2010. This sluggish growth rate and rapid increase in unemployment resulted in the labeling of Portugal as "a new sick man of Europe" by the Economist, they expect GDP growth to be -2.0 percent in 2011 and -2.5 percent in 2012. The unemployment rate was 4.1 percent at the end of 2001, from 2002 to 2007, unemployment rate increased by 65 percent to 10.7 percent in 2010 and now to 12.4 percent in the first quarter of 2011. The labor force is made up of 5.57 million people, of whom 59.8 percent work in the services sector and 11.7 percent work in agriculture. The richest 10 percent of Portuguese share 28.4 percent of the income or consumption; the Gini index is 38.5. Portugal invests 19 percent of GDP in fixed gross investment. The government spends $110.2 billion and earns $93.61 billion in revenues. The public debt is 83.2 percent of GDP. The government is implementing austerity measures, including a 5 percent public salary cut and a 2 percent increase in the value-added tax in order to reduce to budget deficit from 9.3 percent in 2009 to 4.6 percent in 2011. So far, the budget deficit is 6.8 percent in 2011. Industrial production growth rate was negative 0.3 percent by May 2011, down from 0.9 percent in 2010. Portuguese industries include: textiles, clothing, footwear, wood and cork, paper, chemicals, auto-parts manufacturing, base metals, dairy products, wine and other foods, porcelain and ceramics, glassware, technology, telecommunications; ship construction and refurbishment; tourism. Portugal produces 4,721 bbl/day of oil but produces 272,200 bbl/day. Oil imports are 323,000 bbl/day. 59

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Exports total $46.27 billion of agricultural products, food products, wine, oil products, chemical products, plastics and rubber, hides, leather, wood and cork, wood pulp and paper, textile materials, clothing, footwear, and machinery and tools. Export partners include: Spain 26.25 percent, Germany 12.99 percent, France 12.04 percent, Angola 7.21 percent, and UK 5.54 percent. Imports total $68.22 billion and are made up of agricultural products, chemical products, vehicles and other transport material, and optical precision instruments, computer accessories and parts, semi-conductors and related devices. Portugal trades with Spain 31.58 percent, Germany 12.41 percent, France 8.58 percent, Italy 5.55 percent, and Netherlands 5.31 percent. Portugal's current account balance was -$19.03 billion in 2010. Portugal has $16.03 billion in reserves of foreign exchange and gold. The external debt is $497.8 billion; stock of direct foreign investment at home is $105.7 billion and $63.64 billion abroad. Portugal is being increasingly overshadowed by lowercost producers in Asia and Central Europe as a destination for foreign direct investment. Since austerity measures have limited stimulus measures, the government is focusing on boosting exports and implementing labor market reforms to increase GDP growth and increase competitiveness. The current account deficit was $20.8 billion by April 2011. A poor education system and rigid labor market have also become obstacles in the way of Portuguese economic success, hindering investment. 4. Spain 60

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The Spanish economy is the 12 th largest in the world, $1.369 trillion GDP (PPP). The per capita income is close to that of Italy and slightly less than Germany and France, at $29,400. The economy maintained above average GDP growth for 15 years before the 2008 recession when GDP contracted by 3.7 percent. The GDP contracted again in 2010 by 0.2 percent making Spain the last economy to emerge from the global recession. In the first quarter of 2011, GDP expanded by 0.8 percent. The Economist expects GDP growth to be 0.7 percent for 2011 and 1.1 percent in 2012. Declining construction, flooded housing market, and falling consumer spending contributed to the contracting economy of recent years. The inflation rate was 3.2 percent in June 2011. Spain's labor force numbers 22.96 million with an unemployment rate of 20.9 percent, up from 18.1 percent in 2009 and eight percent in 2007. The richest 10 percent of households share 26.6 percent of income or consumption; the Gini index is 32. The country's fixed gross investment is 22.9 percent of GDP. The government spent $648.6 billion and earned $515.8 billion. The budget deficit was 9.7 percent of GDP in 2010, increasing from 3.8 percent of GDP in 2008. In 2011, the budget deficit was 6.5 percent of GDP. The public debt is 63.4 percent of GDP and inflation is 1.3 percent, up from -0.3 percent in 2009. Spain's industry has suffered since the recession, industrial production contracted by 2 percent in 2010. Industries hurt by the contraction include: textiles and apparel, food and beverages, metals and metal manufactures, chemicals, shipbuilding, automobiles, machine tools, tourism, clay and refractory products, footwear, pharmaceuticals, and medical equipment. This year, industry managed to expand by 0.8 61

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percent. Spain consumes 1.482 million bbl/day of oil while only producing 27,230 bbl/ day. Thus, oil imports are 1.716 million bbl/day, total imports cost $324.6 billion. Spain exports $268.3 billion of machinery, motor vehicles, foodstuffs, pharmaceuticals, medicines, and other consumer goods to France 19.27 percent, Germany 11.11 percent, Portugal 9.21 percent, Italy 8.24 percent and UK 6.18 percent. Spain imports machinery and equipment, fuels, chemicals, semi finished goods, foodstuffs, consumer goods, measuring and medical control instruments from Germany 15.02 percent, France 12.82 percent, Italy 7.17 percent, China 5.8 percent, Netherlands 5.22 percent, and UK 4.7 percent. The country has a current account deficit of $63.9 billion, down from $66.74 billion in 2010 and $80.38 billion in 2009. Italy has $28.2 billion in foreign exchange and gold reserves with an external debt of $2.166 trillion. The stock of direct foreign investment at home is $668.5 billion and $641 billion abroad. Spanish banks' high exposure to collapsed domestic construction and real estate market poses risk to banking sector; government reform of the sector started in 2010 with a $15 billion capital injection to various institutions. The banking sector remains problematic as there seem to be more troubled banks on the way, although the Bank of Spain is pressuring others to come clean on losses and consolidate in order to survive. 5. Italy The Italian economy is industrial and diversified; the predominant industry varies by region, the north is more highly developed and dominated by private companies. On the other hand, the southern region is welfare-dependent and agricultural with high 62

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unemployment. The economy is driven by manufacture of high-quality consumer goods produced by small and medium-sized firms, mostly family owned. Italy's GDP is $1.774 trillion or $30,500 per person (PPP). Real GDP grew by one percent in the first quarter of 2011 and by 1.3 percent in 2010, both improving from the 5.2 percent contraction suffered in the previous year. The Economist expects that GDP growth will remain around one percent in the next year and a half. The inflation rate was 2.7 percent in June 2011, almost double the 1.4 percent inflation rate posted in 2010. Italy's labor force numbers 25.05 million people with an unemployment rate of 8.1 percent in May 2011, similar to the 8.4 percent and 7.8 percent rates in 2010 and 2009, respectively. The richest 10 percent of households in Italy share 26.8 percent of the income or consumption; the Gini index is 32. Italy's industrial production growth rate was 1.8 percent in May 2011, up from 0.5 percent in 2010 and comes from tourism, machinery, iron and steel, chemicals, food processing, textiles, motor vehicles, clothing, footwear, and ceramics. Italians consume 1.537 million bbl/day of oil while only producing 146,500 bbl/ day. Thus, Italy imports 1.911 million bbl/day of oil. Italian imports total $459.7 billion and consist of engineering products, chemicals, transport equipment, energy products, mineral and nonferrous metals, textiles and clothing, food, beverages, and tobacco. Italy obtains imports from Germany 16.68 percent, France 8.82 percent, China 6.53 percent, Netherlands 5.63 percent, Spain 4.3 percent, Russia 4.12 percent, and Belgium 4.08 percent. Exports total $458.4 billion consisting of engineering products, textiles and clothing, production machinery, motor vehicles, transport equipment, chemicals, food, 63

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beverages and tobacco, minerals, and nonferrous materials. Export partners include Germany 12.6 percent, France 11.57 percent, US 5.92 percent, Spain 5.69 percent, UK 5.13 percent, and Switzerland 4.69 percent. The government spent $1.042 trillion in 2010 while earning $904.3 billion in revenues. Italy's public debt is 118.1 percent of GDP while the budget deficit was over 5 percent in 2010. In 2011, the budget deficit was cut to four percent. Gross fixed investment is 19.1 percent of GDP. Italy's external debt as of June 2010 was $2.223 trillion. Italy has $405.1 billion of direct foreign investment at home and $601.1 billion abroad. Reserves of foreign exchange and gold are $132.8 billion. The current account deficit was $79.6 billion from the first of quarter of 2011 to 2010. 6. Baltic Sates i. Estonia One of the newest entrants into the Eurozone, Estonia began circulating the Euro in January 2011. Estonia has been successful in the transition from command to market economy, successive governments have all pursued, with little wavering, a free market, pro-business economic agenda. The result is a modern market-based economy with one of the higher per capita income levels in Central Europe and the Baltic region; $19,100 in 2010, up from $18,400 in 2009 and down from $21,300 in 2008. Estonia sustained high growth rates since entering the EU in 2004 until the economic downturn of 2008, averaging 8 percent GDP growth per year. In 2010, GDP was 24.69 billion, up from $23.95 billion 2009 and down from $27.81 billion in 2008. 64

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In 2009, GDP dropped by almost 14 percent as a result of an investment and consumption slump that followed the bursting of the real estate market bubble. Real growth rate of GDP jumped to 8.5 percent in the first quarter of this year from 3.1 percent in 2010, and a turn around compared to the 13.9 percent and 5.1 percent contractions in 2009 and 2008, respectively. The Economist predicts that overall GDP growth for 2011 will be 5.2 percent and 3.4 percent in 2012. The inflation rate was 4.9 percent in June 2011, more than double the 2.4 percent inflation in 2010. Estonia has very low public debt, 7.7 percent of GDP in 2010, up from 7.1 percent in 2009. The budget deficit was less than 2 percent in 2010 and was further cut to 1.2 percent in 2011. The Estonian labor force numbers 688,000 people; 74.5 percent of whom are employed by services and 22.7 percent by industry. Industry is the most efficient sector contributing 28.7 percent of GDP while employing only 22.7 percent of labor force. The unemployment rate was 14.4 percent in the first quarter of 2011, dropping from 17.5 percent in 2010 and up from 13.8 percent in 2009. The richest 10 percent of households shared 27.7 percent of income or consumption as of 2004; the Gini index was 31.4 in 2009. The economy benefits significantly from strong telecommunications and electronics sectors in combination with strong trade ties with Finland, Sweden, and Germany. The industrial production growth rate is 26.1 percent, soaring from ten percent in 2010. The economy consumes 30,000 bbl/day of oil requiring 30,590 bbl/day of oil imports. Estonia also imported 1.02 billion cu m of natural gas in 2009. Total imports cost $12.17 billion in 2010, exports were $11.5 billion. Estonia's trade partners are 65

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Finland, Lithuania, Latvia, Sweden, Germany, Russia, Poland, and the US. In 2010, the country had $3.641 billion in foreign exchange and gold reserves, down from $3.981 billion in 2009. The external debt was also reduced from $25.56 billion in 2009 to $25.13 billion in 2010. The current account surplus is $700 million, up from the surplus of $265 million in 2010 and down from the $898.7 million surplus in 2009. In 2010, Estonia's stock of foreign direct investment at home was $17.53 billion compared to $16.23 billion in 2009; abroad, Estonia had $7.134 billion in foreign direct investment in 2010. The Estonian currency is the kroon, one US dollar buys 11.0 kroon, up from 11.8 kroon in 2010, down from 12.473 kroon in 2006, and up from 10.7 kroon in 2008. The Estonian population numbered 1,282,963 in July 2011. The median age is 40.5 years, 15.1 percent of people are between ages 0-14, 67.2 percent are between ages 15-64, and 17.7 percent are 65 years of age and over. The populace is shrinking by 0.641 percent per year, there are over three more deaths than births per thousand people in Estonia. The flow of migrants is not helping, the net migration rate is -3.31 migrants per thousand people. Sixty-nine percent of the total population lives in cities, there were almost 400,000 people living in the capital city of Tallinn in 2009. ii. Latvia Latvia joined the World Trade Organization in 1999 and the EU in May 2004. The economy experienced rapid growth in 2006 and 2007, expanding by more than an 66

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average of 10 percent per year. Unfortunately, great growth led to severe recession, GDP plunged by 18 percent in 2009. The economy got a boost from strong export growth in 2009 and 2010 managing to grow by 2.9 percent in the third quarter of 2010. However, average growth was negative at 0.3 percent for 2010, up from the 18 percent shrinking the previous year and 4.2 percent in 2008. Finally, GDP growth increased to 3.5 percent in the first quarter of 2011. The Economist excepts GDP growth to be 3.5 percent this year and 3.6 percent in 2012. The inflation rate was 4.8 percent in June 2011 as the economy wound up, improving on the -1.3 percent inflation rate in 2010. The GDP for PPP is $32.51 billion in 2010, per capita GDP is $14,700. In 2010, GDP was composed mostly of services, accounting for 75.2 percent of GDP while industry accounted for 20.6 percent of GDP. 61.8 percent of the labor force works in the service industry while 25.8 percent of labor is employed by industry. The unemployment rate was 16.2 percent in March 2011, up from 14.3 percent in 2010 and 16 percent in 2009. The richest 10 percent of households share 27.4 percent of the income or consumption 2004; Gini index was 36 in 2005. Latvia's exports contribute significantly to GDP, exporting $7.894 billion in 2010, up from 7.223 billion in 2009. Exported products include food, wood, metals, machinery and equipment, and textiles. Partners in trade are Lithuania 15.2 percent, Estonia 13.7 percent, Russia 13.1 percent, Germany 8.2 percent, and Sweden 5.7 percent. Industry has recovered from the downturn posting 10.2 percent growth in May 2011, this is a good sign for Latvia since industry has suffered recently as the industrial production shrunk by 1.8 percent in 2010. Latvian industries include processed foods, 67

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processed wood products, textiles, processed metals, railroad cars, pharmaceuticals, and electronics. Latvia produces no oil or natural gas and consumes more electricity than it produces. Thus, much of its resources are imported along with machinery and equipment, consumer goods, chemicals, fuels, and vehicles. Total imports cost $9.153 billion in 2010; 16.4 percent of imports came from Lithuania, 11.3 percent from Germany, and 10.6 percent from Russia in 2010. Latvia's current account deficit was $400 million in May 2011, a turn around compared to the surplus of $1.62 billion the previous year and $2.53 billion in 2009. There was $11.71 billion of foreign direct investment at home in 2010 and a little over one billion dollars of foreign direct investment abroad. The Latvians use the lati as their currency, one lati bought 1.8443 US dollars in 2010 and has remained around the same strength since 2006. Latvia had $7.17 billion in foreign exchange and gold reserves as of December 2010. The countries external debt was $37.28 billion in December 2010, down from $41.58 billion in 2009. The budget deficit was 5.4 percent in 2011. The Latvian population numbered 2,204,708 in July 2011. The median age was 40.6 years; 13.5 percent of people are between ages 0-14, 69.5 percent of people are between ages 15-64, and 16.9 percent of people are 65 years and over. The population is getting smaller by 0.597 percent per year as there are 9.96 birth per thousand people and 13.6 deaths per thousand people. Migration is also not helping since the net migration rate is -2.33 migrants per thousand population. Sixty-eight percent of the population lives in the cities with 711,000 living in the capital of Riga. The annual rate of change of urbanization is -0.4 percent. 68

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iii. Lithuania Lithuania joined the European Union in May 2004. The economy is transitioning from state ownership, privatization of large, state-owned utilities is almost complete. The economy grew 8 percent per year on average from 2004 to 2008. However, after the global downturn, Lithuania's GDP plunged by almost 15 percent in 2009. In 2010, the GDP was $56.69 billion or $16,000 per person (PPP). The real growth rate of GDP was 6.9 percent in the first quarter of 2011, significantly higher than 1.3 percent in 2010 and than the 14.7 percent contraction in 2009, and 2.9 percent growth in 2008. The Economist predicts GDP growth to be 5.0 percent in 2011 and 3.6 percent in 2012. The economy is heating up, the inflation rate was 4.8 percent by June 2011, up from 0.9 percent in 2010 and 4.5 percent in 2009. The labor force numbered 1.633 million in 2010; 56.9 percent of workers are employed by the services sector, 14 percent are employed by agriculture and 29.1 percent in industry. The unemployment rate was 11 percent in June 2011, down from 17.9 percent in 2010 and 13.7 percent in 2009. Only 4 percent of the population is below the poverty line and the richest 10 percent of households shared 27.4 percent of household income or consumption in 2004. In 2010, public debt was 36.7 percent of GDP, up from 29.5 percent of GDP in 2009. The external debt was $27.6 billion as of December 2010, down from $28.69 billion in 2009. 69

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Industry accounted for 27.4 percent of GDP in 2010 and contributed significantly to GDP growth, industrial production increased by 12.8 percent by May 2011 and by 2.5 percent in 2010. Lithuania produced more electricity than it consumed by almost 2.5 billion kWh in 2007. Thus, electricity exports were 6.606 billion kWh in 2008. Oil is another story, Lithuania produced 6,333 bbl/day of oil in 2009 while consuming 74,000 bbl/day. Thus, the country imported 204,000 bbl/day of oil and 3.53 billion cu m of natural gas in 2008. The current account surplus was $200 million in April 2011 compared to $1.231 billion in 2010, exports made $19.29 billion while imports cost $20.34 billion. 29.3 percent of imports and 13.3 percent of exports are made or sent, in or to Russia. Export and Import commodities are similar and include mineral products, machinery and equipment, chemicals, and textiles. Lithuania's stock of direct foreign investment at home was $14.11 billion in 2010, up from $13.81 billion in 2009; abroad $2.507 billion is invested directly by foreigners. Lithuania had $6.418 bullion in reserves of foreign exchange and gold as of December 2010. Lithuania is not yet on the Euro, the Lithuanian litai is the currency and one dollar bought 2.6637 litai in 2010, down from 2.4787 in 2009, and down from 2.7498 in 2006. The population of the country numbered 3,535,547 on July 2011. The median age is 40.1 years with 13.8 percent of people between ages 0-14, 69.7 percent of people between ages 15-64, and 16.5 percent of people are 65 years and over. The population is shrinking by 0.276 percent per year, there are 9.29 births per thousand and 11.33 deaths per thousand. The net migration rate is negative, there are 0.72 migrants exiting 70

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Lithuania per thousand people living in the country. Two-thirds of the population lives in cities, the rate of urbanization is decreasing by 0.5 percent annually. 7. Bulgaria Bulgarian economy entered the European Union on January 2007 and averaged over 6 percent growth from 2004 to 2008. However, the global downturn sharply reduced domestic demand, exports, and capital flows, as well as industrial production. The result was a 5 percent contraction of the economy and stagnation in 2010 despite recovery in exports. In 2010, Bulgarian GDP was $96.78 billion or $13,500 per person (PPP). The inflation rate was 4.4 percent in 2010, up from 1.6 percent in 2009. The Bulgarian labor force numbered 3.4 million in 2009. The unemployment rate was 9 percent in 2010 and 2009. Over 20 percent of the population was below the poverty line in 2008. The richest 10 percent of households shared 23 percent of household income or consumption; the Gini index was 33.5. In 2010, industrial production stalled, growing only 0.4 percent. Bulgarian industries include: electricity, gas, water; food, beverages, tobacco; machinery and equipment, base metals, chemical products, coke, refined petroleum, nuclear fuel. Bulgaria produces little oil and natural gas but consumed 125,000 bbl/day of oil and 2.62 billion cu m of natural gas in 2010. Also, electricity consumption ranked sixty-second in the world in 2009, at 28.3 billion kWh. Thus, Bulgaria imported 189,000 bbl/day of oil and 2.48 billion cu m of natural gas in 2010. 71

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Bulgarian exports were $19.33 billion in 2010, up from $16.53 billion in 2009. Imports totaled $22.78 billion in 2010, up from $22.22 billion in 2009. Over one-tenth of exports went to Germany in 2009, 10 percent to Greece and Italy. Russia is Bulgaria's largest import partner, 13.4 percent of imports are Russian; 12.2 percent are German, 7.7 percent Italian. Bulgaria imports machinery and equipment, metals and ores, chemicals and plastics; fuels, minerals, and raw materials. Exported items include clothing, footwear, iron and steel, machinery and equipment, and fuels. The current account deficit was $12.8 million, down from $5 billion in 2009. In 2010, the government made $15.71 billion while spending $17.52 billion. The public debt was 16.2 percent of GDP in 2010, up from 15.5 percent in 2009. The external debt was $47.15 billion in November 2010, down from $54.37 billion December 2009. The country had amassed $17.27 billion of foreign exchange and gold reserves as of December 2010. Gross fixed investment was 22.8 percent of GDP in 2010. There was $51.28 billion in direct foreign investment at home in 2010, Bulgaria has a little over $1 billion of direct foreign investment abroad. The Bulgarian Lev is the currency, one US dollar bough 1.5138 leva in 2010, up from 1.404 in 2009, 1.3171 in 2008, and down from 1.5576 in 2006. The population numbered 7,093,635 in July 2011. The median age was 41.9 years, 13.9 percent of people are between ages 0 and 14, 67.9 percent are between 15-64, and 18.2 percent are 65 and over. The population is contracting at 0.781 percent per year; there are 9.32 births per thousand and 14.32 deaths per thousand. There are more emigrants than immigrants in Bulgaria every year, the net migration rate is -2.82 migrants 72

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per thousand people. 71 percent of the total population was urbanized in 2010, the annual rate of change of urbanization is -0.3 percent. There are 1.192 million people in the capital city of Sofia. 8. Romania Bulgaria and Romania both joined the EU in 2007. Romania started its transition from Communism in 1989, by 2000 the country emerged from recession due to strong demand coming from EU markets. Before the global economic downturn of 2008 the economy's growth was also fueled by domestic consumption and investment resulting in large current account imbalances. In 2010, GDP was $254.2 billion or $11,600 per person (PPP). The real growth rate of GDP was negative in 2010 and 2009, at -1.3 percent and -7.1 percent, respectively; however, in 2008 the economy expanded by 7.3 percent even feeling the effects of global downturn in the last quarter of the year. The inflation rate was 6 percent in 2010, up from 5.6 percent in 2009. The contraction of GDP in 2010 was due to drastic austerity measures promised as a part of the $26 billion emergency assistance package from the IMF. The Romanian labor force numbered 9.35 million in 2010 with 8.2 percent unemployment, up from 7.8 percent in 2009. In 2006, 47.1 percent of workers were employed by services, 29.7 percent by agriculture, and only 23.2 percent work in industry. The richest 10 percent of households share 20.8 percent of the household income or consumption; the Gini index was 32 in 2008. 73

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Although the economy contracted in 2010, the industrial production growth rate was 1.5 percent. Romanian industries include: electric machinery and equipment, textiles and footwear, light machinery and auto assembly, mining, timber, construction materials, metallurgy, chemicals, food processing, and petroleum refining. Romania produced 58.28 billion kWh of electricity of which it used all but 5.159 billion kWh that was exported. Romania also produced 117,000 bbl/day of oil in 2009 while consuming 214,000 bbl/day; proved reserves of oil are 600 million bbl as of January 2010. Romania also produces natural gas, 11.42 bullion cu m in 2008 but consumed 16.92 billion cu m; proved natural gas reserves were 63 billion cu m as of January 2010. In 2010, Romania's current account deficit was $7.934 billion, down from $7.139 billion in 2009; total exports were $51.91 billion, up from $40.6 billion in 2009. Almost 20 percent of exports go to Germany, 15.4 percent to Italy, and 8 percent to France. Imports were $59.84 billion 2010, up from $50.03 billion in 2009; 17 percent of imports are German, 11 percent Italian, and 8.5 percent Hungarian. Imported and Exported products include machinery and equipment, fuels and minerals, chemicals, textiles and footwear, agricultural products. Romania had $50.51 billion in foreign exchange and gold reserves in December 2010, up from $44.11 billion in 2009. The stock of foreign direct investment at home was $80.16 billion in 2010, up from $73.96 billion in 2009. Romania is not yet on the Euro, the Romanian Lei is the currency; one US dollar bought 3.2 lei in 2010, up from 2.5 in 2008 and 2.809 in 2006. The external debt was $108.9 billion in 2010, down from $110 billion in 2009. The government spent $62 74

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billion in 2010 while making $50.89 billion. The budget deficit was one-thirteenth of GDP in 2010, above the roughly one-thirty-third of GDP budget deficit required by the EU. The public debt was 34.8 percent of GDP in 2010, up from 24 percent of GDP in 2009. The Romanian population numbered 21,904,551 in July 2011. The median age was 38.7 years with 14.8 percent of people between ages 0-14, 70.4 percent of the population between ages 15-64, and 14.8 percent of people 65 years and over. The population is contracting at 0.252 percent per year; there are 9.55 births per thousand with 11.81 deaths per thousand. Net migration is -0.26 migrants per thousand Romanians. 57 percent of the populace is urbanized with a 0.6 percent annual rate of change of urbanization. The capital, Bucharest, was populated by 1.933 million Romanians in 2009. 9. Poland Poland is an emerging European Union member country that managed to sustain the 2008 economic downturn and the only country in the European Union to maintain positive GDP growth through 2008. Attaining EU membership in 2004 and access to structural funds have provided a significant boost to the economy. Poland's GDP is $721.3 billion (PPP), with $18,800 GDP per capita (PPP) and 3.8 percent real GDP growth. By the first quarter of 2011 GDP growth was 4.4 percent. The Economist expects GDP growth to be 4.2 percent in both 2011 and 2012. 75

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Unemployment dropped to 6.4 percent in October 2008 but increased to 11.8 percent for the year 2010. Today, the unemployment rate is 11.8 percent. The labor force consists of 17 million with 53.4 percent of workers in the service sector, 29.2 percent in industry, and 17.4 percent in agriculture. Services make up 64 percent of GDP while industry generates 32 percent of Poland's GDP. The inflation rate reached 2.6 percent in 2009 and climbed to 4.2 percent by June 2011. The highest 10 percent of incomes share 27.2 percent of household income or consumption and the Gini coefficient is 34.9. The country invests 19.5 percent of GDP as gross fixed investment. The industrial production growth rate was 2.0 percent in June 2011 and 6.5 percent in 2010 coming from machine building, iron and steel, coal mining, chemicals, shipbuilding, food processing, glass, beverages, and textiles. Poland produces less than 50,000 bbl/day of oil and consumes 545,400 bbl/day. Exports consist of machinery and transport equipment 37.8 percent; intermediate manufactured goods 23.7 percent, miscellaneous manufactured good 17.1 percent, and food and live animals 7.6 percent. Poland spends $160.8 billion on exports from Germany 26.06 percent, Italy 6.84 percent, France 6.78 percent, UK 6.38 percent, Czech Republic 5.85 percent, and Netherlands 4.14 percent. Poland imports $167.4 billion of machinery and transport equipment 38 percent, intermediate manufactured goods 21 percent, chemicals 15 percent, minerals, fuels, lubricants, and related materials 9 percent from Germany 28.08 percent, Russia 8.65 percent, Italy 6.5 percent, Netherlands 5.59 percent, China 5.27 percent, France 4.6 percent, and Czech Republic 4.05 percent. Thus, Poland's current account balance is -$12.33 billion. 76

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Poland has $99.76 billion in reserves of foreign exchange and gold with $252.9 billion external debt. The government's budget revenues are $91.23 billion while expenditures are $128.4 billion; the budget deficit as of 2010 was 7.93 percent of GDP. This year. Poland cut the budget deficit to six percent in 2011. Poland's stock of direct foreign investment at home is $198.8 billion and 30.71 billion abroad. Foreign investment has increased by 16 billion from 2010 to 2011. Poland used the zlotych as currency; one US dollar is equivalent to 3.0718 zlotych (2010). Poland's relatively large economy and diversified production base (makes up 40 percent of regional GDP) helped to soften the blow of recession. Due to well-managed fiscal policies both Poland and the Czech Republic maintained stability during the recession unlike their neighbors, Hungary and Romania. These countries also differed in quality of institutions; Poland and the Czech Republic had strong supervisory regimes that prevented excessive currency mismatches. Fixed exchange rate regimes encouraged excessive capital inflows and have limited policy options for countries using them, including the three Baltic States and Bulgaria. 10. Hungary The Hungarian economy has transitioned from being centrally planned to market economy in the last two decades. In 2010, GDP was $187.6 billion or $18,800 per person (PPP); roughly two-thirds that of the EU-25 average. In 2009, the economy contracted by 6.3 percent due to the global economic downturn, declining exports, and low domestic consumption and fixed asset accumulation. The economy recovered some what in 2010, 77

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expanding by 1.2 percent, and by the first quarter of 2011 GDP growth was 2.5 percent. The inflation rate was 3.5 percent in June, down from 4.9 percent in 2010 and 4.2 percent in 2009. Hungary's labor force numbered 4.3 million in 2010, 64.4 percent of workers are employed by services, 30.9 percent by industry. The unemployment rate is 11 percent in May 2011, slightly higher than 10.7 percent in 2010 and lower than 11.4 percent in 2009. The richest 10 percent of households shared 22.6 percent of household income or consumption in 2009; the Gini index was 24.7. The government has employed austerity measures since 2006 in order to rein in spending; the budget deficit dropped from over 9 percent of GDP to 3.2 percent in 2010 and even created a surplus of 1.9 percent of GDP in 2011. The country's inability to service short-term debts after crisis resulted in $25 billion assistance package setup by the IMF and the EU. Hungary plans to reduce the deficit to under the three percent of GDP mark that the EU requires by 2011. The public debt was 79.6 percent of GDP in 2010, up from 78.8 percent in 2009. In 2010, Hungary experienced 11 percent growth in industrial production, the sixteenth highest growth rate in the world. However, growth slowed to 2.6 percent by May 2011. To fuel this industry, Hungary imported 9.63 billion cu m of natural gas in 2009 and 171,600 bbl/day of oil in 2010. Hungary also imported 9.879 billion kWh of electricity in 2010. Hungary exported $93.74 billion in 2010, up from $82.1 billion in 2009; over 25 percent of exports went to Germany in 2010. Imports were $87.44 billion, up from 78

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$76.45 billion; 26.1 percent of imports came from Germany, 7.7 percent from Russia, and 6.8 percent from China. Hungary had $44.99 billion in reserves of foreign exchange and gold. The external debt was $148.4 billion as of December 2010, down from $149.8 billion in 2009. Hungary depends on direct foreign investment, in 2010 the stock of direct foreign investment was $82.07 billion, up from $70.41 billion in 2009. The current account surplus was $2.9 billion in the first quarter of 2011. The economy runs on the Hungarian forint (HUF); one US dollar bought 206.15 forints in 2010, up from 171.8 in 2008 and down from 210.39 in 2006. The population of Hungary numbered 9,976,062 in July 2011. The median age was 40.2 years with 14.9 percent of people between ages 0-14, 68.2 percent of people between ages 15-64, and 16.9 percent of people aged 65 years and over. The population is contracting at 0.17 percent per year in 2011; there are 9.6 births per thousand people with 12.68 deaths per thousand. The net migration rate in 2011 was 1.39 migrants per thousand. 68 percent of the total population is urbanized, the rate of change of urbanization annually is 0.3 percent. 11. Slovakia Formerly Czechoslovakia, Slovakia separated from the Czech Republic in 1993. Since then Slovakia has reformed taxation, healthcare, pension funds, and social welfare systems in order to reign in budget deficits and join the EU. In 2009 Slovakia joined the Eurozone adopting the euro. The economy has done well in 2001-08 exceeding expectations mostly due to foreign investment. Privatization of the banking sector, cheap 79

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and skilled labor, low taxes, a 19 percent flat tax for corporations and individuals, no dividend taxes, and a relatively liberal labor code have all helped to bring in foreign direct investment. Stock of direct foreign investment at home in December 2010 was $52.2 billion compared to $50.26 billion in 2009. In 2010 GDP was $120.2 billion (PPP) or $22,000 per person. Slovakia's real GDP growth rate was 3.5 percent by the first quarter of 2011. Real growth rate of GDP was four percent in 2010, up from the 4.8 percent contraction the economy suffered in 2009; much of this growth is due to direct foreign investment at home. The Economist expects GDP growth to be 3.3 percent in 2011 and 3.8 percent in 2012. The inflation rate is 3.9 percent, higher than the one percent posted in 2010 and from 1.6 percent the previous year. The Slovakian labor force numbered 2.673 million in 2010; 3.5 percent of workers are employed by agriculture while agriculture only contributed 2.7 percent to GDP. The service sector is similarly inefficient, 69.4 percent of the employed work in the service industry but only 61.8 percent of GDP comes from services. However, the industry sector is most efficient in Slovakia with 27 percent of the employed population working in industry and contributing 35.6 percent of GDP. The unemployment rate is 12.8 percent, down from 13.5 percent in 2010, and up from 11.4 percent in 2009; in 2003 the unemployment rate was 18 percent, dropping to 7.7 percent in 2008. In 2005, the richest 10 percent of households shared over 20 percent of income or consumption; the Gini index was 26. Slovakia's recent GDP growth can largely be contributed to the industrial production growth rate and increased foreign direct investment. Industrial production 80

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expanded by 10.7 percent this year and by 7.5 percent in 2010; industries include: metal and metal products, food and beverages, electricity, gas, coke, oil, nuclear fuel; chemicals and manmade fibers, machinery, paper and printing, earthenware and ceramics, transport vehicles, textiles, electrical and optical apparatus, and rubber products. Slovakia produced 25.9 billion kWh of electricity in 2009 while consuming 28.75 billion kWh. In 2008, the country also imported 144,000 bbl/day of oil while exporting 75,110 bbl/day; oil consumption was 79,930 bbl/day in 2009. In 2009 Slovakia also imported 6.974 billion cu m of natural gas. Slovakia's current account deficit was $2.7 billion, down from $1.93 billion in 2010 and improved compared to 2009 when it reached $2.819 billion. Exports were $64.18 billion in 2010 compared to $62.43 billion in imports. 35.9 percent of exports are machinery and electrical equipment; 21 percent of exports are vehicles. Most exports come from Germany 20.1 percent, Czech Republic 12.9 percent, France 7.8 percent, and Poland 7.2 percent. The Slovak koruny is the national currency, in 2010 one US dollar bought 23.5 koruny; today, the koruny is worth slightly less at 21.2 koruny per dollar. Slovakia's public debt is 41 percent of GDP in 2010, up from 35.7 percent of GDP in 2009. Slovakia has $59.33 billion in external debt as of June 2010, up from $52.53 billion in December 2008. The country has $1.16 billion of foreign exchange and gold as of January 2010. The global downturn, substantial government intervention, and the option to nationalize companies have resulted in a ballooning budget deficit, 7.4 percent of GDP in 2010 but EU inspired austerity measures have reduced the budget deficit to 5.1 percent of GDP in 2011. 81

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The Slovakian people numbered 5,477,038 in July 2011. The median age was 37.6 years with 15.6 percent of people between ages 0-14, 71.6 percent between ages 15-64, and 12.8 percent sixty-five and over. The population growth rate is 0.117 percent with less than one more birth than death per thousand people. Migrations adds some workers to the labor force as the net migration rate is 0.29 migrants per thousand population. Only 55 percent of people live in cities and that does not seem to be changing soon, the capital city of Bratislava had almost half a million people living in it in 2009. 12. Cyprus The government controlled Republic of Cyprus maintains a market economy that runs off of tourism, financial services, and real estate. The service sector accounted for almost four-fifths of GDP in 2010; GDP was $23.19 billion in 2010 or $21,000 per person (PPP). After joining the European Exchange Rate Mechanism in 2005, Cyprus adopted the Euro as its national currency in 2008. Preparation for the euro helped turn a soaring fiscal deficit of 6.3 percent in 2003 into a surplus of 1.2 percent in 2008, as well as cooling down the economy, bringing inflation to 4.7 percent. Inflation continued to fall to 0.3 percent in 2009, then jumped to 2.4 percent in 2010. The economy went into recession after the start of the global economic downturn in 2009, contracting by 1.8 percent; it has not yet recovered, real GDP growth was less than one percent in 2010. 82

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The Cyprian labor force numbered 400,000 in 2010, seventy-one percent of workers are employed by services. The unemployment rate was 5.6 percent in 2010, up from 4.3 percent in 2009. The reported Gini index in 2005 was twenty-nine. Industry employs 20.5 percent of workers but has suffered in 2010, growing on 0.1 percent. In terms of resources, the Cypriots produce more electricity than they consume but oil and natural gas they do not have. Thus, Cyprus imports 58,930 bbl/day of oil but does not use natural gas. Exports totaled $2.232 billion in 2010, up from $2.065 billion the previous year; export commodities include citrus, potatoes, pharmaceuticals, cement, and clothing. One-quarter of exports are purchased by Greece and almost nine percent go to Germany and the UK; the rest are on the Turkish side going to Turkey. In 2010, imports cost $7.962 billion and include consumer goods, petroleum and lubricants, machinery, and transport equipment. In 2009. one-fifth of total imports were Greek, ten percent came from Italy, nine percent from the UK and Germany, seven percent from Israel, 5.5 percent from China and the Netherlands. The Cypriots had $1.289 billion in reserves of foreign exchange and gold in December 2009. The country's external debt was $32.61 billion in December 2008. The current account deficit was $2.5 billion in 2010, down from $1.915 billion in 2009. Cyprus had $29.36 billion in foreign direct investment at home in December 2010, up from $26.61 billion the previous year. Abroad, Cypriots had $16.57 billion of foreign direct investment. The Turkish governed Cyprus economy has roughly half the per capital GDP of the south, GDP was $1.829 billion (PPP) in 2007. Real growth rate of GDP was -0.6 83

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percent in 2010. In recent years, the Turkish government has aided Cyprus with over $400 million annually. In 2011, there were 1,120,489 people living in Cyprus. The median age is 34.8 years, 16.2 percent of people are between ages 0-14, 73.4 percent are between ages 15-64, and 10.4 percent are 65 and over. The population is growing by 1.617 percent. The net migration rate is also positive, at 11.21 migrants per thousand people. Seventy percent of the people live in cities with a 1.3 percent annual rate of change of urbanization. 13. Malta Malta is a small, Mediterranean island chain between Africa and Italy. The Maltese economy suffers from limited fresh water supplies an has few domestic energy sources; also, Malta produces only 20 percent of the food it needs and is a large target for illegal immigrants emigrating from Africa to Europe. Maltese GDP was $10.41 billion in 2010 or $25,600 per person (PPP). The global economic downturn and high water and electricity prices hurt the Maltese economy due to its dependence on foreign trade, manufacturing, and tourism. GDP contracted by 1.2 percent in 2009 but recovered in 2010, growing by 2 percent. The inflation rate was 3.3 percent in 2010, up from -0.7 percent in 2009. The Maltese labor force numbered 163,100 in 2010, 73.9 percent were employed by services. The unemployment rate was 6.9 percent in 2009, up from 6.1 percent in 2008. In 2007, the Gini index was twenty-six. 84

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The Maltese were able to turn their budget deficit around into a surplus in 2010, earning $4.455 billion in revenues while expending only $3.322 billion. Public debt increased from 68.8 percent in 2009 to 69.1 percent in 2010. The current account deficit was $362.8 million in 2010, down from $574.6 million the previous year. However, the stock of foreign direct investment at home was $16.63 billion in December 2010. As mentioned above, Maltese resources are limited so Malta imported $5.159 billion of mineral fuels and oils, electrical machinery, non-electrical machinery, aircraft, plastics, food, and drink in 2010. One-quarter of imports are Italian while the highest percentage of export, 13.8, go to Germany. Malta had amassed $522 million in foreign exchange and hold reserves as of December 2010. The country's external debt was $5.978 billion in the same year. The Maltese people numbered 408,333 in July 2011. The median age was 40 years; 15.7 percent of the population is between 0 and 14 years old, 68.5 percent is between 15-64 years old, and 15.8 percent of people are 65 years and older. The population grows at 0.375 percent per year with 10.35 births and 8.6 deaths per thousand people. Because of its location, Malta has a positive net migration rate at 2.01 migrants per thousand population. Ninety-five percent of the population inhabit the urban landscape with half a percentage point increase in the rate of urbanization per year. 85

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Chapter IV. Analysis of European Economic Crisis August 2011 In contemplation of the current economic Crisis in Europe and its impact on the continuation, growth, and success of the European Union use is made of the Tree metaphor, facilitating analysis. The Tree represents the European Union as a whole, its roots are the stronger, core countries while its branches are the weaker, peripheral countries. In order for the European Union to prosper both roots and branches need to grow properly. As it turns out, this Tree is sick, the European Union is experiencing continued Financial and Economic Crisis since the Global Economic Downturn of 2008. There are problems at the root of the Union, in strong countries like Germany and France, and even greater problems at the periphery. The most extensive root problem underlying the Crisis of the European Union is sustained low economic growth, certainly, there are too many things that contribute to this problem to enumerate in this paper. It is more appropriate and tractable to discuss the problems that have amassed on the surface and that will ultimately unravel the economic Union if the major root problem is not taken care of. One way to make use of the root and branch analysis is to look at the stronger, core European economies as the root and the weaker, mostly peripheral economies as the branches. The branches have to be sustained by the root if the Tree or European Union is to survive, and the branches themselves must thrive with a strong root as the base for the EU to prosper. In the same way, the core of European economies, namely Germany and France, must give support to the weaker countries in difficult economic times but can only do this properly through 86

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sustained economic growth. The people in the countries at root will be more unwilling to sustain the weaker economies at the periphery if they are suffering at home. In the European case, problems on the surface, that is those of the weaker economies, are able to be remedied by growth experienced by the weaker economies themselves. However, many of these economies depend significantly on the stronger, core economies for economic growth and expansion. The surface or branches are the more problematic, weaker economies of Europe that have been at the center of the current Crisis. Those countries include: Ireland, Greece, Spain, Italy, and Portugal. Within these economies there are also root and surface problems. The problems on the surface, if not abated, will spread exceedingly quickly from branch to branch while the problem at the root deepens. In other words, financial contagion similar to that in South America will cause severe economic distress. The result will certainly be the dissolution of the European Union, at least the current Eurozone. Considering this high risk of contagion, the first economy in Crisis that is considered in the analysis to be the trigger of contagion is the one that is in most trouble, i.e. closest to defaulting causing capital flight and dropping out of eurozone. I have chosen Greece to be the trigger economy of the possible future financial contagion. Although there is evidence that Ireland may be the first economy to drop out of the Union, there is no reason to bother differentiating since if the Greek economy fails it is highly likely that the Irish economy will also fail and the impact will be felt all over Europe. Thus, the Irish economic and financial Crisis will be the second crisis to be 87

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investigated in this analysis. Spain, Portugal, and Italy will be investigated as the third part of the analysis since the economies are in similar positions relative to the trigger economies discussed in the first and second part of the analysis. A. Greece in Crisis The Greeks have suffered since the 2008 global economic downturn. According to the snapshot provided in Chapter Three, the Economist expects the Greek economy to contract by 4.5 percent this year and 1.2 percent in 2012. Unemployment is also on the rise, increasing by over three percent since last year. Since the $110 billion loan by the IMF and EU in May 2010 the Greek economy has gotten worse. The government is attempting austerity measures, tax increases, health spending reform and more in the face of a contracting economy and a culture that is very different from that of those whom are providing the loans. The result has been rioting, reduced effectiveness of government, and discussion of the possibility of dropping the euro as the Greek national currency. In the first week of June 2011, members of the European Central Bank (ECB) repeated the warning that if Greece defaults or restructures its debt, then Greece government and bank debt would not be eligible for use as collateral at the ECB 30 Thus, the leaders of the European Union have Greece stuck, they are bailing Greece out consistently yet do not allow them to restructure their debt in order to have some chance of paying it off. Even with restructuring, default is likely for Greece. The Greek EU commissioner of fishing, Maria Damanaki, warned that: 88 30 Mauldin, John, "Walk Through the Minefield," The Mortgage Market Guide June 1, 2011, 2.

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"The scenario of removing Greece from the euro is now on the table. I am obliged to speak openly. We have a historical responsibility to see the dilemma clearly: either we agree with our borrowers on a program of tough sacrifices with results...or we return to the drachma." In the same week, the IMF warned it may not continue funding Greek debt in the very near term. Eurogroup President Jean-Claude Juncker said, "I'm not the spokesman of the International Monetary Fund, but the rules say they can only disburse if there is a financing guarantee for the 12-month period. Thus, if Greeks cannot afford to finance their budget for the next 12-month period they will be denied aid from the IMF 31 On June 29, 2011 the Greek government passed an austerity bill that covered 28 billion euro of spending cuts and taxes, as well as permission to sell 50 billion euro of assets. This bill is part of the agreement to follow the conditions of the initial loan by the IMF and EU, providing 12 billion euro as the next slice of the package. Greece needs every cent of the 12 billion euro loan because Greek government bonds maturing in July 2011 worth over 6 billion euro must be paid out, as well as another 6.6 billion euro of bonds maturing in August. Greece cannot roll the debt over by issuing new government bonds because financial markets are demanding ludicrously high interest rates on Greek government borrowing since the credit rating is the lowest 32 Without aid from the IMF or EU Greece would certainly default in a disorderly fashion. The attention has turned to those that provide loans to Greece, the European Central Bank system. As of December 2010, Greece had -87.1 billion euro in liabilities 89 31 Mauldin, John, "Walk Through the Minefield," The Mortgage Market Guide June 1, 2011, 3. 32 Wearden, Graeme, and Heather Stewart, "Greek austerity bill passes: what happens now?" guardian.co.uk June 29, 2011.

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within the European Central Banking system. The ECB has 47 billion euro of Greek bonds and spent almost 90 billion euro on refinancing Greek banks by the end of April 2011. Since liabilities of the Greek central bank are part of the ECB system when securities are not worth enough, the euro countries that contribute to the ECB must collectively account for the loss. Germany's central bank, the Bundesbank, accounts for 27 percent of the ECB's capital which means that German's pay for over one-quarter of all losses in the ECB 33 This reiterates a point made earlier, that Greeks differ significantly in political and economic attitude from the Germans that loan them billions of euros. Thomas Friedman, columnist for the New York Times, wrote an article on precisely this issue titled, "Can Greeks be Germans?" 34 The article begins with a description of the loan process as experienced by a Greek journalist, she stated, "they were not here as tourists; we were giving data on how many hours we work. It really felt like we had to persuade them about our values." The "them" in this case were German members of the Bavarian Parliament visiting Athens to figure out whether they should be lending money to Greece for a bailout. The journalist explains that it was like one nation interviewing another for a loan. This is to be expected of the Germans, after all, German money accounts for over one-quarter of ECB capital. So, if the Greeks are to receive German money, they should act like Germans. That is, the Germans are telling the Greeks that they will lend them money if they behave like Germans in how they save, 90 33 Mauldin, John, "Walk Through the Minefield," The Mortgage Market Guide June 1, 2011, 4. 34 Friedman, Thomas. "Can Greeks be Germans?" Sarasota Herald-Tribune July 21, 2011.

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how many hours a week they work, how long a vacation they take, and how consistently they pay their taxes. Tax evasion is the national pastime in Greece. The difference between what taxpayers owed last year and what they paid was equivalent to one-third of total tax revenue or the entire budget deficit. Greece's shadow economy accounts for 27.5 percent of GDP, one of the largest underground economies in the European Union. The result is a tax systems that places too heavy a burden on those that actually pay taxes while being unduly regressive, since people with higher income have a greater chance to cheat on taxes; it is also a wasteful systems, tax collection has become very expensive, relative to GDP, Greece spends four times what the US does on collecting taxes from its people 35 Greeks seem to have very low "tax morale" and a poorly enforced, unhealthy tax system. Politicians use the tax system to advance their political position, mean while the evaders that do get caught are seldom charged since tax courts typically took seven to ten years to resolve a case. Countries where the people believe they have some say in how the state acts, and where there are high levels of trust, tend to have higher rate of tax compliance. On the other hand, Greeks find fraud and corruption as ubiquitous in business, in the tax system, and even in sports; Transparency International recently placed Greece in a three-way tie with Bulgaria and Romania as the most corrupt country in Europe. For example, doctors, singers, and athletes were given favorable tax rates, shipping tycoons paid no income tax at all, and members of other professions were legally allowed to underreport their income. 91 35 James Surowiecki, "Dodger Mania," New Yorker, July 11 & 18, 2011, 38.

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The government, due to pressure from Europe, has had to raise taxes while cutting spending. The result is serious backlash that creates a vicious cycle since those that pay taxes are further burdened and increased taxes create more cheaters. That is, the people begin to trust the system even less, pay less taxes, are required to pay higher taxes, and cheat more; there is a correlation between higher tax rates and higher rates of tax evasion. The problem, according to both Friedman and Surowiecki, is cultural. The Greeks simply have difficultly being Germans. The Greek government is attempting to step up its game by simplifying taxes, doing away with some of the loopholes and increasing enforcement. For example, officials have been sending helicopters over affluent neighborhoods looking for swimming pools as evidence of underreported wealth (ironically enough, Greeks might be spending more on helicopter fuel than is the worth the result of such fuel use). However, efforts have made some difference, the selfemployed are reporting more of their income. Research shows that overemphasizing tax enforcement leads to a decrease in tax morale because paying taxes no longer becomes part of the social contract, freely followed by citizens. The Greek government is attempting to remedy the cultural and political issues that are holding back economic prosperity but they will certainly need political and financial assistance from the core economies of Europe. B. Ireland in Crisis Ireland's recent economic history may be divided into two periods: a period of controlled growth between 1988 and 1997 and the Celtic Tiger period that ended in 92

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collapse. In the twentieth century, the Irish economy was the slowest growing economy in Europe. Therefore, the European Union classified the whole region as a disadvantaged area and poured in money from its regional and structural funds, spending one billion euro per year from 1987 to 1998. Irish invested in higher education and had plenty of young people due to decades of emigration, leaving young, new families. The country had no heavy industry to close or subsidize and appeared, to the outside investor, as a small, hospitable Anglophone country with an educated workforce and relatively low wages. The economy grew, GDP per capita rose to reach the EU average, but the government turned its attention to tax cuts to stimulate consumption and property to replace manufacturing as the source of wealth. Dublin became the single largest location outside the US for the declared pre-tax profits of American companies. Overall, Ireland had turned away from making and exporting goods as the source of economic growth toward the evanescent world of money and debt 36 The result: the Irish economy has seriously struggled since the global economic downturn of 2008, average housing prices fell by 50 percent, GDP plummeted. According to the Irish National Institute of Regional and Spatial Analysis (NIRSA), more than 300,000 new houses were reported to be standing empty in January of 2010, part of six hundred "ghost estates" or "developments" 37 Between 2006 and 2009, there was a 400 percent oversupply of housing in Leitrim county 38 In 2006, construction accounted for almost one quarter of Ireland's GDP and employed one fifth of the workforce, thousands of workers poured in 93 36 Jack, "Ireland: The Rise & the Crash." 37 Jack, "Ireland: The Rise & the Crash." 38 Ibid.

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from around Europe, Ireland was a net importer of labor. The demand for housing jumped, and Bank lending for construction and real estate rose from 5.5 billion euro in 1999 to 96.2 billion euro in 2007 while housing prices doubled. Mortgages became too much, it was cheaper to rent in the city than to pay mortgage for a similar place two hours away, the average Dublin couple spent a third of its income on mortgages 39 The economy has been contracting since 2007 and minimal growth is expected in the next year, roughly 0.5 percent 40 Rob Kitchin from NIRSA told The Irish Times that it could take seven to ten years for property prices to return to "anything close" to their pre-crash levels 41 The existence of "ghost developments" that will likely be knocked down will keep the housing markets depressed in those regions that have many of them. In 2010, the budget deficit reached 32 percent of GDP and in September the government agreed to spend 18 billion euro to bail out Irish banks afraid that the insolvency would bring down the Irish state itself and claiming banks were to blame for their "reckless pattern of lending" 42 However, according to Fintan O'Toole, the government played a large role in accepting and facilitating the housing market boom and bust. Their policies have contributed directly to the destruction of the Irish economy, for example, under regulation Section 23, developers of new housing estates could set their costs against tax. The regulation was intended to encourage the redevelopment of rundown areas in towns and cities but property companies made out, using the regulation as a far broader tax94 39 Ibid. 40 "Output, prices, and jobs," The Economist, August 6, 2011. 41 Jack, "Ireland: The Rise & the Crash." 42 Jack, "Ireland: The Rise & the Crash."

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avoidance measure while local and national governments did nothing. The result, one in every three of Leitrim's houses now stand empty, and 2 billion euro was spent nationally to subsidize houses developed to shelter the taxes of their builders rather than real people 43 The government had to answer to the financial industry and the coalition of voters that included the urban working class, people on welfare, and rural communities. The solution for one party goes against the solution for the other, that is, low taxation and high public spending is not sustainable since the taxes provide revenue for government expenditures. However, the taxes coming in from the property bubble were enough to distract the government from finding a real solution. Ireland has also dealt with corruption between government officials and landowners and developers. For example, the Bailey brothers, Tom and Mick, among the country's largest landowners and developers admitted to systematic tax evasion and paid 22 million euro in settlement. According to Sean FitzPatrick, chairman of the Angle Irish Bank, his bank secretly lent him 84 million euro to invest in property speculation; the banks grew its loan to book from 15.1 billion euro in 2001 to 100 billion euro in 2008. But by Christmas 2008 property assets that secured the loans shrunk in value, driving down the value of the bank's shares. The bank was nationalized soon after, supplying 28 billion euro of the 77 billion euro in loans assumed by the newly formed National Asset Management Agency, the state's "bad bank". Preventing the collapse of the bank cost the Irish taxpayer at least 30 billion euro, equivalent to Ireland's total tax revenue collected in 95 43 Ibid.

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2009; after other banks have been included, the estimate will likely rise to between 45 and 50 billion euro 44 In December the government agreed to a $112 billion loan package from the EU and IMF. According to economist Barry Eichengreen, the package was short-sighted, wishful thinking by EU and German leadership. The package is not economically feasible in the long run and is not politically sustainable in the short run. Eichengreen believes that the European Commission, the ECB, and the German government never miss an opportunity to make things worse 45 "The Irish "programme" solves exactly nothing--it simply kicks the can down the road. A public debt that will now top out at around 130 percent of GDP has not been reduced by a single cent. The interest payments that the Irish sovereign will have to make have not been reduced by a single cent, given the rate of 5.8 percent on the international loan. According to the deal, not just interest but also principal is supposed to begin to be repaid after a couple of years. At that point, Ireland will be transferring nearly 10 percent of its national income as "reparations" to the bondholders, year after painful year." The Irish have to pay reparations on top of an economy that is stagnating at best. The result will likely be civil backlash and political upheaval. It is not politically sustainable, the new government of Ireland might have to renegotiate the loan package terms this year in order to prevent serious backlash. Europe is creating further backlash by forcing the Irish government to engage in "internal devaluation". Europe requires that the Irish reduce wages and costs to conform to EU standards. However, the traditional option of external devaluation through a national currency is not an option since Ireland 96 44 Jack, "Ireland: The Rise & the Crash." 45 Eichengreen, comment on Irish Economy, "Ireland's rescue package."

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uses the euro. The result is "internal devaluation" through reduction in wages and government spending or costs but the more success Ireland has at reducing wages and costs, the heavier will be its relative inherited debt load. Thus, public spending has to be cut even more deeply and taxes have to increase in order to service the debt. This in turn implies the need for more internal devaluation, heightening the burden of the debt and forming a vicious spiral of debt deflation. The point of internal or external devaluation is to reduce the value of outstanding debts, expressed in euros. Eichengreen says that this would have been particularly easy in the Irish case. A line could have been drawn differentiating the third of government debt that guarantees the obligations of the banks and the rest of the government's debt. The third of the debt that represents the debt of the Irish banking system could have been restructured. Bondholders could have been offered 20 cents on the euro, assuming banks still have some residual economic value. Furthermore, if the banks were insolvent, then bondholders could and should have been wiped out. Steps like these might have given the new program a fighting chance of working by preventing higher debt, Irish public debt might have topped out at maybe 100 percent of GDP, up only 6 percent from the 94.2 percent of GDP public debt registered in 2010. The mistakes made in the loan package to Ireland by the European Commission, the ECB, and the German government are likely due to reluctance of European officials to deal with root problems, specifically, debt restructuring. The Irish banks have 145.2 billion euro in liabilities within the ECB system 46 Thus, the governments of Germany, 97 46 Mauldin, John, "Walk Through the Minefield," The Mortgage Market Guide June 1, 2011.

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France, and the United Kingdom are scared to death over what Irish bank debt restructuring could do to their own banking systems. Also, the governments of these economies are scared of backlash by their people who do not want to hear that public money is required for bank recapitalization. leadership would see that French, German, and British banking systems need to be properly capitalized to withstand Irish debt restructuring. C. Portugal, Spain, and Italy in Crises All three of these economies have experienced negative to stagnant growth in the past couple of years and indicators point to more of the same in the future. Portugal is the only country of the three to have been bailed out; however, the ECB started purchasing Italian and Spanish government bonds in August 2011. 1. Portugal Portugal was labeled Europe's new "sick man" for good reason; the economy is expected to contract by 2.0 percent in 2011 and 2.5 percent in 2012, the unemployment rate was 12.4 percent in the first quarter of 2011. Industrial production growth is also negative for the first part of 2011, suffering from competition with lower-cost producers in Asia for foreign direct investment. The country's external debt is $497.8 billion and the current account balance was negative $20.8 billion. Public debt is 83.2 percent of GDP and the budget deficit is down to 6.8 percent from 9.3 percent in 2009. The government is implementing austerity measures, internally devaluating with a 5 percent 98

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public salary cut and a 2 percent increase in the value-added tax; these measures are working to reduce to budget deficit but at a heavy cost. The austerity measure provide limited economic stimulus so the government is focusing on boosting exports and implementing labor market reforms to increase competitiveness and expand the economy. There is room for improvement since labor markets are rigid and the education systems is poor. Portuguese banks have 108 percent of GDP in foreign liabilities or 177 billion euro. In May 2011, the EU bailed out Portugal with a $114 billion loan (Guardian). Portugal was the third country in line, after Ireland and Greece, to receive bailout packages because of financial sector instability. The package calls for Portugal to implement austerity measures proposed and rejected by the government in March: spending reductions for 2012 and 2013, cuts to pensions, will amount to 3.4 percent of GDP. Revenues should increase by 1.7 percent of economic output and 12 billion euros are earmarked for Portuguese banks 47 The aid plan is set to be shorter than the 7 1/2year maturities on the EU-IMF packages for Greece and Ireland. Greece pays 3.5 percent for the first three years and 4.5 percent thereafter; Ireland pays 5.8 percent on average throughout the life of their plan 48 The ECB has chosen to take on billions of euros worth of risky securities as collateral for loans, many of which are not particularly valuable. Many of these securities or assets are only worth 20 or 30 cents on the euro 49 According to Moody's rating agency Portugal, like Greece, is having trouble reducing spending, 99 47 Lima, Joao and Anabela Reis, "Portugal Says Economy to Shrink Twice as Much as Forecast Under Added Cuts." 48 Ibid. 49 Mauldin, John, "Walk Through the Minefield," The Mortgage Market Guide June 1, 2011, 3.

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increasing tax compliance, achieving economic growth, and stabilizing the banking system. The result will certainly be economic contraction, inability to pay interest on loans, backlash, and continued contagion unless restructuring and economic expansion occur. Considering the terms and conditions, as well as the current economic forecast, the loans that have been made to Portugal will likely result in the need for more loans in the future. This type of moral hazard is common in financial systems and the governments that run them, as evidenced by a World history marred by financial and debt crises, continued bail outs, and financial contagion. 2. Spain and Italy The Italian and Spanish economies are the next ones in line to receive bailout loans from the EU. According the foreign liabilities, the Iberian imbalances are than those of Greece, over one trillion euro compared to Greece's 208 billion euro 50 Spain is the 12th largest economy in the world and is very different from the economy of Portugal. Spain does not have a history of defaults, other than in the 16th century, maintaining throughout peacetime in the 20th century unlike the US and the UK. Also, Spain has demonstrated fiscal responsibility, often running budget surpluses from 2000 to 2008. In the same period, public debt was reduced from 66 percent to 47 percent of GDP 51 Despite declining construction, a flooded housing market, and falling consumer spending, the economy is expected to expand slightly in 2012. The unemployment rate is 20.9 percent and the budget deficit was 6.5 percent. The high unemployment rate is a 100 50 Evans-Pritchard, "Fears of Lehman-style' tsunami as crisis hits Spain and Portugal." 51 Marcet, Albert, "Spain's economy isn't like Portugal's."

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temporary shock that is the result of declining demand for workers in construction. Austerity measures designed to reduce budget deficit should not limit economic growth significantly since many of them simply reversed tax cuts or spending hikes that had only been in effect for a year or two. For example, the salaries of civil servants were cut by 5 percent but had gone up by 3 percent the previous year. Also, capital gains tax increased by 2 percent, and income tax for the top pay bracket by 1 to 4 percent but the wealth tax was abolished in 2008 and the inheritance tax has all but disappeared. Thus, purchasing power fell only slightly and total taxation on capital and income is roughly the same 52 The current account deficit is $63.9 billion and the country's external debt is $2.166 trillion. Similarly to Ireland, Spanish banks' high exposure to collapsed domestic construction and real estate market has threatened the banking system. These banks also have huge foreign liabilities, 91 percent of GDP or 950 billion euro. The Italian economy is similar to the Spanish but smaller. The economy is expected to grow by one percent in 2012. Currently, the unemployment was 8.1 percent, less than half of that of Spain. Italian industry grew by 1.8 percent by May 2011, slightly better growth than in Spain. However, Italy's public debt is 118.1 percent of GDP and the budget deficit was four percent in 2011. The country's external debt was $2.223 trillion in June 2010 and the current account deficit was $79.6 billion in 2011. The ECB has been reluctant to buy government bonds directly from the Italian and Spanish markets but did so on August 8th, 2011. As a result, the Italian and Spanish bonds surged, sending 10-year yields down more than 70 basis points. Buying these 101 52 Marcet, Albert, "Spain's economy isn't like Portugal's."

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bonds may require the ECB to significantly expand its balance sheet, opening it up to accusations of bailing out profligate nations, breaching the founding treaty of the euro and undermining its credibility. Tobias Blattner from Daiwa Capital Markets Europe in London estimates the central bank will have to buy 200 billion euros of Italian bonds and 60 billion euros of Spanish securities to make a significant difference in staving off financial contagion 53 The Italian outstanding debt is $2.6 trillion, bond purchases drove down 10-year yields to 5.39 percent from 6 percent the previous week. The purchasing of Spanish securities resulted in a reduction of 10-year yields, down to 5.3 percent from above 6 percent before the securities were purchased. D. Problems at the Root The heads of state and government of the euro area and the EU institutions met on July 21, 2011 to try to agree on the second rescue of Greece and thus stop the spread of the debt crisis in Spain and Italy. The new plan will provide an additional 109 out of 159 billion euro to Greece while eliminating the spread in interest rates on loans to Greece, Ireland, and Portugal and providing banks a set of options for voluntary default. Also, the European Financial Stability Facility (EFSF) was allowed to purchase bonds on the secondary market. However, the ECB is playing the role of stabilizer until the EFSF is ready to take over bond purchases. Michala Marcussen, head of global economics at Societe Generale SA in Paris, says that although bond purchases could act as a buffer, they are not a solution, the real solution is for the euro area to move to some form of 102 53 Brockett, Matthew, and Jeff Black, "Trichet Draws Bazooka' as Italy, Spain Debt Purchases Begin," Bloomberg Businessweek August 8, 2011.

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fiscal union. The next step in this process is increasing the size of the EFSF to at least 1.5 trillion euros, currently the rescue fund has 323 billion euros remaining of the 440 billion euro it was allotted. The Germans have made it clear that they require other European countries to act as they do in order to get German backed ECB loans. However, there are problems at home in Germany. GDP growth is predicted to drop from 6.1 percent in the first quarter of 2011 to 2.1 percent in 2012. Production declined by 1.1 percent in May 2011, in the year, output rose by 6.7 percent when adjusted for working days 54 The indicators may really be worse than expected since there is a question of whether the correct price deflater was used to determine real GDP. The Bureau of Economic Advisors (BEA) continued to use an overall 1.9 percent annualized inflation rate, substantially lower than the inflation rate reported by sister agencies; if this is adjusted to 3.2 percent year-over-year found by the Bureau of Labor Statistics, the annualized growth rate would drop from 1.84 percent to 0.56 percent, real GDP would be shrinking by 1.82 percent (Consumer Metrics) 55 The people of Germany will hardly be able to deal with increasingly large loans to peripheral European countries and economic stagnation at home. The Eurozone has made it very difficult to deal with economic shocks in individual, member states since monetary policy cannot be effective under a single currency union. The divergence in economic performance between the core economies and the peripheral economies of 103 54 Vits, Christian, "German Industrial Output Unexpectedly Fell on Construction," Bloomberg August 5, 2011. 55 Mauldin, John, "Walk Through the Minefield," The Mortgage Market Guide June 1, 2011.

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Europe will become an even larger problem as the weaker economies become more dependent on loans from richer neighbors while implementing austerity measures that reduce consumption and income. For example, the combined current account deficits of Greece, Ireland, Portugal, Spain, and Italy total around $200 billion, averaging almost 5 percent of GDP, compared to the current account surpluses found in the core countries. 104

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Chapter V. Conclusion Many hope that the effects of the global economic downturn of 2008 are becoming a thing of the past; however, this thesis points to a different direction, providing the reader with evidence that 2008 was just the beginning. The future is gloomy, the economies of the core countries of Europe are not expecting great growth; while the peripheral, weaker economies struggle with financial crisis, debt payments, government budget issues, and backlash in the streets. The European Union was organized in order to bring together the economies of Europe to create a larger, more homogenous economy that could compete with the United States in global markets. This plan has not turned into the reality that Europeans were hoping for, instead, shortsightedness and ignorance have created a ticking time bomb waiting to explode, unraveling the European Union as we know it. The reasons for this shortsightedness are not the focus of this paper, although they are discussed, attention is focused on the details of the current crisis. Particularly, how is the European Union dealing with the possibility of financial contagion and economic destabilization? In order to answer this question the analysis first looks into the financial and debt crisis in Greece. In May 2010, the EU and IMF loaned Greece $110 billion to alleviate budget issues brought on by the financial crises. These loans are conditional; the government must cut spending, increase taxes, while reforming and expanding the economy. This is difficult enough to do as it is in Greece without the pressure of loan payments. The Germans require that the Greeks act like Germans in the way they work, 105

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rest, spend, save, and tax. This is the sort of homogenization that was expected to make the EU great; however, it is backfiring, and Greeks are simply not Germans. Tax evasion is the national pastime, the shadow economy accounts for 27.5 percent of GDP, the Greek economy is contracting, the government is cutting spending, government bonds must be paid out, the people are suffering, but still interest payments on loans have not been restructured and must be paid. Where will the money come from? If this continues, the Germans that bailed Greece out earlier will be the ones bailing Greece out in the future. The Irish situation is not very different from that of Greece; the loan package is not economically feasible in the long run because it would trigger a debt deflation spiral resulting in political and social unrest. The debt deflation spiral is brought on by internal devaluation because the euro zone has a single currency and cannot externally devaluate. That is, the government must reduce wages and costs, increasing the relative debt so that it must further cut spending and raise taxes to pay of the debt. The result is a stagnating economy that is unable to repay debts. The EU has to change to conditions of the loan package, restructuring the interest rates on the loans. Spain, Portugal, and Italy are on similar paths. The EU is attempting to save these economies from financial contagion by purchasing their debt. That is, the ECB has taken on billions of Euros worth of risky securities as collateral for loans in order to stabilize banks of struggling economies. However, many of these securities are overvalued and are not worth the money. How long will the EU trade money for nothing? Currently, the possibility of default is great for Greece and Ireland. However, because of issues with budget financing, government bond payouts, and cultural 106

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differences, Greece is more likely to default. Greece has proven that it is not part of the region that forms an optimum currency area in Europe. According to Robert Mundell the region is defined in terms of internal factor mobility and external factor immobility. Internal factor mobility is the ability of factors of production to move from one place to another within a region. External factor immobility refers to the inability of factors of production in places outside of the region to move inside the region. The countries that are having serious economic trouble may fall outside of this region because of relative internal factor immobility, especially labor immobility; this, in combination with a common currency, results in balance-of-payments disequilibrium and internal instability 56 I agree with economist Andrew Lilico from guardian.co.uk who provides a possible future scenario involving a Greek default 57 : When Greece defaults, every bank in Greece will go insolvent, the Greek government will nationalize every bank and forbid withdrawals. Martial law or curfew will likely come into effect in order to keep depositors from rioting (similar situation occurred in Argentina in 2002). All the Greek debt will be redenominated into the new currency, which will be devalued by 30 to 70 percent, effectively defaulting on half of euro-denominated debt. Contagion will follow, Irish and Portuguese governments will likely default on debts after investigating the situation in Greece. Many French and German banks will make sufficient losses, no longer making regulatory capital requirements. The ECB will become insolvent because of its high exposure to Greek and Irish debt. The French and 107 56 Mundell, Robert, "A Theory of Optimum Currency Areas," The American Economic Review Vol. 51, No 4 (Sep., 1961), pp. 661. 57 Mauldin, John, "Walk Through the Minefield," The Mortgage Market Guide June 1, 2011, 6.

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German governments will meet to decide whether to recapitalize the ECB or to allow the ECB to print money. Thus, the ECB could print its way out because of relatively little foreign currency-denominated exposure but that is illegal according to EU treaty. However, the bailouts performed were also illegal according to the treaty and that did not stop the EU. The EU might declare an end to all bailouts, leaving Spain high and dry. Lilico says attention might turn to British banks and so on. The threat of financial contagion is real, unless Europe takes a real hard look at it's banking systems and restructures already existing loans, the European Union, particularly the Euro Zone will cease to exist as it is today. The scenario above is an example of what might happen if financial contagion spreads throughout Europe. Global banking systems are highly interconnected, especially between Europe and the US, as evidenced by the 2008 global economic downturn. Financial contagion in Europe will likely force US banks to look at their balance sheets and liabilities in order to prevent significant losses to US banks from failing European banks. The credit situation in the US is not healthy, as evidenced by the downgrade; it will be difficult to handle another global financial crisis so soon after 2008. Thus, Europe is attempting to further integrate in order to contain the financial and debt crises. Leaders from France and Germany met in August to discuss the formation of a Euro bond and improving peer monitoring of fiscal policies. Since monetary policy is ineffective with a fixed, single currency, the economies of Europe must coordinate fiscal policies in order to keep from diverging in economic performance and to better deal with economic shocks. This will require further integration and even political union. The 108

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United States is committed to seeing its greatest ally succeed and will likely provide financial and political support to guarantee that, once its own economic environment improves. The European Union will have to become as homogenous and credible as the United States if it wants to prosper as it is today. 109

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