UPSC IAS exam preparation - International Institutions - Lecture 5

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The European Union

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1.0 INTRODUCTION

The devastating effects of World Wars I and II led to various moves by nations involved, for a peaceful integration of Europe. These nations began to officially unite in 1949 with the Council of Europe. In 1950 the creation of the European Coal and Steel Community expanded the cooperation. The six nations involved in this initial treaty were Belgium, France, Germany, Italy, Luxembourg, and the Netherlands. Today these countries are referred to as the "founding members".

During the 1950s, the Cold War, protests, and divisions between Eastern and Western Europe showed the need for further European unification. In order to do this, the Treaty of Rome was signed on March 25, 1957, thus creating the European Economic Community and allowing people and products to move throughout Europe. Throughout the coming decades, additional countries joined the community.

The EU has developed a single market through a standardised system of laws that apply in all member states.

With a combined population of over 500 million inhabitants, or 7.3% of the world population, the EU in 2014 generated a nominal gross domestic product (GDP) of USD 18.5 trillion constituting approximately 23.9% of global nominal GDP and 20% when measured in terms of purchasing power parity, which is the largest nominal GDP and GDP PPP in the world. The EU was the recipient of the 2012 Nobel Peace Prize.

In order to further unify Europe, the Single European Act was signed in 1987 with the aim of eventually creating a "single market" for trade. Europe was further unified in 1989 with the elimination of the boundary between Eastern and Western Europe - the Berlin Wall.

2.0 The Modern-Day EU

Throughout the 1990s, the "single market" idea allowed easier trade, more citizen interaction on issues such as the environment and security, and easier travel through the different countries.

Even though the countries of Europe had various treaties in place prior to the early 1990s, this time is generally recognized as the period when the modern day European Union arose due to the Treaty of Maastricht on European Union which was signed on February 7, 1992 and put into action on November 1, 1993. The Treaty of Maastricht identified five goals designed to unify Europe in more ways than just economically. 

The goals are:

1.To strengthen the democratic governing of participating nations

2.To improve the efficiency of the nations

3.To establish an economic and financial unification

4.To develop the "Community social dimension"

5.To establish a security policy for involved nations

In order to reach these goals, the Treaty of Maastricht hasd various policies dealing with issues such as industry, education, and youth. In addition, the Treaty put a single European currency, the euro, in the works to establish fiscal unification in 1999. In 2004 and 2007, the EU expanded, bringing the total number of member states as of 2008 to 27.

In December 2007, all of the member nations signed the Treaty of Lisbon in hopes of making the EU more democratic and efficient to deal with climate change, national security, and sustainable development.

3.0 EU Institutions

The European Union has seven institutions: (i) the European Parliament, (ii) the Council of the European Union, (iii) the European Commission, (iv) the European Council, (v) the European Central Bank, (vi) the Court of Justice of the European Union and (vii) the European Court of Auditors. Competencies in scrutinising and amending legislation are divided between the European Parliament and the Council of the European Union while executive tasks are carried out by the European Commission and in a limited capacity by the European Council (not to be confused with the aforementioned Council of the European Union). The monetary policy of the eurozone is governed by the European Central Bank. The interpretation and the application of EU law and the treaties are ensured by the Court of Justice of the European Union. The EU budget is scrutinised by the European Court of Auditors. There are also a number of ancillary bodies which advise the EU or operate in a specific area.

How do the dynamics work? The EU's broad priorities are set by the European Council, which brings together national and EU-level leaders. Directly elected MEPs represent European citizens in the European Parliament. The interests of the EU as a whole are promoted by the European Commission, whose members are appointed by national governments. Governments defend their own country's national interests in the Council of the European Union.

The European Council sets the EU's overall political direction - but has no powers to pass laws. Led by its President - currently Herman Van Rompuy - and comprising national heads of state or government and the President of the Commission, it meets for a few days at a time at least every 6 months.

4.0 EU Law

There are three main institutions involved in EU legislation:

1. the European Parliament, which represents the EU's citizens and is directly elected by them.
2. the Council of the European Union, which represents the governments of the individual member countries. The Presidency of the Council is shared by the member states on a rotating basis.
3. the European Commission, which represents the interests of the Union as a whole.

Together, these three institutions produce through the "Ordinary Legislative Procedure" (ex "co-decision") the policies and laws that apply throughout the EU. In principle, the Commission proposes new laws, and the Parliament and Council adopt them. The Commission and the member countries then implement them, and the Commission ensures that the laws are properly applied and implemented.

Two other institutions play vital roles:

1. the Court of Justice of the EU upholds the rule of European law,
2. the Court of Auditors checks the financing of the EU's activities.

The powers and responsibilities of all of these institutions are laid down in the Treaties, which are the foundation of everything the EU does. They also lay down the rules and procedures that the EU institutions must follow. The Treaties are agreed by the presidents and/or prime ministers of all the EU countries, and ratified by their parliaments.

The EU has a number of other institutions and interinstitutional bodies that play specialised roles:

1. The European Central Bank is responsible for European monetary policy
2. The European External Action Service (EEAS) assists the High Representative of the Union for Foreign Affairs and Security Policy, currently Catherine Ashton. She chairs the Foreign Affairs Council and conducts the common foreign and security policy, also ensuring the consistency and coordination of the EU's external action
3. The European Economic and Social Committee represents civil society, employers and employees
4. The Committee of the Regions represents regional and local authorities
5. The European Investment Bank finances EU investment projects and helps small businesses through the European Investment Fund
6. The European Ombudsman investigates complaints about maladministration by EU institutions and bodies
7. The European Data Protection Supervisor safeguards the privacy of people's personal data
8. The Publications Office publishes information about the EU
9. The European Personnel Selection Office recruits staff for the EU institutions and other bodies
10. The European School of Administration provides training in specific areas for members of EU staff, and 
11. A host of specialised agencies and decentralised bodies handle a range of technical, scientific and management tasks,

The EU is based on a series of treaties. The first established the European Community and the EU, and then made amendments to those founding treaties. These are power-giving treaties which set broad policy goals and establish institutions with the necessary legal powers to implement those goals. These legal powers include the ability to enact legislation which can directly affect all member states and their inhabitants. The EU has legal personality, with the right to sign agreements and international treaties.

Under the principle of supremacy, national courts are required to enforce the treaties that their member states have ratified, and thus the laws enacted under them, even if doing so requires them to ignore conflicting national law, and (within limits) even constitutional provisions.

Courts of Justice: The judicial branch of the EU-formally called the Court of Justice of the European Union-consists of three courts: the Court of Justice, the General Court, and the European Union Civil Service Tribunal. Together they interpret and apply the treaties and the law of the EU.

The Court of Justice primarily deals with cases taken by member states, the institutions, and cases referred to it by the courts of member states. The General Court mainly deals with cases taken by individuals and companies directly before the EU's courts, and the European Union Civil Service Tribunal adjudicates in disputes between the European Union and its civil service.  Decisions from the General Court can be appealed to the Court of Justice but only on a point of law.

Fundamental rights: 

The treaties declare that the EU itself is "founded on the values of respect for human dignity, freedom, democracy, equality, the rule of law and respect for human rights, including the rights of persons belonging to minorities ... in a society in which pluralism, non-discrimination, tolerance, justice, solidarity and equality between women and men prevail."

In 2009 the Lisbon Treaty gave legal effect to the Charter of Fundamental Rights of the European Union. The charter is a codified catalogue of fundamental rights against which the EU's legal acts can be judged. It consolidates many rights which were previously recognised by the Court of Justice and derived from the "constitutional traditions common to the member states." The Court of Justice has long recognised fundamental rights and has, on occasion, invalidated EU legislation based on its failure to adhere to those fundamental rights. The Charter of Fundamental Rights was drawn up in 2000. Although originally not legally binding the Charter was frequently cited by the EU's courts as encapsulating rights which the courts had long recognised as the fundamental principles of EU law. Although signing the European Convention on Human Rights (ECHR) is a condition for EU membership, previously, the EU itself could not accede to the Convention as it is neither a state nor had the competence to accede. The Lisbon Treaty and Protocol 14 to the ECHR have changed this: the former binds the EU to accede to the Convention while the latter formally permits it.

Although, the EU is independent from Council of Europe, they share purpose and ideas especially on rule of law, human rights and democracy. Further European Convention on Human Rights and European Social Charter, the source of law of Charter of Fundamental Rights are created by Council of Europe. The EU also promoted human rights issues in the wider world. The EU opposes the death penalty and has proposed its worldwide abolition. Abolition of the death penalty is a condition for EU membership.

Acts: The main legal acts of the EU come in three forms: regulations, directives, and decisions. Regulations become law in all member states the moment they come into force, without the requirement for any implementing measures, and automatically override conflicting domestic provisions. Directives require member states to achieve a certain result while leaving them discretion as to how to achieve the result. The details of how they are to be implemented are left to member states. When the time limit for implementing directives passes, they may, under certain conditions, have direct effect in national law against member states.

Decisions offer an alternative to the two above modes of legislation. They are legal acts which only apply to specified individuals, companies or a particular member state. They are most often used in competition law, or on rulings on State Aid, but are also frequently used for procedural or administrative matters within the institutions. Regulations, directives, and decisions are of equal legal value and apply without any formal hierarchy.

5.0 EU TRADE

The EU occupies a primary position in world trade. The openness of its trade regime makes it the biggest player on the global trading scene. The EU has achieved a strong position by acting together with one voice on the global stage, rather than with 28 separate trade strategies.

The EU is committed to pursuing a trade policy that not only boosts economic growth and creates jobs in Europe, but which actively helps countries and people around the world to use trade as a tool for development. 

5.1 Contribution to free trade 

The EU works actively to help developing countries take greater advantage of trade. The EU is the world's largest provider of "Aid for Trade" to developing countries - more than €7 billion a year. This assistance helps developing partners develop the infrastructure and skills needed to trade successfully and achieve the Millennium Development Goals. The European union promotes the following values:

1. supporting the fight to protect our environment and reverse global warming; 
2. striving to improve wo rking conditions for workers in developing countries and 
3. ensuring the highest standards of health and safety for the products we buy and sell.

The EU, as a single entity, remains the largest trading bloc in the world and imports and exports continued to increase in 2011-12, although its share of world trade is declining due to faster growth in other countries. The EU is also an open economy with extra-EU trade in goods and services representing over 33% of GDP in 2011. It s rules and procedures are also transparent and, despite the wide diversity among its member States in terms of their economies, legal systems, and public institutions, it is a highly integrated economic unit with a single trade policy and common legislation in most trade-related areas.

The focus of EU policy over the past two years has been on the financial crises and there have been relatively few changes to trade policies, laws, or institutions in other areas. However, the fact that there has been no retreat into protectionism is, in itself, a positive sign. Among the causes of the crises were lack of appropriate fiscal reforms in a context of easy access to credit and low borrowing costs relative to economic grow th for governments and the private sector which resulted in unsustainable levels of private and/or public sector debt and some banks' exposure to such debts. A related factor that exacerbated the crises was a decline in competitiveness in some member States as their unit labour cost and real effective exchange rates rose relatively quickly.

5.2 Customs procedures

In terms of customs procedures, the EU has been steadily moving towards an EU-wide system of electronic procedures with centralized clearance, with an ultimate deadline of 2020.  Single authorizations for simplified procedures be came more widely used during the review period. For goods coming from outside the EU, it is now possible to complete customs formalities at the port of arrival when the destination is in another member State while an "Entry Summary Declaration" may now be lodged at the destination  in stead of at the point of first entry. 

There have not been any major changes to tariffs or market access generally in the EU. Although there are a large number of duty-free tariff lines and the average MFN tariff is 6.5%, some sectors, particularly agriculture, remain relatively well protected, sometimes by complex or seasonal tariffs. However, relatively few countries trade with the EU on an MFN basis as the EU has a considerable number of trade agreements with other countries as well as a GSP and GSP+, and EBA schemes.

Different member States charge different rates of value added tax and excise duties while corporate and personal taxation systems and rates of tax vary widely from one member State to another. The complexity of the taxation system, including collection and payment, for example for VAT, can result in additional compliance costs for economic operators while the application of reduced VAT rates for some products results in significant revenue transfers to some sectors that are typically not traded. If all reduced rates were removed, the standard rate of VAT could in certain member States theoretically be dropped by up to 7.5% without any impact on overall revenue.

There are some ununiformities with the EU nations regarding personal taxation structures. Also very little information is available about state controlled enterprises. This can create distortions in the free trade concept. 

5.3 Intellectual Property Rights (IPR)

Intellectual property rights (IPR) have become a very essential part of world trade. The EU is continuing a comprehensive process of reviewing and developing the existing body of legislation in order to move towards a coherent and balanced overall framework. For that purpose, the European Commission's "blueprint" of May 2011 to boost creativity and innovation in the EU proposed a comprehensive strategy for the modernization of the IPR regime. Among the most significant developments during the period under review is the creation of a European patent with unitary effect. It will allow future right holders to request the grant of a patent title that provides uniform protection and is automatically valid in the 25 participating member States. In parallel, a unified patent litigation system will be put in place. The EU's trademark system and copyright regime are also undergoing a major review. As part of this process, the Commission has submitted a number of legislative proposals in the field of copyright, including with respect to the collective management and multi-territorial licensing of copyright, and is review ing the legislative framework in general. 

5.4 Geographical indications

Another important step towards a more coherent regime has been made in the field of geographical indications: a unified framework has been set up to promote quality agricultural products and foodstuffs, including through denominations of origin and geographical indications. Also, the establishment of an equivalent legal framework for the protection of geographical indications for non-agricultural products continues to be under examination. Finally, the imminent adoption of the revised customs regulation aims at strengthening the enforcement of IPRs at the EU's external borders. For this purpose, its scope will be extended, customs procedures be simplified, and further clarity will be provided as regards Custom s action in relation to goods transiting the EU. Whether and what type of update of the existing legal framework for the civil enforcement of IPRs within the EU's internal market is needed continues to be subject of an extensive consultation process.

During the review period there was no major change in agricultural policy as implementation of the last set of reforms continued.  Past reforms and higher international prices for agricultural commodities, has led to a declined in the total level of support to the agricultural sector. Due to this the difference that existed between EU prices and international prices is diminishing. 

 

Overfishing remains a serious problem for the EU as total allowable catches have regularly exceeded sustainable limits. However, for some time now the EU has been increasing the emphasis on long-term planning and more reform of the Common Fisheries Policy is required.

5.5 Financial services

On financial services, the policy objectives for reform have been fourfold: 

1. Creation of a banking union through a single supervisory mechanism, a European deposit guarantee system, and a European resolution framework for banks in cases of bankruptcy; 
2. Reform of financial institutions and markets to improve stability through the establishment of European supervisory authorities, higher capital requirements for banks and insurance companies along with specific regulations on credit rating agencies, auditors, securities markets and derivatives, and speculative trading practices that may lead to excessive market volatility; 
3. the third objective is the reinforcement of accountability in the financial system towards consumers; and the fourth is the institution of a financial services tax for some member States. These reforms have maintained third party access and developed new regulatory instruments in that regard such as the notion of equivalence.

5.6 Environment

The most noticable development in the field of environmental services has been a reform of legislative framework to ensure more competition. The rules for the single aviation market are going through a "fitness check" process while other reforms on ground handling, slots, and noise are being considered. The community clause has been generalised. On maritime transport the main developments over the review period relate to competition issues with ongoing revision of state aids and anti-trust guidelines. The third energy package has implications for pipeline transport and contains reinforced unbundling and third party access provisions. 

6.0 THE European SOVEREIGN DEBT CRISIS

The European sovereign debt crisis occurred during a period of time in which many European countries faced the collapse of financial institutions, high government debt and rapidly rising bond yield spreads in government securities. It started in 2008, with the collapse of Iceland's banking system, and spread first to Greece, Ireland and Portugal during 2009. It led to a crisis of confidence for European businesses and economies.

By the end of 2009, when the peripheral eurozone member states of Greece, Spain, Ireland, Portugal and Cyprus were unable to repay or refinance their government debt, or bail out their beleaguered banks without the assistance of third-party financial institutions such as the European Central Bank (ECB), the International Monetary Fund (IMF) and the European Financial Stability Facility (EFSF). Seventeen eurozone countries voted to create the EFSF in 2010 specifically to address and assist the European sovereign debt crisis.

Some of the contributing causes of the sovereign debt crisis include the financial crisis of 2007-2008, the Great Recession of 2008-2012, as well as the real estate market crisis and property bubbles in several countries, and the aforementioned states' fiscal policies regarding government expenses and revenues. This culminated in 2009 when Greece unveiled its previous government had grossly underreported its budget deficit, signifying a violation of EU policy and spurring fears of a euro collapse via political and financial contagion.

A 2012 report for the United States Congress summarizes: "The eurozone debt crisis began in late 2009, when a new Greek government revealed that previous governments had been misreporting government budget data. Higher than expected investor levels eroded investor confidence, causing bond spreads to rise to unsustainable levels. Fears quickly spread that the fiscal positions and debt levels of a number of eurozone countries were unsustainable."

Ireland: Unlike Greece, Ireland had a balanced budget before the crisis hit. However, it also had a huge real estate bubble even larger than the one in the United States. Before the crisis, 25 percent of its economy was involved in home construction compared with less than 10 percent in normal economies. When the financial crisis hit in September 2008, the bubble burst and the government announced it would cover all banks' losses, in an attempt to calm the markets. The promise turned out to be disastrous, as the banking sector continued to implode. In January 2009, Ireland nationalized one of its major banks, and in October 2010 conducted a bailout of some others. At this point, its budget deficit had grown to 32 percent of GDP. The following month, the E.U. and IMF launched a $90 billion bailout of Ireland. This past March, the government was swept out of power, and the new government pledged to reduce the interest payments required under the E.U./IMF bailout, a promise they made good on in July. On July 12, Moody's downgraded  Irish debt to junk.

Portugal: Unlike Ireland and Greece, Portugal had one of the best recovery records during the first part of the economic crisis. However, panic due to the Greek debt crisis hit the country in late 2009 and early 2010, due largely to concern that the country could not grow over the long term, as well as higher deficit forecasts. It has below-average productivity, a legal structure some condemn as outdated, and strict labor market regulations that some say hobble growth. By November 2010, the market had pushed interest rates to a point where the country was under pressure to ask for a bailout. Concern increased when the parliament failed to pass budget cuts in March, and European leaders met to discuss the possibility of a rescue package. Finally, the Portuguese government requested an E.U. bailout in April. It was approved in May and totaled $116 billion. Portugal's center-right party came to power in elections and remains committed to the bailout. 

6.1 The case of Greece, Ireland and Portugal

In early 2010 these difficult developments reflected in rising spreads on sovereign bond yields between the affected peripheral member states of Greece, Ireland, Portugal and Spain, and most notably Germany. The Greek yield diverged in early 2010 with Greece needing eurozone assistance by May 2010. Greece received two bailouts from the EU over the following five years during which the country adopted EU-mandated austerity measures to cut costs while experiencing a further economic recession as well as social unrest. In June 2015 Greece, with divided political and fiscal leadership and a continued recession, was facing a sovereign default. However, on July 5, 2015 the Greek people voted against further EU austerity measures, with a possibility of Greece leaving the European Monetary Union entirely. The withdrawal of a nation from the EMU is unprecedented, and the speculated effects on Greece's economy if the currency is returned to the drachma range from total economic collapse to a surprise recovery.

6.2 What next

Ireland followed Greece in requiring a bailout in November 2010, with Portugal next in May 2011. Italy and Spain were also vulnerable, with Spain requiring official assistance in June 2012 along with Cyprus. By 2014, Ireland, Portugal and Spain, due to various fiscal reforms, domestic austerity measures and other unique economic factors, all successfully exited their bailout programs requiring no further assistance. The road to full economic recovery is still underway. Cyprus, too, reported a slow but steady ongoing recovery, averting further financial crisis thus far.

Implications for the euro zone: Many experts argue that the E.U.'s model, which concentrated monetary policy in the European Central Bank (ECB) while leaving fiscal policy to individual member states, is inherently unsustainable, as it denies member states monetary policy levers with which to help their recoveries. This also makes deficit-funded fiscal stimulus harder, as monetary policy can be used to keep borrowing costs low. When different countries are hit differently by a recession, as has happened now, the common monetary authority will act in ways that help some countries but not others. The ECB has pursued tight monetary policy that may prevent inflation in high-growth states like Germany but could also be worsening the recession in Greece, Spain, and other struggling states.

Most view one of two options going forward as likely. One is that the euro zone will lose members like Greece, Spain and Italy, either by them just leaving or by a default by any one of them, which could unravel the whole monetary union. Barry Eichengreen, a Berkeley economist, has said this would lead to a huge bank run and the "mother of all financial crises." Another option is closer European fiscal union, so that fiscal policy can be coordinated at the continent level as well as monetary policy, bringing the E.U. closer to being a sovereign state.

What it means for the U.S.: U.S. financial institutions hold considerable European financial assets that could plummet in value if the euro zone enters a full-on crisis. For example, European debt makes up almost half of all money-market fund holdings. Direct exposure to the so-called PIIGS countries profiled above is limited, but exposure to France and Germany is high, and given, for example, France's tight linkages with the Italian financial system, a Italian default could roil France and the U.S. in turn. 

The crisis is also leading to heavy spending cuts and reduced borrowing that hurts U.S. exports to Europe, further endangering the American recovery.

In the final analysis, it is important to note the depth of sincerity in the European integration experiment, as such a diverse range of cultures and languages have tried to peacefully come together. An experiment like this can surely become the model for a future ‘world government’.

The European debt crisis can be traced back to October 2009, when Greece's new government admitted the budget deficit would be double the previous government's estimate, hitting 12% GDP. After years of uncontrolled spending and nonexistent fiscal reforms, Greece was one of the first countries to buckle under the economic strain.

Everything seemed to be going well in 2007. The economies of the European Union seemed to be doing well. The GDP was growing and inflation was low. Public debt though on the higher side was considered to be manageable given that economic growth would continue. Only Greece was a worrying factor on this account. Only Greece was a matter of concern in the case of public debt.

However, the sub-prime crisis in the US started a chain of events.

Bank Losses: During the credit crunch, many commercial European banks lost money on their exposure to bad debts in US (e.g. subprime mortgage debt bundles).

Recession: The credit crunch caused a fall in bank lending and investment; this caused a serious recession (economic downturn).

Fall in House Prices: The recession and credit crunch also led to a fall in European house prices which increased the losses of many European banks.

Rise in Government debt: The impact on Government debt was twofold. Due to the recession, there was a fall in tax revenues which resulted in a deterioration in Government finances. During recession the government has to increase spending on unemployment benefits. This caused a rapid rise in government debt. 

Rise in Debt to GDP ratios: The most useful guide to levels of manageable debt is the debt to GDP ratio. Therefore, a fall in GDP and rise in debt means this will rise rapidly. For example, between, 2007 and 2011, UK public sector debt almost doubled from 36% of GDP to 61% of GDP (UK Debt - and that excludes financial sector bailout). Between 2007 and 2010, Irish government debt rose from 27% of GDP to over 90% of GDP (Irish debt).

Markets had assumed Eurozone debt was safe: Investors assumed that with the backing of all Eurozone members there was an implicit guarantee that all Eurozone debt would be safe and had no risk of default. Therefore, investors were willing to hold debt at low interest rates even though some countries had quite high debt levels (e.g. Greece, Italy). In a way, this perhaps discouraged countries like Greece from tackling their debt levels, (they were lulled into false sense of security).

Increased scepticism: Due to the credit crunch investor sentiment changed. They became sceptical and started to question European finances. Looking at Greece, they felt the size of public sector debt was too high given the state of the economy. People started to sell Greek bonds which pushes up interest rates.

No strategy: Unfortunately, the EU had no effective strategy to deal with this sudden panic over debt levels. It became clear, the German taxpayer wasn't so keen on underwriting Greek bonds. There was no fiscal union. The EU bailout never tackled fundamental problems. Therefore, markets realised that actually Euro debt wasn't guaranteed. There was a real risk of debt default. This started selling more - leading to higher bond yields.

No Lender of Last Resort: Usually, when investors sell bonds and it becomes difficult to 'roll over debt' - the Central bank of that country intervenes to buy government bonds. This can reassure markets, prevent liquidity shortages, keep bond rates low and avoid panic. But, the ECB made it very clear to markets it will not do this. Countries in the eurozone have no lender of last resort. Markets really dislike this as it increases chance of a liquidity crisis becoming an actual default. In India the RBI acts as a lender of the last resort.

The European economies now are faced with a huge dilemma. It appears that two approaches can be taken to solve the debt crisis; cut Government spending or don't cut government spending. But both these solutions bring with them their own set of problems.

Cut spending: This would mean an increase in unemployment because Government spending is the biggest employment generator in an economy. The unemployment rate is already over 20% in Spain. Further, a cut in spending by the Government may push wages down to more competitive levels. Even so, lower wages will just make people's debts even harder to repay, meaning they are likely to cut their own spending even more, or stop repaying their debts. And lower wages may not even lead to a quick rise in exports, if all of the European export markets are in recession too. There would be more strikes and protests, increased activism by the labour unions which would make the financial markets more nervous.

Don't cut spending: Attached with this is the huge risk of a financial collapse. Due to economic stagnation and high unemployment , public debt has exploded since 2008. Other European governments may not have enough money to bail a particular nation out. The European Central Bank says its mandate doesn't allow it to. So the question remains as to from where the money would come for the Government to increase its spending.

In 1997, the European economies had agreed to limit government borrowing to 3% of the GDP under the stability and the growth pact. However, no nation with the exception of Spain stuck to this limit. Italy was the worst offender. It regularly broke the 3% annual borrowing limit. But actually Germany - along with Italy - was the first big country to break the 3% rule. After that, France followed. Spain stuck to the limit until the 2008 financial crisis.Of the four, Spain's government also has the smallest debts relative to the size of its economy. Greece, by the way, is in a class of its own. It never stuck to the 3% target, but manipulated its borrowing statistics to look good, which allowed it to get into the euro in the first place. 

In 2012, the EU nations insisted on by Germany agreed to  limit their governments' "structural" borrowing (that is, excluding any extra borrowing due to a recession) to just 0.5% of their economies' output each year. 

The Eurozone crisis however still continues today and with Germany deciding not to increase it's spending, recovery seems remote.

Impact on India

The situation does not bode well for a recovering Indian economy and can have adverse effects like

1. Reduced production of India's employment intensive sectors such as textiles
2. CAD will be higher with an increased trade deficit
3. EU-India FTA will be delayed further

The EU countries have a share of 18.6 percent in India's exports and it is the second largest destination for our exports. The Euro area's instability has been negatively reflected in India's exports. The Euro crisis has also impacted the Indian stock markets adversely in the form of higher quantum of withdrawals by the FIIs. India is also looking at increasing FDI as one of the key drivers of economic growth and stimulus. The intensifying Eurozone crisis has the ability to jeopardise these plans.

 

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