A repeated theme of this book has been that, in concentrating on the improvement of production (i.e. the increase of production), economics has systematically neglected issues of safety, vulnerability and resilience. We saw in an earlier chapter that the research of Kahneman and Tversky suggests that people are risk averse. However, economic decision-making is driven by powerful companies and governments who are frequently able to impose risks and costs on others while taking gains for themselves. There are however other risks which occur, not at local or company level, but in the system as a whole. There is a need to explore what might happen after the limits to economic growth are reached, and whether humanity will face a manageable contraction or a variety of catastrophic collapses. In this chapter, I want to look at some of the conceptual thinking about these issues as they relate to the beginning of the 21st century.
The decline in resilience
As explained by the late David Fleming:
The resilience of a system is its ability to survive without loss of diversity and complexity despite shocks. The diversity and complexity are essential: resilience is an empty concept except when they are implicit in it. The surface of Mars, or a dead coral reef, are resilient in a trivial sense – resilient, since they do not change under assault. There is no loss of diversity and complexity, but that does not make them resilient, since there is no loss of diversity and complexity to lose. (David Fleming, The Lean Economy, p113 of a draft sent to the author)
To get a grasp of the issues it is necessary to contrast and counterpose the idea of resilience to that of productivity and efficiency. For most of the history of humanity, what people were concerned about has been ecological (and economic) resilience rather than production increase and efficiency. From the eighteenth century, the efficiency and “improvement” advocated by Adam Smith and later economists was all about more production by an increased division of labour and increased complexity. But this has brought reduced resilience.
This idea of “resilience” in complex systems has been the subject of much inter-disciplinary study by a group of thinkers who have evolved an interpretation of transformations in nature and human society which they call “Panarchy”. (Gunderson and Holling 2002)
The word “Panarchy” can be understood by breaking it into its two parts “Pan” and “archy”. The Pan word is meant to evoke the idea of Pan, the god of Nature, as well as the word part “pan” as in “panorama” – an overview vision. The word part “archy” is as in “anarchy” or “hierarchy”.
The framework described in Panarchy is one in which transformation of human and natural systems occur through “adaptive cycles”. An adaptive cycle evolves in three dimensions:
1. Productivity and potential: the amount of energy and resources embodied and embedded in the system and its ability to capture and use energy for its purposes.
2. Connectedness: the level of interconnectedness of its parts (e.g. a transport and communications network – the supply chain and financial interdependencies of which David Korowicz writes).
3. Resilience: the ability of the system to withstand or respond to shocks – at its most fundamental by reinventing itself.
Schematically we can apply this to human societies and eco-systems by describing a cyclical process which goes through 4 to 5 phases:
1. Starting with a pioneering phase where, depending on the type of system, human groups or species, manage to survive a collapse and thrive, beginning to develop a new kind of system using the resources and elements released by the collapse of an old one.
2. A structure begins to take shape as connections between these pioneering groups, or species take, place and they begin to develop a new system.
3. The system moves into a consolidation phase and forges its chief structures which become dominant. However, the system now starts to evolve more complexity and “round-about” ways of doing things. In the process, the structure becomes rigid and loses its resilience.
4. Stress surges bring on collapse – the rigid complexity of the system cannot cope with a variety of challenges and problems and breaks down, its productivity and connectedness collapsing with it.
5. The disconnection and decline eventually leads into a new pioneering phase and the emergence of the next social or ecological system – though in our own age it might not….
An example of this cycle in a natural system is provided in the spruce fir forests of eastern North America. An insect called the spruce budworm will defoliate the trees to the point where they die off over extensive areas. Prior to human harvesting and management this occurred in a cycle of 40 to 130 years when a mature forest acquired such a dense volume of foliage that the effectiveness of insectivorous birds that kept the budworm under control was diluted. The budworms spread out of control and the forest died. (Holling C S 2002)
Turning to the human economy, the analogous vulnerability is the complex network that must be kept going to produce almost everything. In his book, The Lean Economy, the late David Fleming placed a particular focus on what he called the “intermediate economy” in his description of the Panarchy cycle. The intermediate economy is where the increasing complexity occurs. It encompasses all those processes that are not wanted for their own sake. They are the increasingly complicated means to a final end. For example, the transport sector is not wanted for its own sake – it is the goods that transport delivers that are wanted, not transport as such. The transport sector is the means to get the inputs and raw materials delivered to production processes as well as the necessary means to get consumer goods to the end consumer. The expanding intermediate economy is where the “internet of things” inflates in phase 3 of the Panarchy cycle.
Technology consists of a great many devices that are powered by energy. These devices process and transform input materials and provide, in turn, outputs and components for other devices to process. There is a dense web of interdependencies all of which depends on infrastructures of finance, trade and energy to keep the networks humming. If the finance, trade and energy hubs fail, then techno civilisation could be in deep trouble. That would feed into a public health crisis and make things worse. An alternative scenario is of a public health crisis being the initial origin of a crisis in the other infrastructures.
A colleague of mine in the think tank Feasta, David Korowicz, has studied the potential for catastrophic breakdowns. He writes about what he calls a “cross contagion” between the financial and the trade/ production networks leading to a supply chain collapse. He argues that if such a collapse persists for a sufficient time period it would not be possible to get the system up and running again – and that period is not very long. He draws upon real life events like the United Kingdom fuel blockade by lorry drivers in the year 2000 and the events following the Japanese earthquake and Tsunami of 2011 to make his point about the possibility of breakdown, which gets progressively worse and leads into a collapse, because of multiple domino breakdowns, cascading through “hub interdependencies”. (Korowicz, 2012, p. 5)
Crucial to understanding the degree of vulnerability of our economic system is the extraordinarily high level of complexity and interdependence in global production systems. There is not only of internet of information, there is, so to speak, an “internet of things”.
We can catch a fragmentary glimpse of this via Eric Beinhocker who compared the number of distinct culturally produced artefacts produced by the Yanomamo tribe on the Orinoco River and by modern New Yorkers. The former have a few hundred, the latter, tens of billions… Consider that a modern auto manufacturer has been estimated to put together 15,000 individual parts, from many hundreds of screw types to many tens of micro-processors. Imagine if each of their suppliers put together 1,500 parts in the manufacture of their input to the company (assuming they are less complex), and each of the suppliers to those inputs put together a further 1,500. That makes a total of nearly 34 billion supply-chain interactions (15,000 x 1,500 x 1,500), five times the number of people on the planet. This is a highly imperfect example but it signals the vast conditionality upon which modern production depends. (Korowicz, 2012, pp. 4-5)
It is possible to question this view – another colleague of the author, Dr Nick Bardsley of the University of Reading, points out that David Korowicz might be better to use the words “supply web” rather than “supply chain”. Webs contain multiple pathways, if one node breaks down, other connections between can be made that route around the breakdown. There is greater resilience in a web than a chain. Bardsley agrees though that commercial concentration tends to turn webs into more vulnerable chains. It is also true that the break-down of hub interdependencies like the financial system would have catastrophic consequences.
Cross contagion vulnerabilities of techno-civilisation
Techno-innovation has brought humanity a long way in terms of production possibilities – but how resilient is this production system? How vulnerable is it? While many experts are, with very good reason, concerned about a catastrophic transformation of the climate system because of the greenhouse effect of fossil fuels, others are concerned that even before a climate crisis has done its worst, the technological infrastructure of society could break down catastrophically in a linked financial, supply chain and public health collapse. For example, at the time of writing in 2014 the spead of Ebola in West Africa shows what a devastating effect diseases can have when they spread through the inter-dependent networks of an economic structure. What I am drawing attention to here is the potential of “cross contagion” between different sources of vulnerability.
While techno civilisation is vulnerable to depleting sources of energy and materials, society is also potentially vulnerable to the disruptive effect of public health crises. In addition there are other sources of instability – for example the growth of the finance sector, and therefore of indebtedness. In the longer term there will also be the effects of climate change. Each of these individually can reduce resilience – together they could interact in ways that are particularly catastrophic.
Hub interdependencies and the dynamics of cascading collapse
The dense interrelated complexity of the modern world means that chain reactions or cascade of problems can pass through the entire system when one problem (i.e. an abnormal state that falls too far outside the organisational routine) leads, domino style, to another one, in a progression of vicious spirals. This is particularly the case if failures occur in “hub interdependencies” – systems that connect everything together like the transport networks, the power supply system, the money system – and also, a connecting “system” that is often unnoticed while everything is operating well, public health.
To take public health first – this is not normally thought of as a connecting thread that holds our society together but we can see what happen when a serious contagious disease like types of avian influenza or Ebola spreads through society. It is not only that people are ill directly, it is also that fear, behaviour change, and the measures taken to prevent the spread of the disease, have extremely disruptive effects on economic activity.
This is discussed in an autumn 2014 study on the economic impact of Ebola by the World Bank. The study emphasises two channels of impacts. Firstly there are the direct and indirect impacts of sickness and death which consume resources in health care and take people out of the labour force – either permanently if they die or temporarily. These disrupt planting and harvesting in agriculture as well as the transport of food and other products to market. This in turn leads to rising food prices, to hoarding and speculation in food products.
The second impact is the result of widespread fear and behavioural changes that come about as a result of that fear. As repeatedly argued in this book, and as explained by Kahnemann and Tversky, people are risk averse and this has major economic consequences. In this case the fear of association with others reduces labour force participation, disrupts transportation, markets and government services. Fear also discourages people seeking medical treatment for other diseases and problems and this has knock on health consequences of other kinds. There are effects on trade, travel, commerce, tourism and the hotel sector. Investors and people with a stake in an area where the illness is raging lose confidence, put their plans on hold and perhaps close down economic activities like mining and evacuate their staff.
Governments find themselves in deficit because of the additional costs of containing and treating the outbreak yet have falling tax revenues. They are forced to divert dwindling resources into combating the disease.
The World Bank authors quote studies which suggest that, in regard to the impact on the economy it is the behavioural change brought about by fear which has the largest effect. “In the recent history of infectious disease outbreaks such as the SARS epidemic of 2002 and the H1N1 flu epidemic of 2009 behavioural effects are believed to have been responsible for as much as 80 to 90 percent of the total impact of the epidemic” (World Bank Group. 2014 The Economic Impact of the 2014 Ebola epidemic. October 7th 2014).
We should remind ourselves that when economists write about “impact” they reduce the meaning of impact to what happens to income. For those in the middle of the nightmare the greatest “impact” as a lived experience is most likely to be the trauma and horror of the disease itself, the chilling effect on human relationships, traumatised abandoned and orphaned children, the experience of living continuously in great fear and whether ones loved ones and oneself lives or dies. However the income impacts do indeed feed back into the epidemic in a vicious spiral.
This matches the experience of previous epidemics. In his 1722 “Journal of the Plague Year,” a fictional description of the plague in London in 1665, Daniel Defoe wrote of the poor who
“might be said to perish not by the infection itself but by the consequence of it; indeed, namely, by hunger and distress and the want of all things: being without lodging, without money, without friends, without means to get their bread, or without anyone to give it them; for many of them were without what we call legal settlements, and so could not claim of the parishes, and all the support they had was by application to the magistrates for relief, which relief was (to give the magistrates their due) carefully and cheerfully administered as they found it necessary, and those that stayed behind never felt the want and distress of that kind which they felt who went away in the manner above noted.
“Let anyone who is acquainted with what multitudes of people get their daily bread in this city by their labour, whether artificers or mere workmen—I say, let any man consider what must be the miserable condition of this town if, on a sudden, they should be all turned out of employment, that labour should cease, and wages for work be no more.
“This was the case with us at that time; and had not the sums of money contributed in charity by well-disposed people of every kind, as well abroad as at home, been prodigiously great, it had not been in the power of the Lord Mayor and sheriffs to have kept the public peace. Nor were they without apprehensions, as it was, that desperation should push the people upon tumults, and cause them to rifle the houses of rich men and plunder the markets of provisions; in which case the country people, who brought provisions very freely and boldly to town, would have been terrified from coming any more, and the town would have sunk under an unavoidable famine.” (Defoe, 1722. Project Gutenberg EBook #376 )
In a similar manner the epidemics in West Africa have reduced food supply and increased poverty and the people are now dependent on international support.
At the time of writing it is unclear how well the so called “developed countries” will do to avoid these kind of impacts because they are able to keep Ebola out of their populations.
Governments confidently state that they are well prepared. Even if this proves to be true the protection for populations in the global north is likely to prove highly expensive. The cost of the successful treatment of one person in an isolation clinic in Eppendorf near Hamburg was about 2 million Euros according to the news magazine Der Spiegel. This was partly because the patient vomited over expensive ultrasonic equipment and a mobile X ray machine.
Holding Ebola at bay, to the extent that it is possible, is going to be resource intensive. Consider, for example, what it took the health authorities in Nigeria to manage the situation when the virus was “imported” by a single traveller who flew into Lagos in 2014. From this single traveller there were 19 confirmed cases of further infection. 8 of these resulted in death. So how did the Nigerians contain the situation, for now at least? (December 2014). The answer is that they had a polio eradication programme using similar procedures and skills. This programme had spare capacity because of its success and could be reassigned to contain Ebola. However, containing Ebola created when just one man entered Nigeria required 1,800 health staff. These had to be properly trained and equipped with safe wards to fall back on. They had to be able to make 18,000 visits to check on 900 people.
As long as the disease continues to grow in West Africa it can be expected that “exports” of cases to other countries will become more frequent. A lot of resources may be required in tracing and in managing at risk contacts. It is easy to imagine situations where a cluster of cases overwhelms the wafer thin resource available in some countries to contain the disease. (Tomori, O, 2014).
The current confidence about controlling Ebola transmission in developed countries like the UK is based on the assumption that it will be possible to keep the reproduction number of the virus below 1. The reproduction number is the number of people an infected person infects. At the moment the reproduction number in West Africa is about 1.5 to 2 or more additional infections for each infected person which is why the number of cases has doubled every month.
If something doubles every month it means that if you throw resources at that problem then, in a months time your resources might be only achieving one half as much as a month earlier if their positive impact is not fast enough. Studies suggest that at this level even improved contact tracing, new medication, lower infection rates occurring in hospitals and lower infections through better burial practices is likely, at best, to slow the growth of the disease. (Rivers CM et al 2014)
The danger is then that the growth of the disease in West Africa will also spread through cross border “exports” – both in Africa itself and trans-continentally – perhaps into the densely populated slums of other cities. If there is double the number of cases in the countries in which Ebola is originating and you would expect double the number of “exports” unless rigid quarantines can be enforced. In three months if you double the number of cases, double it again and double it again you have 8 times the number of “exports”, all other things being equal. In 6 months the epidemic would be 64 times the size.
The point here is that if the resources available for the response are swamped by its growth rate then the control response will break down. At some point along a process of this kind the possibilities for standard public health measures for control of the disease by “importing countries” could disintegrate – and not just because of the increasing numbers of “exports” – also because of the growing geographical spread of sources from which infectious “imports” would be coming. Here is why:
If you look at the advice of agencies like the UK government organisation “Public Health England” what they do is talk about control measures for people who are exhibiting particular symptoms – e.g. fever, headaches, vomiting, and diarrhoea – AND who come from the currently most affected countries in West Africa. If a person comes from Germany, or Japan or most other places and they have those symptoms they can be pretty much ruled out as having Ebola. This is tremendously useful as a lot of possible cases can be ruled out as too unlikely to warrant committing resources for someone who one can confidently predict is not going to be an Ebola case.
However, the more countries that Ebola spreads to the more difficult it would – or will – become to rule out an Ebola diagnosis for each of these people. So the number of cases that “might be” Ebola will increase and, after a certain point, the resource requirements of contact tracing and then the monitoring of all these people for up to 21 days would become quite impractical. The epidemic would overshoot resource availabilities and preparedness.
On top of the control costs there are the fear and behavioural consequences. The first case of Ebola in New York chilled financial markets in the USA and Asia. Stocks in hotel operators, airlines and holidays fell. The word “contagion” in an interdependent world can therefore have non-medical meanings. Public health threats and fear contaminate economic processes.
Other Vulnerabilities in ‘Hub Dependencies’
Ebola is not the only reason to be concerned. It is one of a number of vulnerable interdependencies in our society where a breakdown would have far reaching consequences. One has only to see what happens when the electricity supply grid breaks down for it to become clear how vulnerable we could be to a collapse of a “hub-interdependency”. Of course, many organisations will have their own power generators as “back-ups” for emergencies but, should these run out of fuel, the mechanisms of our complex civilisation would grind to a halt. An overlapping network of intermediate economy and state functions would break down – computer and telecommunications, lighting; traffic management and transport; production systems and food delivery arrangements; water and sewerage… In the resulting public health crisis the health service would be hard pressed to manage, dependent as it is too, on a dense network of complicated arrangements and energy intensive hospitals.
Another potential vulnerability is transaction, payment, money and accounting systems. There are circumstances in which they could fail too. If they did, nothing in our civilisation would be able to move and that, in turn, would unleash another kind of public health crisis.
There is a connection between the crisis in the production and energy system and the crisis in the financial system, and it is not only because electronic payments systems require electrical power. People and companies have to service their debts and they must also pay their fuel bills. One reason the world’s central banks have been desperate to drive down interest rates is that high energy costs make it difficult for people and companies to service their debts and if interest rates were high the debt servicing burden would become unsustainable and the finance system would collapse.
In his article reviewing the 40 year evidence about the Limits to Growth study, Graham Turner explores the links between the “general financial crisis” and the other limits to growth trends, although financial problems were never part of the original Limits to Growth modelling. Although the immediate causes of the financial crisis of 2007 appear to have been massive defaults on high risk debts like sub-prime mortgages, a contributory factor was the very high oil and food costs which made debt servicing very difficult for low income earners. This is one connection between the financial system crisis and the energy and production crises. One analyst who explored the connection between oil prices and economic activity found that whereas previous oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007–08 was caused by strong demand confronting stagnating world production. Although the causes were different, the consequences for the economy appear to have been similar to those observed in earlier episodes, with significant effects on consumption spending and purchases of domestic automobiles in particular. Absent those declines, it is unlikely that the period 2007Q4–2008Q3 would have been characterized as one of recession for the United States. This episode should thus, be added to the list of U.S. recessions to which oil prices appear to have made a material contribution. (Hamilton, 2009)
There is an end of the technological road that humanity is currently following. Techno-optimists claim that new technologies can provide the answer to our problems. It is true that we desperately need science and technology to provide answers. However, many new technologies involve a further clever use for energy in further more complicated arrangements.
Ultimately, no one can exactly foresee the future, yet from analysing what has already happened we can see potential developments. Consequently, it seems likely that a central determinant of how fast a crisis might evolve lies in the inter-play between the financial markets, developments in the energy sector, public health and mass emotion.
The financial sector is hugely inflated in the form of loans and derivative contracts which can only be serviced and honoured in conditions of general prosperity. All financial securities ultimately derive their worth from claims to a share of the income arising in the real world of production and service provision and, if that world of production and services is not growing, the ability to service debts declines and disappears. Since growth in the general economy is largely dependent on the growth of the energy supply, the implications of energy depletion for the financial markets are rather obvious – the financial sector is in trouble. A deflationary melt-down could also come about as a result of changes in mass behaviour as a result of novel diseases.
That said, some players in the finance sector might still identify investment options. The more catastrophes, the more assets can be purchased cheaply. The more conflicts over scarce resources, the more weapons can be sold. The more desperate people, the greater will be the market for tranquilisers and illegal drugs. The more epidemics the greater the desperation for vaccinations produced by the pharmaceutical companies. Furthermore, when we reach the limits to economic growth, that means that “natural capital” will be scarce – land and water, for example. So there is money to be made by buying these scarce assets and then charging very high prices to desperate people for their use. Uneconomic growth, even collapse, is full of opportunities, including for vulture capitalists. A sort of growth could continue – with a growing market for undertakers.
Over the last few years much thinking has gone into the interplay between the “energy descent” and financial market instability. Would a rapid slide in the production of fossil energy mean a collapse in financial market confidence? On a day to day basis, the financial markets depend on trust and confidence for their operation. However, these have been known to evaporate virtually overnight, producing a chain reaction, a domino crisis in which interest rates rise, debts are called in and those people and companies operating with high leverage suffer huge losses. Unable to honour their debts, they then ruin their counterparties who, in turn, are unable to honour their commitments to others. In a crisis like this, credit and payment systems can freeze up and, if banks go down, then the entire system might go into shock. You can’t buy your groceries at the supermarket because your bank card won’t work and the supermarket can’t pay its suppliers because its payment arrangements will be paralysed too.
The question then arises – how fast and in what way will the financial markets take in the idea of the limits to economic growth, of the depletion of energy source? How serious could an infectious epidemic and its consequences get? I have colleagues who think a collapse could happen very quickly with shocking and near apocalyptic consequences.
Perhaps they are right – though other futures seem possible too. I have been at pains to explain in this book that faiths, particularly collective ones, do not always shift very rapidly. They are subject to considerable inertia. After over 200 years’ growth, there is an argument that it will take some time for very powerful institutions and individuals to take in the idea that that growth is over. Neoclassical economics, growth, technology are salvation faiths which many people are extremely reluctant to abandon, even in the face of a huge amount of evidence. These faiths are their general orientation in the world, the way that they make sense of things. To abandon them will not be easy – indeed it could be terrifying.
This helps us to contextualise the shale gas boom, as well as other processes like ripping apart Alberta in Canada for its tar sands, biofuels and all the other granfalloons. Despite all the evidence about the immense risks and damage done by shale gas, despite the very rapid rate of depletion of shale gas wells, shale gas is central to the strategic thinking of a large part of the elite. It and the other technologies have a function in the systems of faith – they foster the belief that there is life yet for the carbon economy and for the oil and gas sector. They have not reached the end of the road. The rock strewn dirt track at the end of the road is not a mirage, it is a viable way forward. Growth is still possible. America will become the next Saudi Arabia of gas. The diseases can be contained by new vaccines. The financial markets are safe.
Humanity, at least that part that lives in the rich countries, has found new technological ways to rescue its way of life.
Yes – maybe….or maybe not. At the end of 2014 the surge in production of shale oil brought about by fracking in the US coincided with a faltering with the powerhouse of the global production economy, China. A glut in supply met a fall in demand. The price of oil fell and the Saudi Arabian elite were not inclined to cut production to keep the oil price up. They needed to pay for their state expenditures and if the falling oil price undermines the US high cost producers, the Iranian economy and the economy of Russia, then for the Saudi elite so much the better. However, over a number of years a lot of Wall Street’s money, available at very low interest rates because of Federal Reserve policy, has gone into junk bonds to fund the fracking bubble. Many of these bonds have now become “distressed debt”.
Text Box on the Eurozone crisis
Things are not always as straightforward as they seem. It is sometimes difficult to make out the connection between particular developments and the larger picture. Thus the Eurozone crisis is often presented as if it were due to inadequate financial discipline by states, i.e. governments have spent too much and not taxed enough so they have needed to borrow and the debt has got out of hand. In this narrative governments need to adopt policies which cut expenditure, raise taxes and privatise assets instead of spending and borrowing so much. The story is that this would not be so difficult without a massive amount of corruption and cronyism by the elite which protects itself first of all so that the burden falls on those least able to bear it. This is no doubt true – but the accusation could equally, if not more apply, to corruption in the elites of the creditor countries. Wall Street is not noted for its ethics while the City of London has survived as a global financial centre with its network of offshore tax havens by catering to those who want to evade financial regulations.
An alternative way of understanding the Eurozone crisis is as a symptom of the decline in resilience in the context of slowing economic growth. It is part of the bigger picture. To use a metaphor, it is very difficult to stay balanced on a bicycle unless it has forward momentum. Likewise a growing economy can cope with the debts that arise between partners if both partners are prospering and growth is occurring. However, when growth falters imbalances and inequalities are exacerbated by debt – then debt grows until that point where it becomes unpayable. This is illustrated in the Eurozone crisis which is better understood as the inevitable outcome of imbalances and competitive stresses between economies in Europe as the global economy has faltered.
In the common currency zone Germany has out-competed the peripheral countries but they are no longer in a position to devalue their own currencies. Before the common currency was introduced countries that could not compete with Germany (and other countries in the Eurozone) retained competitiveness because their separate national currencies could be depreciated against the deutsche mark.
For example, if Italy was importing more goods from Germany than it was exporting back to Germany the lira could be depreciated against the deutsche mark. In that situation for Italians to continue buying German goods meant more lira had to be offered for the German currency and for the German goods which would thus become more expensive in Italy. By contrast, as the lira depreciated against the mark, Germans buying from Italy would get more lira for their deutsche marks and this would be encourage them to spent more in Italy. Imports of German goods would fall and Italian exports to Germany would rise and the imbalance situation would be rectified.
In the common currency zone this adjustment can no longer happen. Imbalances actually got worse instead. A common currency zone enhances existing inequalities. In 2012 it was being suggested that many southern Europe peripheral countries were 30% overvalued compared to Germany but could not devalue. Greece was probably 60% overvalued.
For a time the peripheral countries borrowed from Eurozone banks to pay for their import surpluses. However that is a temporary solution. The German economy is undermining the economies of its competitors who are also its customers. This also had knock-on effects on property markets and then on state finances in the peripheral countries. Property development was one field where foreign competition was limited because you can’t trade buildings and the property market was also partly pumped up by European Union infrastructure spending which was added to the bank loans. Eventually the property bubble burst. The broken banks passed their property market losses over to governments who passed the losses onto populations impoverishing them further (e.g. in Ireland and Spain).
Falling incomes created government deficits because tax receipts fell and welfare and unemployment benefit payments rose. The import surplus of German goods made state funding even more of a problem. Healthy domestic businesses from which tax revenues could be raised are fewer because of the northern European competition while people have needed to claim welfare and unemployment benefits because they could find no work. (Until these benefits were cut too.)
These developments were added to the fact that over a number of years most peripheral countries had reduced taxes on the rich, as well as on property and real estate, and put taxes on ordinary people and labour instead.
This situation led to a “sovereign debt crisis” with soaring interest rates payable on the debts of government like Greece. Higher interest rates had to be financed out of state budgets so lead to more tax on ordinary people (though not on elites), cuts in services and privatisations. These austerity measures reduce income and spending as people and companies cut back more, reducing the tax take again while elites took their money to tax havens like Switzerland or London’s offshore tax havens. Government deficits got worse. Rating agencies downgraded country debt ratings again and interest rates rose further.
Riots, strikes and protests eventually mean that governments fall. The choice is then to accept “technocratic” politicians – i.e. unelected rulers – usually former bankers and their associates or politicians of a more radical persuasion. Bankers who have “insured debt” against default lean on politicians behind the scenes lest they have to pay out on default insurance and this creates pressure for further austerity on the people. People who cannot pay don’t pay – so the prospect of default looms anyway. Banks fear bankruptcy and a domino chain of failures as state bonds are downgraded and their assets lose value. The crisis got worse until the European central bank adopted a more relaxed approach to creating money to buy up the debt of the countries in difficulties, much to the frustration of some German economists who are fixated on questions of monetary discipline.
Whatever. The policies of the European Central Bank merely bought time and nothing has really been resolved. Countries that have joined the Eurozone have been told that they can never leave…