The Euro Crisis and Ramifications for Israel

- Nadav Kedem The financial crisis in Europe raises several economic and political questions, including the effect on the European Union in general and relations between EU states in particular, as well as the possible impact on Israel.

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The European Economic and Monetary Union (EMU) is not only an economic project designed to achieve economic growth. Rather, it is first and foremost a political project to advance and deepen European integration and the international status of the EU. In fact, an economically powerful nation that generally conducts itself with fiscal responsibility is liable to pay a steep economic price when it joins a monetary union with states that are economically weaker and do not maintain the same measure of fiscal responsibility. Germany, for example, the leading economic power in Europe, initially joined this project out of political considerations: advancing and enhancing the EU and its own status within it (e.g., many claim that agreeing to the EMU was the price Germany paid to the EU in general and France in particular for the unification of Germany), despite the potential economic costs like the ones that are required of Germany at present. By joining the project, Germany loses its autonomy in terms of its monetary policy, is vulnerable to inflation and much economic uncertainty, and as is now evident, is liable to have to extend economic aid to economically weaker nations in the EMU. In contrast, states such as Greece, Spain, and Portugal gain economic stability (the danger of inflation drops and economic certainty rises) and, as demonstrated by the current crisis, enjoy the economic guarantee of stronger states. The EMU thus helps encourage many states to want to join and undergo the required economic and political reforms. At the same time, a monetary union also generates political gains for the strong nations. The EMU as well as the EU are a force multiplier for the dominant member nations on the international arena. For the stronger states, enhanced European integration is a road to political and economic influence and usually, also a key to political, economic, and even security stability both within the EU and beyond. Accordingly, any changes in the EMU occur against the background of the many political implications far beyond the euro and the eurozone. Furthermore, there is no legal way to oust any member from the EMU (the same is true for the EU) and certainly there is no fixed mechanism in place for such a move. Despite the many stringent official demands of EMU members (the scope of debt relative to GDP, the size of government deficit, and the rate of inflation), there is no effective tool to enforce their implementation. In fact, even Germany has failed to meet them all. And in any case, any attempt to expel Greece from the EMU would be opposed by many states, lest they too be candidates for ouster. Moreover, one may assume that such a move would affect a host of European integration processes and set them back. Nonetheless, it is likely that after the crisis abates, European states, especially Germany, will try to introduce changes to the EMU in order to prevent a future crisis. They will also likely be much more stringent with new candidates seeking to join the EMU. Despite the difficulties in states beyond Greece – Portugal, Spain, Ireland, and even Italy and Great Britain – these states still appear at a stage where brisk economic steps could prevent a crisis and put them on a path that would allow them to meet their obligations. Moreover, the recent general mobilization of EU leaders and the International Monetary Fund to support the euro sharply lessened the possibility that the Greek crisis might spread to other states. However, there is real doubt about Greece’s ability to undertake fundamental economic reforms and pay its debts. The aid to Greece expected to be given by the EU and the IMF actually consists of loans or loan guarantees allowing Greece to enjoy cheap credit; this will enable it to recycle its debt and postpone the payout dates until the economic steps it is supposed to take (such as significant budget, salary, and pension cuts, raising the retirement age, and more) make themselves felt. However, there still is grave concern whether Greece will in the end be able to repay all its debt, which means that the aid package does not necessarily spell the end of the crisis. The Greek crisis is liable to continue casting its shadow over the euro and encourage speculators to bet against it. A possible solution may be in Greece voluntarily withdrawing from the EMU in return for an economic aid package. The cost (in the broadest sense of the term) for Germany and other nations – of continuing to support the euro while Greece remains in the EMU – might be much higher than giving it a one-time real aid package (not just cheap loans). Thus far the crisis has not affected the Israeli economy in any fundamental way. However, the relative portion of foreign trade in Israel’s GDP is particularly high. A large part of Israel’s exports go to Europe (in 2009, Israeli exports totaled some $48 billion, with some $12.4 billion associated with exports to EU member states). Greece's economy is small relative to the bloc’s total, and therefore the direct effect of the Greek crisis on Israel is negligible (Israeli exports to Greece totaled some $300 million in 2009). Nonetheless, and especially if the crisis lingers over time, a string of other elements might have a negative impact: market uncertainty (which harms economic growth and the scope of investments); the euro’s loss in value, reducing export profitability to the euro bloc and increasing import profitability (which damages Israel’s GDP as well as its trade balance); instability in currency exchange rates; low growth rates and deferred recovery from the crisis in Europe (which would affect the scope of Israeli exports); and various austerity measures throughout Europe to prevent a similar crisis in other nations would damage economic growth. Therefore, should the crisis in Greece and elsewhere in Europe continue over a long period, it is liable to damage Israel’s exports and its GDP. The Israeli economy’s ability to handle the challenge in the short term is limited. Israel has no influence on what is done in Europe with regard to the crisis. The trade agreements to which Israel is also a signatory will make it difficult for the government to exert any fundamental, immediate, and concerted influence on the structure of Israeli exports, i.e., to attempt to steer exporters who are finding it difficult to export to Europe toward other markets such as East Asia, and thereby decrease the impact of the crisis on Israel. Nevertheless, in the short term, the Bank of Israel could intervene to boost the euro by buying euros for Israeli shekels. This is a partial solution, but one that was adopted by the Bank of Israel in its attempt to handle the drop in the value of the dollar. In the longer term, the State of Israel could continue to promote free trade agreements more vigorously, as well as improve current agreements with as many states as possible. The Israeli market is relatively healthy and is coping with the crisis better than larger, stronger economies. The continuation of the crisis will spur Israeli exporters to penetrate new markets and to diffuse risks. On a grander scale, the scope of the problem will continue to force the economic powerhouses in Europe and the world to tackle it with maximum efforts, despite the inherent political difficulties. The EMU in particular and the EU in general are projects too large and important to allow significant damage by a crisis in a country such as Greece.

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