[Smart Q&A: Lee Yong-wook] Eurozone Crisis Outlook and Korea's Challenges

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Professor Lee Yong-wook holds a Ph.D. in International Politics from the University of Southern California and is currently an Associate Professor in the Department of Political Science and International Relations at Korea University.

Causes of the Eurozone Crisis

“Triggering Cause: Rapid Financial Liberalization on a Fragile Institutional Foundation”

“Sustaining Cause: Divergent Views within the Eurozone on Causes, Prescriptions, and Responses, and Lack of Leadership”

The Eurozone crisis was triggered not only by various factors at national, regional, and global levels but also by a complex interplay of economic, social, and political issues. To properly understand the multifaceted causes of the Eurozone crisis, it is necessary to analyze them analytically by dividing them into 'triggering factors' and 'sustaining factors.' Of course, the triggering and sustaining causes of the crisis are not mutually exclusive.

Let us first examine the triggering causes. According to existing research, the following four factors have been discussed as causes of the Eurozone crisis: 1) The absence of banking regulation at the Eurozone level, leading to excessive lending and the expansion of non-performing loans by European banks; 2) Trade imbalances within the Eurozone, weakening the fiscal stability of smaller countries such as Greece, Spain, and Portugal; 3) Bubble formation due to prolonged low interest rates, particularly the inflow of funds into smaller countries that fueled real estate investment and consumption-driven fiscal spending; and 4) Rapid crisis contagion due to strong financial interconnectedness within the Eurozone.

However, upon closer examination of the more fundamental causes, it becomes clear that 'rapid financial liberalization on a fragile institutional foundation' triggered the Eurozone crisis. This is not significantly different from the causes of the 1997-1998 East Asian financial crisis, which we refer to as the 'International Monetary Fund (IMF) crisis.' In the wave of neoliberal deregulation, the advent of the Euro, a single currency, led to rapid, unregulated financial liberalization within Europe after 1999. This significantly contributed to the excessive lending and non-performing loans by banks mentioned earlier, the formation of low-interest rate bubbles, and the interconnectedness of the Eurozone financial system, characterized by mutual sensitivity and fragility. Furthermore, with the introduction of the Euro, Europe was reborn as a single currency economic zone with completely eliminated currency barriers and exchange rate risks. This led to the weakening of national competitiveness in smaller countries, exposing them to fiscal fragility due to repeated economic stimulus measures.

Next, examining the sustaining causes, we can point to the 'divergent views among Eurozone countries and the lack of leadership' regarding the causes, prescriptions, and responses to the Eurozone crisis. In particular, a vicious cycle has formed where disagreements between France and Germany, the two main pillars of European integration, lead to a lack of leadership. In such a situation, even if European countries share a common policy vision, it is difficult to reach an agreement on policy preferences and priorities, leading to difficulties in formulating pan-European crisis resolution measures. This acts as the most significant factor in the prolonged continuation of the Eurozone crisis.

Evaluation of European Countries' Responses and Future Outlook for the Eurozone Crisis

“Due to lack of leadership, both liquidity supply and fiscal soundness issues remain unresolved, perpetuating a vicious cycle.”

“As long as the political objectives for the creation of the Eurozone are shared, the Eurozone will not be dismantled.”

The responses of European countries to the Eurozone crisis thus far can be broadly categorized into two main policy objectives: the first is efforts to resolve the liquidity crisis, and the second is measures to restore fiscal soundness and improve economic structure. The former is emphasized by Southern European countries, led by France, while the latter represents Germany's position. The problem lies in the fact that these two policy objectives have been pursued competitively rather than complementarily. As a result, liquidity has not been sufficiently supplied, and the pursuit of fiscal soundness policies has led to a lack of growth and economic recession in fiscally vulnerable countries, perpetuating the Eurozone crisis.

At the European Union summit held on June 28-29, five measures were dramatically agreed upon to overcome the Eurozone crisis: 1) Conclusion of a growth pact; 2) Establishment of an integrated banking supervisor at the EU level; 3) Direct support for non-viable banks by the European Financial Stability Facility (EFSF)/European Stability Mechanism (ESM); 4) Allowing EFSF/ESM to directly purchase government bonds; and 5) Waiver of the senior creditor status for the ESM. The first measure was advocated by France, the second by Germany, and the remaining three by Spain and Italy, reflecting a compromise of each country's position. While the agreement reached at the European summit appears to have laid the groundwork for resolving the Eurozone crisis, given that disagreements over policy priorities continue to emerge in the subsequent implementation process, the possibility of encountering further difficulties cannot be ruled out.

As the Eurozone crisis persists, voices expressing concern about the possibility of the Eurozone's collapse have grown louder. To forecast the future of the Eurozone, it is necessary to consider how it was initially created. The Eurozone was actually initiated for political rather than economic reasons. That is, the Euro was created to compete with the US dollar and secure autonomy from it. Therefore, to forecast the future of the Eurozone, it is necessary to pay closer attention to changes occurring in the political arena rather than the economic one. Of course, if mutual distrust among European countries accumulates during the prolonged crisis, the Eurozone could collapse. However, the likelihood of this is not high at present.

Korea's Challenges

“National Level: ① Securing Industrial Competitiveness ② Developing Alternative Markets”

“Regional Level: Establishing Regional Financial Safety Nets and Developing Regional Financial Markets”

“Global Level: Presenting Policy Ideas and Visions during a Period of Transformation in the Global Financial Order”

To respond to the global financial crisis, including the prolonged Eurozone crisis, South Korea must make efforts at the national, regional, and global levels.

First, at the national level, efforts must be made to secure industrial competitiveness. As mentioned earlier, countries experiencing fiscal crises within the Eurozone commonly suffer from weak industrial competitiveness, which leads to fiscal and financial instability. The reason South Korea was able to overcome the IMF financial crisis relatively quickly was the recovery of exports through the restoration of industrial competitiveness. This implies that even countries experiencing temporary fiscal crises can recover quickly if they possess strong industrial competitiveness, making the securing of industrial competitiveness a paramount task in Korea's response to the Eurozone crisis. Second, it is necessary to develop and penetrate alternative markets due to the prolonged economic downturn in Europe and the United States. In addition to developing the domestic market, penetration into emerging markets, symbolized by East Asia and BRICs (Brazil, Russia, India, and China), is crucial.

Next, at the regional level, South Korea must actively participate in the development of regional financial safety nets and financial markets for resource mobilization, such as the Chiang Mai Initiative Multilateralization (CMIM) and the Asia Bond Market Initiative (ABMI), to secure financial stability and ensure stable access to investment funds.

Finally, at the global level, South Korea must secure a position as a bridge country connecting developed and developing nations within the ongoing discussions on the restructuring of the global economic order, such as the G20. Through this, South Korea should strive to ensure that its policy preferences are reflected in global economic governance. Furthermore, as the global economic order is currently undergoing restructuring, efforts must be made to present sound policy ideas and visions. Unlike periods of stable order, policy vision can be a more critical variable than national power during periods of transformation. Therefore, South Korea must recognize that it has an opportunity to move from a position of adhering to existing rules to one that leads the change in rules and respond proactively.■

The East Asia Institute (EAI) is receiving financial support as a core research institution selected for the MacArthur Foundation's 'Asia Security Initiative' program. EAI has been conducting Smart Q&A, an interview-based video series with domestic and international experts, aiming to provide timely and in-depth analysis of current issues through question-and-answer sessions with experts in relevant fields. This manuscript was compiled from interview content by Researcher Kim Yang-gyu (EAI Center for Asian Security Studies) and Team Leader Kim Ha-jeong (EAI Center for Asian Security Studies). The opinions expressed are those of the individual experts and do not represent the views of the East Asia Institute. Please cite the source when quoting from Smart Q&A.