The most serious problem for the world economy now is Europe. The European Union’s existence is at stake. The future of Euro – one of the world’s most major currencies – is uncertain. Both these developments mean a lot of turbulence in the world economy. Businesses are unsure about what the world economy will look like if the European Union does not exist and the Euro no longer remains a major global currency. The uncertainty is affecting investors and markets all over the world. This is reflected in the general dampening of the global economy, volatilities in stock exchanges all across the world and the fluctuations in values of several major currencies.

But what exactly is wrong with the European Union and Euro?

Governments in most European countries have accumulated very high debts. The debts have become so high that there are serious doubts whether the governments will be able to pay back the debts. This is because what the governments are earnings through revenues are hardly fractions of the debts they are holding. Thus the abilities of the governments to repay are questionable.

The debt problem first came to notice with Greece. The global financial community was unanimous that Greece was likely to default on its debt repayment obligations. Soon after, similar problems were noticed in bigger European economies such as Spain, Portugal and Italy. In fact, these heavily debt-burdened economies are being uncharitably referred to as the ‘PIGS’ (Portugal, Italy, Greece and Spain). It is being told that while the BRICS (Brazil, Russia, India, China and South Africa) is trying to revive the world economy, the PIGS is active in pulling it back.

But why is the European Union as a whole in trouble if only a few of its members have high debts? The problem is that most of the debts are held by European banks. The high-debt European country governments have borrowed largely from their national banks and European banks. German and French banks have extended lots of credit to member countries in the region. If the PIGS or other countries holding debts now default on their repayments, then the banks would be in deep financial trouble as they will not be able to recover what they have lent. Indeed, it is not only European banks that hold large debts of European countries; several other major global banks as well as private creditors also do so. The financial prospects of all these institutions are considerably bleak.

The international community is fully aware of the problems that the European Union has created for the world. It has been active in mobilizing resources for helping the European countries. The European Central Bank (ECB) has been particularly active in raising resources for arranging ‘bail outs’ for the debt-affected PIGS members. The International Monetary Fund’s corpus for extending credit has also been stepped up. Indeed, emerging markets have also been contributing to this corpus. The Indian Prime Minister announced a contribution of US$10 billion to the IMF corpus as India’s support at the last G20 meeting that took place in Mexico some weeks ago. There are also possibilities of India and some other major emerging market developing countries such as China and Brazil buy bonds issued by the European Central Bank.

The European Union is in several ways the world’s largest economic entity. For all parts of the world, revival of Europe is an imperative. This is particularly true for large developing countries like China and India, for whom, Europe is among the largest trading partners. India is in the final stages of concluding a bilateral free trade agreement with Europe, which is unlikely to deliver its full benefits unless Europe experiences an economic recovery.

But would the European Union be able to stage a comeback? Unfortunately, in this respect it is difficult to be entirely optimistic.

The international community has mobilized large amount of resources for helping the debt-ridden countries. These resources are meant to bail out the affected countries. In other words, they are meant to ensure that governments have enough money not to default on their repayments. But what these resources have not factored in are the very large debts held by individuals in European countries. High propensity to consume and low propensity to save has led to over-spending becoming a common habit in Europe. Individuals have been spending beyond their means thanks to extensive use of credit cards and other forms of plastic money. These credits are also significant parts of the loans extended by European banks. While governments have large possibilities of default and European banks are worried about the possibility, they are as much, if not more worried over the possibility of individual debts becoming an insurmountable problem.

Individual spending habits in Europe are unlikely to change because of the generous social security extended to individuals. Austerity measures proposed for improving financial conditions have not gone down well in Europe. The biggest example is the election result in France where the new President is less inclined to hard austerity measures. Though Greece, where economic problems have generated political turbulence as well, finally has a government which is inclined to pursue a path of financial discipline, Europe requires a fundamental change in living standards and habits for getting out of its financial mess. Such a possibility appears distinctly remote. While in the short-term European governments might avoid the embarrassment of defaulting thanks to the help of the whole world, the long term requires much greater determination and change on part of Europe. However, Europe shows little signs of changing.

(The author is Visiting Senior Research Fellow with the Institute of South Asian Studies in the National University of Singapore)