The PIIGS are a group of five countries (Portugal, Ireland, Italy, Greece, Spain) whose economies are suffering particularly badly as a result of the recession, and are struggling to recover. These countries all share common characteristics, which may help to explain why they are having such a hard time. The common themes include the continued membership of the euro, the loss of competitiveness and the structure of the PIIGS economies.
Before the global recession hit, the PIIGS economies were performing very well, at above average rates. Ireland and Spain in particular had seen massive growth pre-recession. However, the problem with this massive growth was that it was extremely demand led, and was not being stimulated by growth in the supply side of the PIIGS economies. When rising demand in an economy is not matched by rising supply, it causes inflation to occur. If the UK was to experience inflation, the Bank of England could simply raise interest rates to reduce demand and lower inflation. However, the problem within the euro area is that, if not all the countries are experiencing the same rate of inflation, its difficult for the European Central Banks to set one interest rate that suits all the different economies. The rates that have been set have been two low to sufficiently reduce the inflation in the PIIGS economies, and the reason the rate has been set low is to suit the larger economies such as Germany and France. This means that in the PIIGS economies, inflation has remained high. Usually, high inflation in an economy leads to a weakened economy and thus a weakened currency. When a currency weakens, goods become cheaper to trading partners and the economy becomes more competitive. However, because the Euro rate is “fixed” for the PIIGS, this mechanism cannot operate, and so they remain uncompetitive both within and outside the Euro area. This loss of competitiveness can be seen when looking at the change in output and labour cost throughout the Euro area. The PIIGS economies have seen a larger rise in output and labour costs than the rest of the Euro area, meaning they have become far less competitive. Usually if a country wishes to become more competitive with other countries, it will devalue its exchange rate to make its exports more competitive. However, because the euro is fixed for the PIIGS against competitive countries like Germany and France, they cannot devalue to become more competitive.
Another problem that the PIIGS have faced as a result of demand led growth pre-recession is a very weak supply side in their economies. Economic growth can occur as a result of both short term and long term factors. Short-term factors are demand-led, such as changes in consumer and business confidence, monetary and fiscal policy or increased wages. Long-term factors are supply led, such as growth in the working population, growth of capital, growth of productivity and technological improvements. In the case of the PIIGS, their pre-recession growth was as a result of short term, demand led factors. When the recession hit, the demand disappeared, and the PIIGS were left with a very weak economy as they had ignored the supply side factors that are vital for long-term growth. Another issue is the type of industries that the PIIGS had high demand for pre-recession, for example property and construction, which was a massive industry in countries like Ireland and Spain. When a recession hits, the Construction and Property tend to be the industries worsely affected by loss of demand. These industries also take a very long time to recover demand, because buying a house is a decision that requires massive consumer confidence, which simply doesn’t exist during a recession. This means the PIIGS are left with huge property and construction industries, but no demand from consumers. This has left massive spare capacity within the PIIGS economies, which causes high unemployment.
To conclude, there are various contributing factors as to why the PIIGS are having such difficulty recovering from the recession. With artificially low interest rates causing high inflation, and such a strong currency, they are remaining very uncompetitive both within and outside the euro area. Within their own economies, they have been left with very little demand, and a poor supply side in place, meaning their long-term growth potential is very limited. Many argue that continued membership of the Euro is a bad idea for the PIIGS, and the best idea would be for them to revert to their own currency, which they can then devalue, leading to increased competitiveness and causing export led growth.