From the start, the euro has rested on a gamble.
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When European leaders opted for monetary union in 1992, they wagered that European economies would converge toward one another: The deficit-prone countries of southern Europe would adopt German economic standards — lower price inflation and wage growth, more saving and less spending — and Germany would become a little more like them, by accepting more government and private spending, as well as higher wage and price inflation. This did not occur.
Now, with the euro in crisis, the true implications of this gamble are becoming clear.
Over the past two years, the eurozone members have done a remarkable job managing the short-term symptoms of the crisis, although the costs have been great. Yet the long-term challenge remains: making European economies converge — that is, assuring that their domestic macro-economic behaviors are sufficiently similar to one another to permit a single monetary policy at a reasonable cost. For this to happen, both creditor countries, such as Germany, and the deficit countries in southern Europe must align their trends in public spending, competitiveness, inflation and other areas.
Aligning the Continent’s economies will first require Europe to reject the common misdiagnoses of today’s crisis. The problem is not primarily one of profligate public sectors or broken private sectors in southern European debtor countries. Greece is exceptional. Most euro-zone crisis countries had relatively prudent fiscal policies; most ran up smaller deficits than Japan, Britain and the United States. And severe housing and banking crises are hardly specific to southern Europe; they have recently occurred across the Western world.
Although big deficits and broken private sectors may have been part of the problem, the deeper cause of today’s crisis lies in contradictions within the euro system itself. Ten years after adopting a common currency, Europe is still not an optimal currency area.
Instead, the single currency exaggerates existing differences between countries. And its adoption eliminated the policy instruments economically weaker countries had used to overcome them, including currency devaluation and unilateral control over interest rates.
Meanwhile, Germany underprices its exports and racks up the world’s largest trade surplus. In this regard, Germany is acting as the China of Europe — but euro membership permits it to pursue mercantilist policies while escaping the blame. Bankruptcy in southern Europe and prosperity in Germany are in fact two sides of the same coin.
Policy proposals for budgetary austerity, the micromanagement of national budgets, fiscal federalism, bailouts, or large funds to stave off speculators are insufficient to solve this problem. As long as the eurozone countries continue to take such radically different trajectories regarding labor costs, government spending, private-sector behavior and competitiveness, Europe will face a long-term economic catastrophe that could drain its wealth and power for the rest of this decade and beyond.
How should European economies be made to converge? The German view — that the future of the euro rests on southern European countries making tough reforms and cutting public spending — is partially correct. It would be foolhardy for Germany to assume liabilities for deficit countries without such reforms. That is why Berlin has insisted that the recently negotiated E.U. fiscal compact require governments to incorporate balanced-budget provisions into their national constitutions.
Yet imposing the primary cost of recovery on deficit countries in the form of austerity is likely to fail both pragmatically and politically. Economies without growth cannot support or sustain debt reduction or structural reform. This is why even Mario Monti, the technocratic Italian prime minister, recently made clear that the deficit countries could embrace austerity and reform only if Germany changed its policies to accept a greater adjustment burden in the form of domestic spending and inflation, as well as appropriate E.U. policies.
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