The High Cost Of Maintaining The Euro

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Recent developments in Cyprus, Greece, and Portugal have demonstrated that Europe is unequivocally committed to the preservation of the single currency area. The high price tag of maintaining the euro should lead us to ask us why.

It seems that the single currency area is best viewed as a means, not an end. The explicit, principal objective of European integration since the Treaty of Rome in 1957 has been security and stability. Designed to curtail the xenophobic and nationalistic tendencies that precipitated two world wars, the agreements have sought to support broader market access, robust economic growth, wide social inclusion, and democratic governance. Since the heat of the crisis began in 2009, Europeans have shown a willingness to sacrifice all of these ends to preserve the idealistic mean of European integration.

During the crisis, European defense budgets have been seen as a piggybank from which to borrow to support other funding priorities. External threats to Europe are hopefully abstract and long-term, and therefore bearing the cost of a defense budget is harder to justify to impassioned electorates when seeking fiscal consolidation. Europe's ability to combat external military threats has fallen as defense budgets have been slashed. While some demilitarization in the aftermath of the Cold War and Balkan conflicts makes sense, NATO Secretary Anders Fogh Rasmussen may have put it best: "There is a point where you no longer cut fat; you're cutting into muscle, and then into bone."

But more immediate threats to European security have come from within. The toxic combination of fixed exchange rates and large-scale austerity engendered a deep recession that has left millions unemployed as economic activity dries up and bloated wage rates are kept from adjusting. Double digit unemployment rates in 11 of 17 euro area nations propelled the euro-wide unemployment rate to 12 percent, its highest point on record. These unemployment rates have cast a pall of suspicion towards immigrants, who are perceived as a threat to domestic labor. The European Union Agency for Fundamental Rights reports that member states experienced a 24 percent rise in incidents of racially-motived violence between 2011 and 2012.

This security threat has entered the political arena as voters have become increasingly disenchanted with their elected officials. Across the periphery, fragmentation has led to stand-offs between European Commission-approved technocrats and increasingly extremist political factions. Since 2009, democratic governments have fallen in 13 of 17 euro area nations. Belgium gridlocked over the formation of a coalition for 541 days. The Cypriot government resigned in 2011 then cobbled together a weak coalition in 2013. Finland deposed its 56-year ruling party. Vitriolic elections in France encouraged the German chancellor to openly campaign for the losing incumbent. Greek extremist parties have captured 45 percent of parliamentary seats on promises of war tribunals for finance officials and land mines along the border. Ireland's emergency elections installed an impotent coalition. Italy's political dysfunction has failed to produce a coalition while providing corrupt former Prime Minister Berlusconi with a shot at regaining power. Malta's opposition party won a sweeping victory over the long-tenured ruling party. The Dutch cabinet resigned mid-tenure in 2012; Portugal has likewise seen large-scale resignations. Slovakia failed to agree to IMF demands before its government coalition collapsed, and Slovenia dissolved its parliament mid-session. Spain's pro-austerity ruling party, now rocked by scandal, unseated the former ruling party in emergency elections.

Meanwhile, the unemployment crisis has imputed a social cost, as evidenced by marked rises in poverty rates. In 2013, the European Commission estimates that one in five Europeans is at risk of poverty, including one in four children. Indeed, on a continent dedicated to social inclusion and market access, the European Commission strikingly reports that 38 percent of Europeans experience financial exclusion because of restricted credit, falling asset and housing prices, and high unemployment.

Part of this social crisis is due to the under-funding of discretionary government services as governments struggle with high debt and are forced to choose between social transfer payments - pensions, income security, retirement security, and so on - and domestic services - education, transportation, defense, and the like. As one European Commission report laments, the European transportation system is currently underfunded by at least €1 trillion. Underfunding of this nature is the rule, not the exception, in Europe's present.

All of this is the outgrowth of a common currency area nominally committed to democratic liberalism, political stability, social welfare, and economic growth. Nevertheless, it seems Europeans will do whatever it takes to save the euro.

In March, Cypriot depositors learned the hard way the European Commission would sacrifice the spirit - and perhaps the letter - of the law to "bail-in" banks through the confiscation of bank deposits, so long as European cohesion would be preserved. Indeed, the imposition of capital controls in Cyprus to prevent bank runs in the aftermath of Cypriot agreement flirts with violation of Article 59 of the EU Treaty which requires a majority of states to assent to unilateral capital controls.

Clearly, there is no natural barrier to what nations will do to avoid the disruption and uncertainty of exiting the euro area. Despite major resentment of the conditions imposed on Cyprus, beleaguered president Nicos Anastasiades has specifically spurned abandoning the euro as "gambling with the country's future."

But why? The costs of euro membership are high and rising. Leaving the euro will be a large question mark for any country that moves that way, but for now, the real high risk gamble is that the current euro area arrangement can deliver on the promises of integration.

Daniel Hanson is an economic researcher at the American Enterprise Institute. 

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