Can the Euro Survive?
Despite the cobbling together of a last-minute deal on Greece, the crisis has demonstrated how much the European
project needs a new leap forward.
face retreat.” This 1987 slogan of Édouard Balladur, then French Finance Minister, signaled that the very existence
of the European integration project was threatened by repeated crises in the region’s exchange rate system. He and
other European visionaries managed to end that sclerosis and build agreement on the euro, which was born a decade
later in 1999.
|A Flawed Beginning
The birth of the euro came at a great cost. It was created only on the basis that it was not accompanied by any kind
of fiscal integration, nor by any mechanisms to foster structural convergence for labor, capital, banks and other key
areas. Member countries continued to set their own fiscal policies and issue their own debt. Discipline was provided
only by investors supposedly penalizing profligacy via higher borrowing costs.
The latest Greek crisis shows how domestic political resistance to austerity and reforms can force the rest of the
system to make a bail-out on a disproportionately large scale, as well as bringing the governments across the Eurozone
to the brink of having to accept a debt write-off that sets a dangerous precedent. To persist on this route represents
today’s version of the “retreat” that Mr. Balladur referred to in 1987. The alternative is to advance.
Early Blueprints for a Stronger Euro
The key question is what form that advance can take. Many of those who founded the euro believed the direction should
be toward a central European “economic government”. There were various competing blueprints, but the broad thrust was
that it would have power to set sustainable and appropriate fiscal policies for member states, align the structure of
labor markets, and perhaps oversee some common liability for government debt of member states.
Resistance to this transfer of political power from individual countries made it impossible to introduce such an
“economic government” when the euro was first created. A decade and a half later in 2005, a new attempt at centralized
power was made with proposals for a powerful European president, who would have held office for up to five years and
been elected by national heads of state. These ambitious plans failed, perhaps because they were not conceived at a
moment of crisis. This failure left the Eurozone to enter the financial crisis with broadly the same weak structure
that it had been born with.
A Pragmatic Step-By-Step Approach
By 2010, the advent of the first Eurozone crisis laid bare those weaknesses, giving impetus to a new attempt at
building the missing foundations. This time, the focus was on pragmatic step-by-step moves rather than a great leap
to political union. This discussion led to the Fiscal Compact, a treaty signed in March 2012 by all members of the
Eurozone. This is a significant step forward from its predecessors because it requires every signatory to enact
domestic legislation that progressively brings down debt when it exceeds pre-set targets. But we do not yet know how
this will work in practice and, with most countries still far away from meeting the targets, the early signs are not
While progress on the Fiscal Compact grinds slowly on, the creation of the Banking Union has surged forward and the
result is arguably the greatest success in “filling in the gaps” of the original euro construction. True, it will not
be fully implemented until the start of next year, it has not been tested in a system-wide crisis, and it still lacks
a euro-wide deposit insurance. But it is installed within the ECB, the strongest of the euro area institutions and it
covers both large banks and, indirectly, the smaller ones.
In another key area, labor markets, for the euro to be stable, its member countries have to find a reasonable balance
between security and predictability in jobs versus the flexibility needed to cope with shocks and new technologies.
Before the crisis, this had been lacking in many countries. As a result of the crisis, bailouts in countries such as
Spain were contingent on implementation of labor reforms, and the same now applies in Greece.
The related issue of labor mobility between countries is double-edged. This, alongside free capital movement, is seen
by economists as essential for single currency zones. The theory is that a booming region attracts labor from places
with slack, reducing overheating in the former and lowering unemployment in the latter. Free movement of labor is one
of the core pillars of the Eurozone (and the broader EU and Switzerland, subject to current changes in laws). The
resulting flows of people have probably reduced short-term macroeconomic imbalances, but are also associated with an
undesirable structural hollowing out. What is needed are ways to help countries exploit their natural comparative
advantages, ideally creating new clusters of industrial strength to attract labor back in.
Some Progress, But Much More To Do
What might the next steps be? A key milestone would be to revive earlier proposals for Eurobonds – these would be
issued by a group of Eurozone governments that would share liability for repaying them. This may seem a major step,
but one irony of the current situation is that a form of mutual liability already exists. If Greece were to default,
it is the European institutions who would ultimately bear most of the cost. In this sense, debt already exists at
the Eurozone level.
More controversially, should there be a formal exit process? Although the Greek experience may seem to suggest that
there could be attractions to setting out processes for this in advance, there are dangers. If all contracts and bank
deposits contained a break-up clause, the integrity of the euro would be undermined, the difference between an Italian
euro deposit and a German one would be a daily reality rather than a distant future possibility. This suggests that
any exit procedure should be designed to operate only in extremis, amid default and controls, which is roughly where
we are now.
Advance or Face Retreat
The system is less vulnerable than in the past, perhaps most specially for banks. But it is unresolved whether a
series of technocratic and intergovernmental institutions will have legitimacy in times of crisis.
Without a strong central political authority, the risk is that this haziness may limit the power of banking union
in times of crisis, if it has to take key decisions to shut banks. Maybe the euro and the EU will just keep “muddling
through” with late-night negotiations as has happened so many times in the past. And maybe some of the deepest
conflicts between powerful states like Germany and France can, ultimately, only be resolved that way rather than
though some central authority. Some skeptical investors may conclude that this means an unsound euro that must
ultimately collapse, but the euro remains supported by a central bank whose powers can be changed only after a long
As this article was being finalized, President Hollande made a major call for “a government of the Eurozone [with]
a specific budget as well as a parliament to ensure its democratic control” reviving earlier plans for a strong
central political body. We do not yet know how Chancellor Merkel will respond, whatever the outcome of such debates,
the over-riding conclusion is that, for stability and growth in the Eurozone, it is essential that the current
crisis becomes an opportunity to make further advances.
Source – «Credit Suisse»