Thursday, October 23, 2014
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The Euro Catalyst

PARIS – In 2000, shortly after the launch of the euro, I wrote a book arguing that countries adopting the common currency should be forced in one way or another to implement structural reforms. Ten years later, where do we stand?

Surprisingly, the first country to reform was Germany. Thanks to an environment favorable to export-oriented firms and, most notably, to wage discipline, Germany began to post significant balance-of-payment surpluses. This is evident today on a dramatic scale, and is sustaining German economic growth, and one of the lowest unemployment rates in Europe.

The story is markedly different in other eurozone members. The “PIIGS” (Portugal, Italy, Ireland, Greece, and Spain) greatly benefited from the euro, thanks not only to the removal of currency-related trade barriers, but also because their interest rates suddenly fell to levels unthinkable in pre-euro times.

Furthermore, because these countries no longer faced current-account constraints, they could spend beyond their means without any immediate apparent damage to their economies. With this artificial boost to their economic growth, they had little incentive to press ahead with unpopular reforms in line with the European Union’s Lisbon agenda.

Then came the global crisis. During these hard times (2007-2009), the euro’s usefulness and the eurozone’s resilience were welcomed the world over. Only during the exit from the crisis did problems begin to surface.

The size of public debts, which had been ballooning in many countries during the crisis, together with growing competitiveness gaps between member states, began worrying markets. Some investors, doubtful of the sustainability of some countries’ public debt, began to worry about the viability of the euro itself.

Reactions to this perilous momentum came without delay. At the European level, there has been a swift and impressive mobilization of resources. And EU President Herman van Rompuy is preparing a framework for enhanced fiscal surveillance, prevention, and resolution. As Jean Monnet, one of the “founding fathers” European integration, presciently observed in his memoirs 35 years ago, “the European construction is moving ahead during crisis, and it will be the sum of the solutions brought about in order to overcome them.”

No one can deny that structural reforms are currently underway in all eurozone countries that have been struck by the crisis. Suddenly, reform became une impérieuse obligation, if not – given the pressure of financial markets – a matter of outright survival.

Consider Greece, the eurozone member in the most acute predicament. Reforms of the labor market, the pension system, and those underway or planned in many sectors and professions – all of which generate huge reserves for enhanced growth and, therefore, hope – reflect a profound change in the public’s perception of the country’s long-term needs. Indeed, despite endemic social unrest, a large majority of Greeks acknowledges the need for change and does not oppose it.

Euroskeptics will say that it is not the euro, but the crisis itself, that has catalyzed reform. To be sure, the euro alone has not been a sufficient trigger. But, given past European experience, there is serious reason to doubt that, in the absence of the euro, the crisis alone would have provided the necessary impetus.

Before the euro, a country facing a public-finance crisis would have been forced into a predictable, hopeless sequence: devaluation of its currency, followed by inflation, which alleviated the public-debt burden. It wasn’t long before it was back to “business as usual,” with hardly any structural reform. How many Greek crises, after all, paved the way to Greece’s current crisis? 

Competitive devaluation, which skeptics are calling for, must be avoided this time around. Eurozone members facing a loss of competitiveness can no longer afford to skirt difficult but necessary reforms through a monetary “quick fix” that shifts the burden onto their trade partners: as always, beggar-thy-neighbor policies reward laxity and penalize virtue.

As for the structural reforms now underway or in the planning stage, the most important question is not whether the euro, the crisis, or a combination of the two brought them about, but whether they will succeed. Clearly, failure would impose huge political costs that leaders will be impelled to take all necessary steps to avoid. They already have shown remarkable determination, providing grounds to be optimistic that this time things will, indeed, be different.

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