Thursday, April 24, 2014
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The Re-Division of Europe

ATHENS – As the eurozone debt crisis has steadily widened the divide between Europe’s stronger northern economies and the weaker, more debt-laden economies in the south (with France a kind of no man’s land economy in between), one question is on everyone’s mind: Can Europe’s monetary union – indeed, the European Union itself – survive?

While the eurozone’s northern members enjoy low borrowing costs and stable growth, its southern members face high borrowing costs, recession, and deep cuts in incomes and social spending. They have also suffered substantial output losses, and have far higher unemployment rates than their northern counterparts. Unemployment in the eurozone as a whole averages about 12%, compared to more than 25% in Spain and Greece (where youth unemployment now stands at 60%). Indeed, while aggregate per capita income in the eurozone remains at 2007 levels, Greece has been pushed back to 2000 levels, and Italy today finds itself somewhere in 1997.

Europe’s southern economies owe their deteriorating circumstances largely to excessive austerity and the absence of measures to compensate for demand losses. Currency devaluation – which would boost the competitiveness of domestic industry by lowering export prices – obviously is not an option in a monetary union.

But Europe’s stronger economies have resisted pressure to undertake more expansionary fiscal policies, which would lift demand for its weaker economies’ exports. The European Central Bank did not follow the lead of other advanced-country central banks, such as the US Federal Reserve, in pursuing a more aggressive monetary policy to cut borrowing costs. And no financing has been offered for public-investment projects in the southern countries.

Moreover, fiscal and financial measures aimed at strengthening eurozone governance have been inadequate to restore confidence in the euro. And Europe’s troubled economies have been slow to undertake structural reforms; improvements in competitiveness reflect wage and salary cuts, rather than productivity gains.

While these policies – or lack thereof – have impeded recovery in the southern countries, they have yielded reasonable growth and very low unemployment rates for the northern economies. In fact, by maintaining large trade surpluses, Germany is exporting unemployment and recession to its weaker neighbors.

As Europe’s north-south divide widens, so will interest-rate differentials; as a result, conducting a single monetary policy will become increasingly difficult. In the recession-afflicted south, continued fiscal consolidation will demand new austerity measures – a prospect that citizens will reject. Such impasses will lead to social tension and political crisis, or to new requests for financial assistance, which the northern countries are certain to resist. Either way, financial and political instability could lead to the common currency’s collapse.

As long as the eurozone establishes a kind of wary equilibrium, with the weaker economies stabilizing at low growth rates, current policies are unlikely to change. Incremental intergovernmental solutions will continue to prevail, and Europe’s economy will soldier on, steadily losing ground to the US and emerging economies like China and India.

For now, Germany is satisfied with the status quo, enjoying stable growth and retaining control over domestic economic policy, while the ECB’s limited powers and strict mandate to maintain price stability ease fears of inflation.

But how will Germany react when the north-south divide becomes large enough to threaten the euro’s survival? The answer depends on how Germans perceive their long-term interests, and on the choices of Chancellor Angela Merkel. Her recent election to a third term offers room for bolder policy choices, while forcing her to focus more on her legacy – specifically, whether she wishes to be associated with the euro’s collapse or with its revival.

Two outcomes now seem possible. One scenario is that the economic and political crisis in the southern countries spreads, inciting fears in Germany that the country faces a long-term threat. This could drive Germany to withdraw from the eurozone and form a smaller currency union with other northern countries.

The second possibility is that the crisis remains relatively contained, leading Germany to pursue closer economic and fiscal union. This would entail the mutualization of some national debt and the transfer of economic-policy sovereignty to supranational European institutions.

Of course, such a move would carry considerable political costs in Germany, where many taxpayers recoil at the notion of assuming the debts of the fiscally profligate southern countries, without considering how much Germany would benefit from a stable and dynamic monetary union. But a new grand coalition between Merkel and the Social Democrats could be sufficient to make this shift possible.

Even so, there could be victims. Indeed, the continued failure of smaller countries like Greece and Cyprus to fulfill their commitments reinforces the impression that they will forever be dependent on financial assistance. The exit of one or two of these “undisciplined” countries could be a requirement for the German public to agree to such a policy shift.

Europe’s north-south divide has become a time bomb lying at the foundations of the currency union. Defusing it will require less austerity, more demand stimulus, greater investment support, deeper reforms, and meaningful progress toward economic and political union. One hopes that modest recovery in the south, aided by strong German leadership in the north, will steer Europe in the right direction.

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  1. CommentedPaul A. Myers

    Increasing globalization and deepening trade integration almost demand a return to national currencies or to at least two currency unions in the EU. Diverging competitiveness between countries and differential abilities to make structural adaptations demand that the variable of currency be the agent of flexibility and restoring equilibrium.

  2. CommentedLeo Arouet

    De alguna manera estoy de acuerdo. Va a ser imposible una sobrevivencia de la unión europea a largo plazo; si no se actúa para elevar la competitividad de los países del sur, no se podrá mantener a flote la unión... Es necesario reformas profundas, económicas y las relacionadas con la defensa, las cuales están siendo desatendidas conscientemente.

  3. CommentedProf. Robert Cope

    I'm surprised most of the arguments about north and south were not also made about east and west, where the east at present (Ukraine and Turkey) seem to be pulling away.

  4. CommentedWilliam Wallace

    Perhaps a better question would be "Why should the EU survive as it is?" In light of all the factors mentioned in the article, what stands out is that highly similar economies can indeed successfully create a common currency. On the other hand, a common currency spanning the countries in the EU today doesn't make, and never made, any economic sense. Southern Europe would be far better off today had those countries remained outside the Euro zone.

  5. CommentedLennart fredrikson

    The only way we presently will see a weaker Euro is US starting
    tapering that might come soon.! The debasement of USD by ongoing QE stimulus is an of chart experiment only possible within a FIAT
    Monetary system. The ongoing Global debasement of Currencies
    =Currency War, will not improve competetiveness. Real growth
    comes only from Innovations,Investments,Jobcreation. A new
    Global Currency system is likely in médium term. The last
    Gold standard was abandoned 1971 now we face a Global need
    for reformed Monetary system. Eurozone in itself cannot survive
    longterm in present form without modifications.!

  6. CommentedJason Gower

    I completely agree with Mr. Hermann below as given technology, globalization, etc., the world is now inextricably intertwined; what happens in Asia or Africa, for example, can now indirectly impact European or North American economies in ways that we, to this point, never really contemplated.

    The problem is of course human nature and a sort of global prisoner's dilemma that unfortunately has (and will likely always) leave us with a less than optimal global solution. If one assumes that climate change is real then we can use the lack of global coordination to solve the problem as a prime example. Individual nations will always assume that taking the lead on such an issue will compromise its competitiveness and thus nobody will take action until it is potentially "too late."

    This example of the EU and Eurozone is no different. What is most troubling is that, right or wrong, Draghi did buy the member governments time with his pledge. However, as expected the EZ governments are completely squandering this valuable opportunity, presenting this pause in market pressure as an indication that a solution has been found (as if they have done anything to solve the structural problems which are pretty clear to most observers). Again, EU/EZ problems ultimately come back to self-interest, which is only exacerbated by the cultural differences and stereotypes that exist in Europe. Thus until the next crisis emerges (a matter of when not if given the current structure of the EZ) and the north feels that its long-term best interests are threatened, they will continue to support the status quo as the best of a bad set of alternatives.

  7. CommentedZsolt Hermann

    We evolved into a globally interconnected and interdependent world.
    The experiment they started in Europe with the Union and with the single currency is a good move, fitting the external, existential conditions we find ourselves in today.
    But if we want to unite, if we want to create a mutual cooperation it cannot happen in a partial way because then it causes more harm than benefit.
    Union, mutual cooperation cannot exist unless it is absolute.
    Our body could not exist, life would not be possible if in the natural system the mutual cooperation worked the same way we imagine it at present.
    In the human system I only cooperate, I only join a mutual system if I benefit from it, and moreover beyond my necessities I try to exploit this mutual system as much as I can, ignoring the consequences.
    In truth today every nation, every individual operates in the global, mutual system as cancer cells, only considering their own benefit, how much they can suck out of the system for themselves, irrelevant of anybody else.
    I agree with the writer, if the countries do not change their attitudes towards each other, if the basis of the Union, the Eurozone is still self-centred calculation, exploiting the others, if ruthless competitions is still allowed to exist, the European Dream will fall apart with a bang, just as the American Dream is falling apart for the same reasons.
    In a mutual, interdependent system every calculation, action should first of all serve the benefit of the whole, and only when the survival, the optimal function of the whole is secured than do the individual parts take out whatever they deserve for their contribution they made into the common part.
    Both "North" and "South" have their own responsibilities to consider and fulfil. Nobody can expect to stay the way they used to be , and that only the others will change themselves.
    In our global world everything has to happen mutually with mutual responsibility and mutual guarantee.
    Otherwise we do not match the conditions of the system we exist in, and we pay the price.