The Euro’s House Divided

BRUSSELS – The European Commission’s latest economic outlook paints a disheartening picture: unemployment rates close to or above 5% in Austria, Germany, and the Netherlands in 2014, but above 25% in Greece and Spain and roughly 15% in Ireland and Portugal. In the same year, per capita GDP is expected to be almost 7% above its pre-crisis level in Germany, but about 7% below in Ireland, Portugal, and Spain – and a terrifying 24% below in Greece. So the deep economic and social divide that has emerged within the eurozone is expected to persist.

Such a gulf within a monetary union cannot be sustained for very long. As Abraham Lincoln said, “a house divided against itself cannot stand.” The same monetary policy cannot possibly fit the needs of a country that is in depression and another that is at or close to full employment. Indeed, the single most important question for the future of the eurozone is whether the gap between prospering and struggling members is being closed.

The optimistic reading is that, despite no sign of improvement in the labor market, economic performance has in fact started to improve, and an adjustment process is under way. The proof, it is often argued, is that external deficits have contracted substantially.

External accounts clearly matter, because they reflect the balance between domestic saving and investment. Until 2007, imbalances within the eurozone largely resulted from too little saving and/or too much real-estate investment, resulting in a growing accumulation of private debt. So the contraction of external deficits is a sign that a correction is under way, and the rebalancing is impressive. In Spain, Portugal, and Greece, the deficit has been reduced by more than seven percentage points of GDP since 2007, and in Ireland the current-account balance has swung into surplus.