Can the Euro be repaired?

When Wolfgang Schäuble, Germany’s finance minister, recently tabled the option of a Greek exit from the euro, he wanted to signal that no member could abstain from the monetary union’s strict disciplines. In fact, his initiative triggered a much broader discussion of the principles underpinning the euro, its governance, and the very rationale for its existence. Only a fortnight before Schäuble’s proposal, Europe’s leaders had barely paid attention to a report on the euro’s future prepared by European Commission President Jean-Claude Juncker and his colleagues from the other European Union institutions. But the new dispute over Greece has convinced many policymakers of the necessity to return to the drawing board. Meanwhile, citizens wonder why they share this currency, whether it makes sense, and if agreement can be reached on its future. For currencies, as for countries, founding myths matter. The conventional wisdom is that the euro was the political price Germany paid for French acquiescence to its reunification. In fact, German reunification only provided the final impetus for a project conceived in the 1980s to resolve a longstanding dilemma. European governments were both strongly averse to floating exchange rates, which they assumed would be incompatible with a single market, and unwilling to perpetuate a Bundesbank-dominated monetary regime. A truly European currency built on German principles appeared to be the best way forward. In retrospect, German reunification was more a curse than a blessing. When exchange rates were locked in 1999, Germany’s was overvalued, and its economy was struggling; France’s was undervalued, and its economy was booming. During the ensuing decade, imbalances slowly grew between a resurgent Germany and countries where low interest rates had triggered credit booms. And when the global financial crisis erupted in 2008, conditions were ripe for a perfect storm. No one can say how Europe would have evolved without the euro. Would the fixed-exchange-rate system have endured or collapsed? Would the Deutschemark have been overvalued? Would states have reintroduced trade barriers, ending the single market? Would a real-estate bubble have developed in Spain? Would governments have reformed more or less? Establishing a counterfactual baseline against which the euro’s impact could be assessed is impossible. But that is no excuse for complacency. Over the last 15 years, the eurozone’s economic performance has been disappointing, and its policy system must answer for this. What really matters is whether a common European currency still makes sense for the future. This question is often evaded, because the cost of exiting is deemed too high to consider it (and could be higher still if the break-up takes place in a crisis and sharpens reciprocal acrimony among participating countries). Moreover, pulling the plug on the euro could unleash the dark forces of nationalism and protectionism. But, as Oxford’s Kevin O’Rourke recently argued, this is hardly a sufficient argument. It is the logical equivalent of advising a couple to remain married because divorce is too expensive. So does the euro still make sense? It was expected to deliver three economic benefits. Monetary union, it was assumed, would foster economic integration, bolstering Europe’s long-term growth. Instead, intra-eurozone trade and investment have increased only modestly, and growth potential has actually weakened. This is partly because national governments, rather than building on currency unification to turn the eurozone into an economic powerhouse, tried to hang onto their remaining power. This was perhaps logical politically, but it made no economic sense: Europe’s huge domestic market is one of its main assets, and opportunities to strengthen it should not be squandered. Second, it was hoped that the euro would become a major international currency (particularly given how few countries are equipped with the necessary legal, market, and policy institutions). And, according to recent ECB statistics, this hope has been largely fulfilled. With international use of the euro behind only the US dollar, this achievement can help Europe to continue shaping the global economic order, rather than sliding into irrelevance. Third, it was (somewhat naively) believed that the institutions underpinning the euro would improve the overall quality of economic policy, as though Europe-wide policies would automatically be better than national ones. The acid test came in the aftermath of the 2008 global financial crisis: because it overestimated the fiscal dimension of the crisis and underestimated its financial dimension, the eurozone performed worse than the United States and the United Kingdom. If the euro is to create prosperity, further reforms of the policy system are therefore needed. But an agenda can be designed and implemented only if there is a broad consensus on the nature of the problem. And, as the on-going dispute over Greece illustrates, agreement remains elusive: Participating countries have developed contradictory analyses of the causes of the debt crisis, from which they derive contradictory prescriptions. Richard Cooper of Harvard University once observed that in the early days of international public health cooperation, the fight against global diseases was hampered by countries’ adherence to different models of contagion. They all favoured joint action, but they could not agree on a plan, because they disagreed on how epidemics crossed borders. That is the problem the eurozone faces today. Fortunately, it is not unsolvable, as significant reforms like the creation of the European Stability Mechanism and the launch of banking union show. Disagreements also did not prevent the ECB from acting boldly, which illustrates that the governance of institutions does matter. But the fact that reforms and actions were undertaken only lately, and under the pressure of acute crisis, is a sobering reminder of the difficulty of reaching consensus. Europe cannot afford to procrastinate and pretend. Either the eurozone’s members find agreement on an agenda of governance and political reforms that will turn the currency union into an engine of prosperity, or they will stumble repeatedly from dispute to crisis, until citizens lose patience or markets lose trust. Clarity is a prerequisite of serious discussion and ambitious reform. Each of the major participants now has an obligation to define what it regards as indispensable, what it considers unacceptable, and what it is ready to give in exchange for what it wants.