This partial collapse of the euro is inevitable, and Europe's leaders should focus on the next step: Their challenge now is to lay the groundwork for a sustainable currency union in the future, once exiting countries reform themselves enough to rejoin. To do so, however, they will need to take stock of the institutional deficiencies undermining the current union, so that the new eurozone is more crash-proof than the last one.
Europe must do far more to cut the growth of government spending -- the only credible path to preventing ballooning deficits. But it needs to go even a step beyond that: Europe must agree on measures that prevent countries from behaving irresponsibly to take advantage of their membership in the eurozone. One of the reasons that Italy and Greece spent so much is that their interest rates on debt fell dramatically when they joined the eurozone, making deficit finance more attractive. There is no substitute for the creation of a fiscal union, which would centralize enforcement power that could credibly control spending. A currency union cannot survive without a corresponding fiscal union.
But fiscal reform is not enough without measures to strengthen the competitiveness of southern Europe. Southern European countries, notably Spain, Italy, Portugal, and Greece, are finding it increasingly difficult to compete in global trade -- the result of restrictive union contracts and labor laws -- and have accordingly suffered from high current account deficits and high unemployment. If left unchecked, these dynamics will produce a political powder keg of widening interregional economic-welfare differences that would threaten the long-term cohesion of the union. |