Castles in the Sky The Fundamental Problem with Efforts to Save the Euro

In the battle to save its common currency, Europe is too busy focusing on the same old failed policies. Rather than set aside ever higher sums for bailouts, the bloc needs to set up an independent institution to oversee the debts of EU nations.

An Essay by Michael Sauga

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Next September, the Canadian economist Robert Mundell will celebrate the 50th anniversary of the publication of his work "A Theory of Optimum Currency Areas," which not only earned him the Nobel Prize for economics, but also remains a fundamental point of reference in the debate over the euro. Mundell argued that for a monetary union to function, workers and capital must be able to move about within its borders as freely as possible. For former German Chancellor Helmut Kohl, the idea of "maintaining an economic and monetary union in the long term without a political union" was an "absurd notion."

It is this context that makes Mundell's insights seem more relevant than ever. Politicians in Berlin, Paris and Brussels are currently outdoing each other with proposals for greater coordination of their economic and financial policy. German Finance Minister Wolfgang Schäuble promises "progress in European integration." In the future, says his French counterpart Christian Lagarde, every country will have to "take into account the effects of its economic policy on others." And European Commission President José Manuel Barroso feels that it is his duty to endow the European Union with greater powers, saying: "We must further intensify and strengthen political coordination within the European Union."

The beneficiary of these avowals of community spirit is already clear. Last week it was becoming obvious that Barroso's native Portugal would follow Ireland and Greece and become the third euro-zone country to apply for emergency loans.

It Works or it Falls Over

The status quo still applies when it comes to the affairs of the EU. Whenever something goes wrong in the gears of the community, European politicians call for more integration. They see the crisis as an opportunity and, in doing so, are adhering to the traditional Brussels motto that Europe functions like a bicycle: if it doesn't move forward, it falls over.

For dedicated Europeans, it is self-evident that the road leads to Brussels, and it comes as no surprise that the European heads of state portrayed themselves as great promoters of the European idea at their last summit. They want to beef up their shared bailout fund for the euro, they want an economic government and a competition pact, and the European Commission now has the authority to keep a closer eye on national fiscal policy. According to German Chancellor Angela Merkel, it is a question of "solidarity coupled with soundness and improved competitiveness."

These are laudable concerns, but they are poorly suited to curing the acute sickness of the common currency. Last week's resolutions offer no solution to the continent's debt problems. Instead, they are a largely unconvincing attempt to continue building old European castles in the sky, which require both a more tightly knit political union of the continent and the promise of sound budget management.

The public has long known that the powerful in Europe behave like smokers when it comes to borrowing. On New Year's Eve, they loudly proclaim they will quit their unhealthy habit, but by the morning of New Year's Day they are already lighting their next cigarette.

"3.0 is 3.0"

This pattern of behavior is notorious in the history of the economic and monetary union. When the euro was introduced in the late 1990s, European governments committed themselves to strict budgetary discipline. Under the so-called Stability Pact, those that went too deeply into debt could expect sanctions. To prevent anyone from circumventing the established debt limits with tricks and fraud, then-German Finance Minister Theo Waigel pronounced his famous equation: "3.0 is 3.0," in reference to the 3 percent ceiling on the deficit-to-GDP ratio.

Twenty years later, it is now clear that completely different mathematics apply in Europe. EU countries have exceeded the deficit limit of 3 percent of their gross domestic product (GDP) on 97 occasions, but in not a single case were sanctions imposed.

Instead, an exception clause for economic emergencies was added to the once-strictly worded pact in response to German pressure, under the tacit assumption that Europe is in a constant state of economic emergency.

Given this arbitrary interpretation of the European treaties, it isn't hard to understand why the results were not at all as expected. Since the introduction of the common currency, the euro nations have in fact accumulated more debt, not less. What was conceived as a stability pact has proven to be an agreement that increases instability.

The second project of European governments was related to economic growth. With typical Brussels modesty, the EU set itself the goal, at the turn of the millennium, of transforming Old Europe into "the most competitive economic area in the world" within a decade. The effort, dubbed the "Lisbon process," represented probably the world's only attempt to use the tools of a monstrous bureaucracy to generate economic dynamism.

It was an ambitious undertaking. The problem was that European leaders could never agree on what they defined as competitiveness. As a result, in the course of their growth initiative, EU countries not only failed to catch up with but in fact fell behind comparable industrialized nations like Canada and New Zealand, not to mention emerging economies like India and China. A year ago, European Commission President Barroso complained that he had "always felt that the Lisbon goals were unrealistic."

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lakechamplainer 03/30/2011
1. Key: Bankers doing better
The key to this whole story about the Euro zone and the rescue packages is: the banks are doing better. Kind of reminds of the US, where "the rich" and "the banks" are likewise doing fine after trillion dollar plus bailout, regular people not so fine.
joe sixpack 03/30/2011
2. Rather than set aside ever higher sums for bailouts...
Zitat von sysopIn the battle to save its*common currency, Europe is*too busy*focusing on the*same old*failed policies. Rather than set aside ever higher sums for bailouts, the bloc needs to set up an independent institution to oversee the debts of EU nations. http://www.spiegel.de/international/europe/0,1518,753509,00.html
...the bloc needs to discuss if Greece really should be a member of the Euro club. Same for Ireland and the rest of the PIIGS.
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