Eurozone leaders have mobilised money and rhetoric to fight a debt crisis, but the fate of the alliance could now depend on a willingness to transform speeches and stopgap measures into a deep policy overhaul.
There is a growing conviction in European financial circles that the malaise afflicting the eurozone lies beyond the reach of multibillion-euro bail outs, of the sort accorded Greece and Ireland and for which Portugal and Spain may yet have to apply.
But eurozone authorities have hardly been idle in the face of the turmoil. In fact, in the last year they have taken steps that could radically alter the eurozone’s underlying financial architecture.
Three potential routes to economic stability have emerged: a permanent rescue fund for troubled euro nations; a common eurozone bond that would allow financially weak members to pool their credit standing with stronger nations; and the creation of a federal, fiscal transfer union.
The latter approach would imply a degree of federal tax management and the transfer of funds from the strong to the weak in what would resemble the federal structure of the United States.
What is striking to many observers, however, is that initiatives such as emergency bail outs, spurned a year ago, have now become institutionalised.
A European Union summit earlier this month decided to create a permanent financial rescue mechanism for ailing euro nations starting in mid-2013.
That arrangement would replace a €750-billion ($1-trillion) emergency fund established by the EU and the International Monetary Fund in May.
The European Central Bank, known as the guardian of the euro, has meanwhile broken with its preferred practice and since mid-May has been stepping in to buy eurozone government bonds worth €72,5-billion.
That has helped ensure that debt markets keep functioning, but it has also stoked controversy, with critics insisting that the ECB should not be in the business of financing deficits run up by improvident euro governments.
In another groundbreaking step, eurozone leaders have overcome their sovereign sensitivities and agreed to submit their draft budgets to the European Union for review. Greece and Ireland are having their economic policies and finances vetted and approved by the IMF.
While many analysts are dismissive of the measures, eurozone officials insist they contain the seeds of far-reaching operational reform that could at last impose the discipline the bloc needs if it is to survive future recessions.
Common economic policy
German Chancellor Angela Merkel, speaking at the recent EU summit, said that while “it is important to have stable budgets and stable finances” in the eurozone, “it is important to develop, step by step, … a common economic policy”.
French President Nicholas Sarkozy, speaking at the same summit, said “it is now necessary to go further and to make clear in the eurozone the need for the convergence of economic policies”.
The priority in the new year would be “the establishment of an economic government” for the zone, he said.
Sarkozy’s finance minister, Christine Lagarde, last week appeared to fine-tune the president’s comments, telling a German newspaper that “an economic government means seeking the approval of other states” before taking action.
But her remarks drew an immediate and negative response from German Economy Minister Rainer Bruederle, which suggests that the eurozone’s two leading powers remain at odds over precisely what common economic governance entails.
Bruedele described the idea as “not a good plan”, calling instead for a “permanent protection mechanism for the single currency” and sanctions against eurozone members who failed to exercise budget restraint.
For many analysts however, there is a more serious split in the eurozone.
This one divides nations such as Germany, with productive economies powered by substantial savings and trade surpluses, from those considered to be on the “periphery” — Portugal, Spain, Ireland and Greece — that are less disciplined and have run up massive debts and deficits.
It is this divergence that has given rise to disputes over economic management.
“What we have now is a fierce debate about the shape of European policy,” said Goldman Sachs chief European economist Erik Nielsen.
On the one side, “Germany and other net savers are calling for policy adjustments in the periphery, aided by official financing as necessary,” he said.
Those on the other side however “are arguing for various forms of fiscal federalism … which prospective net contributors oppose”.
Either way, according to Commerzbank analyst Christophe Weil, the peripheral countries cannot escape the need to implement domestic reform, which in many cases means lower public sector wages, higher taxes and reduced pension payments.
“The crisis countries will have to implement fundamental reform in the goods and labour markets and social security schemes to restore their competitiveness and boost economic growth,” he said.
While harsh austerity steps have been taken in Greece, Ireland, Spain and Portugal, “it will take several years for the full effect of these measures to unfold”, he warned.
And then there is a clear potential for a damaging political rift, according to a recent study by the American Enterprise Institute and the Legatum Institute of Britain.
In this scenario, the strong refuse to rescue the weak and the public in weak countries rebel against austerity.
“It would seem unreasonable to expect that voters in the eurozone north, and especially in Germany, will indefinitely acquiesce to the transfer of large amounts of bailout money to the eurozone south in an effort to keep those countries afloat,” wrote economist Desmond Lachman in the study.
“And it would seem even more unreasonable to expect voters in the south to indefinitely endure the severe economic and social pain associated with austerity measures attached to the financing they receive from the north.” – AFP