WHAT THE EUROZONE MUST DO IF IT IS TO SURVIVE / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( HIGHLY RECOMMENDED READING )

What the eurozone must do if it is to survive

By Wolfgang Münchau

Published: January 31 2010 19:57

First Greece, then Portugal, and then what? The project of European monetary union is entering the most dangerous phase in its 11-year history. Last week, eurozone governments started preparations, for the first time, to bail out one of their fellow members. Greece will probably require a bridging loan at some point. Portugal might too. But they are small countries. No matter what happens, it will not break the euro.

The clear and present danger to the eurozone is Spain. Daniel Gros of the Centre for European Policy Studies argued on these pages last week that Spain is in a better position than Greece because of its higher rate of gross national savings. But I believe that Spain is likely to squander that advantage. Spain, like Greece, has suffered from an extreme loss of competitiveness during a period in which it relied on a housing bubble to generate prosperity. While the Greek government is at least beginning to recognise the need for reform, perhaps too late, Spain’s political establishment remains in denial.

So what if Spain gets into trouble? Will the eurozone falter, as Nouriel Roubini, professor of economics at New York University, predicted in an interview last week? The question is unanswerable. I find it more constructive to ask what the eurozone will need to do to survive the strains ahead. Three measures are, in my view, essential for survival; a further three almost so.

The first of the essential conditions is a robust and transparent system of crisis management. Maybe the Greek bail-out will provide a blueprint for such a system. But in any case, it would need to be worked out formally and approved by national parliaments to achieve a maximum degree of legitimacy. This should not be imposed by diktat.

A good crisis-resolution system must also minimise moral hazard. Countries that benefit from help will have to accept a partial loss of sovereignty, and for this reason it is important that any such regime has wide political backing in all the member states. While eurozone members lack the political will for unconditional bail-outs, they accept that they need to help each other during a crisis. But this help is attached to the condition that the recipient takes corrective action.

The second essential prerequisite for survival is a reduction in internal imbalances, which lie at the core of the current crisis. This is an issue that requires action both in countries with large current account deficits, such as Greece and Spain, and in those with large surpluses such as Germany. While Spain, for example, would need to reform its labour market to bring about adjustments in real wages, Germany should implement policies to stimulate consumption, including a long-overdue income tax reform. The build-up of these imbalances is the underlying reason why the Greek problem got out of hand.

The place to handle this co-ordination is the eurogroup of the finance ministers of the eurozone, which now constitutes an official European Union institution under the Lisbon treaty. Jean-Claude Juncker, the prime minister of Luxembourg and chairman of the eurogroup, should make imbalances the defining issue of his agenda and propose binding policies.

Third, the EU should at some point revisit the now almost totally decaffeinated proposals for financial supervision. What started off as a deeply unimpressive set of recommendations by the De Larosière committee ended up further diluted as it proceeded through the EU’s legislative mills. The financial system remains the single biggest threat to the long-term stability of the eurozone economy. Fragmented financial regulation makes no sense in a monetary union and is potentially lethal.

Over and above those essential steps, there are a number of policy actions the eurozone can, and should, undertake to strengthen its political and economic cohesion. The single most important of those is to maintain the fine political balance in the European Central Bank, which enjoys trust and respect in countries as diverse as Greece and the Netherlands. If Angela Merkel, the German chancellor, gets her way to install Axel Weber, the president of the Bundesbank, as the next ECB president, I fear that this balance might be upset. I am not talking about the geographic diversity among the ECB’s top officials in numerical terms, which can easily be maintained. My concern is about what will invariably be perceived as a power grab by Germany during an extremely sensitive period.

Second, the eurozone should sort out its external representation. The presence of German and French national officials in organisations such as the International Monetary Fund, each defending their national position, is pathetic. The eurozone in particular needs to strengthen its voice in the macroeconomic debates in which it has a vital stake, the most important being the future of the global monetary system.

Finally, the EU – not the eurozone – needs to rebuild the internal market, which was damaged during the crisis. This offers by far the biggest opportunity for the EU to generate the productivity gains needed to maintain prosperity.

The reason I have become more sceptical about the eurozone’s long-term prospects is not the inherent economics of monetary union. It is that I doubt the political will exists to do what is necessary.
Copyright The Financial Times Limited 2010.