20 June 2011

Charles Grant: A smaller eurozone would be stronger

CER director, Charles Grant, writes that a single European currency has the merit of encouraging trade and investment across frontiers, and thus growth. But countries with inflexible, badly-run economies should never have been allowed to join the euro. The sooner the eurozone shrinks, the sooner it will stabilise.

A country such as Greece with large budget and current account deficits cannot stay in the euro unless two conditions are met. First, it needs a political consensus to support many years of painful austerity.  But a lot of Greek politicians oppose  further cuts. Second, Germany and the “core” members of the eurozone must be willing to sign up to one expensive bail-out after another, indefinitely. That commitment is questionable. The prime minister of one eurozone country told me recently that it would not contribute to any more bail-outs and that Greece should quit the euro.

There are two reasons  for  pessimism about  the  eurozone. One is the constant bickering and dilatoriness among Europe‟s leaders. The euro is like a patient on a sickbed, surrounded by doctors who do not agree on the nature of the malady or the medicine required to cure it.  Leaders have failed to convince markets that they know what they are doing. The second is the growth of  eurosceptic  sentiment across the EU. In  "peripheral" countries there is  increasing  opposition to further  spending cuts,  given the meagre prospects of a return to growth.  In  core countries  such as Finland, Germany and the Netherlands, there is growing hostility to further bail-outs. So even if the doctors find the perfect remedy and agree  on the treatment, parliaments in northern and southern Europe may spurn it.

Much of the current mess stems from poor leadership. The Commission has stayed on the sidelines, pushed there by France and Germany. The ECB has retained its integrity and independence but its fixation on avoiding any  debt  restructuring  – for fear of contagion  – may make the restructuring more painful when it comes. France has allowed Germany to lead. But as one Berlin official admitted to me last week, much of Germany‟s line on the euro has been driven by domestic politics. “We are learning as we go along and we have not  understood  markets well”,  he said. Such candour is encouraging and suggests that a somewhat smaller eurozone has a future.

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