Part of Foreign Affairs Report: The Future of the Eurozone

Europe After the Crisis

How to Sustain a Common Currency

From the start, the euro has rested on a gamble. When European leaders opted for monetary union in 1992, they wagered that European economies would converge toward one another: the deficit-prone countries of southern Europe would adopt German economic standards -- lower price inflation and wage growth, more saving, and less spending -- and Germany would become a little more like them, by accepting more government and private spending and higher wage and price inflation. This did not occur. Now, with the euro in crisis, the true implications of this gamble are becoming clear. 

Over the past two years, the eurozone members have done a remarkable job managing the short-term symptoms of the crisis, although the costs have been great. Yet the long-term challenge remains: making European economies converge, that is, assuring that their domestic macroeconomic behaviors are sufficiently similar to one another to permit a single monetary policy at a reasonable cost. For this to happen, both creditor countries, such as Germany, and the deficit countries in southern Europe must align their trends in public spending, competitiveness, inflation, and other areas. 

Aligning the continent's economies will first require Europe to reject the common misdiagnoses of today's crisis. The problem is not primarily one of profligate public sectors or broken private sectors in debtor countries. It is rather the result of a fundamental disequilibrium within the single currency zone, which applies a single monetary policy and a single exchange rate to a diverse group of countries. Policy proposals for budgetary austerity, the micromanagement of national budgets, fiscal federalism, bailouts, or large funds to stave off speculators are insufficient to solve this problem alone. Instead, Europeans should trust in the essentially democratic nature of the EU, which will encourage them to distribute the costs of convergence more fairly within and among countries. The burden must be shifted from Europe's public sectors and deficit countries to its private sectors and surplus countries. If this does not occur, the survival of the euro will be called into question and Europe will face a long-term economic catastrophe that could drain its wealth and power for the rest of this decade and beyond.

A RISKY BET

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