How to Prop Up the Euro

Originally published in the New York Times

Here’s the critical takeaway from last week’s European rescue plan: Nothing in it addresses the endemic economic weaknesses that nearly propelled the euro zone into a meltdown.

However successful the package may prove in quelling turbulent markets (a questionable assumption, particularly after Greece’s decision to submit its latest rescue plan to a referendum), the members of the common currency still face the more daunting challenge of how to restructure their Rube Goldberg contraption so that such turmoil doesn’t recur.

The initial misstep by European leaders, of course, was lashing their nations to a common currency without integrating other critical policies, such as government borrowing and regulation.

That allowed differences in growth rates among the countries to persist — and even expand — during the boom-bust cycle of the past half-decade.

Visit Germany and be struck by the palpable energy and drive within the business community. In part because of a “grand bargain” nearly seven years ago that blended deregulation, job security and wage restraint, German productivity and economic output both grew by almost 10 percent between 2000 and 2010.

Contrast that with Italy, where Sergio Marchionne, the exceptional chairman of both Fiat and Chrysler, has lambasted worker efficiency, even threatening to quit the country. In 2009, each worker at Fiat’s Italian factories assembled an average of 30 cars per year, compared with nearly 100 per year in Poland, while being paid more than three times Polish wages.

Italy was the only major European country in which productivity stagnated in the last decade. Its economy barely grew.

Italy is not alone in its difficulties. Spain is digging out of the wreckage of a euro-fueled borrowing and construction boom, with unemployment stuck above 20 percent thanks to its rigid labor market. Like Greece, Portugal is struggling with an uncompetitive economy and bloated government payrolls. Of the weaker countries, Ireland has made perhaps the most progress in adjusting to the hangover from a real-estate-fueled splurge.

By having a single fiscal policy and regulatory framework, the United States has experienced far fewer internal stresses and strains. Our federal budget includes “automatic stabilizers” that, without further congressional action, shuttle money to hard-hit areas.

For example, the federal government reimburses individual states for half the cost of extended unemployment insurance. In Europe, these programs, known as “transfer payments,” evoke strong negative emotions in wealthy countries — and not just Germany.

Similarly, regional differences in unemployment in the United States are mitigated by the propensity of Americans to move in search of work, as they have done in leaving cities like Detroit for fast-growing Sun Belt locales. Impeded by language, cultural traditions and other barriers, Europeans don’t relocate as readily.

To date, European leaders have focused on treating the symptoms of what ails the common currency, rather than the disease itself. Assembling enormous pools of capital and creating lenders of last resort does nothing to resolve the inherent tensions among countries growing at such disparate rates.
Already, the markets are signaling skepticism: The interest rate on Italy’s debt has breached 6 percent, three times what Germany pays to borrow money.

Absent a fresh approach, prospects for the weaker economies are grim — a grinding down of government budgets and private-sector wages in a perhaps vain effort to become competitive with Germany (what the Europeans euphemistically call “internal devaluations”). None of these countries has yet demonstrated the fortitude to navigate this difficult route to competitiveness. And at every sign that efforts are flagging, bond market vigilantes remain ready to pounce.

What are the alternatives to just muddling through? The 17 euro nations could decide to abandon the common currency, allowing the weaker countries to deploy the more conventional approach of devaluation. Such a reversal would entail unimaginable complexity and bring its own form of chaos.

Instead — and ideally — Europe should move forward with much greater speed toward true integration. To be sure, greater flexibility in labor markets cannot be achieved by mandates.

However, nothing prevents the adoption of a single fiscal policy (including transfer payments) and a harmonized approach to competitiveness except the tortuous politics of national pride and a fear of German domination.

Both are certainly understandable. But if the euro members remain committed to the vision of an integrated continent spawned in the post-World War II ashes, they need to think as Europeans.

Otherwise, European policy makers won’t be able to restrain the markets, any more than King Canute could hold back the sea.