The collapse of Lehman Brothers three years ago triggered a financial crisis and brought the world economy to its knees. In recent months, there has been a fear that a collapse in the eurozone might have equally damaging consequences.
In recent months, the combination of excitable markets and ineffective politicians has seen the euro crisis spread. While the core of the eurozone, led by Germany, has been strong, the economies on the periphery have suffered badly, with recession and rising debt. Worries about default in Greece and a failure to resolve the problem has seen Spain and Italy dragged into the mess.
This led European leaders to gather in Brussels for another crisis summit on July 21. The outcome was a deal that pulled the eurozone back from the brink and which eased immediate pressure on Greece. More government money was provided and the private sector participated, ensuring a sharing of the burden. Despite this, the latest deal does not solve the underlying economic problems in the eurozone.
In my view, a two-speed euro has always seemed the most natural scenario for the eurozone. Perhaps now is the time to consider it seriously. It would allow eurozone countries to stay committed to the project, while trying to address the need for economic growth in the countries on the periphery, particularly Greece, Portugal, Spain and Ireland.
The problems inflicting the eurozone should not have come as a surprise. Since its inception, the euro has faced multiple economic challenges. These issues have always been met by a solid political commitment to make the project succeed. Just as those outside the eurozone should not underestimate this political commitment, it would be wrong for politicians in the eurozone to underestimate the economic pain ahead for many countries as they try and remain in the common currency area.
In monetary terms, one size does not fit all. The interest rate for one region or country may not be the same as for another. Indeed, the recent decision by the European Central Bank (ECB) to raise policy interest rates, driven by the solid core economies of Germany and France, will likely compound the problems for the periphery.
Therefore, as has been widely recognized, a central Treasury is necessary in order to fund fiscal transfers from the core, or the richer regions, to the periphery, or those in most need. Yet even a central Treasury may not be enough.
I wrote as long ago as 1997 that a historical analysis shows that no monetary union of large sovereign nations has survived without becoming a political union. That, ultimately, may be what is necessary for the euro to survive. However, that is not going to happen yet.
The challenge is that in the core economies, such as Germany, things are seen differently. In terms of Economic and Monetary Union (EMU), the view there is that monetary union has worked well. In contrast, the economic aspect has failed. Therefore the core sees the need for the periphery to make the economic adjustment needed.
Hence the tough conditionality asked of the likes of Greece and Portugal, among others, in return for any help from the center. The central aspect of this are the measures to make the periphery more competitive, through austerity and supply-side policies. In short, the Greek economy needs to become like Germany’s — an almost impossible task.