Why E.U. collapse is more likely than the fall of the euro

 

European politics has become a giant Jenga game. Since June 2010 governments have fallen in the Netherlands, Slovakia, Belgium, Ireland, Finland, Portugal, Slovenia, Greece and Italy. The question is not: Who will be next? That’s easy. (Spain’s Socialist government will be pulverized in this weekend’s elections.) The real question is: When will the Jenga tower topple?  Many people assume that the tipping point will come when one country — most likely Greece — leaves or is ejected from Europe’s monetary union. But the scenario that worries Eurocrats is different. They fear that a country could leave the European Union itself. This is by no means an irrational anxiety. Under E.U. law, it would be much easier for Britain to leave the European Union than for Greece to leave the euro zone. Thus the process of European integration has reached a richly ironic point: The breakdown of the European Union is now more likely than the collapse of the single currency that was supposed to bind it together. This is not surprising. In March 2000, Larry Kotlikoff and I wrote in Foreign Affairs, “History offers few examples of successful adjustments on the scale necessary in certain European countries today. What it does offer are several examples of monetary unions disintegrating when fiscal strains became incompatible with the unpleasant arithmetic of a single currency.” The euro, we predicted, “could degenerate — not overnight, but within the next decade.” Our timing was not bad. The degeneration of the single currency began in 2010, though the crisis has certainly intensified in recent months. We specified “degeneration” to highlight the generational imbalances arising from Europe’s combination of aging populations and over-generous welfare systems. Even if there had been no financial crisis emanating from the U.S. subprime mortgage crisis that began in 2007, the European monetary system would still have degenerated as public debts soared. But we also struggled to see how, once assembled, the euro zone could be dismantled. The costs of exit would be prohibitive for a small peripheral country such as Greece, which would overnight lose access to any source of external credit. And a Greek departure would raise the probability of others leaving, causing contagion throughout Southern Europe. Finally, if all the weaker brethren were to leave the monetary union except Germany, Austria, the Netherlands and Finland, the strengthening of the euro would cause significant pain to the exporters of those countries. In short, almost nobody would gain from a breakup of the euro zone. This is why I am not among the growing throng of pundits predicting the degeneration of the euro — a number of whom argued with equal self-confidence a dozen years ago that the euro would be a great success. Anyone who closely followed events of the 1990s had a clear idea of what a monetary union with the Federal Republic of Germany would entail: short-term spending power but long-term unemployment mitigated by handouts.