The quarter-century experiment in a common currency was supposed to have produced a Europe of rough equals, nations with comparable rates of productivity and competitiveness. Instead, the region’s economies now appear profoundly out of balance. A few are thriving, but others may be so far gone they need permanent subsidies.
That schism, as much as the debt and banking-sector problems troubling the region, is at the root of the current crisis and may prove the most difficult issue to overcome.
Politicians insist that with the right set of policies and a few years of bailout loans, “convergence” among the nations will still take place.
But studies by the European Central Bank, the International Monetary Fund and others have reinforced the notion of a euro zone fundamentally split between nations such as Germany that have navigated the new global system and those — potentially including France and Italy — that have steadily lost world market share.
“We have not seen some countries within the euro area maintain competitiveness,” Mahmood Pradhan, a deputy director of the IMF’s European department, said in a conference call last month on the euro zone.
Money did begin moving more freely after the countries adopted a common currency, removing the risk of fluctuating exchange rates. But it fueled what Pradhan referred to as “skewed development” — property bubbles in places such as Spain and Ireland — instead of investment that would produce sustainable long-term employment.
An earlier IMF paper found that the euro region’s southern tier — France included — was steadily losing out under the global trading system. A spring paper from the European Central Bank concluded bluntly that there was “no evidence” of convergence among the euro-zone countries in the critical area of labor productivity.
The issue is crucial to the euro’s long-run durability.
As currencies go, the euro and the nations that use it exist in a kind of halfway house. Its members are not fully integrated in the type of federal system that unites American states and are free to set many of their own economic policies, including budget and tax policies. Yet they have surrendered control over their money, interest rates, exchange rates and other monetary matters to a central authority that has to set a common policy for 17 nations.
The euro’s designers knew there were substantial risks involved in trying to bring such a disparate set of countries together under one roof, and they argued for years over whether to delay the common currency until they could make an “all in” commitment to economic federalism. Richer nations such as Germany, with its strong mark currency and world-class industrial base, worried about tying up too closely with countries that might not be as productive and that would eventually need help. Other nations did not want to surrender sovereignty to a central authority that would hold sway over their power to set taxes, sell debt or — the ultimate political prerogative — spend public money.
Convergence provided a way to square the circle. The theory was that the use of a common currency would encourage investors to seek out the higher returns typically associated with building up a less-developed country — a Greece or a Portugal — instead of pumping more money into an already highly developed one such as Germany. That flow of capital, in turn, would raise the productivity of workers and help each nation make products to sell within the euro region and around the world.
Between faith in that process and treaty provisions — ultimately unenforceable — dealing with public debt, the risks of a half-complete currency union were judged to be manageable.
Except the convergence never occurred. Incomes did rise steadily in Greece — a trend cited in the euro’s early years as an example of convergence at work and a sign of the euro’s success. But they were rising for the wrong reasons, as the government added employees and raised public salaries and easy credit fueled a consumer spending binge.
The common monetary policy set by the European Central Bank meant low interest rates across the board, quick integration of the region’s financial system — and an excess of borrowing in countries that did not deploy the money effectively.
“We all got sold on the ‘convergence trade,’ ” said Carl Weinberg, chief economist at the High Frequency Economics consulting firm. “In Europe, everyone got convinced there was one government and they would all stand behind each other. . . . When Greece stood up in the spring of 2010 and said ‘We are in trouble’ and everyone said ‘Go fish,’ the convergence trade was busted.”
As an example of what was expected to happen, foreign investment flowing into Eastern Europe from Germany, China and elsewhere has driven down unit labor costs and raised productivity in Poland, the Czech Republic and other nations that were relative backwaters when the euro was being debated.
In hindsight, Eastern Europe held some natural advantages. It was undergoing a full-on economic transformation from Soviet-style central planning to market capitalism and began the process with much lower wage levels than southern Europe. It was a blank slate when it came to labor rules and other regulations that manufacturers complain about in Greece, in Spain and elsewhere in the euro zone.
The European politicians trying to hold the currency union together now face the question of whether they can do so without the political and economic compromises involved in a fuller type of economic federalism, with countries surrendering sovereignty in return for broader burden sharing.
Some steps are already in the works. The region is expected to adopt new banking rules that will centralize financial oversight and deposit insurance. That will allow the regulation and risks of the euro-zone financial system to be spread across all of its members instead of leaving each country to stand on its own, a situation that sank Ireland and which is threatening Spain. More central control of government budgets is also being developed.
But even that may not be enough. Analysts note that regions sharing a currency almost always have ways to transfer money from richer to poorer areas and that workers move easily to higher-employment or higher-wage regions.
Some American states, for example, routinely generate less in federal taxes than their residents receive in Medicare, Social Security or other benefits, but because the federal system is so entrenched, that does not provoke controversy. The United States also has seen several waves of job-related migration — gold rushes, oil booms, the rise of tech centers such as Silicon Valley — of a sort unusual in Europe, where cultural and linguistic barriers still loom large even if borders are legally open.
Unless nations such as Greece, Portugal, Spain and Italy find a path back to growth, both types of transfers may be needed for the currency union to survive.