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True, for the moment, the problem is still economically manageable. Eurozone growth is respectable, and the PIGs account for only 6 per cent of the eurozone's GDP. But by stubbornly arguing that these countries are facing a liquidity crisis, rather than a solvency problem, euro officials are putting the entire system at risk. Major eurozone economies such as Spain and Italy have debt problems of their own, especially given the anaemic growth and lack of competitiveness. The last thing they need is to be led to believe that an implicit transfer union is already in place, and that economic restructuring can wait.
EU officials argue that it would be catastrophic to restructure any member's debts proactively. Certainly, contagion will rage after any Greek restructuring, and will stop spreading only when Germany constructs a firm and credible firewall, presumably around Spanish and Italian central-government debt. This is exactly the kind of hardheaded solution that one would see in a truly integrated currency area. So, why do Europe's leaders find it unimaginable?
Perhaps it is because they believe they do not have the mechanisms in place to make tough decisions. EU's fractured institutions dispose of less than 2 per cent of eurozone GDP in tax revenues. Any bold decision essentially requires unanimity. It is all for one and one for all, regardless of size, debt position and accountability. There is no point is drawing up a Plan B if there is no authority or capacity to execute it.
Might Europe get lucky? Is there any chance that the snowball of debt, dysfunction and doubt will fall apart harmlessly before it gathers more force? Amidst so much uncertainty, anything is possible. If eurozone growth wildly outperforms expectations in the next few years, banks' balance sheets would strengthen and German taxpayers' pockets would deepen. The peripheral countries might just experience enough growth to sustain their austerity commitments.
Today's strategy, however, is far more likely to lead to blowup and disorderly restructuring. Why should the Greek (not to mention the Irish and the Portuguese) accept years of austerity and slow growth for the sake of propping up the French and German banking systems, unless they are given huge bribes to do so? Countries can rarely be squeezed into making net payments (payments minus new loans) to foreigners of more than a few per cent for a few years. The current EU/International Monetary Fund strategy calls for a decade or two of such payments. It has to, lest the German taxpayer revolt at being asked to pay for Europe in perpetuity.
Perhaps this time is different. Perhaps the allure of belonging to a growing reserve currency will make sustained recession and austerity feasible. I doubt it.
True, against all odds and historical logic, Europe seems poised to maintain the leadership of the IMF. Remarkably, in their resignation to the apparently inevitable choice for the top position, emerging-market leaders do not seem to realise that they should still challenge the US's prerogative of appointing the Fund's extremely powerful number-two official. The IMF has already been extraordinarily generous to the PIGs. Once the new bailout-friendly team is ensconced, we can only expect more generosity.
Unfortunately, an ultra-soft IMF is not what Europe needs. The IMF needs to help the eurozone make the tough decisions it cannot make on its own. It needs to create programmes for Portugal, Ireland and Greece that restore competitiveness and trim debt, and offer realistic hope of economic growth.
Absent the IMF, the one institution that might be able to take action is the fiercely independent European Central Bank. But if the ECB takes over entirely the role of ‘lender of last resort', it will ultimately become insolvent itself. This is no way to secure the future of the single currency.
The endgame to any crisis is difficult to predict. Perhaps a wholesale collapse of the euro exchange rate will be enough, triggering an export boom. Perhaps Europe will boom anyway. But it is hard to see how the single currency can survive without a decisive move towards a stronger fiscal union.
The author is Professor of Economics and Public Policy at Harvard University, and was chief economist at the IMF.
Copyright: Project Syndicate, 2011
(This story was published in Businessworld Issue Dated 13-06-2011)