Confronted with turbulence in the provinces, the euro zone has sent in new governors. In place of the wayward George Papandreou, Greece now has Lucas Papademos, former vice-president of the European Central Bank. Instead of the unruly Silvio Berlusconi, Italy has Mario Monti, former head of competition policy at the European Commission. Europe is putting in place these new governors in members that have descended to the status of clients. Will this work? Not without a huge amount of support from the centre.
What is at stake today is not only the stability of the European – perhaps the world’s – economy, but the survival of the most successful – and certainly most civilized – effort to unite Europe since the fall of the western Roman empire 1,535 years ago. As Walter Scheidel of Stanford University notes in a fascinating essay: “Two thousand years ago, perhaps half of the entire species had come under the control of just two powers, the Roman and Han empires.” Both collapsed. But the Chinese empire was repeatedly restored and enlarged, while the Roman empire divided irretrievably. Yet the dream of reunification never died. It was apparent in the claims of popes and “holy Roman emperors.” It was carried by Napoleon’s eagles. It is the aspiration embedded in the European Union.
The shift in the centre of economic gravity northward is also old.
So, when Germany’s Angela Merkel, chancellor of Europe’s most powerful state, calls “for Europe to build a ‘political union’ to underpin the euro and help the continent emerge from its ‘toughest hour since the second world war,’ ” I take her seriously. I have little doubt, too, that the majority of the German business and political elite believes that the survival of the euro and of a united Europe is in the country’s interest. The question is whether they are prepared to pay the price.
In the centuries after the fall of Rome, Europe became Babel. Uniting such diversity is a daunting challenge. Politics are local, not European, as are the politicians. This might not matter if decisions taken at the European level were of little import. But monetary and fiscal policies or labour market regulation are at the core of democratic politics. The greater the economic divergence within the euro zone, the greater the stresses. Unfortunately, divergences in competitiveness, before the crisis, and in the price of credit, after it, have been extreme.
This, then, is where the postwar European project itself has arrived. On its fate hangs the European economy, the global banking system and perhaps the world economy.
My interpretation of the actions of Chancellor Merkel is that “just enough, just in time” is itself the strategy. In this way, she may hope, the German people will come round to doing more. In this way, too, she may expect, peripheral members will be brought into line. She will not allow things to get so bad that the euro zone collapses; but she will not give so much money that the backsliders slacken their efforts.
Just enough, just in time has been too little, too late. What was once a crisis in small peripheral countries has become a conflagration. Spreads on sovereign credit have reached the stratosphere. Worse, sovereign spreads now include some risk of a breakup.
Mr. Monti and Mr. Papademos are, almost certainly, the last hope for successful reform and adjustment in their countries. While a failure by Greece would be a nuisance, one by Italy would be devastating. If Italy were forced to default, it might well elect a populist government set on exiting from the euro. If it did so, few would be safe, including France.
Yet what Mr. Monti must do is enormously tough. As Gavyn Davies argues, Italy might need to tighten fiscal policy by more than 5 per cent of gross domestic product, to reverse the widening spreads and start bringing gross public debt down from its exalted level of over 120 per cent of GDP. Given the inevitable adverse effects on output, the attempted tightening would have to be greater than this. Yet investors are unlikely to regain confidence in Italian debt if its economy does not recover. Austerity is not enough.
The social and political unrest triggered by the envisaged structural reforms, particularly those affecting the labour market, will also shake confidence. Given the weakness of domestic demand under such a fiscal austerity program, Italy will need export-led growth. But regaining the competitiveness lost in the 2000s is going to take a long time. It will itself generate a mixture of labour-shedding with falling nominal wages – a recipe for unemployment, unrest and creditor unease.
The chances that this is going to work smoothly are not high. The turnaround period is going to be many years. With Mr. Berlusconi surely prepared to condemn Mr. Monti’s government as a mere tool of foreign interests, the political obstacles will also be daunting. Mr. Berlusconi will be able to use his media to make his attacks louder.
Mr. Monti is going to need a great deal of luck. He is also going to need an enormous amount of help, of three kinds: first, at least backstop financing for the rollover of sovereign debt, to the tune of nearly €1-trillion ($1.38-trillion); second, profitable and dynamic external markets; and, finally, a credible strengthening of the political underpinnings of the union, sufficient to make a breakup inconceivable. All of these are going to depend on bold German decisions. They are also going to depend on the ECB. If it allows slow growth, let alone an outright recession, to grip the euro zone, the chances for big peripheral members are grim. Italy is not little Ireland. That should be obvious to everybody.
The euro zone has fiddled until Rome itself started to burn. With the new government, it has what may turn out to be a last chance to put out the fire. Yes, it is conceivable that Italy would remain in the euro zone even after a default. But that cannot be likely. In any case, an Italian default would batter bond markets across the continent and banks across the world. The time for too little, too late has passed. What is needed, instead, is “too much, right now.” Power brings responsibility. Germany alone has the power. It is up to it to exercise the responsibility.