A project in peril

Published : Jun 04, 2010 00:00 IST

ANGELA MERKEL, THE German Chancellor.-MICHAEL SOHN/AP

THE European Union (E.U.) was almost first and foremost a political project. And it was certainly one that required vision and daring. To bring together countries that are so different in size, culture, language and often even aspiration, and historically have been at war with one another, and to persuade them to give up quite a lot of policy autonomy to a federation, was no small achievement.

The subsequent expansion of the Union was also brave, as several formerly socialist countries of central and eastern Europe were admitted despite a relatively recent history of extreme antagonism. But the economic union was even bolder in design and more far-reaching in its consequences. It was also a prolonged and tortuous process, but there is no doubt that this is the most ambitious project of economic unification without complete political union that has ever been attempted anywhere in the world.

The process had its origins in the greater economic interdependence of the post-War period (that was perversely encouraged by Marshall Plan aid from the United States), proceeded through hesitant steps in the treaties of Rome in 1957, through the customs union and the Maastricht Treaty that set the schedule for the Single Market, and culminated in the creation of the Eurozone, which contains only a subset of all the countries in the E.U.

That remarkable process may now be unravelling. Whether it does actually unravel depends critically not only on the vision and commitment of the leaders, especially those of the large countries, but also the predisposition of the people in different countries, and this too cannot any more be taken for granted.

The future of the currency union particularly whether it remains relatively broad-based or turns into a much smaller union of a set of economies that see themselves as stronger, will depend critically on Germany. Angela Merkel, the German Chancellor was widely criticised in other Eurozone countries for her tardy, hesitant and relatively stingy response to the crisis in Greece, which probably fuelled the speculative attacks against Greek government bonds and intensified the crisis.

Finally, when it became clear that inaction would only add to the problems with each passing day, she and other European leaders delivered what many had argued to be the minimum required to recover from the first signs of the crisis: a clear statement of commitment to financial markets by underwriting Greek debt and providing significant amounts of emergency finance.

Greece is to be provided with 80 billion euros of debt from the E.U. over two years, at somewhat (but not very much) lower interest rates than the market is currently demanding, to add to the 30 billion euros to be provided by the International Monetary Fund. A total of 450 billion euros has been pledged to help other Eurozone economies that may face difficulties, though this is still only a potential credit line.

It is not clear that this will really provide anything more than a temporary palliative, since the underlying economic contradictions that have caused the problem have not really gone away. Essentially, the funds provided will only help Greece to meet its debt-servicing requirements (and, therefore, help to indirectly bail out French and German banks).

In return for this relief, which is expected to reduce the battering of Greek bonds in markets, the government is being asked to impose an austerity programme that is staggering in its sweeping intensity. It requires massive cuts in wages, pensions and employment, and will have very large negative multiplier effects on the small family-run businesses that constitute the backbone of the Greek economy. Nor is the painful medicine to cause a quick recovery: the economy is anticipated to decline for several years (in some projections, until 2017) with no hope of anything getting better, until markets deem that the right balances have been achieved once again.

Obviously, there is widespread resistance to this, and the austerity programme in Greece may yet collapse because of popular resistance and lack of legitimacy. Meanwhile, the other countries in potential or actual difficulty, such as Spain, Ireland, Portugal and Italy, have received a temporary reprieve but this may not be sustained either. As long as membership of the Eurozone prevents nominal devaluation in these countries, the deflation they will be forced to impose on their citizens will be so harsh that it may not be politically acceptable, even with some protection in the form of funds that help them to continue to service their debts.

But the other side of the coin is that Germany, which must remain the paymaster for the Union if any of this is to be sustained over the medium term, may be unwilling to deliver for too long. Angela Merkel's unwillingness to get involved was not simply a personal choice: it reflected the deep unpopularity in Germany of such a bailout. In fact, her government was punished with a comprehensive defeat for her party in the regional election in North Rhine-Westphalia, which has deprived the ruling coalition of a majority in the Upper House of Germany's Parliament.

The current inwardness of Germany's electorate reflects the uncertain economic conditions as well as the nature of Germany's own recent growth. Germany has remained a powerful exporter through the previous global boom and survived the global crisis largely by ensuring that rapid productivity increases were not accompanied by real wage increases. This was made possible by the large pool of educated surplus labour of East Germany. But it does mean that workers have not benefited from the boom even as they are now threatened by the crisis. This has made the people of Germany much less willing to support the larger project of the E.U. with German public funds.

Political change in another part of Europe also augurs ill for the project of European integration. In the United Kingdom (U.K), the recent Mick Jagger election (cannot get no satisfaction for anyone) yielded a result that has created an unlikely and potentially uncertain coalition between the Conservatives and the Liberal Democrats, who differ hugely on most policy matters of significance.

The election result in Britain can be interpreted most broadly as a general disaffection with the electorate's own state of being and with politics in general, expressed not so much as a vote for positive change but as a declaration against everyone. This seems to be in keeping with the public mood in Britain at present, which is characterised by an almost palpable sense of gloom; a general feeling of joylessness; a perception that the country is in decline and perhaps on the verge of crisis; a sour, almost brittle resentment at other nations and nationalities that at least superficially appear to have better prospects.

Much of this can be related to economic pressures. The U.K. appeared to have come out of the global financial crisis relatively quickly compared with other developed economies. In fact, the relatively quick response of the Gordon Brown government in terms of massive monetary easing and increased fiscal spending did cushion the economy from the worst effects of the crisis and allow for a relatively quick emergence from recession.

The U.K. economy has many macroeconomic features that are quite similar to the countries in the Eurozone that are now seen to be in trouble: large current account deficits; large fiscal deficits that are adding to the already large ratio of public debt to the gross domestic product (GDP); large private debt to GDP ratios largely driven by the earlier housing boom; poor employment generation in the recovery phase, reducing the increases in effective demand that would generate sustained recovery.

The big difference with these other countries, of course, is that Britain did not join the Eurozone and, therefore, is able to use the exchange rate as a macroeconomic tool for adjustment. The pound sterling has indeed depreciated over the past year, by around 25 per cent in trade-weighted terms. This has allowed Britain to avoid the more deflationary forms of adjustment that would have otherwise probably been imposed on it by the bond markets. The economy is supposed to be growing at 1.5 per cent this year, while growth next year is largely expected to be driven by exports, reflecting the exchange rate change. This lesson would not be entirely lost on other countries in the Eurozone.

However, such a recovery would also be affected by the major public spending cuts that the new government in the U.K. has already promised. In addition, the Conservative Party, which is the dominant party in the ruling coalition, has a long and sometimes fierce tradition of euro-scepticism. It is unlikely to be enthusiastic about any moves to deepen integration in Europe or be involved in bailouts of other countries. It has already extracted a promise from its partner in the coalition (the Liberal Democrat Party) that there will be no attempt to join the Eurozone during the life of this Parliament.

The currency union between such disparate partners may have been a flawed project from the start, especially as it did not incorporate a real commitment to fiscal federalism. But it would be a pity if the difficulties of that project also affected the more noble and attractive aspects of European integration, which emphasised pluralism and cooperation in ways that other regional groupings could try to emulate.

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