The Eurozone Will Not Be Ready for the Next Downturn

Last September, French President Emmanuel Macron gave a rallying speech at the Sorbonne, featuring plans for how the European Union (EU) should reinvent itself to counter the appeal of Eurosceptic populism. In particular, the euro area needed to complete its fiscal and banking union through the creation of a European Monetary Fund (EMF) and a European finance minister, among other measures. The proposals were familiar but delivered with a flair of poetry and a sense of urgency. The European Union had a mandate to capitalize on a period of robust economic growth by making progress on these fronts right away, before an economic shock (a trade war, for example) pushed the eurozone into another untimely debt crisis. Eight months later, Macron—who has branded himself as a pro-European reformer—has little to show for all his speeches and efforts. The European Commission released a blueprint for eurozone reform in December, but it was virtually ignored by the bloc’s member states. In any case, nothing would ever be achieved until Germany—the bloc’s largest economy and France’s most important EU partner—had formed a government. The lack of progress so far has not prevented pro-European optimists from hailing the renewal of the Franco-German relationship, citing high-level meetings between Macron and German Chancellor Angela Merkel as evidence that the EU is ready to move forward with significant changes to the currency union. Although Macron and Merkel may get along personally, media emphasis on the leaders’ warm relationship masks an underlying truth: Germany, France, and other EU members still hold deep-rooted philosophical differences about what ails the eurozone and what should be done to fix it. The fact that mainstream pro-EU leaders are desperate for a win against Europe’s populist insurgents does not change this reality. The problems start with member states’ incompatible overarching visions for the eurozone. Northern countries like Germany and the Netherlands want to see the bloc evolve toward a rules-based system requiring member states to clean up their banking systems and lower public debt through government spending cuts. In their world, following EU prescriptions work. That’s why Spain and Ireland’s economies returned to strong growth after their governments complied with the EU blueprint for fiscal consolidation. According to France and Italy, the emphasis on sovereign debt reduction is misplaced because the eurozone crisis was not brought about by fiscal profligacy, but by structural imbalances in the euro area that encouraged excessive accumulation of private debt. Reform should therefore focus on creating flexible institutions designed to smooth out imbalances and deploy targeted fiscal stimulus in the event of a crisis. As evidence, they point to the eurozone’s slow, grinding recovery from the Great Recession, and the fact that Italy and Greece’s GDP still haven’t returned to pre-crisis levels. These differences lurk behind every conversation about eurozone reform. Most member states agree on the need for reform and can reference similar proposals. But those proposals mean different things to different countries. To France, a European Monetary Fund is a mechanism for facilitating the transfer of risk toward the EU level. To Germany, it is an extension of the rules-based European Stability Mechanism, ensuring that members qualify for bailout funds only under strict conditions. France wants member states to retain control over their own fiscal policy. Germany wants control over the decision to bail out other member states. Both will be reluctant to cede sovereignty to the EU under the other country’s framework. Disagreements between member states do not spell the death of the euro. Reform almost always entails compromise. The hope that France, Germany, and other EU countries might find common ground rests on the assumption that each country will understand the others’ perspective and make necessary concessions. Unfortunately, recent events show that key eurozone members are digging in their heels. Germany’s newly-formed government—far from unlocking the next step in the reform process, as originally anticipated—has already dismissed several key eurozone reform proposals, including some staples of the bloc’s banking union plans. In Italy, the eventual governing coalition may well feature at least one of two populist hardliners, Lega and the Five Star Movement—whose main area of agreement is their willingness to flout the EU’s rules on deficit limits. Across the European Union, populist parties are narrowing the space for compromise on nearly all of the bloc’s most pressing issues. At best, leaders might manage to eke out some superficial reforms that won’t fundamentally alter the currency union’s structure nor move the needle in the event of a crisis. At that point, pro-European optimists will likely declare victory and rush to the next item on the agenda. But the eurozone will be left vulnerable to the next downturn. About the author: Elizabeth Rust is a Europe Fellow at Young Professionals in Foreign Policy (YPFP). She serves as an economic consultant with Keybridge LLC, advising industry associations and corporate strategy clients on global macroeconomic and political trends, with a focus on advanced economies. Rust holds a Master's degree in international economics and European studies from Johns Hopkins University (SAIS) and a Bachelor's degree, magna cum laude, from Cornell University.