The Future of the Euro

The Greek bride was sick and tired of being bossed around by the domineering northern Europeans and is considering going home to Mama Drachma. It’s true that she was not very good at keeping to her budget, but enough’s enough. Now the Italian marriage has fallen apart and the markets were able to do what the democratic process couldn’t – get rid of the Great Seducer. While the Italian bride has been better at keeping to her budget overall than Greece has, she is considerably weightier in debt terms. Saving Italy could bankrupt the entire European Union. The events of this November show that the Eurozone crisis is due much more to deep-seated political problems in the European Union and in each of its member countries than to economic fundamentals. As last month’s article showed, the unfolding of the Greek crisis was clearly understood, predictable, and – from a Eurozone point of view – could have been resolved months earlier without endangering Eurozone stability (although for the Greeks, the pain of the reforms is another matter altogether). But focusing on the technocratic solution misses half the story. In the loose confederation of broadly democratic countries that makes up the European Union, sometimes the best technocratic solutions are simply not politically feasible. The eminent Nobel Prize-winning economist Paul Krugman states it thus: Paul Krugman’s diagram attempts to show that in the Eurozone crisis there is no intersection between the set of politically feasible policy decisions on the one hand, and the set of technocratic solutions to the crisis on the other. No technocratic solution to the current European crisis would be acceptable politically. This is a reflection of the absence of legitimate Eurozone-wide institutions designed to deal with such a crisis – the lack of a Eurozone-wide decision-making apparatus that is not beholden for every decision to the parliaments of each of 17 member states; the lack of a fiscal coordination mechanism with teeth, able to impose a hard budget constraint on countries that are out of line; and the lack of a lender of last resort. In the absence of these institutions, what is going to happen to Italy and the other European countries? The reason why the Italian crisis is so much more worrisome than Greece lies in the size of its economy (the third largest in Europe); in the size of its massive public debt (€1.9 trillion, or almost 120% of GDP); and in its dismal growth record over the past decade (only 0.2% per annum, against 2.1% for Germany and 1.7% for the Eurozone as a whole). We are not talking about a Greek problem in Italy. As Silvio Berlusconi pointed out in a letter sent on October 26 to the EU authorities before he was forced to resign as Prime Minister (and conveniently leaked to the Financial Times shortly after it was sent and before he resigned), Italy’s budget deficit in 2010 was 4.6% of GDP, closer to that of Germany (revised up from 3.3% to 4.3%) than that of France (7.1%), Spain (9.3%) or Greece (10.6%). But Italy’s budget deficit is not the real issue. The Italian economy has been stagnant for a decade and without growth, Italy can never reduce its massive debt mountain. That is the real issue. Low growth in Italy results from a business environment that is rigid and over-regulated, and a large informal economy. In the World Bank/IFC’s 2012 country ranking of the ease of doing business in 183 countries, Italy is ranked 87^th in the world, behind Albania (82^nd), Mongolia (86^th) and Ghana (63 …