The Rumors of the Euro’s Demise Are Greatly Exaggerated

by Pierpaolo Barbieri | December 13, 2011

Another month, another EU Summit. And once again, markets are judging the compromise as, at best, incomplete—at worst, disastrously insufficient. On top of everything else, the new agreement has managed to formally isolate Britain from the other 26 EU member states. (British euroskeptics are applauding their country's newfound estrangement, but more considered commentators realize the situation is fraught.) So is Europe ultimately doomed to all that jazz about euro breakup and financial apocalypse?

Not quite. What we are seeing in Europe is the messy product that results when the demands of financial markets collide with those of politics. Markets tend to reward under-promising and over-delivering. Consider for instance Apple’s time-honored strategy of under-estimating future performance, providing investors consistently low targets for everything from sales to cost margins—only to see itself rewarded when humble estimates are met with blockbuster performance. The laws of electoral politics could hardly be more different: Politicians generally benefit from over-promising and under-delivering. (Consider a typically grandiose speech from any French politician and you'll realize the political cost of optimism is low.) The public rarely rewards politicians peddling unadulterated gloom at election time, even when circumstances are indeed dire.

Contrary to what many commentators have argued, however, this latest imperfect compromise does not portend the collapse of the European project. Taking a close look at how political forces have been aligning in key continental capitals reveals that the will for European integration is stronger than ever.

Take crisis-hit Greece and Italy. The partisan administrations of George Papandreou in Athens and Silvio Berlusconi in Rome have left the stage in favor of technocratic governments, led by former ECB vice-president Lucas Papademos and EU former commissioner Mario Monti, respectively. These technocratic governments are committed to the arduous task of restoring credibility while honoring European commitments their predecessors had undermined through dithering and inaction. Despite the painful adjustments they announced, electorates have thus far supported them. Papademos’ high approval ratings are practically unprecedented in Greece’s fraught political scene.

Many expect political will to founder in those countries that are underwriting the bailouts—namely France and Germany. Provided one reads between the lines of domestic politics, however, there is no wavering in their commitment to European integration in general and the euro in particular.

Sarkozy is a prisoner of his own reelection campaign, to be fought this coming May against the Socialist Party’s most credible candidate in the wake of the Dominique Strauss-Kahn scandal, François Hollande. Sarkozy’s electoral strategy involves a blend of German-inspired fiscal discipline and traditionally cocky Gaullism. The President may yet move further to the right to fend off a challenge from a revitalized National Front, the only relevant member of the French political scene that rejects integration.

Its leader, Marine Le Pen, deplores the euro—but on the basis of a gauzy romanticized nationalism rather than plausible economics. Her monetary agenda is not only demagogic, but also inextricably linked to her xenophobic anti-immigration stance. Ever since promising to drop the euro, Le Pen’s poll ratings have plummeted. Ultimately, disgraced DSK has a higher likelihood than she does to be enthroned President of France.

Gallic businesses, meanwhile, have publicly campaigned for the euro. One such effort to educate the electorate about the benefits of the single currency and common market earlier this year was forthrightly titled, “The Euro Is Indispensable.” Tellingly, the campaign was coordinated with none other than the bulwarks of German engineering: Siemens, BMW, ThyssenKrupp, Daimler.

But if the continent’s business community—including Germany’s—is pushing for the euro to be saved, how come Angela Merkel has been so cautious? The German Chancellor remains opposed to Eurobonds—joint and several liabilities for Eurozone government debt that many economists have argued would serve as the definitive answer to the crisis.

To be sure, Merkel is hoping to earn a third term in the federal elections scheduled for 2013. But it is far too simplistic to argue that Merkel hesitates because Germans are opposed to bailing out their European partners. If presented with a binary choice between transfers to the periphery or the end of the euro , polls suggest the electorate would choose the former.

Merkel’s beleaguered junior coalition partners, the FDP, have toyed with euroskepticism—only to lose further ground in the polls. For her part, Merkel delivered an impassioned defense of the integration project at her party conference in late November. Against a banner proclaiming, “Für Europa, für Deutschland” (“For Europe, For Germany”) Merkel branded Europe a Schicksalsgemeinschaft—literallya “community of fate.” Ultimately, her nation has reserves of attachment to the European project that extend far beyond economics.

The fact that Merkel is treading carefully actually has to do with two intertwined domestic issues. First, a particularly German aversion to moral hazard, itself related to the country’s self-defeating experiences with overly accommodating monetary policy in the aftermath of the World War I. And second, the prospect of legal limits imposed by its Constitutional Court, which earlier this year heard—before eventually dismissing—challenges against the early bailouts.

For all the market gloom, it is worth noting that Friday’s agreement promises large commitments to the struggling periphery, in the form of concurrent official support mechanisms – the EFSF and the ESM – as well as more funds triangulated through the IMF. This may not equal “Eurobonds,” but these mechanisms will involve real transfers to countries seeking to correct their competitiveness issues (and resulting current account deficits). And that is leaving aside an ECB that remains extremely unlikely to render itself redundant. 

Despite all the talk about constitutional debt breaks, Keynesians need not be outraged just yet —the devil will be in the details that have yet to be negotiated. The final agreement is likely to retain enough flexibility to allow for counter-cyclical expenditures in times of crisis. The goal is to eradicate deficits that are structural in nature, which themselves undermine the ability of governments to act counter-cyclically when needed most. It is therefore not unlike what Britain’s governing coalition is struggling to do in the United Kingdom and the Obama administration says it wants to enact (but is failing to) in the United States.

Indeed, this is the political consensus among German elites. If Merkel were to lose power in the next election, the next chancellor would almost certainly be a member of the forthrightly pro-European Social Democrats. Their best-positioned candidate, Peer Steinbrück, has strongly defended the euro and supported Eurobonds. Last week, at his party’s conference, Steinbrück warned that the failure of the euro would lead to the “political renationalization” of Europe. The German left, it turns out, understands integration in the same 1945 key that Merkel does. And ultimately, just as in France, Italy, and even Greece, no credible party in Germany is fundamentally skeptical of the European project.

Spain’s great 20th century philosopher, José Ortega y Gasset, put it best long ago. Looking at the fraught politics of his homeland—a Spain where internal polarization would lead to the paradigmatic civil war of the 20th century, itself a mere preview of the conflagration to come—the thinker proclaimed: “Spain is the problem, Europe is the solution.” A century on, politics still encumber the quicker moves markets would want. Yet the intergenerational project is little changed: integration marches on.

Pierpaolo Barbieri is Ernest May Fellow at the Belfer Center for Science and International Affairs at Harvard Kennedy School. His book, Hitler’s Shadow Empire: Nazi Economics and the Spanish Civil War, will be published by Harvard University Press in the fall of 2012. 

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