The three Crises of the Eurozone

The eurozone finance ministers agreed a new bailout for Greece last night; but this will not end the eurozone crisis. Over recent months, it has become increasingly challenging to keep track of what is going on, but as far as I can see we are caught in three overlapping crises that are becoming increasingly difficult to solve: a structural crisis, a policy crisis and a democratic crisis.

The structural crisis became evident first. The eurozone in its current form is a halfway house that is not future proof. The big question is how the building can be developed and reinforced. There are basically two ways of looking at the current situation: is the eurozone a loose group of 17 national economies, chained together by the same currency and monetary policy for political reasons, that need to find a way to coexist in this framework? Or is it effectively one big economy in the making with the political institutions, financial transfers and fiscal policy integration needed to make it work on their way?

When Angela Merkel talks about a “fiscal union” it sounds like the latter but she really means the former. If you chain small open economies together with a joint currency economic imbalances need to be adjusted and 17 different fiscal policies must be made sustainable. This is what she tries to achieve by severe cutbacks in the crisis countries and exporting the German idea of debt brakes across the eurozone.

Constraining the 17 eurozone economies even further has, however, not worked in the past and is very unlikely to succeed in the future. And a full-blown economic union is politically impossible at the moment. Most likely, a workable model for the eurozone is a hybrid that combines elements of economic rebalancing across the eurozone with fiscal policy integration, new political institutions, eurobonds, a reformed role for the European Central Bank and some level of fiscal transfers. But even in the third year of crisis it remains unclear where we are headed.

The second crisis is a crisis of policy. If you don’t know where you are going it is unsurprising that the policies – the tools to get you where you want to go – are a mess too. No matter what kind of eurozone model you prefer, there must be structural adjustments and sustainable debt reductions. But one has to be realistic about the timeframe in which this can be achieved and under which conditions. It has become blatantly obvious that you cannot turn around debt dynamics if you are in a depression like Greece. The eurozone needs growth, not austerity, to accomplish the difficult tasks of structural reforms and debt sustainability. If we continue down the austerity path, the “cure” is likely to kill the patient. We need an immediate change of approach or the situation will blow up sooner or later.

The problem is, however, that without political change in key countries such as Germany and France such a change of policy is unlikely. While French voters will elect a president this spring, the most critical country – Germany – only votes in late 2013. In the run-up to the national election there is very little chance that the Merkel government will admit defeat and change the policies it has been wedded to for years. Unfortunately, it is therefore almost certain that we will continue on the current path to economic and political disaster.

This leads me to the third crisis that is becoming more and more critical: a deepening crisis of democracy. The euro serves all citizens of its 17 member states but having 17 decision-making processes does not work as there are policy externalities and – in the case of direct help – conditionalities that decisions of one country impose on other eurozone countries. This became apparent when Greece manoeuvered itself into its predicament, creating policy externalities by effectively forcing other eurozone countries into rescue measures.

But the rescue measures themselves are problematic too. When for instance the German government makes bailout funds conditional on a sovereign country effectively giving up its budgetary authority or even postponing national elections (which would be unconstitutional in Germany), we have reached a stage at which bailout conditionalities are no longer compatible with democratic principles. There is already great anger about austerity policies and the last thing we need is a full-blown democratic crisis, fuelled by an increasingly heated war of words, in which democratic principles can only be upheld by denying help and running into a messy default with a possible eurozone breakup.

Yesterday’s Brussels meeting again bought some time (at a high costs). But as long as the three overlapping crises of the eurozone remain unaddressed, the predicament will continue. We need to know what kind of eurozone we want to build, we need realistic policies that help us to get there and we need to find a way to strengthen and not trample on democracy in the process. If we cannot bring these three elements together the ride will get even tougher.

This column was first published by The Guardian