Europe's Trojan horse Project Syndicate

Barry Eichengreen | Thursday February 18, 2010 00:00

This will make it possible for the Greek government to service its debt. The markets will settle down. The longer-term consequences will not be savoury, but they will be problems for another day.

Some will say that the fatal mistake was allowing Greece to adopt the euro in the first place. That the country was unprepared should have been clear. Its fiscal policies were already out of control when it joined the monetary union in 2001, and its trade unions were agitating to push wages up to European levels, despite lagging productivity.  But this answer is too simple, given that such signs of dysfunction are not limited to Greece. Spain, with its 20percent unemployment rate and exploding budget deficit, sees in Greece an image of its own future. Or, if it doesn't, the markets do. Portugal and Italy are little better.

Like Greece, these countries now face sharp budget cuts. Like Greece, they can't devalue to encourage exports. Like Greece, they face deep recessions. Like Greece, they will be tempted to ask for help. 

All of this raises the obvious question: Was the real mistake creating the euro in the first place? Since I was one of the few Americans to advocate a single European currency, you would be justified in asking: Am I having second thoughts?

My answer is no, creating the euro was not a mistake, but it could still be a mistake in the making. The Greek crisis shows that Europe is still only halfway toward creating a viable monetary union. If it stays put, the next crisis will make this one look like a walk in the park.

Completing its monetary union requires Europe to create a proper emergency financing mechanism. Currently, other member states can provide assistance to Greece only by bending the rules, which prevent them from lending except in response to natural disasters or circumstances beyond a country's control. This heightens uncertainty. When Europe's leaders do help, it makes the public and markets think that they are being dishonest. If it is the Lisbon Treaty that creates these problems, then the Lisbon Treaty should be changed.

Moreover, assistance should come not just with conditions, but with temporary control of the national budget by a committee of 'special masters' appointed by the European Union. Mere promises by the recipient, history tells us, are not enough.

No doubt, countries to which these measures are applied will express outrage. Well, no one is forcing them to take the money. Worried about moral hazard? Here's your solution. Note also that this would also be a much more effective disciplining mechanism than the defunct Stability and Growth Pact.

You might well ask: how would Californians feel if their state was forced to turn over its budget temporarily to a special master appointed by President Barack Obama's administration? Actually, they would probably feel okay.

The special master would not be a fellow Californian, but he would be a fellow American. People would understand that he was acting in the interest of the state as well as the country. They would also be reassured by the fact that California sends representatives to Washington, D C, where the special master's marching orders would be issued.

Europeans don't do these things because they see themselves as Greeks and Germans first. They don't interfere in the 'sovereign prerogatives' of other member states. Germany is especially reluctant, given memories of its World War II conduct, not least in Greece.

Well, if Europe is serious about its monetary union, it will have to get over its past. It needs not just closer economic ties, but also closer political ties. Those running a strong emergency financing mechanism will have to be strongly accountable. They will have to answer to a strong European Parliament.

German Chancellor Angela Merkel's constituents hate bailouts, because they know that it is they who will be doing the bailing. They oppose anything that smacks of European political integration.

But Germany is not innocent of responsibility for this crisis. It demanded an extraordinarily independent and unaccountable central bank that is now running an excessively tight monetary policy, aggravating the plight of the PIIGS (Portugal, Ireland, Italy, Greece, and Spain). Germany's enormous current-account surplus aggravates their problems further. Germany has also done too little in terms of fiscal stimulus to support the European economy.

Germany has benefited enormously from the creation of the euro. It should repay the favor. It should push for the creation of an emergency lending facility, and for political integration to make that feasible. It should provide more fiscal support. And who better to press for a more accountable European Central Bank?

The Greek crisis could be the Trojan horse that leads Europe toward deeper political integration. One can only hope.

Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley. Copyright: Project Syndicate, 2010.