The eurozone: beginning of the end game

17 Apr 12
John Chown

As renewed problems in Spain and Italy highlight the deteriorating situation across the eurozone, are we approaching the end game for this fundamentally flawed union?

The previously unthinkable idea that the euro zone might not last is now becoming a commonplace in political and economic discussions. But before asking whether, when and how all this will happen, we first need to see how we got here.

The European Union (not an optimum currency area) was launched with serious design faults, making the change 'irreversible',  and with no provision for countries to leave or be expelled from the union. Critically too, it was launched with no mechanism for dealing with the inevitable asymmetric shocks.

For a monetary union to survive, there need to be arrangements for ensuring that each country maintains fiscal discipline. Whilst recognising the need for occasional inter-state transfers, it is vital to  ensure that these do not tempt countries away from the path of prudence.

In reality, the 'convergence' assumption that, for example, Greek debt was as sound as German debt was a major cause of the problem. And the ineffectual Stability and Growth Pact was breached by both France and Germany.

This has been a disaster waiting to happen. A related one, which is still with us, involves the cost of pensions in the ageing populations across the EU. Corporate mergers these days are complicated by pension liabilities, and this is even more true for national mergers.

Eurostat figures in 2001 set out the range of projected future state pension costs in the EU member states for the next half century. They vary widely, particularly between countries with or without funded pension schemes. Little has been done to heed the warning spelt out some time back in a Chatham House paper, and implied by Eurostat, whose figures specifically assumed 'unchanged policies'. Their 2009 analysis is even more frightening.

When it became obvious that Greece would have to exit, devalue or default, the EU authorities, instead of facing up to the long-term problem, simply threw money at it. This has, and will continue to become more and more expensive the longer the 'end game' is delayed.

Indeed there is now a risk that trying to save the eurozone experiment will threaten the future of the  European Union itself and even the solvency of its banking system.

The latest proposal would appear to involve a botched fiscal union, whatever this means. Politically, it will fall far short of a federal union (which would require a very different constitution) but may  offer less freedom on tax and expenditure being granted to provinces and cantons in existing federal countries.

But will anyone really accept central control of economic policy? Prospective members, before they sign up, will need to know a lot more about the real assets and liabilities of their fellow members.

Solvent outsiders (notably the UK and Sweden) will have to make sure that they protect their economies, and their financial markets in particular, from decisions taken by the inner group. Meanwhile the weaker members may have to choose between opting out, devaluing and defaulting - or some looser arrangement with the inner core, along Bretton Woods lines.

John Chown is an international tax adviser at Chown Dewhurst LLP. Along with Matthew Hancock MP, Roger Bootle of Capital Economics and other speakers, he is addressing an Institute of Economic Affairs/Bloomberg event on the eurozone on 18 April,



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