The creation of Europe’s economic and monetary union is unique in the history of sovereign states. The eurozone constitutes a “society of states” of a completely new type, one that transcends the traditional Westphalian concept of sovereignty.
Like individuals in a society, eurozone countries are both independent and interdependent. They can affect each other both positively and negatively. Good governance requires that individual member states and the EU’s institutions fulfill their responsibilities. Above all, economic and monetary union means just that: two unions, monetary and economic.
Europe’s monetary union has worked remarkably well. Since the euro’s launch in 1999, price stability has been maintained for 17 countries and 332 million people, with average yearly inflation of just 2.03 percent — better than Germany’s record from 1955 to 1999. Moreover, the eurozone has created 14.5 million new jobs since 1999, compared to 8.5 million to 9 million in the US. This is not to say that Europe does not have a serious unemployment problem; but there is no obvious inferiority in Europe: all advanced economies must boost job creation.
Likewise, on a consolidated basis, the eurozone’s current account is balanced, its debt to GDP ratio is well below that of Japan and its annual public finance deficit is well below that of the US, Japan and the UK.
The euro per se thus does not explain why the eurozone has become the sick man of the global economy. To understand that, one has to consider the weakness of Europe’s economic union.
For starters, the Stability and Growth Pact (SGP), intended to ensure sound fiscal policies in the eurozone, was never correctly implemented. On the contrary, in 2003 and 2004, France, Italy and Germany sought to weaken it. The European Commission, the European Central Bank (ECB) and the small and medium-sized eurozone countries prevented the SGP from being dismantled, but its spirit was gravely compromised.
Moreover, eurozone governance did not include monitoring and surveillance of competitiveness indicators — trends in nominal prices and costs in member states and countries’ external imbalances within the eurozone. [In 2005, long before the crisis, I called, on behalf of the ECB’s governing council, for appropriate surveillance of a number of national indicators, including unit labor costs.]
A third source of weakness is that no crisis management tools were envisaged at the euro’s launch. For much of the world at the time, “benign neglect” was the order of the day, particularly in the advanced economies.
Finally, the high correlation between the creditworthiness of a particular country’s commercial banks and that of its government creates an additional source of vulnerability, which is particularly damaging in the eurozone.
Fortunately, much progress has been made, including significant improvements to the SGP and the introduction of surveillance of competitiveness indicators and national imbalances. New crisis management tools have been put in place and there is a consensus that the EU’s stability and prosperity requires completion of the single market and obligatory structural reforms for all 27 members. A proposed banking union would help to separate the commercial banks’ creditworthiness from that of their government.