The euro had been enshrined in a treaty but not yet come to life in the autumn of 1997, when Martin Feldstein, the influential president of the National Bureau of Economic Research, published an essay arguing that European leaders’ hopes that a monetary union would foster greater harmony and peace in a Continent repeatedly ravaged by wars were misplaced.
It “would be more likely to lead to increased conflicts,” wrote Mr. Feldstein, a former chief economic adviser to President Ronald Reagan.
War within Europe, “would be abhorrent but not impossible,” he added. “The conflicts over economic policies and interference with national sovereignty could reinforce longstanding animosities based on history, nationality and religion.”
Needless to say, Mr. Feldstein’s sobering forecast was widely derided in Europe and even treated as beyond the pale by a number of economic commentators in the United States, including the editorial board of The Wall Street Journal.
It doesn’t look so outrageous these days. True, not all of his observations hit the bull’s-eye. He expected Europe’s monetary union to proceed toward deeper unification, including a common foreign and defense policy, and even a unified military. Interestingly, he feared a more assertive Europe might go to war with Russia if it were to invade Ukraine.
A European Morass
Forced to accept tough austerity measures to raise money for their debt payments, countries along the periphery of the eurozone have fallen into a deep economic downturn. But with economic activity crimped, their debt load has increased rather than lessened.
Change in gross domestic product
per capita since 2008
+
10
%
Germany
United States
0
Portugal
Spain
Ireland
–
10
Italy
–
20
Greece
–
30
’08
’09
’10
’11
’12
’13
’14
Net government debt, as a share
of gross domestic product
200
%
Greece
150
Portugal
Italy
100
Ireland
Spain
50
0
’08
’09
’10
’11
’12
’13
’14
In a conversation last week, he clarified that the editors of Foreign Affairs, where the essay appeared, spiced up his account. What he meant at the time was that the euro, which went into effect in 1999, could aggravate tensions between member countries — leading to heated conflict but not to real armed war.
But despite the misses, the last five years have more than justified his conclusion: Tying together a set of disparate economies with rigid common rules that barred them from pursuing independent policies on government spending or interest rates was doomed to fail as soon as their economic fortunes diverged. No democratic political system could handle it.
To be fair, many economists — mostly on this side of the Atlantic — have long recognized the flaws of the euro area’s monetary arrangement. But still wedded to the notion of European solidarity, euro advocates failed to grasp the crucial, irreducible obstacle to their economic plan that Mr. Feldstein highlighted: Politics are still local.
“They made the mistake of thinking that a solution had to happen at the eurozone level rather than at the country level,” Professor Feldstein told me. “That anything they could do to increase the sense of European solidarity would be a good thing.”
Desperate Greek voters ignited the latest panic in Europe’s rolling crisis. Last week they elected a new populist government that promised to put an end to the drastic budget-cutting imposed by Europe in exchange for financial support.
But Greece is hardly the only problem. Political contagion is in the air. In Spain, “Podemos,” a left-wing party born last year out of anger at Europe, has surged in the polls ahead of general elections to be held later this year. If elected, it promises to write off much of Spain’s debt.
“The politics we see now are the result of an economic strategy,” said Paul De Grauwe, a former member of the Belgian Parliament now at the London School of Economics. “When you push countries to impose deep austerity policies, you shouldn’t be surprised that the unemployed push for extreme parties.”
The economics are pretty straightforward.
The euro area suffers, principally, from a lack of growth. Indebted countries on Europe’s periphery — which include not only Greece and Spain but also countries like Italy and Ireland — have been slashing their budgets, cutting jobs and trimming wages, hoping to lighten their burden of debt.
Germany, the biggest creditor country and main architect of the European Union’s strategy, argues that such austerity is an indispensable corrective for the boom years, when low interest rates fueled spending binges — in Greece by the government, in Ireland and Spain by the private sector.
But the traditional corrective hasn’t worked: Indebted economies are shrinking faster than their debt. “The killer incriminating fact is that for all the costs and all the pain, the debt-to-G.D.P. ratios are nevertheless much higher than before the crisis,” said Jeffrey Frankel of Harvard’s Kennedy School. “Even if you don’t care about the distress and the extremist governments, you haven’t even restored financial stability.”
Fixing this is not impossible. The most direct way would be for the creditors in Europe’s north to relax the tight conditions on debtor countries, provide them with debt relief and allow them to spend more to kick-start growth. Alternatively, they might just invest more themselves, which would lead to higher wages and prices at home, encouraging more output in their poorer neighbors.
This path presents some political complications, however. Voters in Germany and other rich northern countries have no appetite for transfering resources to the vulnerable neighbors around Europe’s edge. And, comfortably insulated by their own prosperity and conditioned by memories of hyperinflation after World War I, they still fear higher inflation. Even the direst warnings of impending doom seem unlikely to shift the public mood.
And that sets the political constraint on the other end of the field. “The right policies would defuse the political crisis in the peripheral countries at the expense of intensifying it in Germany,” Mr. De Grauwe said. “It would prevent communists taking over in the south but would fuel the extreme right in the north.”
The eurozone might have been built differently. Simon Wren-Lewis of Oxford University argues that had governments been allowed to employ countercyclical fiscal policy — tightening budgets when the economy was expanding robustly and actively spending more when economies slowed — much of the present crisis could have been avoided.
Germany’s obsession with budget deficits prevailed, however.
That leaves the ball entirely in the court of the European Central Bank, which is institutionally sheltered from popular democracy, though certainly not unaware of the political environment.
The E.C.B. has kept the euro from collapsing over the last two years by acting as lender of last resort to its weakest members. It now hopes to stimulate growth through quantitative easing, buying up bonds to reduce long-term interest rates, much as the Federal Reserve has done in the United States.
But bond-buying, Mr. Feldstein argues, will have little impact. Long-term interest rates are already low.
Few other options fit within the political constraints.
Mr. Frankel suggests that the central bank buy United States Treasury securities, which would further devalue the euro and stimulate euro area exports. Mr. Feldstein proposes revenue-neutral tax incentives: accelerated depreciation of new investment, say, accompanied by higher corporate taxes. Governments might commit to future increases in the value-added taxtied to reductions in the income tax, to accelerate spending.
Could these ideas pull Europe from its morass? Perhaps, but the latest academic proposals seem a bit like clutching at straws. “They might not try it, or it might not work,” conceded Mr. Feldstein. “If so, there may be no solution to the euro crisis.”
What then? In a recent column, the Financial Times economist Martin Wolf argued that creating the eurozone was its members’ second-worst idea. Letting it break up would be the worst. If the euro is to survive, voters in not just Greece and Spain but most of all those in Germany and the Netherlands must be persuaded of the necessity of compromise. Nothing we’ve seen so far suggests they are.
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