The European Union (EU) is changing, fundamentally so. But many people are missing these developments because they are waiting only for big-bang, top-down reforms. They do not recognize change unless it comes in the form of Eurobonds, new European treaties or U-turns by Angela Merkel.

Let me make the case for small steps, for muddling through and for market mechanisms. I suspect that the focus on big top-down reforms is rooted in our analysis of what caused the euro crisis. Most Germans, Dutch and Finns would say that the cause of the crisis was that Greece, Spain, Cyprus and others spent too much and did not regulate their banks and markets properly.

But others tell us that it was the euro itself that has landed these countries in such deep trouble. The one-size-fits-all monetary policy of the European Central Bank created destabilizing imbalances in the Eurozone. Interest rates were too low for Southern Europe, where governments and people binged on cheap loans. Interest rates were arguably too high for a Germany already held back by the economic burden of reunification. The result: the Southern Europeans spent too much, the Northern Europeans not at all.

If these imbalances were the result of the euro itself, Europeans cannot resolve the crisis at the country level. They must fix the flaws of the currency union itself.

For this, the argument goes, the Eurozone needs three things:  banking union, fiscal union and political union.

The banking union really is necessary to break the vicious circle of weak banks and struggling governments. Its outlines are fairly clear and it is already under construction, if only slowly.

When it comes to fiscal union, things get muddy. The analysts and politicians who call for a fiscal union do not usually spell out what they mean by this. It is implied that a fiscal union should include a much larger central EU budget, presumably financed by some kind of EU taxes; Eurozone unemployment insurance; and Eurobonds or some other kind of debt mutualization.

Such a centralization of financial and fiscal powers at the European level of course would require more accountability. Hence we need a political union, too, with European officials being directly elected and a European Parliament with vastly more powers.

Will this happen? It’s unlikely, at least in the foreseeable future. Does that matter? Perhaps not as much as many people say.

First, if we construct an elaborate institutional union on the basis of what happened over the last five years, we risk fighting the last war rather than looking ahead to the next challenges.

It is right that the rapid falls in interest rates that resulted from the introduction of the euro led to excessive spending in Greece, Spain and Ireland. It is right that German wage restraint during the long years of German stagnation has created a problem for its neighbours.

The Eurozone imbalances were indeed the result of the introduction of the euro and to a lesser extend of German reunification.

But neither event will happen again.

Second, the imbalances that we inherited from the euro’s first decade are already being resolved – as they should be, given how much pain the Southern Europeans and Ireland have been going through. External deficits have now closed, unit labour costs are falling, and Spanish exports are rising faster than German ones.

Some of these trends will slow or reverse once growth returns to Southern Europe. But the changes that countries such as Spain and Portugal are making to their labor laws, pension systems and regulations are encouraging. Improvements in Spain and Portugal will put pressure on France and Italy to follow suit. Europe as a whole might yet become more competitive.

Third, the crisis has accentuated the role of Germany – with its economic size and big surplus – and made everyone else look weak. If the Europeans thrash out a fiscal and political union now, it would look too rigidly rules-based, too Germanic. The ongoing crisis also means that all institutional changes have redistributive consequences. At the moment, it’s all about who pays.

Germany’s relative strength will lessen as the rest of Europe recovers and Germany squanders some of its economic strength by going slow on reforms at home. A European Union without one overly dominant power could probably come up with institutions that are more durable and acceptable.

Some of these trends will slow or reverse once growth returns to Southern Europe. But the changes that countries such as Spain and Portugal are making to their labour laws, pension systems and regulations are encouraging. Improvements in Spain and Portugal will put growing pressure on France and Italy to follow suit. Europe as a whole will become more competitive.

If we have already corrected some of the problems that we inherited from the euro’s first decade, and if future problems will be of a different kind and magnitude, then perhaps we do not need Eurobonds and EU taxes. And if we do not have redistribution on a large scale and joint debt, then we do not need a political union either, at least not immediately.

Even without a fiscal and political union, the European Commission has gained new powers to supervise not only fiscal spending but also other macro-economic developments, such as wage growth and real estate prices, which could lead to the re-emergence of imbalances. The European Central Bank, together with national supervisors, is getting the power to supervise big Eurozone banks, and if need be, close them.

Importantly, additional discipline will not only come from Brussels but from London, Frankfurt and New York: financial markets are likely to be more vigilant in the future.

And here, to my mind, lies the discrepancy between those who put their faith in only institutional fixes and those who trust a more bottom-up approach. Many people, especially in London and New York, seem to define the “solution” to the euro crisis as a return to the Elysian state in which all European government bonds were equally risk-free assets. For Germans, Dutch and Austrians, spreads are not the problem. They are part of the solution. They impose pressure that goes beyond the new powers of Brussels institutions.

The new institutional framework in the Eurozone does not have to direct the fiscal and economic policies of 18 countries. It just needs to be strong enough to allow markets to recognize and react to worrying developments. And it needs to be able to offer real help for countries that find themselves temporarily in trouble. This is doable and it is being done.

Author: Katinka Barysch is director of political relations at Allianz SE. She is also a World Economic Forum Young Global Leader and is participating in the World Economic Forum’s Annual Meeting 2014. The views expressed here are her own.

Image: giant European Union flag hangs from La Pedrera, designed by architect Antoni Gaudi, to celebrate European Union Day in central Barcelona REUTERS/Albert Gea

 

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