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What the eurozone must do if it is to survive

By Wolfgang Münchau

Published: February 1 2010 02:00 | Last updated: February 1 2010 02:00

First Greece, then Portugal, and then what? The project of European monetary union is
entering the most dangerous phase in its 11-year history. Last week, eurozone governments
started preparations, for the first time, to bail out one of their fellow members. Greece will
probably require a bridging loan at some point. Portugal might too. But they are small
countries. No matter what happens, it will not break the euro.

The clear and present danger to the eurozone is Spain. Daniel Gros of the Centre for European
Policy Studies argued on these pages last week that Spain is in a better position than Greece
because of its higher rate of gross national savings. But I believe that Spain is likely to
squander that advantage. Spain, like Greece, has suffered from an extreme loss of
competitiveness during a period in which it relied on a housing bubble to generate prosperity.
While the Greek government is at least beginning to recognise the need for reform, perhaps
too late, Spain's political establishment remains in denial.

So what if Spain gets into trouble? Will the eurozone falter, as Nouriel Roubini, professor of
economics at New York University, predicted in an interview last week? The question is
unanswerable. I find it more constructive to ask what the eurozone will need to do to survive
the strains ahead. Three measures are, in my view, essential for survival; a further three
almost so.

The first of the essential conditions is a robust and transparent system of crisis management.
Maybe the Greek bail-out will provide a blueprint for such a system. But in any case, it would
need to be worked out formally and approved by national parliaments to achieve a maximum
degree of legitimacy. This should not be imposed by diktat.

A good crisis-resolution system must also minimise moral hazard. Countries that benefit from
help will have to accept a partial loss of sovereignty, and for this reason it is important that
any such regime has wide political backing in all the member states. While eurozone members
lack the political will for unconditional bail-outs, they accept that they need to help each other
during a crisis. But this help is attached to the condition that the recipient takes corrective

The second essential prerequisite for survival is a reduction in internal imbalances, which lie
at the core of the current crisis. This is an issue that requires action both in countries with
large current account deficits, such as Greece and Spain, and in those with large surpluses
such as Germany. While Spain, for example, would need to reform its labour market to bring
about adjustments in real wages, Germany should implement policies to stimulate
consumption, including a long-overdue income tax reform. The build-up of these imbalances
is the underlying reason why the Greek problem got out of hand.

The place to handle this co-ordination is the eurogroup of the finance ministers of the
eurozone, which now constitutes an official European Union institution under the Lisbon
treaty. Jean-Claude Juncker, the prime minister of Luxembourg and chairman of the
eurogroup, should make imbalances the defining issue of his agenda and propose binding

Third, the EU should at some point revisit the now almost totally decaffeinated proposals for
financial supervision. What started off as a deeply unimpressive set of recommendations by
the De Larosière committee ended up further diluted as it proceeded through the EU's
legislative mills. The financial system remains the single biggest threat to the long-term
stability of the eurozone economy. Fragmented financial regulation makes no sense in a
monetary union and is potentially lethal.

Over and above those essential steps, there are a number of policy actions the eurozone can,
and should, undertake to strengthen its political and economic cohesion. The single most
important of those is to maintain the fine political balance in the European Central Bank,
which enjoys trust and respect in countries as diverse as Greece and the Netherlands. If
Angela Merkel, the German chancellor, gets her way to install Axel Weber, the president of
the Bundesbank, as the next ECB president, I fear that this balance might be upset. I am not
talking about the geographic diversity among the ECB's top officials in numerical terms,
which can easily be maintained. My concern is about what will invariably be perceived as a
power grab by Germany during an extremely sensitive period.

Second, the eurozone should sort out its external representation. The presence of German and
French national officials in organisations such as the International Monetary Fund, each
defending their national position, is pathetic. The eurozone in particular needs to strengthen
its voice in the macroeconomic debates in which it has a vital stake, the most important being
the future of the global monetary system.

Finally, the EU - not the eurozone - needs to rebuild the internal market, which was damaged
during the crisis. This offers by far the biggest opportunity for the EU to generate the
productivity gains needed to maintain prosperity.

The reason I have become more sceptical about the eurozone's long-term prospects is not the
inherent economics of monetary union. It is that I doubt the political will exists to do what is