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The Euro Is Killing Europe

From Cyprus to Portugal, the common currency has been a disaster.

Are the best days of the European Union already behind it? Just a few months ago, having won the Nobel Prize for Peace, it could boast of decades without a major war, the westward turn of the former Soviet satellites, and flourishing internal trade. But now its one big mistake -- the euro -- threatens to tear the union apart.

In 1999, the traditionally hard currencies of Europe's north merged with the softer currencies of the south to form a new money that was somehow supposed to be stronger than any of the ones it replaced. Under the stewardship of the European Central Bank (ECB) in Frankfurt, the euro was meant to -- and did -- become a reserve currency to rival the dollar. Though the supposedly prudent northern countries didn't always keep their budget deficits under control, they still managed to survive the worst of the global economic downturn. By contrast, the profligacy of the south, together with its flawed banking systems, has created a hotbed of crises that stretch 2,300 miles from Lisbon to Nicosia.

These crises would have been a lot shorter if the countries involved -- Greece, Portugal, Spain, now Cyprus, soon Slovenia, and perhaps Italy for a second time -- had possessed their own currencies. But all of them use the euro, so their monetary policy is set in Frankfurt at the ECB. Instead of devaluing their currencies in order to spur exports and ease the repayment of debts, all of these countries have had to undergo some combination of fiscal austerity, deflation, and, most notably in Cyprus's case, loss of assets.

The people of Europe's south are understandably unhappy. Indeed, the daily indignities of their economic Calvary would be bad enough if they were of completely domestic origin. But southerners also have the irksome feeling that bureaucrats and politicians in Frankfurt, Brussels, and other northern capitals are forcing these troubles upon them. Not long ago, some of the same bureaucrats and politicians were the ones luring the southern countries into the euro, often paying scant attention to their questionable fiscal situations.

Savvy operators in the south have not hesitated to exploit this volatile brew of economic hardship and hypocrisy, mixed with a generous dash of historical resonance. Parties at the extremes of the political spectrum have been gaining adherents, with nationalism a strong current on both sides. And so, in most of the southern countries, the balances of political power have been starting to fragment.

One way to measure this fragmentation is the Herfindahl Index, which economists use to measure the degree of market power held by companies in an industry. Applied to a parliament, the index adds up the squared shares of the seats held by the parties; higher values indicate more concentration of power. Here is how the index evolved in southern countries that imposed austerity after the global financial crisis began in the fall of 2008 (where applicable, the lower house of parliament is measured):

In all four countries, the concentration of power fell following cuts to the public sector and other belt-tightening measures. Fringe parties gained power on the left and the right, from the racist, ultra-nationalist Golden Dawn party in Greece to the leftist Basque separatist Amaiur party in Spain. Naturally, the ruling centrist parties have responded to the threats from the fringes. In Spain, for example, the People's Party is reinstating bullfighting across the country, aggravating Catalans and Canarians who had outlawed the practice.

The political fallout of the euro's shortcomings is not limited to Europe's south. In Britain, the Conservative Party has been dialing up its euro-skeptic rhetoric in response to the growing power of parties that oppose the country's membership in the European Union. Even in Germany, linchpin of the eurozone, a new party has proposed scrapping the common currency but remaining in the political union.

Last week Jorgo Chatzimarkakis, a German member of the European parliament who is of Greek extraction, warned that Brussels and Frankfurt had already awoken Europe's "nationalist demons." To save the euro and the union, he suggested replacing austerity with "solidarity" via a grand redistribution to the crisis countries. Yet the northern countries, some of which already subsidize the south through the European Union's internal budgeting, have little appetite for this kind of gesture, especially since they see the problems as entirely of the south's making.

In the long term, these problems will only worsen. The southern countries have built up heavy pension obligations to future retirees, and their economies tend to do a relatively poor job encouraging entrepreneurship and innovation. In general, they face bigger risks and smaller opportunities than their neighbors to the north. Even if the euro survives the current crises, its prospects will continue to dim.

As I have written here before, the euro was supposed to bring the countries of the European Union closer together, facilitating commerce and synchronizing business cycles. But because the euro also lengthens and deepens economic crises, it creates an opportunity for those who oppose the EU's founding principles of egalitarianism and mutual respect. 

One of my old academic advisers, Martin Feldstein, predicted in 1997 that the euro would "change the political character of Europe in ways that could lead to conflicts." He added: "War within Europe itself would be abhorrent but not impossible. The conflicts over economic policies and interference with national sovereignty could reinforce long-standing animosities based on history, nationality, and religion." Though war is not on the immediate horizon, paring down the eurozone now may be preferable to picking up the pieces later.

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Daniel Altman

Trade Coalitions of the Willing

Forget about the WTO. Here's how Obama is about to change the game on free trade.

Feel that whiplash? Trade has gone from zero to 60 in the White House's agenda just weeks after Barack Obama's second inauguration. Two blockbuster deals -- the Trans-Pacific Partnership, which Japan will soon join, and a free trade agreement with the European Union -- could finally leave the World Trade Organization's ill-fated Doha Development Round in the dust. In fact, these deals offer more hope for world trade than the WTO ever did.

At its founding in 1995, the WTO was the first global mechanism for lowering barriers to commerce. Since then, it has done very little to fulfill its primary mission. The Doha Round, projected by the World Bank to raise global economic activity by $500 billion, has dragged on for a dozen years without agreement. In the meantime, estimates of its potential economic gains have dropped as low as $84 billion -- about 0.1 percent of global output -- with just $16 billion going to poor countries.

Any deal now would be lucky to generate even that amount. The Doha Round is a failure because of its complexity and the WTO's negotiating system. Everything except military hardware is on the table, and it has been impossible to reconcile every country's views on agriculture, services, and manufactured goods. Yet because every country has a veto, that reconciliation is exactly what is required for a deal.

Throughout the past 12 years, the WTO's most ardent supporters have urged countries big and small to stay committed to the Doha Round, resulting in a massive waste of resources. This has been especially tragic for poorer countries that have only small teams of diplomats and lawyers responsible for pursuing bilateral, regional, and global trade deals around the world. Dozens of them, from Belize to the Gambia, don't even have permanent representatives at the WTO's headquarters in Geneva, and have to rely on semi-annual "Geneva Weeks" to touch base with their colleagues.

Yet in spite of the futility engendered by perennially lower expectations, negotiators have kept on meeting because, as one put it, "the problem is no one knows what Plan B is." Now there is a plan B: the formation of big trade blocs including big and small countries, which will eventually find it in their mutual interest to negotiate with each other.

This is a huge step forward. In global trade talks, a few countries -- notably France and India -- have relished the role of spoiler. Deals that don't insist on being global don't have that problem; these big trade blocs are essentially coalitions of the willing. Their members are the leaders, and the laggards will have two choices: join, or get the short end of the stick.

When Japan signaled its intent to sign onto the Trans-Pacific Partnership (TPP) last week, it joined Australia, Brunei, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the United States in negotiations. The most important aspect of this bloc is its diversity, which will result in big gains from trade. Together, these countries will lower trade barriers -- and get richer.

For the United States this represents the next logical step in trade liberalization: bilateral and regional deals becoming the building blocks for a bigger free trade bloc. The TPP includes several countries with which the United States already has free trade agreements: Canada and Mexico through NAFTA, plus Australia, Chile, Peru, and Singapore through bilateral arrangements.

The White House hopes to attract other members of the Asia-Pacific Economic Cooperation to the TPP, including China, Russia, Indonesia, and South Korea. It's unlikely that every country will join, but that hasn't stopped the United States before. Even though the Free Trade Agreement of the Americas failed, Washington managed to sign bilateral and regional deals with 10 of the potential members, including Chile and Peru.

Of course, those would pale in comparison to a U.S. free trade agreement with the European Union, which Obama proposed last month in his State of the Union address. The economic gains could be enormous -- these are the two biggest economies in the world -- and they could not come at a better time. But there are still plenty of legal, political, and perhaps even cultural hurdles. For one thing, any agreement would have to be consistent with the obligations of all the other pacts that both economies already have on their books, presumably including the EU's special programs for its former colonies in Africa, the Caribbean, and the Pacific.

The creation of big blocs may just change the game, however. While the United States pushes forward with the TPP, the EU has been seeking deals with members of the Association of Southeast Asian Nations, in hopes of bundling them into a regional agreement. A deal with the United States would pave the way for a megadeal between the TPP and an EU-ASEAN bloc. In total, these countries represented about 65 percent of the world economy in 2011, and a pact between them would come a lot closer to a global trade agreement than anything the WTO has done lately.

Once that happens, the world will be split into trade leaders and trade laggards. The leaders will get richer as their trade intensifies, but, as I wrote in my 2011 book, their living standards and product offerings will also converge. As a result, they'll be looking for new trading partners to restore the diversity of their blocs. At the same time, the laggards will see their own living standards fall behind, which could make them more eager to pursue foreign trade and investment.

These incentives will bring even more countries to the bargaining table, ultimately leading to trade agreements that cover the entire globe. And unlike the Doha talks, which haven't lowered a single trade barrier in 12 years, the benefits of free trade will build at every step of the way. Obama may have gotten a late start on trade, but a shift to regional deals will give him a great chance to finish strong.

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