Continental Divide

Can the European Union Survive?

When Harold Macmillan was asked what caused him the greatest difficulty while he was prime minister of the United Kingdom, he replied simply, “Events.” In the past two years, the events that have proved most difficult for Europe’s political leaders are rooted in the global economic crisis that, like the Great Depression of 1929, began in the United States but swiftly spread throughout the developed world.

To understand what it is at stake, it is important to remember that Europe faces both an immediate sovereign debt crisis, caused by large budget deficits in many countries, and a potential banking crisis, caused by the fact that European banks are heavily invested in government bonds. Because seventeen of the European Union’s twenty-seven members share a common currency, a default of any member government or a failure of any important bank is bound to have an impact on the system as a whole.

As of midsummer 2011, the end of this dual crisis is nowhere in sight. On July 21, European leaders agreed to a complex package of measures to save Greece, Europe’s most vulnerable economy, from default and also to establish mechanisms that could deal with the broader problem of sovereign debt. Meeting in an emergency session in Brussels, the heads of states in the euro zone agreed to use the European Financial Stability Facility (EFSF), a holding company established in May 2010 and owned by the euro-zone nations, to support the bond market by buying distressed government debt and to lend money to countries whose banks were in danger of collapse. Most of the funds for this will come from Germany and France, with additional money from Italy and Spain.

Markets responded positively to these measures, but their initial enthusiasm subsided as uncertainty about the details of the plan emerged. In any case, it is not clear that the proposed funding will be sufficient to save Greece from some sort of default. Many experts think the question is not whether Greece will default but when and how it will happen and what implications it will have for the rest of the euro zone. Can a Greek default be contained or will its shock waves carry away other fragile economies like Ireland and Portugal? And might this turn into a financial tsunami that would threaten Spain and even Italy, economies that are much too large to be saved by even the most generous possible European response? (Italy, for example, has $2.6 trillion in sovereign debt, more than three times as much as the combined totals of Greece, Ireland, and Portugal.) Most European banks will probably be able to survive a Greek (and maybe an Irish and Portuguese) default, but a sharp enough decline in the value of Spanish or Italian government bonds could easily produce a cascade of bank failures, which would have catastrophic results not only for the European, but also for the global economy. Deep uneasiness about the Europe’s economy—and especially about Italy and Spain—is among the reasons for the American equity market’s dramatic August collapse.

Considering the risks posed by the current crisis, the response of European leaders has been slow and uncertain. Although the gravity of the situation has been clear for some time, it took months of deliberation and delay before they could agree on a relatively bold and potentially effective response. And while the agreement of July 21 was a step in the right direction, many of its provisions are still vague and the level of support among European publics remains uncertain. This has not been Europe’s finest hour, although to be fair, the European response compares favorably to the debased spectacle played out in Washington during the self-created crisis surrounding the debt ceiling renewal of late July.

European politicians’ lackluster performance is in part due to their lack of imagination and political will, but the most important reason why they have had so much trouble responding to the economic crisis is that there are profound disagreements about who should provide the financial resources to assist Greece and, if necessary, the other weak economies. A case can be made that the main burden should be borne by the Greeks themselves, whose governments have for decades spent beyond their means, created a bloated public sector, and tolerated pervasive tax evasion. But even if one thinks the Greeks should pay, they do not have the capacity to pay enough to save themselves or to prevent the contagion of default from spreading. Others believe that the burden should be borne by those banks and private investors who earned handsome profits by imprudently lending Greece money without much thought about its ability to pay its debts. But even if one thinks that the banks and bondholders share responsibility for the crisis, to force them to pay too much might put the whole financial system at risk. That leaves the taxpayers of Europe’s richest countries—especially Germany—who have the greatest resources and therefore the most to lose from an economic collapse. But even if the rich nations can pay, are their citizens willing to jeopardize their own prosperity in order to bail out their profligate neighbors?

It is not surprising that the search for an answer to these questions, in which are entangled a set of complex moral, fiscal, and political issues, has been long and arduous and that, even with the agreement of July 21, it remains unfinished. Behind these disagreements about cost sharing and responsibility are two deeply rooted problems, both of which have been brought to the surface and aggravated by the current crisis.

The first of these has to do with the structure of the European Union itself and particularly with the euro. The euro was introduced in 1999 as part of the renewed campaign to deepen European integration that began with the Single European Act of 1986 and culminated with the creation of the European Union five years later. The common currency was an important step toward further uniting European economies. It promised significant benefits for rich, export-oriented countries like Germany, as well as for poor countries like Greece and Portugal, which were able to get loans and grants-in-aid. Some European leaders also regarded the euro as a decisive move toward the political unity that, since the Treaty of Rome in 1957, had always been seen as the ultimate goal of economic integration. In fact, as was true for the integration process from the start, the economic dimensions of the common currency worked much better than the political. Countries adopted a single currency with remarkable ease, but efforts at strengthening the union’s political institutions lagged. Europe has neither taxing power nor direct control over national budgets. There are lots of European institutions, but the weakest of them is the European parliament, which does not provide the Union with an effective democratic foundation. As a result, the euro zone has a common currency but not a common economic policy and—even more serious—it lacks the political institutions necessary to create and legitimate one. As long as things were going well, this disjunction could be overlooked, but when things began to go badly, it immediately came to the surface. (As the successful American investor Warren Buffett once remarked, “Only when the tide goes out do you discover who’s been swimming naked.”) European leaders are now confronted with painful decisions that they will have to sell not to “Europe” but to their own national constituencies. In the end the fate of the agreements made in Brussels on July 21 will be determined by the German parliament when it reconvenes this month.

The second deeply rooted problem revealed by the crisis concerns the European economy as a whole. Even before 2008, global competition, persistent inequalities within the union itself, declining birth rates, and an aging population had begun to weaken the capacity of governments to afford the impressive social programs and services their constituents had come to expect. Once the crisis began, the social contract in which governments promised to deliver economic growth, a higher standard of living, and extensive welfare benefits had to be radically revised, not only in poor states like Greece, Ireland, and Portugal, but to some extent everywhere in Europe. Thus began a vicious circle: austerity, budget cuts, and deficit reduction were unavoidable because without such measures the cost of government borrowing would continue to grow and servicing the sovereign debt would absorb an ever greater amount of the budget, thus further eroding the ability of states to meet their obligations. At least in the short run, these austerity measures have made the economic situation worse in many countries: public projects have been cut back, government workers have lost their jobs, benefits have been reduced. Austerity has certainly not brought greater prosperity to countries like Ireland, Portugal, and Greece, which face continued economic contraction and higher unemployment. More austerity is likely to make things a good deal worse before they get a little bit better. Europe’s future in large part depends on whether powerful countries are willing and able to provide the resources necessary for their weaker neighbors to break out of this downward spiral.

Throughout the EU, leaders face the unpalatable task of advocating policies that, under the best of circumstances, can do no more than prevent matters from getting worse. For poor nations like Greece, this means painful austerity; for rich nations like Germany, it means paying for what appear to be someone else’s mistakes. Not surprisingly, most politicians have pursued these policies with great reluctance and a not inconsiderable amount of dissembling. Only George Papandreou, the increasingly besieged prime minister of Greece, seems willing to keep telling his fellow countrymen things they do not want to hear.

This is not a good time to be an incumbent: if there is a trend in European politics at the moment, it is not toward the left or right but away from whichever party holds office. In February 2011, Fianna Fáil suffered the worst electoral defeat by a governing party in Irish history; in June, Portugal’s Socialist Party was ousted by the center-right Social Democrats. No national elections were scheduled to be held this year in Spain, Italy, and Germany, but in all three countries the ruling party—José Zapatero’s Socialists in Spain, Silvio Berlusconi’s coalition in Italy, and Angela Merkel’s Christian Democrats in Germany—suffered huge losses in state and local elections, traditionally a way for voters to register their disapproval of government policy. In a rather desperate attempt to preserve a Socialist majority, Zapatero, who announced he will not seek a third term as prime minister, has called for national elections to be held in November. In France, President Nicolas Sarkozy is deeply unpopular, but he may prevail in next year’s elections because of his Socialist opponents’ disarray following the Strauss-Kahn scandal and the growing specter of the right wing National Front, now led by Marine Le Pen, the photogenic and articulate daughter of the movement’s longtime chief. France is not the only place where there has been a resurgence of the Right: in June 2010, the anti-immigrant Party for Freedom became the third largest party in the Dutch parliament with 15 percent of the vote, while in April the “True Finns,” running on a populist and nationalist platform, won a surprising 19 percent of the Finnish vote.

Outside of parliaments, popular discontent is apparent throughout Europe. In one city after another, crowds have taken to the streets to demonstrate, often peacefully, but sometimes violently, against their governments.

Thus far these protests have been symptoms of dissatisfaction rather than the basis for powerful alternatives to the status quo. In fact, the more violent and destructive the demonstration, the less obvious its ideological agenda. This was, for instance, certainly the case in the extraordinarily destructive riots that shocked London and other British cities during the second week of August. From London to Athens, people are angry and they are likely to become angrier as the full implications of the current crisis begin to hit home.

As they watch the unraveling of the assumptions and expectations on which the postwar order rested, some Europeans have started to wonder if the European Union’s common institutions can continue to exist. But while there is good reason for concern, it seems much too early to predict the end of the euro, much less of the European project as a whole. The transaction costs of dismantling European institutions would be high; the alternatives remain uncertain and unappealing. Nor should we underestimate the power of inertia, often a strong undercurrent in human affairs that inhibits radical change and protects stumbling institutions. But while the European Union will probably survive its current discontents, it will, like someone who has survived a life-threatening disease, never again be quite the same.


Related: Los Indignados: Spain's Youth Revolution, by Jordi Pérez Colomé

Published in the 2011-09-09 issue: 

James J. Sheehan, a frequent contributor, is Professor Emeritus of History at Stanford University.

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