The structural flaws of the eurozone as currently configured have long been identified. A Centre for Policy Studies paper published today reviews the three options open to the European Union in trying to solve the crisis. The first, which the EU has so far tried to pursue, entails eliminating the competitiveness differentials between northern and southern countries through domestic price adjustments. So far, Germany has been unwilling to accept inflation of its own production costs as part of this, meaning that the burden has been expected to fall on the southern European countries through internal devaluation. This is clearly not working.
An unpublished compliance report, which found its way onto the web recently concluded that Greece - for example - will have to impose a further fiscal squeeze next year amounting to 5.5 per cent of gross domestic product. But without growth, this settlement will never gain political support within Greece, as evidenced by the recent election results. The supply-side measures necessary take time to bed-in and should have been undertaken in benign conditions. But the people's tolerance for austerity within southern Europe is clearly waning. Coupled with Germany's aversion to inflation and the huge scale of the adjustment required, this solution is looking highly unlikely.
The second option is for a full system of transfer payments from areas of high to low productivity through grants. Some large transfers of this kind have already taken place – we have seen the bail-outs of Greece, Ireland and Portugal, for example. And over recent months the weaker countries in the single currency area have been increasingly dependent on the European Central Bank for financing. But without a full fiscal union, and German taxpayer support for a permanent system, this again is a sticking plaster solution. What is more, Germany is only likely to ever accept this if the reforms it thinks the southern states must undertake are upheld.
Given that this looks very difficult to achieve, our paper argues that we should now be prepared for a euro break-up - in particular, for a Greek exit. This requires careful planning, both to enable an orderly exit and to prevent contagion across the continent. In the paper, we set out why we think that the International Monetary Fund is the only fire brigade in town. The report argues that only the IMF has the "necessary detachment and economic credibility" to help sort out this crisis. The eurozone institutions are blinded by ideology and each country has their own interests to represent. Only the IMF is in a position to highlight the options available to the single currency economies and to set out the advantages and disadvantages of each.
With the Spanish banking system in deep trouble and most probably in need of a bailout, the markets severely doubt the government will be able to service its debts – particularly, with the structural reforms needed to improve productivity and internally devalue. The time has, therefore, come for the EU to choose one of the three options outlined above and to stick to it. The lack of action in the single currency area is feeding uncertainty and worsening the outlook for other non-eurozone economies. But the IMF is well-placed both to represent the interests of non-eurozone members and to give independent advice to the European leaders. Without clear leadership, currently lacking at a European level, the eurozone crisis has the capacity to engulf us all. Though many might say we should back off and let the eurozone deal with its problems, it is clear that decision-making at that level is flawed. The solutions so far have delayed the reckoning, but this delay must be now used effectively to present a lasting solution.
Ryan Bourne is head of economic research at the Centre for Policy Studies – a British think-tank
This article first appeared on publicserviceeurope.com: Let IMF manage eurozone restructuring, urges think-tank