Back in the spring of 2018, I wrote an article for The Chicago Journal of Foreign Policy, a student journal at the University of Chicago. This article would go on to serve as the foundation for my Masters’ Thesis and as the subject of multiple Shatterpoints articles published over the summer of 2021. Below is the article published in its entirety. I leave it up to you, dear reader, to judge how well this piece has aged.
In recent years, there is increasing concern over the possible demise of the liberal international order. Many of these concerns stem from the two pivotal events of 2016: Brexit and the election of Donald Trump as President of the United States. As uncertainty remains regarding the United Kingdom’s future in Europe and America’s commitment to the current configuration of the international system, it is understandable why these high-profile cases would be emphasized as the primary challenges to the stability of the liberal international order. Indeed, figures such as Colgan and Keohane have rightfully documented the gravity of these challenges. Yet, the greatest internal danger to the liberal international order is not Britain’s volatile Brexit negotiations with the European Union, America’s unpredictable foreign policy under President Trump, or even Europe’s worrisome flirtations with democratic backsliding; it is the possibility of the collapse of the Eurozone.
The Eurozone is one of the most vital entities within the global financial system. This currency zone comprises of some of the world’s most important powers and economies such as Germany and France. If the Eurozone were to collapse, this could potentially undermine the future of European integration while triggering an economic and financial crisis in the heart of Europe as well as the rest of the global economy. The consequences of such an event would unquestionably strike a heavy, perhaps even mortal, blow to the heart of the liberal international order. Certainly, the future of the Eurozone has been questionable in the aftermath of the 2008 Financial Crisis. However, since the 2015 crisis in Greece, it would appear that the Eurozone has stabilized. And despite the recent slowdown in economic growth, a strong 2017 performance has helped allay fears of fragility within the Eurozone. Nevertheless, the relative quiet within the Eurozone ought to be reason for concern as it indicates that the systemic problems which plague the zone still remain. To fully understand the Eurozone’s precarious status, it is necessary to review the history of Eurozone’s formation, the present status of the Eurozone, and the primary barriers to reform.
Since its official launch in 1999, the Euro has become one of the world’s leading currencies and is the official currency of 19 of the European Union’s 28-member states. It has served as a key instrument for helping create a common European market and ensuring “an ever closer union among the peoples of Europe.” As a result, the Eurozone must be considered an extension of the European Union’s political project to foster political integration rather than a purely economic project. This sentiment is reflected by scholars of the Eurozone such as Brunnermeier et. al who note that French President François Mitterrand desired to use the Eurozone as a tool to end Germany’s hegemony in the realm of monetary policy and spread French views regarding government’s role in the national economy. Additionally, France saw the possibility of a monetary union with Germany as an opportunity to enhance France’s power in monetary affairs instead of merely responding to Germany’s monetary decisions. Germany’s political goals for forming the Eurozone, however, were far different. For instance, German Chancellor Helmut Kohl advocated for a currency union within Europe in the hopes of binding Germany’s fate with that of the rest of Europe. This echoes the capitalist theory of peace that increased via economic interdependence will decrease the likelihood of war.
Although there is strong evidence to suggest the formation of the Eurozone was driven by political goals, economic interests certainly played an instrumental role. The Euro was created by Eurozone countries pegging the value of their currencies to one another. For Germany, this provided the opportunity to institutionalize its export advantage. Germany also saw the Eurozone as a prospect to institutionalize its national preference for price stability and low inflation rates across Europe, thus enhancing Germany’s economic wellbeing. France likewise saw the economic benefit in low inflation rates and sought to benefit from Germany’s fiscal discipline. Additionally, France and other Eurozone nations in the periphery saw the currency order as an opportunity to help relieve competitive trade pressure from Germany.
Despite the clear political and economic benefits of the Eurozone, the currency order contained a potential fatal flaw due its failure to form an optimal currency area (OCA). It is precisely this flaw which haunts the Eurozone today. A currency order provides the legal and regulatory framework for a currency system to operate and, consequently, all nations within the Eurozone utilize a fixed exchange rate and collectively form a regional currency order. For a currency order to qualify as an OCA, it must meet the following four conditions: 1) Members must possess similar economic structures 2) Members must possess similar economic cycles 3) Members must share a common market 4) Members must share a similar economic culture. Even though the economic interests of its members converged, the Eurozone was still primarily a political project and not an economic project. From the start, it was obvious the Eurozone members had different economic cycles. For instance, whereas Germany’s trade surplus in 2016 represents 8 percent of its total GPD, Greece had a trade deficit of 0.7 percent. In addition to possessing different economic cycles, there was a significant divergence of economic philosophies between the Eurozone’s core members, France and Germany. Furthermore, although the Eurozone had restrictions regarding deficit spending and macroeconomic policy, there lacked an adequate enforcement mechanism to make these restrictions viable. As a result, the Eurozone was created in a haphazard manner that overlooked its structural deficiencies.
The strong indication that the Eurozone is not an OCA has profound implications for Eurozone members. If a currency order is not an OCA, then it is possible for one area of the currency order to flourish while another area is languishing. This unfortunate reality is reflected by the systemic problems the Eurozone faced and continues to face in the aftermath of the 2008 Financial Crisis. In years preceding the financial crisis, the structure of the Eurozone allowed Germany to increase its dependency upon exports and enabled peripherally nations such as Spain and Greece to borrow funds at extraordinarily low, and sometimes negative, interest rates. After the 2008 financial crisis undermined economy growth in peripheral nations, a Eurozone debt crisis rapidly emerged. Eventually, this debt crisis morphed into a balance of payment crisis which threatened to unravel the entire Eurozone.
Although the Eurozone is not an OCA, there are three adjustment tools which the currency order may employ to remain solvent. These three mechanisms include devaluation via austerity, increased capital and labor mobility, or the creation of Eurozone fiscal union. The great challenge of deflationary pressure is that it is particularly devastating to a nation’s standard of living. This makes deflationary adjustments politically unpopular. Similarly, entrenched interests in Europe’s labor and capital markets make significant domestic reforms well-nigh impossible. Additionally, these two types of reforms must be implemented in nations which are currently languishing economically, thus further increasing the difficulty of reform.
While the Eurozone exists within the framework of the European Union and thus possesses regulatory qualities that encourage capital and labor mobility between states, there is little evidence of meaningful movements of capital and labor. Based on data on foreign direct investment flows from the OCED, foreign direct investment originating from other Eurozone nations has amounted to less than one percent of gross domestic product for Germany, France, Italy, Greece, and Spain since the 2008 Financial Crisis with only minor exceptions. In fact, Italy witnessed capital outflows. Despite the most recent data running until only 2012, it is unlikely these figures have changed significantly. Thus, due to the importance of these economies within the Eurozone, it is reasonable to conclude that capital is relatively fixed within the Eurozone.
Similarly, inspection of national unemployment rates in the same five nations suggests labor is also relatively fixed. Germany, the Eurozone’s largest economy, has the best unemployment rate of under four percent, full employment. Meanwhile, France and Italy, the second and third largest Eurozone economies, have unemployment rates hovering around ten percent. And disturbingly, Greece has persistent unemployment rates over of 20 percent while Spain’s unemployment rate has only recently dipped below 20 percent. The data also shows that unemployment rates in these five nations have been static for the past several years, thus indicating labor is not moving to regions with better economic opportunities.
The realities of the lack of capital and labor mobility coupled with the political unpopularity of austerity measures makes the creation of a Eurozone fiscal union the only remaining option to ensure the currency union’s long-term survival. In its simplest form, a formal fiscal union is an arrangement which features permanent financing in the form of transfer payments via debt relief for banks and sovereign governments. The creation of a formal fiscal union provides Eurozone nations the opportunity to escape the present economic malaise without having to enact politically unpopular austerity measures or labor reforms. Therefore, the Eurozone nations faced with costly domestic economic adjustments could effectively utilize the international institution of the currency union as a form of redistributive cooperation to externalize the cost of adjustments.
Though the creation of a Eurozone fiscal union would potentially solve the zone’s systemic problems, there is significant resistance from Germany, the Eurozone’s economic hegemon. From the Eurozone’s founding, there was evidence that suggested Germany’s economic hegemony due to other countries pegging their currencies to the Deutsche Mark prior to the creation of the currency order. Additionally, following the recent Eurozone crisis, Germany’s status as the economic hegemon is unquestionable. Due to the Germany’s status at the economic hegemon, it has the final say in the creation of Eurozone fiscal union. This reflects the ability of an economic hegemon to set the pace and tone of negotiations and the reality that it must also bear the disproportionate level of costs when enacting reforms.
Due to Germany’s reliance upon exports and the competitive advantage it gains through its membership in the Eurozone, the Germans have a strong economic incentive to preserve the currency union. Indeed, the value of Germany’s exports is equal to 46.1 percent of its GDP, 36.3 percent of which go to EU countries. It is likely that if the Eurozone collapsed and Germany readopted the Deutsche Mark, Germany’s economic heft would make its currency appreciate relative to its neighbors, thus causing Germany to lose its competitive export advantage. Nevertheless, Germany faces also economic pressures which cause it to resist the creation of a Eurozone fiscal union.
Because of German economic theory’s premium on fiscal restraint and responsibility, Germany possesses a stable economic system and is willing to undergo short-term economic hardship in order to make necessary economic adjustments. Since France and other Eurozone nations do not similarly value fiscal restraint and responsibility, Germany fears that if it were to enter a fiscal union and provide continual financial assistance to the rest of the Eurozone, a moral hazard would emerge. This moral hazard assumes that France and other Eurozone nations would take German emergency assistance for granted and subsequently be willing to engage in risky macroeconomic policy. Therefore, in the advent of another Eurozone crisis, Germany would incur the costs of saving the Eurozone. If such a crisis were severe enough, then it is possible that the costs incurred by Germany’s membership in the fiscal union outweighs the benefits it gains through export competitiveness within the Eurozone. There is also the danger that, in the worst-case scenario, Germany may not possess the financial wherewithal to save the Eurozone. Consequently, Germany would incur the cost of the fiscal union in the short-term and still lose the benefits to its exports in the long-term.
This examination of Germany’s conflicting economic interests helps explain Germany’s interest in preserving the status quo. Yet, the lack of reforms means that the structural problems that emerged after the 2008 Financial Crisis still haunt the Eurozone today. As one of the pivotal actors within the global economy and the financial system, the continued stability of the Eurozone is paramount to the longevity of the liberal international order. Additionally, the collapse of the Eurozone could possibly undermine the future of European integration, thus further fragmenting the international system.
Unfortunately, it would appear that the prospects of fiscal union are increasingly unlikely. In Germany, Angela Merkel’s fragile position as Prime Minister makes agreement upon any drastic Eurozone reforms which would cost Germany highly doubtful. And while French President Emmanuel Macron has made great strides in implement labor reforms, stiff protests from French unions will likely limit his ability to make further domestic reforms designed to counterbalance the Eurozone’s adverse effects. Additionally, it is expected the stunning victory of the anti-EU populist Five Star Party in Italy will further complicate reform efforts.
Although collapse is by no means a foregone conclusion for the Eurozone, the inability to address its deep system problems raises serious concerns. In the face of growing political complexity within the Eurozone, leaders in both Europe and the United States must recognize the inherent fragility of the currency union and work together to help promote economic and financial stability. If the Eurozone is to survive, its member states must be willing to make mutual sacrifices for the collective good. Ultimately, just as the creation of the Eurozone is rooted in European politics so shall its survival rest upon the future of European politics.