* * *

By Samuel Brittan

Imagine a corner shop that is not doing well. At best it cannot provide its owner with a minimum standard of living. At worst it cannot even cover its costs and is kept going by loans and donations from relations, friends and well-wishers. One of these was even heard to remark that he would do what was necessary to keep the shop going, and added: “Believe me, it will be enough”.

All analogies are imperfect but this one is quite near the mark for the eurozone’s uncompetitive members. Since the euro was inaugurated in 1999, German unit labour costs have risen by less than a cumulative 13 per cent. During this time, Greek, Spanish and Portuguese labour costs have risen by 20 to 30 per cent, and Italian ones by even more. It is hardly surprising that Germany has a current account surplus of 6 per cent of gross domestic product, while Greece, Italy, Portugal and Spain have a bare balance. Estimates need to be taken with a very large pinch of salt but their general message is all too plausible. No so-called banking union or fiscal harmonisation will suffice while these imbalances remain. 

The economic theory – such as there was – behind the creation of the euro was that the single currency itself, and the supposed impossibility of devaluation by members, would act as a harmonising force. But this has not happened and present relationships have become unsustainable. Herbert Stein, an economist active in Washington towards the end of the last century, said that if a policy or situation was unsustainable, it would not be sustained. But he did not indicate how long it would take for such situations to unravel. 

Meanwhile, it is in the interests of the eurocrats to make the problems seem as complicated as possible so that only a small number of so-called financial experts can even discuss them; and we have had one financial package after another and one guarantee after another to keep the structure going. But loans and guarantees do not make the unsustainable sustainable. There is only a limited number of ways that the situation could develop.

First, “austerity” in the peripheral countries could succeed. By this, I mean the demand squeeze imposed on them results in a fall in costs and prices, relative to their eurozone neighbours, leading to greater competitiveness, an eventual recovery in living standards and a sharp drop in unemployment. A variant of this would be an improvement in non-price competitiveness: more imaginative Aegean tourist trips or more attractive hotels in the Algarve. The key question is how many years – or decades – the correction would take.

Second, the peripherals could continue to stagnate. Unemployment is now 22 per cent in Greece, 24 per cent in Spain, 18 per cent in Portugal, 15 per cent in Ireland and 10 per cent in Italy. (By comparison, it is 8 per cent in the US and the UK). I am afraid a variant would be for their situation to grow still worse; and emigration beckons.

The third option is unlikely, but included for completeness. Germany and other northern euro members could pursue more “expansionary” (read inflationary) policies, thus reducing the agony of the south. Alternatively it could continue to subsidise the peripherals indefinitely.

The fourth option is for one or more of the peripherals to leave the eurozone. All hell would then break loose, not only among the departing but also in the remaining euro countries, where banks have large and potentially depreciating euro assets on their books. But eventually the ex-euro members would pick up the pieces and emerge with more tolerable performance, as occurred with Argentina when it severed a supposedly unbreakable link with the US dollar. Some economists would like to approach matters the other way round and would prefer Germany and its neighbours to take the initiative and appreciate out of the euro; but this will not happen irrespective of the results of he forthcoming German elections.

Of course, one can imagine any number of permutations and compromises among the above four conjectures, but the possibilities are limited. If I had to bet (which I don’t), my money would be on number 4. But I would not bet at all on when it will occur. The Holy Roman Empire – which was proverbially neither holy nor Roman nor an empire – was founded by Charlemagne in 800 and lasted until it was dissolved by Napoleon in 1806. The German Confederation was inaugurated after the Napoleonic wars and had no real powers over member states. It was reinforced by a customs union (Zollverein) in 1834 and the whole rickety structure lasted until it was dissolved into the German Reich by Bismarck in 1871. 

History may have since sped up, but we do not know by how much, and the timescale of euro disintegration is anyone’s guess. There is a limit to how much forward guidance one can give.

Copyright The Financial Times Limited 2013.