The eurozone must shrink to survive

Financial Times – Mohamed El-Erian

Extreme political dysfunction is now undermining a Greek economy already hobbled by imploding consumption, explosive joblessness, accelerating capital outflows and debt insolvency. The consequences are multi-faceted and extend well beyond the country’s borders. For the longer-term stability of Europe and the global economy, European leaders need to urgently redefine their historical unity project rather than leave it in the hands of increasingly disorderly conditions on the ground.

A week ago, the Greek electorate delivered three devastating messages to the country’s political elites: an unambiguous rebuke of traditional parties; unusual migration to fringe parties that are eager to dismantle the past but lack coherent plans for the future; and disgruntlement with economic policies that hurt but don’t work (to adapt a phrase that British politician Ed Miliband used in a different context).

It should come as no surprise that post-elections Greece is having problems forming a government. The political landscape is now full of parties with different interpretations of the past, present and future. As a result, the three with the biggest share of the recent vote failed last week to garner sufficient support to form a ruling coalition. This was followed by President Karolos Papoulias’ inability on Sunday to coerce the major parties into an emergency government.

Political dysfunction is the last thing that Greece needs at this historical juncture. It undermines the fulfillment of policy commitments made under the bailout provided by the Troika (European Central Bank, European Union and the International Monetary Fund). It also precludes the design of a better policy mix that would warrant disbursement of much-needed external support but under a more promising approach.

All this puts Greece’s eurozone partners in a very difficult position. Absent an urgent and imaginative response, they face a lose-lose situation: they lose by disbursing more good money after bad and see that too evaporate with no sustained benefits for Greek citizens and their European counterparts; or they lose by not disbursing and accelerating Greece’s slide into chaos, with unpredictable consequences for Europe and the world economy.

It is time for the eurozone to pivot away from an approach that offers little prospects of growth, jobs and financial stability. This involves a very difficult but needed redefinition of the eurozone, and a tricky combination of exit and different support mechanisms for countries that are not up to the new reality.

Given conditions on the ground, the current 17-member eurozone needs to evolve into a smaller and less imperfect union if it is to avoid the growing risk of total fragmentation – namely a closer economic and political union among the big four (France, Germany, Italy and Spain) along with other members with similar initial conditions.

This is a very complicated and outright awkward evolution. It only occurs in the context of a better policy mix for individual countries; stronger internal funding and coordination mechanisms, including regional firewalls; a less vulnerable banking system; and quite a bit of luck too. Moreover, as they redefine the eurozone, European leaders need to establish an off ramp to allow countries exiting the zone to remain in the 27-member EU and access post-exit stabilisation funds, as well as technical assistance to establish over time a credible monetary policy.

None of this is remotely straightforward and success is far from assured. But what should be increasingly clear in European capitals is that the current approach is faltering badly and will be even more costly down the road – and not because of the willingness of politicians to keep the eurozone intact but because of developments on the ground.

The eurozone’s fate is shifting from politicians and directly into the hands of the population, a portion of which is both angry and disillusioned. And having already forced a change in eight governments but still sensing an equally bleak future, the probability is increasing that they opt for a bigger mix of economic, financial, political and social rejection.

Looking beyond Greece, European politicians and policymakers still have the ability – indeed, the obligation – to channel the more direct involvement of citizens into a redefinition of the important European project. It will be expensive and initially disorderly. But the alternative of fragmentation is much, much worse for all involved. They better hurry up if they wish to remain relevant in a proactive, rather than just reactive fashion.

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