The EU must confront a crisis of leadership

As controversy over France's expelled Roma, or gypsies, continues to dominate European headlines, the news that many EU citizens are reluctant to hear is that their Union is on the verge of economic collapse.

As controversy over the fate of France's expelled Roma, or gypsies, continues to dominate European headlines, the news that many EU citizens are reluctant to hear is that their Union is on the verge of economic collapse. Though many of Europe's top economists agree on what is needed to reform economic governance, Europe's governments, the European Commission and the European Central Bank do not.

Germany wants quasi-automatic sanctions imposed on over-spenders, ranging from a loss of EU payments for their farmers to a suspension of voting power in EU decisions. Other EU countries, including France and Italy, balk at this idea. To make matters worse, the Franco-German alliance - traditionally the motor behind big integration projects - is fraying. Chancellor Angela Merkel and President Nicolas Sarkozy do not get on and they disagree on fundamental points of eurozone reform. Ms Merkel prioritises strict rules for all EU members and sanctions on fiscal sinners while Mr Sarkozy wants discretionary economic policy coordination among the eurozone members.

Because they diverge on so many points, there are almost daily consultations between Berlin and Paris. In this consultation process, smaller countries risk being painfully ignored. Slovakia - one of the zone's latest additions - voted with its feet, simply deciding not to contribute to the Greek bail-out package. Poland, which sees itself as a future euro member, observes this growing rift with irritation.

Even if EU powers agreed, the rules currently in place offer little practical application. There is the possibility of fining countries that consistently violate fiscal rules, for example, but they have never been used, partly because it makes little sense to burden an already struggling government with further financial penalties, and partly because in a tightly-knit club like the EU, bad political blood is best avoided.

Additionally, the political constellations of Europe hinder rather than help quick and effective reform of the eurozone. For the first time in 50 years, Germany has is showing signs of euroscepticism. A majority of Germans opposed bailing out Greece and most now think that the euro is bad for them. The EU's central institutions, most notably the European Commission, have also been sidelined in the crisis, with those members outside of the eurozone merely watching from afar.

The EU has already decided to set up a new watchdog led by the European Central Bank to monitor bubbles, bad loans, ballooning trade deficits and other sources of financial instability. This may help to prevent future slip-ups from countries such as Greece, which violated the EU's 3 per cent limit on budget deficits every year since it joined the euro. Such a watchdog could also monitor countries such as Spain and Ireland, which ran budget surpluses alongside ballooning private sector debt and unsustainable housing bubbles. Much of this debt quickly ended up on government books. Today, Ireland and Spain run double-digit budget deficits, and investors still worry about the health of their banking systems.

Still, though a watchdog system may be set up, it is not clear how this "systemic risk board" will be linked to a new system of fiscal surveillance and sanctions. If the Europeans manage to make the changes required to render the euro truly sustainable, however, the currency could be a boon, encouraging competition, growth and monetary stability. The euro would remain attractive to those countries that have not yet joined. It could even someday rival the dollar as a global reserve currency, encouraging the EU to be more outward-looking and confident.

For this scenario to come about, the euro needs to be underpinned by a better system of economic management. Reminded of the fiscal profligacy of Greece and other spendthrift Southern Europeans, eurozone officials must implement binding budgetary targets and be tougher on enforcement. It might be more promising for the EU countries to adopt national rules to guarantee long-term fiscal stability. Germany has already changed its constitution to force future governments to balance the budget, cyclically adjusted, from 2016. The country would do well to lead as an example, as it is also partly to blame for the current crisis: a post-reunification slump in the 1990s led to businesses tightening their belts to regain competitiveness. Wages in the country have thus hardly grown in a decade.

France is contemplating a similar plan along the lines of Germany; others should follow in due course. National rules would be policed by national parliaments and the media in a way that external rules are not. There's a growing consensus on what the EU needs to do to escape the euro crisis. But the crisis has exposed a dearth of leadership and solidarity in the European Union. Though the political commitment to the euro is likely to preclude the eurozone's break-up, such disagreements could leave Europe stumbling from crisis to crisis.

If events continue to play out in this fashion, the result would be an a slow-growing, inward-looking and bad-tempered EU that will muddle through without making the euro the success it deserves to be. Katinka Barysch is deputy director of the Centre for European Reform, an independent London-based think-tank © Yale Global