Tipping Point For The European Union?

June 26, 2011

NPR Staff

When European Union leaders met in Brussels last week, they faced some difficult decisions. For the past year, the EU has continually bailed out its debt-ridden member countries to keep the bloc and its currency afloat. Despite this assistance, Greece may yet default on its obligations, plunging Europe and much of the world into another financial crisis.

This is just the latest challenge for the euro zone, the group of 17 countries that banded their financial destinies together since 1999.

Even if Greece can be saved, there are other euro zone members — Ireland, Portugal and Spain — struggling to keep their economies afloat.

A Call For Help

When Greece nearly defaulted on its debt in May 2010, it received bailout funds from the European Central Bank and the International Monetary Fund. But these funds came with strings attached — Greece had to drastically cut spending and raise taxes, using that new revenue to pay off its obligations.

The result? Greece plunged further into recession. Unemployment surpassed 14 percent. Angry citizens took to the streets in protest.

Many economists, including Mark Weisbrot of the Center for Economic and Policy Research in Washington, D.C., foresaw these negative consequences.

"They did kind of the opposite of what we did here in the United States where we had a fiscal stimulus," Weisbrot told Rachel Martin, guest host of Weekend All Things Considered.

So why did the ECB and IMF demand these austerity measures?

"They're looking at it more from a creditor's point of view," he said. "And from a creditor's point of view, a government that they think has engaged in bad behavior has to be punished."

If the ECB and IMF were to give Greece no-strings-attached bailout money, Weisbrot says, then there would be a strong precedent to do the same for Ireland, Portugal and Spain, which also facing debt crises. The punishment of austerity is a warning for other countries to keep their financial houses in order.

"They're not really concerned that it's a collective punishment of the entire population," Weisbrot said.

Exporting Panic

The Greek parliament is set to vote next week on the newest round of austerity measures in order to get the next installment of bailout funds. If parliament votes down the measures and the IMF and ECB withhold the bailout, Greece could enter into a chaotic default.

Weisbrot says the U.S. government has not adequately prepared for such a scenario. Greece's near-default last May sent the U.S. stock market plummeting. A chaotic default could do even more damage.

"It could lead to a crisis of the kind that followed the Lehman Brothers' collapse," Weisbrot said. "And where is our government right now preparing for it?"

Rewrite the Rules

This lack of preparation for crisis goes back to the very beginning of the EU. When the euro, the bloc's single currency, was created, none of the "founding fathers" laid out a plan of action for the type of crisis we see now.

They didn't create an emergency exit or even rules to follow for when countries like Greece are on the brink of default.

"They have to rewrite the plans," says Simon Johnson, former chief economist at the IMF and current professor at the Massachusetts Institute of Technology.

Johnson explains that allowing Greece an orderly exit from the euro would risk creating a dangerous precedent. If other struggling countries, such as Spain and Portugal, see Greece drop out, they could choose to do so as well and make it more difficult for those countries to borrow.

The alternate route for EU member states is to come closer together than ever before, which is exactly what ECB President Jean-Claude Trichet proposed last week. He called for an EU that would be a "confederate of sovereign states of an entirely new type," and suggested creating a European ministry of finance.

Johnson says such a ministry would create a fiscal authority that could levy taxes and completely change the dynamic of the EU.

A Lesson From The United States?

The EU's predicament is well understood by America's Founding Fathers.

"The United States, before the Constitution was written, was a confederation, in which the Continental Congress didn't have the ability to tax," Johnson explains. "It actually could issue money but it couldn't tax. It couldn't raise revenue and the result was not good."

America's Founding Fathers had to make a decision: either disband or bring the 13 colonies together and create a fiscal union. They chose the latter, and accepted a proposal by Alexander Hamilton to consolidate the colonies' financial power and create a central bank

"If you're going to stay together, you need to make the same type of decision the United States made in 1787 to have a fiscal union," Johnson said.

It is possible to prevent countries like Greece from defaulting without creating an even more united EU, but Johnson says the long-term health of the euro will remain at risk.

Copyright 2011 National Public Radio. To see more, visit http://www.npr.org/.

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