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Azeem Ibrahim

Azeem Ibrahim

Posted: November 29, 2010 07:59 PM

So Ireland is the latest recipient of EU bailout money. It is now clear to everyone that the Eurozone is very much a two-tier affair. On the one hand are countries like Germany and France, who remain relatively resilient by European standards. On the other, there are those such as Portugal, Ireland, and Greece (often known by their acronym as the PIGs), whose public finances remain precarious. They are characterized by high deficits (Ireland's is almost a third of its total GDP), low growth, and a flirtation with the prospect of having their public debt downgraded, which would make it harder for them to raise money to service those debts and deficits, and pay for their public services.

The PIGs may yet be able to ride out the storm if austerity works. But if it does not -- or even if the bond markets decide that it is not working fast enough -- more drastic solutions might be called for. Some are suggesting that they might have to leave the Eurozone altogether and revert to their old currencies.

It may not come to that. But if it does, I would argue that there is a simpler solution.

What if, instead of the PIGS leaving the Euro, the stronger economies of France and Germany did so? Reverting to the Franc and the Deutschmark would allow a newly weak Euro to render the PIGS more competitive. It would also allow France and Germany to set interest rates which were right for their economies, which need to encourage spending less urgently than those of the PIGs.

Of course, critics will argue that to have two of the Eurozone's strongest economies leave it would be to throw the baby out with the bathwater. They might also argue that monetary union had long been a European ambition, and it took a lot of painstaking work to make it a reality -- so why unravel it now?

The answer is that growth is more important than monetary union. Sacrificing some monetary unity to kick-start growth would be a net gain. After all, growth raises everyone's living standards, monetary union does not. Growth lifts people out of poverty, monetary union was always essentially a political aspiration, supported by that percentage of European citizens who want to see an ever closer union between the Eurozone countries. Ultimately, a flourishing economy brings more benefit to more lives than being able to travel and trade across borders in a single currency.

Having France and Germany leave the Eurozone also makes sense from multiple points of view.

Most urgently, it would benefit Portugal, Ireland, and Greece. Currently, Germany and France's strong economies relative to theirs keep the Euro relatively strong. With Germany and France out, the Euro would depreciate, making the PIGs automatically more competitive. They would start selling more goods and services, become much more attractive (because cheap) destinations for inward investment, and would reap the benefits in increased tourism, as Lisbon, Dublin, Athens and the like suddenly became bargain destinations for holidaymakers.

Of course, gradual devaluation would not be painless. If your family savings were held in Euros, they would suddenly be worth less, and of course, the cost of imported goods within the Eurozone would rise.

But the short-term pain would be outweighed by the long-term benefit: growth. Look what happened to Britain when the pound dropped low enough to fall out of the Exchange Rate Mechanism, the forerunner to the Euro, in 1992. However embarrassing it was, the newly cheaper pound set the stage for one of the strongest and most sustained booms in living memory. Even Argentina -- so indebted in 2001 that it committed the largest national default in economic history -- was enjoying an average annual growth rate of 8% only five years later thanks to its newly rock-bottom currency. Of course, both these scenarios differ in important ways from the challenges faced by the PIGs today -- economic history never repeats itself precisely -- but the general lesson is clear: allowing a currency to fall gives a significant boost to the economy. With the PIG economies barely able to eke out single digit growth rates recently, ageing workforces, international debts to repay and credit ratings precarious, anything that fosters a faster recovery should be looked at.

This plan would also enable France and Germany to set their own interest rates. And most of all, it would appease those French and German voters who are increasingly asking how long they will have to play Bank Of Mum and Dad to the PIGs, bailing out ever more money to keep the Eurozone together. Certainly, reversion to the Franc and the Deutschmark would be cheaper than another bailout, and it would enable the French and German governments to reply that it won't happen again in the foreseeable future. Nor would French and German savers have to endure interest rates set low just to try to stimulate the Portuguese, Irish and Greek economies.

Even Britain -- long an outlier -- would find that its role as a central EU member not in the Eurozone was no longer so exceptional, and a two-speed Europe -- always an idea more popular in the UK than elsewhere, would be a reality.

There might even be a case to be made that if it came to it, having Germany and France drop out of the Euro would protect the Eurozone. It would be less damaging to it than having three, maybe four, Eurozone economies drop out. After all, if in time the Eurozone was to be repaired, it would be easier to rerun the monetary union in two countries than four.

It may yet not come to the point where the Eurozone has to split. But if it does, it should be France and Germany, not the PIGs, who should do the decent thing.

Dr. Azeem Ibrahim is a Research Scholar at the Kennedy School of Government at Harvard University, Member of the Board of Directors at the Institute for Social Policy and Understanding and Chairman and CEO of Ibrahim Associates.

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