09/30/2012 03:09 pm ET Updated Nov 30, 2012

Austerity Has Failed in Europe, but What's Next?

Speculation about the euro's fate remains rife. Some in the American elite never liked the idea of a European currency, perhaps because they believed it might some day give the dollar a run for its money as the global reserve currency, a status that provided the United States an array of economic, military, and political privileges and was therefore an important element in Pax Americana. Their reaction to Europe's current crisis contains more than a little schadenfreude. To many Europeans, pronouncements that a monetary union without a fiscal counterpart could only have ended in a train wreck smack of an "I told you so" smugness.

There's a bigger problem with this conceited view. It glosses over the reality that the malign economic consequences of the euro's unraveling will travel far beyond the continent and will be aggravated by the continuing weakness of the American and Japanese economies and the slowing of the galloping growth rates of China and India.

There is no clean and painless procedure for dismantling the eurozone. Nor is there a cost-free way to evict Greece from the currency union. That step would quickly make Spain's problems worse and turn the markets against Italy, the eurozone's third-largest economy. Those who understand this believe that the euro must be saved. But there's no consensus on how to do it.

Keynesians, notably Paul Krugman, argue that tying assistance from the European Central Bank (ECB), the European Stability Mechanism (designed to succeed the European Financial Stability Facility), and the International Monetary Fund to draconian budget cuts in Greece and Spain is perverse. In their view, this approach merely increases unemployment, reduces tax revenues, and perpetuates the problem, which can only be solved by economic growth fueled by consumers who are willing to spend because they either have secure jobs or are confident of finding them.

There's much merit in the Keynesians' case. The budget shrinking in Greece, Spain, and Portugal has increased citizens' misery. Who would have thought we'd be reading stories about Spaniards foraging for food in garbage cans? Austerity has also generated political instability in Greece and Spain, but without producing the economic growth essential to escape the dependence on loans, ECB bond purchases, and other such Band-aid solutions. Governments facing massive street protests and the lingering threat of mass violence -- and in Spain's case, secession -- cannot reasonably be expected to continue slashing budgets without let up. To sustain austerity, they must be able to convince their citizens that the cutbacks will improve their lives. But they can't do that because there's no evidence to back such an argument and lots of data, to say nothing of daily experience, to prove that it's false.

What's missing from the Keynesians' critique, however, is an appreciation for politics. While their economic analysis is persuasive, a prescription that's technically sound isn't useful if it's politically infeasible. True, austerity hasn't produced growth. Yes, northern Europeans' continued prosperity is tied to their Mediterranean cousins' fate. Seen thus, helping the South is not a matter of charity but self-interest. Also true.

But it's tough to sell this logic to a Northern electorate prone to seeing the South's predicament as a plain instance of profligacy (a diagnosis that is surely off the mark in Spain's case). German politicians specializing in contrasting Teutonic prudence with Mediterranean irresponsibility have the sound bite advantage, not least because they pander to prevailing stereotypes. So do their counterparts elsewhere in Northern Europe.

It's impossible for Greek and Spanish leaders to muster support for continued belt tightening when their citizens see nary a hint of gain accompanying the pervasive pain. It's also hard (though, in fairness, not nearly as hard) for Angela Merkel and other Northern European leaders to convince voters that they should bear the costs and risks of helping the South now because it's good for their future. Part of the case for such a long-run view is that most of the EU's exports stay within Europe. Consider Germany, eight of whose top ten trade partners belong to the EU and nearly two-thirds of whose exports go to EU economies. The problem, though, is that politics is about the short run.

There's another challenge. In times of economic hardship, it's tough for leaders to mobilize sentiments that transcend nationalism. In Europe's case, the truth of this generalization is illustrated by the ubiquity of blame games (Greeks angry about being victimized by overbearing Germans, Germans resentful about having to "pay" for the excesses of Greeks, Portuguese, and Spaniards) and the paucity of a "we Europeans" discourse stemming from an expanded conception of community and obligation, which is among the principles underpinning the EU project.

So what are we left with? First, Europe's problems are as much political, if not more so, than economic. Second, short-term political realities ensure that European leaders (especially in the South) won't gain citizens' open-ended support for economic solutions that require them to think beyond the present and to be patient in the meantime. Third, any sound solution to Europe's crisis must reconcile austerity's evident failure with the Northern electorate's need for assurances that allowing Southern governments to try Keynesian policies will produce an economic turnaround rather than a failure that increases their need for aid.

If the eurozone's future remains tenuous, it's because a leader who can articulate what such a new policy would involve in its specifics and then build support for it across the North-South divide is nowhere in sight.