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The eurozone will not break up. The price of departure is simply too high for any one country. Indeed, when European Central Bank President Mario Draghi announced on Sept 6 that the ECB would buy unlimited government bonds, the continent crossed the bridge to its future.
Europe's leaders must see that the drawbridge has been lifted behind them. Since they cannot back out, they thus must steel themselves for the journey ahead. They must also realize that for the European project to succeed, which it must, monetary union must be accompanied by four other kinds of union: a banking union, a fiscal union, a "competitiveness" union or convergence, and, to all intents and purposes, a political union. And to be sustainable over the long term, the continent's political economy must be capable of reintegrating its youth and present an ideal worth fighting for.
This is a long and ambitious list, but the deeper one thinks about the European situation, the more inevitable these conclusions become.
The euro itself has provided major economic rewards: It eliminated exchange risk, lowered inflation, increased trade across the eurozone and more tightly integrated European financial markets. More generally, the single currency has contributed to an underlying culture of monetary stability and predictability within the eurozone, a critical point often forgotten in today's discussions.
The critical flaws in the eurozone's structure, however, surfaced with the debt crisis. Europe lacked a strong and common fiscal policy. Divergence in competitiveness between the northern and southern economies created a risk of default that had gone unrecognized. And the absence of a banking union created intolerable systemic risks. Adding fuel to the fire, the complexity of European political institutions and the increasing democratic deficit that it represents in the view of the public have led to an "executive deficit": the inability to make real decisions.
What is clear is that the euro must survive in more or less its current form, but the deficiencies in the institutions that surround it must be addressed. The first is a banking union, which is an absolute prerequisite for a monetary union to succeed. A robust banking union must have shared bank supervision, a shared bank recapitalization mechanism and a shared bank deposit guarantee.
The good news is that the first of these was put in place on Sept 12 with the proposal of a single supervisory mechanism under the ECB. The two others are destined to follow, with the ever-present caveat in Europe that negotiations will be complex and take years to resolve.
As the talks on a banking union drag on, they will inevitably lead to discussions on a fiscal union, because the different pieces are intertwined and complement each other - the idea of a banking union without a fiscal backstop makes little sense. There will be three parts to any kind of fiscal union in Europe: a program of direct bank recapitalization - in Europe's case, by the European Stability Mechanism, an EU-wide system of deposit insurance that prevents a run on banks in weaker countries and reduces moral hazard, and some form of debt mutualization.
Before the anti-federalists recoil in dismay, it is important not to fall prey to binary thinking - it is not "everything or nothing". Between no fiscal union of any kind and a full-fledged "United States-" or Swiss-style confederation, many possible intermediate states exist that will contribute to a much greater sense of fiscal solidarity and discipline.
Reform of European financial governance is a necessary but not sufficient condition for success. It will not be able to gloss over the major issue at the center of the crisis: the competitiveness gap between Europe's north and south. Fixing the EU banking system and regaining macroeconomic stability will do a lot to help southern countries increase their productivity but, importantly, these countries will need to engage in a long-term project to increase their labor market flexibility, foster competition, and make more and better investments in growth-enhancing areas such as education, technology and innovation.
A crucial consequence of all these reforms must be the injection of entrepreneurial energy into the continent's "lost generation". Youth unemployment is a cancer at the heart of the European economy, stealing its future and sapping its growth potential for decades to come.
Thankfully, reforms are underway. Despite slow progress in implementation, the "Europe 2020" strategy is designed to kick-start competitiveness in the region. I believe that the path ahead is clear, that Europe's leaders will begin to look forward with hope and optimism and not backward with fear, and that Europe is more likely to confound pessimists with the passage of time.
The continent's optimism will strengthen as leaders recognize that Europe stands together or falls apart. There is no country on the continent sheltered from the pain of this crisis. What is important now is for the continent's polity to envision the gain that will emerge from the pain and articulate this in a way that pulls EU countries toward their shared future.
The author is founder and executive chairman of the World Economic Forum. His e-book, The Re-Emergence of Europe, will be published on Dec 14 and available free of charge.
(China Daily 12/15/2012 page5)