European policymakers never admit to the slightest doubt about the prospects for the long-term unity of the eurozone. But they do occasionally make comments that allow a mere blogger to ask the fatal question.

Such a comment came on Monday, at a meeting of eurozone finance ministers, from the lips of Jean-Claude Trichet, the European Central Bank president. He made the observation that, if Europe’s monetary and economic union were to be designed all over again, it might make sense to have a "stability pact for unit labour costs".

Politically feasible or not, this is an intriguing idea. It hints at the long-term problem faced by a single-currency area in which some members keep down their labour costs, others don’t, and the competitiveness gap gets wider and wider. Can such a union stay together?

This may not be just idle speculation. Policymakers clearly feel some unease at the fact that, since the euro’s birth in 1999, Germany has raced ahead of other countries - above all, those in southern Europe - in containing labour costs. Between 1999 and 2006, Germany’s competitive advantage has gone up by 20 to 25 per cent compared with, say, Italy.

All this was disguised in the early years of Europe’s monetary union by Germany’s relative economic weakness, caused by the cost of reunification and the replacement of the D-Mark by the euro at a relatively high exchange rate. But now Germany has more than recaptured its competitiveness. It is beginning to do exactly what some forecasters in the early 1990s said it would. It is starting to dominate the European economy by means of monetary union.

No one should begrudge Germany its new-found success. The real question is what the eurozone laggards, especially Greece, Italy and Portugal, are going to do about their own performances. Corporate restructuring, more labour market flexibility, wage moderation, pensions and healthcare reform and cost-cutting all round are the usual answers. 

But are their societies ready to accept such measures, which would have to last many years to have a real impact? Perhaps the only way to ensure the survival of the eurozone in its present form would be to insist on enforceable cost-cutting rules, precisely as Trichet suggests.

Because one thing is sure. Neither the German government, nor German companies, nor the international shareholders of German companies are going to accept any relaxation in the drive for ever greater German competitiveness, merely to save the day for a few friends in the Mediterranean.

November 13th, 2007 in Economic policy | Permalink