Richard Dunbar: Euro not beyond salvation, but radical rethink essential

THAT Greece is even a member of the euro is demonstration enough that the single currency is a political rather than economic project.

The fact is that Greece’s fleeting achievement of the Maastricht criteria in 2000 raised eyebrows at the time, and that was before we knew the full detail of the creativity of their accountants.

The hope from the politicians (and many economists) was always that, once in the single currency, member countries’ economies would converge – despite the obvious deficiencies in performance at the outset. But as we now know to our cost, the opposite occurred. Now, an increasing number of investors are already making preparations for, and placing bets on, its demise. So is there any hope for the euro?

The first question to address is: why did convergence not happen in the first place? Politicians had hoped – even expected – that sound money and price transparency would lead to faster economic growth. Without the “easy” devaluations of the previous decades, countries would be forced to compete directly with the best in the currency area. Labour markets would have to become more flexible and productivity would rise.

What actually happened was that in the very early days of the single currency, member states experienced “reform fatigue”. Countries – or their accountants – had worked so hard to get the books into shape to meet the Maastricht criteria that they didn’t really want to do any more. They saw the formation of the single currency as an end rather than a beginning. As a result, the all-too-difficult but vital supply-side reforms were put firmly in the “important but not urgent” pile.

The result? A decade where there was little improvement in the underlying growth rate of the eurozone versus the previous decade. This was a tragically wasted opportunity. The net result was a club which – rather than forcing convergence – actually made it easier to continue the bad habits of before. There was a great party at the club; no-one stopped to consider why those Maastricht criteria remained important and why those supply-side reforms that seemed so crucial all those years ago remained key to the success of the project.

So the party is now firmly over. As we enter our fourth year of crippling hangover, is there any hope that these supply-side reforms may find their way into the underused tray marked “important and urgent”?

There are some straws in the wind that provide a glimmer of optimism. After more than a decade of falling productivity, labour market reforms are being implemented in Italy and Spain.

But perhaps the best – and certainly the most developed – example of this supply-side reform is in Ireland. In the past two years, unit labour costs have fallen 9 per cent relative to the rest of the eurozone. They are still falling. A near-halving of office rents, while painful for the owners and their banks, puts Ireland back in the pack as regards office costs. Exports are up. Foreign direct investment is rising as Ireland capitalises on its advantages – a well-educated, English-speaking workforce, in the right time zone, with a low tax regime and in the euro – and now, all at a lower price. Ireland’s economy is still in trouble, but at least it has a political leadership and a population that appreciates the problem. With resolve, Ireland is plotting a course out of its problems.

Wim Duisenberg, the first president of the European Central Bank, once said: “The euro is much more than just a currency. It is a symbol of European integration in every sense of the word.” He was right in 2001 and he remains right today. The chaos in the eurozone reflects accurately the current state of European integration, leadership, mutual trust and respect.

However, all is not lost. While the economist in me remains sceptical of the whole euro project, perhaps this crash course in convergence may be part of a formula that eventually settles markets. The risk of course (and unfortunately the most likely outcome) is that it is too little too late, and that markets dictate the fate of the euro before we see any benefit from belated attempts to converge.

This would be unfortunate, to put it mildly. Supply-side reforms will be painful, but they will have to happen anyway – whatever happens to the euro. In their heart of hearts, the politicians know this.

• Richard Dunbar, investment director at Scottish Widows Investment Partnership (Swip).