Which direction will the eurozone take?

Chronic economic problems in the region would seem to require greater integration, as suggested by the recent competitiveness report by former ECB head Draghi. But politically, many countries are veering towards a more nationalistic approach with the rise of more extreme parties. So which direction will the euro zone take? More integration driven by the EU Commission following the proposals of the Draghi report? Or more fragmentation as political nationalism takes precedence over economic integration? Steve Barrow, Head of Standard Bank G10 Strategy, said it would seem like the two doctrines will continue to butt heads, meaning that the region’s demise will continue.

The euro zone has been hit by three key factors: the loss of cheap Russian energy, the demise of the Chinese consumer and the scaling back of the US security umbrella. But, as bad as these things are, they are certainly not the only factors at play as the region has endured a structural decline that pre-dates all of these developments.

Former ECB head Draghi charted this decline in his recent competitiveness report. He argued that it will cost some 5% of GDP on an annual basis to get the region back on track through things such as bolstering private and public investment, deregulation, a proper capital market to help finance such activity, and integration in other areas such as the creation of common debt. It is an ambitious plan.

Could the gravity of the situation facing the euro zone right now, with France’s government falling, Germany on the brink of emergency elections, and “tariff man” Trump waiting around the corner prove the kick from behind that pushes the euro zone to finally embrace structural change that, in many cases, such as the capital markets and joint debt issuance, have been talked about since EMU started? Steve Barrow said the answer would seem likely to be ‘no’.

For a start, many eurozone countries have already signalled their unwillingness to entertain the idea of joint debt issuance, except in the sort of crisis situations where we have seen it issued in the past. This prompted Draghi to suggest that joint debt is not a necessary part of his plan, but we feel it is crucial.

A second point is that, if the eurozone debt crisis back in 2010-2012 failed to make eurozone members really grasp the nettle on many of the problems Draghi discusses, it is hard to believe that the current situation will produce a more determined response. In fact, the rise of more populist and far-right parties in the eurozone, some of which have gained a foothold on power, suggests that the political momentum for such integration is lacking.

A third issue is that many countries are already flouting existing efforts at integration. The flouting of budget rules has been a perennial problem, and presumably a key reason why many countries resist the idea of joint debt issuance. More recently, border rules have been flouted as well as even mainstream governments have felt compelled to pander to far-right pressures over high levels of immigration.

In short, the euro zone seems to be moving further away from the sort of integration that Draghi talks about. Turning the economic and political momentum around to Draghi’s way of thinking will be like trying to turn a super tanker, and we doubt that his report will be the spur that can do it.

So, what does this mean? Does it imply that the region will just drift apart and never be able to achieve its full economic capability? Most likely. Does it mean that EMU will break up? Steve Barrow said it is impossible. For when crises occur, politicians have shown that they can come together to fix the problem, as we saw with the rescue of Greece in 2012 or the issuance of joint debt to fund aid through the pandemic. But the question is whether this piecemeal approach amounts to little more than putting plasters over a gaping wound; in the end, they are not sufficient to stem the bleeding. And if that means that the eurozone economy will fall short of its true potential the same thing can be said about the shared currency, the euro, as well.