Every state has its founding myths. Perhaps the most persistent myth associated with the European project was articulated by one of its founding fathers, Jean Monnet: Europe will be forged during crisis and will be the sum total of the decisions made during crisis. Europe’s blessing, as Monnet saw it,  is its ability to successfully reform in troubled times. In light of the events that have unfolded since Monnet’s death, however, this does not strike one as a meritorious claim.

The story of the single currency is now a familiar one. Instead of producing the economic convergence envisaged by the signatories of the Maastricht Treaty, the ‘convergence criteria’ – price stability, low interest rates and fiscal restraint – led to divergence between the core surplus countries and periphery deficit countries. As a result of the crisis, the deficit countries ended up trapped in high-debt, high unemployment and low-growth trajectories, stripped of the ability to adjust, either by means of discretionary fiscal policy or by competitive devaluation.

The euro’s lack of ‘embeddedness’ in a financial union has resulted in a banking system on permanent life-support, a huge liability to countries without the means to bail out troubled lenders. Meanwhile, the economic repercussions have severely undercut the EU’s ‘output legitimacy’ and have given impetus to right-wing nationalists trying to capitalize on the rising levels of inequality and unemployment.

It would be wrong to suppose, however, that the eurozone has not undergone reform. There have been significant reforms, yet they have all been retrograde. The signing of the European Fiscal Compact saw a tightening of the budgetary rules set out in the Stability and Growth Pact, seemingly in disregard of the fact that after years of austerity, the fiscal position of most countries is worse than before. It is not surprising, therefore, that calls for alternative reform proposals have been growing louder, partly because of the election of Emmanuel Macron in France. What are the chances that these efforts will succeed?

The solidarity gap

While there seems to be some agreement that the eurozone is not working, there are continuing political disagreements about what must be done to enable it to function. The disagreements primarily involve the willingness of political participants to introduce risk-sharing mechanisms that distribute the cost of risk among all participating countries. The most salient forms of risk-sharing required for a single currency to function are a common deposit insurance to vouchsafe stability in the banking system, fiscal transfers between countries and some form of debt-mutualisation, as suggested by Macron.

The most high-profile reports to come out of the European Commission in recent years however – the Four Presidents Report, the Five Presidents Reports, a consultative White Paper and a subsequent reflection paper published in May – reflect a continuing scaling-back of reform ambitions. Though the reflection paper mentions the possibility of European finance minister, it is coy about any explicit policy paths. This scaling-back is the expression of a widening political gap, a gap between the countries that support risk-reduction by way of tighter fiscal rules and limits on the macroeconomic discretion of national policy-makers, and countries who want to share risk to create conditions more favourable to those eurozone countries trapped in low-growth, high unemployment equilibria.

Put differently, it is a gap of monetary solidarity. In the context of European integration, solidarity can be defined as deliberate or at least consciously tolerated risk-sharing. Rather than being the expression of a technical disagreement, the gap is the result of two conflicting political visions of how the eurozone should be governed. The widening or narrowing of the gap is a result of the complicated bargaining and distributional politics in the eurozone. The policy decisions and frenzied institution building since the crisis are not the reflection of a narrowing solidarity gap. Far from being an unconditional transfer, the Greek bailout mechanism was a bailout of German and French banks, implemented under the guise of solidarity, granted under punitive conditions that belie economic common sense and have immiserated Greece.

Eminent Virginians

How then did other monetary unions close the gap? As a historical analogy, the United States is the example that merits most attention. Alexander Hamilton’s plan to federalize the union’s debt proved to be a disintegrative, politically load-bearing move. For the wealthy states in the union such as Virginia, mutualizing state debt meant paying future taxes to service the debt accrued by other states. In a now infamous dinner, James Madison and Thomas Jefferson agreed to Hamilton’s plan nonetheless, in return for relocating the capital to the Potomac. More schematically, Virginia was made a side-payment before it would acquiesce to pooling risk with other states. The decision was not democratically contested and was in fact deeply unpopular in the Virginia state legislature. Jefferson and Madison eventually came out against the plan. The unresolved conflict over Hamilton’s plan culminated in the First Party System and in decades of claims against the authority of federal government which set the stage for the Civil War.

In the United States, closing the monetary solidarity gap was a politically toxic process. Bloodshed and coercion were required for a monetary union in the United States to fully materialize. Putting it mildly, similar violent scenarios have not played out well for Europe in the past. Indeed, the single currency was initially conceived as part of the effort to secure permanently peaceful relations.

To suggest that Europe’s equivalent of Virginia, Germany, could be made to consent to some Hamiltonian plan by way of some tradeoff seems downright presumptuous. A good indicator of Berlin’s willingness to compromise can be found in the fierce legal battle waged against the European Central Bank (ECB) over its unconventional monetary policies, namely the quantitative easing programme, the Long-Term Refinancing Operation  – both aimed at shoring up banks’ balance sheets and lowering sovereign borrowing costs – as well as the much lambasted Target 2 payment settlement system.

German policy-makers are, on the whole, already recalcitrant to existing monetary policies not in line with their own perceived short-term economic and electoral interests. Germany’s leverage to stake out demands for its own version of reform is increased by the unique position of its constitutional court and its ability to legislate on the compatibility of monetary policy with German Basic law, a position that in practical terms heightens the bargaining power of the Bundesbank in Brussels. The possibility of the current Bundesbank chief Jens Weidmann succeeding Mario Draghi at the helm of the ECB might lead to a distribution of power even less conducive to reaching a compromise on risk-sharing, a compromise sought by Europe’s closest equivalent to Alexander Hamilton, the newly incumbent Macron.

Monnet’s curse and the paradox of risk-sharing

This growing imbalance between the core surplus countries around Germany and the rest of the eurozone around France and Italy, prompts consideration of more a fundamental paradox at the heart of the eurozone: risk-sharing is only beneficial if the pool of countries involved is sufficiently diverse, and yet it is precisely this diversity that makes the prospect of risk-sharing hard to attain. Moreover, given the tendency of crises to throw up otherwise dormant divisions or to decisively shift the balance of power, it is particularly then, when solidarity is needed most to drive reforms, that it proves a decidedly scarce resource.

This paradox informs a remarkable new book by LSE economist Waltraud Schelkle (The Political Economy of Monetary Solidarity, Oxford University Press, 2017). Regarding Europe’s ability to reform in troubled times, Schelkle departs from the convenient myth espoused by Monnet. It is arguably this conceit, which Schelkle calls Monnet’s curse, that led the French political leadership to agree to a monetary union they knew to be flawed, guided by the belief that any eventual crisis would provide further opportunity for accommodating a newly reunited Germany within the framework of more deeply integrated monetary arrangements. In fact, most successful institution-building has been the result of cooperation in normal times, while that which is introduced during crises may prove a disruptive obstacle to further integration. The result of the divergent dynamics of the eurozone and subsequent crisis policy, however, has been to dramatically alter the balance of power in favour of Germany – the very country that adamantly opposes any reform effort aimed at enhancing solidarity towards genuine risk-sharing. Depending on how Macron’s reform efforts play out, Monnet’s curse and the French acquiescence to the conditions of the Maastricht Treaty might well prove to be the most consequential example of political malpractice in post-war Europe.

The political problems facing the ailing eurozone seem practically insurmountable. The recent publications by the Commission and the prospect of a new German government more opposed to genuine solidarity than ever indicate that the gap is wide open and not set to close anytime soon. But if substitutes or equivalent solutions to demands of joint fiscal liability are not found, the European project might prove unsustainable. And as the saying amongst economists goes: that which is unsustainable, will not be sustained.