Enlargement and the euro - two big mistakes that ruined Europe

The single currency is a trap and eastern expansion forced the EU to take its eye off the ball

There has hardly been a year when the EU has not been on the brink of some crisis: banking, sovereign debt, Russia’s annexation of Crimea and now refugees. You can always point fingers at individual politicians and assign blame. But it is highly implausible that the EU’s serial failures can always be explained as the product of accident and malice.

I put it down to two catastrophic errors committed during the 1990s and at the beginning of this millennium. The first was the introduction of the euro; the second, the EU’s enlargement to 28 members from 15 a couple of decades ago. You might agree with one or other of these statements, or with neither of them. But few people will agree with both.

I was among those who supported monetary union at the time of its introduction. Advocates of the euro at the time came from two different groups, who struck a Faustian Pact.

Members of the first group believed the euro as constructed would fail, and hoped it would somehow be fixed. The others thought the system would stay rigid, and bend the economies of its members into a new shape. This latter group knew that, to withstand the rigours of a fixed-exchange system that resembles nothing so much as the gold standard, countries would have to adjust to economic shocks through shifts in wages and prices — a course, they believed, that the euro’s members would be forced to take.

The admission that the euro was a mistake should not be confused with a desire to dissolve it. That would be even more catastrophic. It is merely a recognition that we are trapped in a dysfunctional monetary system.

But how does enlargement play into this? This is not an argument about any particular member state with whose actions one happens to disagree. Nor is it an argument about the principle of enlargement, which is fundamental to the EU. My quarrel is with the speed of accession, and the criteria that aspiring members have to meet. Just as countries have maximum absorption capacities for migrants, the EU has a maximum absorption capacity for new members. I have no idea what that number is in any given time period, but it surely is not 13 members in a single decade.

Enlargement affected Europe's ability to respond to the shocks of subsequent years in two ways. First, it forced the EU to take its eye off the ball at a critical time when it should have focused on building the institutions needed to make the euro work. Second, enlargement meant that EU countries that were not in the eurozone suddenly found themselves in the majority. That shift naturally shaped the EU's own agenda. I recall the obsession during those years with competitiveness, a typical small-country economic issue. Debates on the reform of Europe's treaties during those years focused on voting rights and the protection of minorities. It was the overwhelming view of European officials and members of the European Parliament that the eurozone itself did not need to be fixed.

At that time it would have been comparatively easy to set up a banking union. But once the crisis set in, and banks suffered huge losses, countries could no longer share their deposit insurance schemes, let alone to create a single one for everybody. After the crisis had started, the debate about common insurance mechanisms became intertwined with one about transfers. The crisis thus rudely interrupted the EU’s time-honoured, step-by-step approach to integration.

An optimist might interject at this point that it is worth hanging in there. Crises come and go. The EU will still be there. Perhaps so, but then ask yourself: why was the period from the 1950s to the late 1990s more stable compared with the period since?

In the first years of the then European Economic Community, the external security risks were taken care of by Nato. There were almost no risks to financial stability because regulation was extremely stringent by today's standards. While the economic shocks, such as the oil and inflation crises of the 1970s, were no less severe than today, EU members had the ability to absorb them through flexible exchange rates.

Today Brussels suddenly has to look after its own foreign policy interests and run the world’s second-largest economy. The EU is not institutionally ready for either job. And its leaders are intellectually not ready either.

We should expect to see more crises, more unilateral action by member states, greater willingness to explore opt-outs, invocation of exceptional circumstances to suspend EU-level action, more rule breaking and the like.

The real risk is not a formal break-up. That would be technically hard to do. But this is no consolation. The real danger is that the EU is simply going to wither away and turn into a ghost.

-Copyright The Financial Times Limited 2015.