Reforms to Save Euro a Tall Order, Even for Germany

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Now that the euro has bankrupted Greece and pushed Italy and other Mediterranean states to the brink, Angela Merkel proposes tough, EU-administered disciplines on national deficits. Those would thrust the Mediterranean states into decade-long recessions without fixing flaws in the eurozone architecture that caused all the borrowing and crushing debt in the first place.

At the end of 1998, wages, prices and government bonds were converted from national currencies into euro according to prevailing exchange rates. To the extent those rates reflected market prices, the euro adequately priced labor, exports and public debt across borders.

Unfortunately, among the 17 members of the currency union, labor market policies, social programs, and industrial policies are separately established and financed, and vary much more than among the 50 states in the dollar zone. Specifically, union and worker protection rules are federally enforced in the United States, the 50 states don't own big chunks of industrial enterprises, as do German Landers, to build exports and block outsourcing, and Social Security and Medicare/Medicaid are federally financed.

Owing to significant differences in labor-market and industrial policies, investment and productivity grew more rapidly in Germany and other strong northern economies, and labor and exports became overpriced in Italy and other now troubled southern economies.

Generally, the European Central Bank permitted the euro to float, and its value against the dollar yen tends to reflect wages, productivity and economic strength of the 17 eurozone countries as a whole. Consequently, the euro is undervalued for the German and other northern economies, making them export juggernauts, and woefully overvalued for Italy and other Mediterranean states, imposing on them chronic trade deficits.

In the South, imports chronically exceeding exports created huge holes in demand for domestic goods and labor, and deprived national governments of tax revenue. Huge budget deficits became endemic to prop up employment and finance social programs.

The terrible debt now burdening the balance sheets of Mediterranean states is the direct result of flaws in the architecture of the eurozone -- the absence of unified labor market regulations, genuine limits on mercantilist industrial policies, and a fiscal regime to finance benefits for seniors, health care, unemployment insurance and the like. German Chancellor Merkel's disciplines on member country budgets won't fix those imperfections.