Economic theory explains why a single European currency didn’t bring geographical convergence—but only political action can realise that.

Covid-19 is first of all a health crisis. Its economic consequences, however, are no less severe. Given the pandemic’s uneven progression across Europe, unequal fiscal starting points geographically and this month’s ruling by the German constitutional court, the coming months and years will put the eurozone to the test once more.

In its current architecture, the eurozone is a web of glass—superficially stable, but brittle when subject to shocks. To avoid a break-up and render it resilient for the long term, the sources of this fragility must be identified and remedied.

Fundamentally, they are political. Technical proposals for rendering the eurozone robust have been tabled time and again: a eurozone investment budget, a European deposit-insurance scheme, a proper eurozone unemployment-(re)insurance system, the issuance of joint- and several-liability eurobonds. And, time and time again, these have been discussed, diluted and typically disposed of in a drawer.

The truth is there is insufficient trust to move forward. Resilience requires risk-sharing; risk-sharing requires trust. Trust, however, has been eroded by disappointment—disappointment that a decade of austerity has failed to reduce debt, disappointment that two decades of the euro have failed to bring convergence.

Promise unfulfilled

At Maastricht in 1992, the contracting parties ‘resolved to achieve the strengthening and the convergence of their economies’. A ‘single and stable currency’, backed by low inflation, small budget deficits and falling ratios of public debt to gross domestic product, was supposed to contribute to long-term convergence of living standards—across all regions.

This promise has not been fulfilled. On the contrary, the eurozone has been drifting apart—since long before the current crisis. While in 1999, GDP per capita in northern Europe was around €2,000 above the eurozone average, by 2019 it was €4,500 higher. Conversely, Italy and other southern-European countries have lost ground, from about €4,000 below the eurozone average in 1999 to €7,500 below 20 years later. Instead of shrinking, the gap has doubled.

Economics helps explain why the member states are diverging. Successful companies tend to cluster in areas with lots of other high-productivity, high-value-adding companies. Even though wages, rents and other costs may be lower elsewhere, companies prefer clusters because they offer strong regional labour markets, supplier and customer networks, research-and-development spillovers and other synergies. Successful hubs have a head start and they extend their lead over time.

This mechanism has been acting continuously—and visibly—in the eurozone over the last two decades. The results speak volumes: the promise of convergence has not been kept.

One way forward would be to acknowledge this, to abandon the promise and to downgrade expectations. This would align words with outcomes but it would weaken the euro’s legitimacy and damage its reputation. Doubts about the future of the currency might lead international investors to divest and the euro’s role as a driver of European integration would be lost. It is unclear, at best, whether the single currency would survive.

Matching words and actions

A better way forward is to reaffirm the promise and match the words of yesterday with the actions of tomorrow. Only thus can trust be restored and the euro endure.

Fostering convergence through permanent fiscal transfers is neither politically nor economically viable. Even in the past, proposals along these lines failed to find majority support; there is little to suggest this will change after the coronavirus crisis. And within-country experiences in Germany and Italy show that income transfers alone—whether through pensions, unemployment insurance or welfare payments—do not lead to underlying economic convergence among regions.

A more promising approach is to even out the regional distribution of value added. Andalusia, the Uckermark and metropolitan areas such as Naples or Thessaloniki should be brought to similar levels of productivity as Munich, Milan or the Amsterdam metropolitan area.

The tools exist—lacking is the political will and ambition. A European industrial strategy, or the co-ordination of national ones; targeted investments in infrastructure, research and development and key technologies; a rethink of European Central Bank policy, possibly with regional differentiation; a European investment budget deserving of the name—all these could help upward convergence across the regions, not by redistributing the fruits of growth but by spreading economic activity more evenly.

Industrial policy

The Green New Deal could be the framework and Silicon Valley the model for a European convergence project. Just as the United States government has strengthened the valley through public investment, particularly in high technology, structurally weak parts of the eurozone could be promoted through similar approaches. Mariana Mazzucato is a valuable source of inspiration: a European industrial policy could deliberately place parts of green and strategic value chains—battery production, medical supplies or green mobility—in structurally weak regions. Public procurement, particularly for high-value products, could be used just as strategically.

Countries such as Japan, Taiwan, or South Korea provide valuable lessons in how to ensure the effective use of public funds. By linking public support to success in export markets—an indicator which is hard to game—these countries have succeeded in concentrating state funds on promising companies, avoiding waste and corruption.

Of course, much remains unknown about how to drive the regional distribution of value added. Compared with national and supranational regulatory, fiscal and monetary policy, geographic targeting of economic policy has long been a low research priority.

In particular, we know very little about whether and how monetary policy could be implemented in a regionally differentiated manner—even though regional deviations from the ECB’s inflation target are bigger than deviations from the average over time. (In 2019, for example, annual inflation ranged from 0.4 per cent in Portugal to 2.8 per cent in the Netherlands and 3.2 per cent in Slovakia, while the monthly average for the eurozone as a whole moved only between 0.7 and 1.7 per cent.) To flank a political convergence project, an appropriate research programme is needed.

In any case, the future of the eurozone requires a political decision: either we abandon the euro’s promise or we recommit to it. If the latter, then a political and economic convergence project must follow. Only thus can we achieve sustainable prosperity for all.

And only thus can we renew the faith of the citizenry in European integration.

An earlier version of this piece appeared in German in the Frankfurter Allgemeine Zeitung