No Longer So Hard to Do?

They say that breaking up is hard to do
Now I know, I know that it’s true
Don’t say that this is the end
Instead of breaking up I wish that we were making up again
–Neil Sedaka, "Breaking Up Is Hard to Do"

For years, the nations of Europe appeared to be on an occasionally contentious but steady march towards full-scale integration.

Many pro-Europe supporters argued, in fact, that each step forward made it impossible for member nations to turn back.

However, if the following two reports are anything to go by, it may be only a matter of months before the dream of a united Europe is relegated to the trash heap of history.

First up, from yesterday’s Telegraph, "Breaking Point for the Eurozone?":

Ireland’s ‘miracle’ economy has turned terrifyingly sour – and as it strains against the inflexibility of the euro, its next crisis may shake the entire EU.

 They can barely let the words pass their lips, but some of the EU’s most important policymakers were forced this week to discuss what was once unthinkable: that at least one of the 16 eurozone countries might be on the brink of ditching the single currency.

Jean-Claude Trichet, president of the European Central Bank, admitted that the 10-year-old eurozone was under "extreme strain", with weaker countries struggling to keep their economies afloat in the face of the devaluation of other currencies, such as sterling and the dollar.

Joschka Fischer, Germany’s former foreign minister, darkly suggested that we would soon find out whether the eurozone would turn out to be "a disaster", while the German finance ministry is vacillating on whether it would be prepared to bail out insolvent states.

The current thinking is that Germany and France, as the strongest economies in the zone and "lenders of last resort", would have to bail out failing states: the prospect of the eurozone breaking up would bring the future of the EU into question.

But the most startling fact to emerge this week is that the country which is seen as the most vulnerable, and therefore the most likely to ditch the euro, is not Slovenia, or Cyprus, or Greece, but Ireland.

Until a year ago, the Republic’s Celtic Tiger economy, which attracted such blue-chip companies as Dell, Microsoft and Intel, seemed unstoppable. In a decade, the Irish economy grew by almost 90 per cent, catapulting it from one of the poorest countries in Europe to the fourth-richest per capita. Government advisers from as far afield as Chile and Israel made pilgrimages to marvel at a model that they were desperate to emulate.

Not any more. All of a sudden, Ireland’s debt-fuelled economy, built largely on a construction boom, has collapsed in a more spectacular manner than almost any other in Europe. Irish government bonds are rated as the riskiest in the EU (see graphic), and there has been panicky talk of Ireland as "the next Iceland".

On the streets, there is a whiff of revolution, with 120,000 people staging Dublin’s biggest mass rally in 30 years last weekend to protest at the government’s handling of the economy and its decision to impose what amounted to a pay cut on public sector workers. The unions have now threatened a "Doomsday" strike next month if the prime minister, Brian Cowen, does not think again. As the celebrated Irish economist David McWilliams put it: "The entire Irish episode will be studied internationally in years to come as an example of how not to do things."

So how did it all go so wrong?

Visiting Dublin this week, I took a stroll down the south bank of the River Liffey, to the site where Ireland’s tallest building, the U2 Tower, should by now have been rising out of the ground as the ultimate symbol of the Celtic Tiger’s "economic miracle". Designed by Lord Foster, the 60-storey glass skyscraper was to have housed dozens of one-million euro apartments (£1 million), topped by a penthouse recording studio for Ireland’s most successful band.

Instead, there was nothing to see but dead grass, crushed beer cans and a rusting skip inhabited by 3ft weeds. Two months ago, the developers postponed the project indefinitely. This scruffy patch of former dockland represents the end of the dream for Ireland, whose "economic miracle" was largely based on a crazy construction bubble, fuelled by tax incentives, which, when it finally (and inevitably) burst, created a black hole that threatens to suck in the rest of the failing economy.

In 2006, Ireland (population 4.2 million) built 88,000 houses, compared with 150,000 in the UK (population 60 million). At one point, a fifth of the workforce, swelled by tens of thousands of immigrants, worked in construction.

Irish families on middle and even low incomes cashed in their pensions or borrowed heavily to buy second, third or even fourth properties, believing they could rent them out to the migrant workers who had caused net immigration for the first time in Ireland’s history. They could borrow from banks that enjoyed one of the loosest regulatory regimes in Europe, and which shipped in money from abroad to further stoke up the boom.

Ireland now has up to 350,000 empty homes – more than its entire private rental market – many of them simply abandoned as builders went bust. House prices are expected to fall by 80 per cent.

Ireland might have been able to withstand Europe’s most savage property collapse had not its export trade been shredded at the same by currency devaluation in its two key markets – Britain and America.

The relative rise in the value of the euro against sterling and the dollar has made Irish goods – and wages – prohibitively expensive. Businesses in the north of the Republic are on their knees because competitors in Northern Ireland are undercutting them by as much as half.

In an ominous sign of things to come, the computer firm Dell has announced 250 redundancies at its plant in Limerick, simultaneously confirming that it intends to create thousands of new jobs in Poland.

The slump in the Irish job market means that the country’s youth, who for years now have been able to find jobs at home, are once again having to look abroad for employment, so that the Republic may soon return to its traditional pattern of net outward migration. Already, large numbers of Irish workers are moving to Britain seeking work.

Crucially, the Irish government is powerless to act because, as a member of the eurozone, it has no control over interest rates or currency devaluation.

While the Bank of England could cut interest rates to one per cent and plans to devalue sterling with "quantitative easing", the Irish has to resort to desperate measures to reduce their budget deficit, such as the public sector wage cuts which led to the mass demonstrations.

Evidence of the effect on Ireland’s real economy, as unemployment heads towards 10 per cent, is everywhere.

In Dublin’s docklands, once expected to become a sort of European Dubai, row upon row of kitchen suppliers, interior design and furniture shops have closed since my last visit nine months ago, their windows covered in a thick layer of grime.

Catherine Claffey, whose family have sold flowers at the same pitch in Grafton Street, a few yards from Chanel and Louis Vuitton, for 85 years, told me business was down 60 per cent on last year.

"I’ve only been able to keep going because I’ve never taken out any big loans," she said. "But I have friends earning very modest salaries in the public sector who have been told their wages are going to be cut by 500 euros a month. How are they going to survive?"

A hundred yards down the road, a group of taxi drivers was staging a noisy protest over the government’s failure to manage taxi numbers. Thousands of workers who have lost their jobs in other sectors have been allowed to set up as cabbies, meaning that Dublin now has 16,000 licensed taxis. New York, with a population 17 times as large, has 13,000.

Andy Doyle, a cabbie for 20 years, said: "There are so many taxis now that you can be waiting two-and-a-half hours on a rank before you pick up a fare. Yesterday I waited an hour and three quarters for a 6.20 euro fare. You just can’t live on that. But the government is happy to let it go on because it keeps the unemployment figures down. It’s madness."

The resounding "No" vote in last year’s referendum on the European Constitution suggested that Ireland has finally fallen out of love with Europe. But will it now take the ultimate step and ditch the euro?

Sean Murphy, director of policy at the business organisation Chambers Ireland, believes not.

"Everything positive in the Irish economy for the past 30 years has been driven by our membership of the EU," he said. "In the long term it will continue to benefit us. We have a small, flexible economy, which means we will be able to turn it round much quicker than a bigger economy like the UK’s.

"It’s becoming clear that we need a more balanced, diverse economy, with more jobs in things like alternative energy and information technology. I believe our EU membership can only help with that."

But if the Irish economy, and that of other struggling EU states, continues to nosedive, the cohesion of the eurozone is likely to be tested to breaking point.

And from tomorrow’s New York Times, "Concept of One Europe Is Strained by Financial Crisis":

The leaders of the European Union gathered Sunday in Brussels in an emergency summit meeting that seemed to highlight the very worries it was designed to calm: that the world economic crisis has unleashed forces threatening to split Europe into rival camps.

An urgent call from Hungary for a large bailout for newer, Eastern members was bluntly rejected by Europe’s strongest economy, Germany, and received little support from other countries. Chancellor Angela Merkel of Germany, facing European elections this summer and federal elections in September, said countries must be dealt with on a case-by-case basis.

“Saying that the situation is the same for all Central and Eastern European states, I don’t see that,” Mrs. Merkel told reporters. She spoke after Prime Minister Ferenc Gyurcsany of Hungary warned: “We should not allow that a new Iron Curtain should be set up and divide Europe.”

With uncertain leadership and few powerful collective institutions, the European Union is struggling with the strains this economic crisis has inevitably produced among 27 countries with uneven levels of development. The traditional concept of “solidarity” is being undermined by protectionist pressures in some members states and the rigors of maintaining a common currency, the euro, for a region that has diverse economic needs. Particularly acute economic problems in some newer members that once were part of the Soviet bloc have only made matters worse.

Europe’s difficulties are in sharp contrast to the American response. President Obama has just announced a budget that will send the United States more deeply into debt but that also makes an effort to redistribute income and overhaul health care, improve education and combat environmental problems.

Whether Europe can reach across constituencies to create consensus, however, has been an open, and suddenly pressing, question.

“The European Union will now have to prove whether it is just a fair-weather union or has a real joint political destiny,” said Stefan Kornelius, the foreign editor of the German newspaper Süddeutsche Zeitung. “We always said you can’t really have a currency union without a political union, and we don’t have one. There is no joint fiscal policy, no joint tax policy, no joint policy on which industries to subsidize or not. And none of the leaders is strong enough to pull the others out of the mud.”

Thomas Klau, Paris director of the European Council on Foreign Relations, an independent research and advocacy group, said, “This crisis affects the political union that backs the euro and of course the E.U. as a whole, and solidarity is at the heart of the debate.”

The crisis has implications for Washington, too, which wants a European Union that can promote common interests in places like Afghanistan and the Middle East with financial and military help.

“All of that is in doubt if the cornerstone of the E.U. — its internal market, economic union and solidarity — is in question,” said Ronald D. Asmus, a former State Department official who runs the Brussels office of the German Marshall Fund.

The problems are basically twofold: within the inner core of nations that use the euro as their common currency, which together have an economy roughly the size of the United States’; and within the larger European Union.

The 16 nations that use the euro — introduced in 1999, and one of the proudest European accomplishments — must submit to the monetary leadership of the European Central Bank. That keeps some members hardest hit by the economic downturn, like Ireland, Spain, Italy and Greece, from unilaterally taking radical steps to stimulate their economies.

Germany once vowed never to bail out weaker members in return for giving up its strong national currency, the deutsche mark. But German leaders are now faced with the unpalatable prospect of having to put German money at risk to bail out less responsible partners that do not adhere to European fiscal rules.

Within the larger European Union, fissures are growing between older members and newer ones, especially those that lived under the yoke of Soviet socialism. Some countries of Central Europe, like the Czech Republic and Poland, are doing relatively well. Others, including Hungary, Romania and the Baltic states, are in a state of near-meltdown. But only two newer members — tiny Slovenia and Slovakia — are protected by being among the countries that use the euro, and there was little support on Sunday for changing the rules to allow more to join quickly.

Many new members have seen their currencies plummet against the euro. That has made their debt repayments to European banks, their primary lenders, a much greater burden even as the global recession has meant a plunge in orders from consumers in the West. Some countries are asking for aid, both from their European partners and from the International Monetary Fund, to prop up their currencies and the banks.

While Western European countries are reluctant, with their own problems both at home and among the countries using the euro, there is a deep interconnectedness in any case. Much of the debt at risk in Eastern Europe is on the books of euro zone banks — especially in Austria and Italy. The same is true for the problems farther afield, in Ukraine.

Having watched the Soviet Union collapse, the countries of Central and Eastern Europe embraced the liberal, capitalist model as the price of integration with Europe. That model is now badly tarnished, and the newer members feel adrift. Before the larger summit European meeting on Sunday, the Poles called an unprecedented meeting of nine of the new member states in the East to discuss common grievances.

Prime Minister Mirek Topolanek of the Czech Republic, which holds the rotating presidency of the European Union, tried to ease tensions, insisting that no member would be left “in the lurch.”

“We do not want any dividing lines; we do not want a Europe divided along a north-south or east-west line, pursuing a beggar-thy-neighbor policy,” Mr. Topolanek said.

But his Hungarian colleague, Mr. Gyurcsany, called for a special European Union fund of up to $241 billion to protect the weakest members. His government circulated a paper on Sunday suggesting that central Europe’s refinancing needs this year could total $380 billion.

“Failure to act,” the paper said, “could cause a second round of systemic meltdowns that would mainly hit the euro zone economies.”

Mrs. Merkel, however, opposed an undifferentiated package, although she suggested on Thursday that targeted help might be offered to specific countries, like Ireland.

Governments of the countries of the European Union have already spent a total of $380 billion in bank recapitalizations and put up $3.17 trillion to guarantee banks’ loans and try to get credit moving again.

On Friday, the European Bank of Reconstruction and Development, the European Investment Bank and the World Bank said they would jointly provide $31.1 billion to support Eastern European nations, but much more will be needed.

Mr. Klau, of the European Council on Foreign Relations, sees a worrying loss of faith in a certain brand of capitalism. “It’s politically dangerous there since they’ve just emerged from an ultraregulated and stifling system, were confronted with shock therapy that created great hardship, and are just beginning to recover and stabilize,” he said. “Now they’re thrown back into an economic and political cauldron.”

The new members are finding that their European partners are putting their own national interests ahead of “collective and necessary solidarity,” Mr. Klau said.

Charles Grant, director of the Center for European Reform, a research group in London, is more sanguine, however. “My expectation is that the euro zone countries, out of pure self-interest, will bail each other out,” he said. “For Central and Eastern Europe it is too early to say there won’t be solidarity. But non-E.U. countries in the east — particularly Ukraine — seem to be the No. 1 worry.”