After a week in which the EU took drastic measures to wrest the initiative from financial markets, EU leaders are finally using a debt crisis to launch painful reforms that could prevent it becoming a spent force. After weeks of failing to resolve Greece's debt problems, the EU agreed its part in a $1-trillion rescue fund for euro zone countries early on Monday, and Spain and Portugal have bitten the bullet since then by announcing austerity plans. The unveiling of European Commission proposals for tighter budget discipline has also shown Europe is at last getting to grips with a crisis which German Chancellor Angela Merkel says is an “existential test” for the euro zone and the 27-nation EU. “There is still a long way to go. We have opened the gate. Now we have yet to go through it,” said Ulrike Guerot, an analyst at the European Council on Foreign Relations think-tank. “The crisis has shown us we need to animate moves towards closer political union as well as monetary union and we need a quantitative jump. The EU has used crises in the past to make that kind of jump and this is what is needed now.” The big leap may have been agreement on a “Special Purpose Vehicle” with funds of 440 billion euros to provide loans for euro zone states and an extra 60 billion euros set aside for countries with balance of payments problems. For the first time in the crisis, the EU appears to be getting ahead of the curve and has the support of the International Monetary Fund and the European Central Bank. It has bought itself some time to tackle long-term challenges, but needs to use that time well. “They've reached a very impressive and significant agreement that gives them some respite, some time,” said Uri Dadush, head of the International Economics Program at the Carnegie Endowment for International Peace in Washington. But he added: “The real decisions needed to deal with Europe's crisis have to be taken in Portugal, Spain and Italy. They won't get anywhere without going through enormous pain.” New start Policy announcements this week by two vulnerable countries in the 16-state euro zone pointed to the new sense of urgency in the EU, which represents 500 million people. Spain announced measures on Wednesday including five percent reductions in civil service pay and job cuts, and Portugal drew up steps on Thursday to reduce its budget deficit, including five percent pay cuts for top public sector staff and politicians. Greece had earlier announced its own austerity plans. The moves reflect the understanding that hit many EU leaders last week that matters had got out of control and the future of the euro zone was at stake because of financial markets that Sweden's finance minister likened to “wolf packs”. “We were totally unprepared for what was happening. It was clear by the end of the week that we had to act,” one senior EU official said of the EU's decision to change tack. The European Commission, the EU executive, showed its determination to avert more crises by announcing proposals on Wednesday to toughen sanctions against states that miss fiscal targets and to assess national budgets before parliaments. Some of these proposals ruffle feathers in France and Germany but Paris and Berlin signaled they went in the right direction. This could be the fuel injection needed to put Europe on course towards closer political and economic union, the goal that drove its founding fathers and leaders a generation ago such as Germany's Helmut Kohl, France's Francois Mitterrand and former European Commission President Jacques Delors. But plenty of tensions lie ahead because France favors tighter economic governance, or more central control, and Germany resists this. Without the two biggest economies and most powerful political forces on board, EU policies rarely work. “The crisis has generated a fiscal consolidation consensus in Europe. And there will be mechanisms to enforce fiscal reforms. In broad terms this consensus will hold in for the rest of 2010,” said Keat Preston of the Eurasia research group. “But there will also be serious tensions, particularly in the intermediate term. At the strategic level, Germany and France still have fundamentally different views about how to manage the tradeoffs between inflation and growth and this will continue to inform their approaches to fiscal reform.” Long-term challenges remain An important challenge is restoring economic growth, now running at about one percent annually and expected to grow more slowly than the United States and emerging economies such as China in the next few years. Despite the time created for countries to turn around their economies, they have probably only 18 months to meet or at least come close to meeting targets they have announced to cut their budget deficits and may face tough obstacles. A group of elder statesmen said in a report on May 8 that strong political will, solidarity and leadership were needed to enable the EU to reform rather than decline. This is going to be hard with leaders under pressure from voters to go easy on some of the tough medicine that is needed to tackle labour reform, economic imbalances between strong and weaker states, demographic changes that will reduce the taxpayer base and an over-dependence on Russia for energy. A report by former EU Competition Commissioner Mario Monti called for concessions by all sides to protect the EU's single market for free movement of people, goods, services and capital which is the cornerstone of EU prosperity. “This is the last chance to still be relevant in the world,” said Hans Martens, chief executive of the European Policy Centre think-tank in Brussels. “It's clear to everyone that Europe is becoming marginalized.” For all the signs of a more united approach after weeks of divisions and weak leadership, the EU has a long way to go. “Europe faces a critical choice between greater integration and disintegration,” Simon Tilford, chief economist at the Centre for European Reform think-tank, wrote this week. “Unless the reality is brought into line with the rhetoric, the euro zone will unravel.”
