Will 2012 be the make-or-break year for the Euro?

Could 2012 be the beginning of the end of the European Union? Could it herald a return to the dark ages of European nationalism, or will it present an opportunity for courageous reforms and deepening integration? What started as a contained fiscal challenge at Europe’s periphery has now engulfed the entire continent and threatened the stability of the world economy.

While Eurozone governments have taken important steps over the course of 2011 to address the escalating debt crisis, they failed to spell out a long-term vision for the future of Europe. The timing and extent to which these steps will be implemented remains unclear and significant uncertainty arises from the perceived imbalance between enforcing fiscal responsibility and promoting long-term economic growth across the Eurozone.

Such muddling through is no longer an option in 2012, which could well be the “make-or-break” year for the euro. To act boldly, policy-makers need to adopt a shared view of the challenges.

Over the last eight months, the World Economic Forum has facilitated strategic conversations around the Eurozone crisis to understand the perspectives of different stakeholders and what can be done to contribute to a lasting solution. This work has highlighted an interesting contradiction – although the structural dynamics that have fuelled the crisis are clear, a lack of shared understanding among stakeholders is hindering an effective response to the crisis. The figure below outlines the central dynamics of the crisis, which include:

• Peripheral countries have experienced a relative loss of competitiveness following the adoption of the euro. Long-term interest rates fell and removed liquidity constraints for corporations and households, driving credit growth. Simultaneously, wage growth and lack of structural reforms drove up external deficits and fuelled capital misallocation to the non-tradable sector, such as construction and real estate.
• The Eurozone as a whole has accumulated large internal macro-financial imbalances. Capital outflows from core countries that built up significant surpluses were as much a driver of this dynamic as unsustainable fiscal policies in some periphery countries that took advantage of decreasing borrowing costs.

A comprehensive strategy for stabilizing the currency union needs to focus on all these aspects of the system, rather than merely addressing the symptoms. In 2012, Europe’s leaders have to put in place a governance model that lastingly fixes these structural tensions while simultaneously putting the European Union back on a path of economic growth and innovation.

The Annual Meeting in Davos-Klosters will provide an opportunity for spelling out those strategies and work towards a common vision for the way forward. German Chancellor Angela Merkel will kick-start the discussions with her opening address, followed by discussions with incoming European Central Bank President Mario Draghi, as well as by a number of interactive sessions with finance ministers, central bank governors, CEOs from financial institutions, civil society leaders and academic experts from across the world.

The Annual Meeting 2012 will be the launch pad for a make-or-break year for Europe.

Related World Economic Forum Initiatives:

Global Agenda Councils (Fiscal Crises, International Monetary System)

Liana Melchenko
Associate Director, Global Agenda Councils

Global Agenda Council on Europe & Remodelling Europe Initiative

Stephen Kinnock
Director, Head of Europe