Why collapse of the euro equals collapse of the EU

The end of the euro could mean the end of the European Union

Many statements from senior eurozone policymakers treat the continuation of the euro and continuation of the European Union as much the same thing.  Some of those commenting upon these events dispute that.  They point out that the Single Market was there before the euro.  They imagine that schemes in which Germany and few other countries form an "Eastern euro" whilst France leads a "Western euro" would be compatible with the continuation of the Single Market.

They are wrong.  And it is actually the fact that eurozone breakup (by which I mean any arrangement in which any of France, Germany and Italy ceases to be in a currency union with the others – Greece's quasi-inevitable exit from the euro would not be what I mean by "eurozone breakup") would very probably lead to collapse of the EU that generates most of the costs of that catastophe scenario, rather than the costs of breaking up the euro itself.  It is a grave mistake to imagine that just because the Single Market existed before the euro (and could surely have continued for some considerable time if the euro had never happened) it therefore follows that the Single Market could continue if the euro were to break up.

To understand why Eurozone breakup leads to EU breakup, let's for the sake of the discussion assume that, post-euro, each former eurozone member would establish its own currency.  (Nothing fundamental changes if there are other currency unions, but it makes describing things simpler if we set that aside.)  The way each country would establish its own currency would be (overnight) to pass a law declaring that all contracts established under its national law would be re-denominated from euros into the new national currency (Mark, New Franc, New Lira, etc.).  Any country the currency of which seemed likely to devalue would also introduce capital controls, so that there was not capital flight in fear of devaluation.  Amongst the traditionally higher-inflation countries, the level of devaluation required to create the sort of one-way bet that would not induce capital flight would be so high as to generate inflation - a number of such countries would probably prefer to try to keep their currencies slightly strong and introduce capital controls.

The threat of capital flight would be enduring, so capital controls would not be simply a matter of a day or two.  Capital controls eliminate one of the four pillars of the Single Market – namely the free movement of capital.  That leaves the free movement of labour, goods and services.  With the collapse of the euro, a number of states would be perceived as likely to enter very serious recessions, even just from the costs of euro collapse, such as the collapse of their banking systems – probably accompanied by their brief nationalisation and the introduction of martial law (in violation of a number of human rights provisions under EU Treaties).  Fearing these recessions, there could be large exoduses of workers into states perceived as less likely to have recessions (e.g. Germany, Finland).  The states into which people would want to go would probably close their borders, to avoid swamping; the states from which they were leaving would probably close their borders, to prevent their highest-value workers going in a brain drain.  Thus, free movement of labour would collapse.

The large recessions associated with these events would be unevenly distributed across parts of the economy.  A number of states would be very likely to respond by introducing extensive subsidies of certain industries, in violation of state aids rules.  They would also almost certainly attempt to use government procurement to boost domestic suppliers at the expense of foreign contractors.  Such state aids and preferential procurement would constitute non-tariff barriers, destroying the free movement of goods and services.

These are just a few illustrations of how the Single Market would directly be undermined by the natural responses of countries to collapse of the euro.  And that is before we even start to consider the huge recriminations and antipathy that would arise.  Governments, facing recessions at home, will naturally seek to blame the governments of other countries.  We see this already in the over-heated rhetoric in the Greek and German press.  Actual collapse of the euro would magnify this tenfold.

The EU is most unlikely to continue without the euro.  Sudden and disorderly collapse of the EU would induce a massive further phase of recession.  I happen to think that the UBS figures of 20-25 percent contraction in GDP for strong countries and 50 percent for weak countries are somewhat emotional.  But it would certainly involve a recession on a scale beyond modern experience or comprehension in a Western democracy.

Let's not go there.