Slow reform could bust up eurozone

The eurozone risks breaking up in the near future putting the entire EU single market into jeopardy unless member states – particularly Italy - undertake crucial economic reforms, according to a new report.

Entitled Will the eurozone crack?, the report by the London-based Centre for European Reform, argues that instead of European Monetary Union in 1999 leading to progress in the reform needed for membership of a single currency zone, it resulted in national governments becoming complacent and no longer feeling obliged to push through unpopular economic changes.

The result is that today the 12-nation zone faces a situation where Italy, the laggard among the EU economies that matter, could eventually be forced to leave the common currency because the economic costs of staying in outweigh those of leaving.

"A failure by Italy to regain competitiveness would ultimately bring into question its membership of the eurozone and the sustainability of EMU itself," says the 59-page report which puts the odds of an Italian eurozone exit as high as 40 percent.

Outlining the economic problems facing Italy is a lack of competition across much of the service sector coupled with low levels of investment, the report suggests that Italy's biggest problem may be "that there is no real sense of national crisis, despite the fact that its economy is heading for serious trouble."

It argues that to haul itself out of its "dreadful productivity performance" and persistent high inflation, the country must reform its budgetary process, liberalise the services sector and introduce greater labour market flexibility.

Putting the chances of an economic renaissance in the country at only 20 percent, the report says that if Italy were to leave the eurozone it would probably cause other countries – such as Spain and Portugal – to follow suit, unable to remain inside when confronted with a suddenly competitive Italy.

This would probably lead other member states, such as France, possibly backed by Germany, to ask for trade barriers against Italian imports – a demand, which if not rejected by the European Commission, could lead to the slow collapse of the single market.

To avoid this worst case scenario, the eurozone at the "very least" requires "very flexible labour markets, a high level of competition across all sectors, full integration of the participating economies and sound management of public finances."

Keeping the EMU on the right track will above all depend on changes in Germany, the bloc's biggest member state.

At the moment the country is depending too heavily on export-driven growth, says the report, whereas for the eurozone to succeed it must become a source of demand.

The chances of this happening will, however, depend on the current government's willingness to push through reforms in a hostile popular climate.

"It is not too late to prevent Italy from being forced to leave the eurozone but time is running out," the report concludes sombrely.