Cyprus, Greece, Ireland, Italy, Portugal, and Spain share a problem. With massive debt, no control over monetary policy, and no leeway for fiscal stimulus, they appear headed for a lost decade of high unemployment and low GDP growth. Such a path would drain the political establishment of legitimacy and prevent a real recovery in Europe.
With structural reforms having proved inadequate to deliver sustained growth, a change in the external environment is needed. The most obvious scenario would be for the global economy to grow rapidly enough to rescue Europe from stagnation. But the growth slowdown in emerging economies and mixed economic news from the United States make this unlikely.
Alternatively, the eurozone could change course, stimulating demand, mutualizing debt, and loosening monetary policy. But this would be impossible without Germany, and it is unlikely that the new German government – almost certainly to be led by Angela Merkel again, with Wofgang Schäuble returning as Finance Minister again, will be willing to pursue such a strategy. The problem is that this scenario may well be the only way that the eurozone’s troubled economies can avoid a lost decade. In this sense, any chance at recovery will require skillful foreign policy as much as effective economic policy.