Europe's peripheral vision.

• Author: Ezrati, Milton
• Position: Structural economic reform in Europe

It's too soon to pop the champagne corks. Europe, mired in gloom for years, still faces many high hurdles to resolve its crisis. Nonetheless, there are some auguries of prosperity that might invite a stockpiling of party hats and noisemakers. In December 2013, Ireland successfully emerged from its bailout, and Portugal followed this May. This verifiable progress represented a first for members of Europe's struggling periphery. But this news should only lift spirits so high. If these financial gains make anything clear, it is the need now to go beyond budget control to more fundamental and structural economic reform. Ireland's finance minister, Michael Noonan, summed up the situation well, characterizing his nation's emergence from the bailout as a "milestone," not the "end of the road." To secure their economic and financial future, Ireland, Portugal, the rest of Europe's periphery and France (which increasingly resembles the periphery) will have to reform long-standing labor, product and tax practices, and even industrial structures, to promote rather than impede organic growth. These nations must do nothing less than reshape the political-economic models under which they have operated for decades.

Such structural reform has huge significance. Success or failure on this front will effectively determine power relationships throughout the euro zone and the European Union. German dominance, even hegemony, will expand if France and the nations of Europe's beleaguered periphery fail to enact fundamental economic reform. Without it, they will remain economically weak, financially fragile, dependent on Germany and subject to its lead. With effective reform, however, France and the periphery have a chance to regain economic vitality and shed the need for German support. These are the options. Ironically, all the initiative lies with the weaker countries. Germany is bound to the union. It will have to play the hand France and Europe's periphery deal it. They will determine whether Berlin gains dominance or whether Europe can restore its former balance.

For all that remains to be done, Dublin, Lisbon and Brussels are entitled to some rejoicing. In 2009, Ireland and Portugal were insolvent. Each country's ongoing budget deficit ran at more than 10 percent of its gross domestic product (GDP). They had to pay double-digit interest rates to borrow on global capital markets, an expense that intensified their financial strains. The official bailout lifeline, 85 billion [euro] for Ireland and 78 billion [euro] for Portugal, bought time for needed budget reform. It also enforced it. Unlike in the ad hoc arrangements made for Greece, Europe was much better organized when it moved on to Ireland and Portugal. Germany and other stronger nations pooled their resources in what they called the European Stability Mechanism, which then, in concert with the International Monetary Fund (IMF) and the European Central Bank (ECB), supported the bailouts. This troika, as it is called, offered subsidized financing in a series of tranches, each conditioned on certain budget and deficit milestones. And the process can claim success. Now, Ireland expects deficits at 4.7 percent of GDP in 2014 and Portugal at 4.0 percent. The improvement has allowed both governments to return to capital markets, where investors have shown considerable interest in their bonds, allowing them to borrow at significantly reduced interest rates.

Gratifying as this success is on one level, it has undeniably come at a terrible cost. The budget austerity demanded by the troika has driven both Ireland and Portugal into deep recessions, especially coming, as the bailout demands did, while these economies were still reeling from the 2008-2009 financial crisis. Unemployment in Portugal remains a heartbreaking 14.3 percent of the workforce. In Ireland, unemployment, having peaked at 15 percent of the workforce in 2012, has improved to about 11.6 percent, but more from mass emigration than economic gains. Worse, ongoing austerity threatens to keep these economies in recession or stagnation at best. Indeed, continued austerity runs the risk of creating a vicious cycle in which the budget restraint so depresses the economy that, despite the best efforts of the authorities, slow growth and additional demands for social services en large budget deficits, eliciting more austerity that causes more recession, more budget problems and so on in a downward spiral.

What makes matters even worse is that there is little room for fiscal latitude. Even now, as these countries emerge from troika controls, Ireland and Portugal know that promoting growth and employment through expansive fiscal policies, as France has suggested on occasion, is out of the question. Though they have regained control over their ongoing budget situations, they cannot so easily shed the legacy of past profligacy. Because this legacy has created suspicion among investors and left capital markets with a huge overhang of their debt, the slightest hint of a turn away from austerity now would panic investors. The same constraint applies throughout Europe's...