A eurozone beyond saving

Global markets watched with a growing sense of despair as European leaders remained at loggerheads ahead of an important summit later this week.

German Chancellor Angela Merkel again vowed that she would not be pressured by France, Italy and Spain into guaranteeing eurozone debts and bank deposits, saying that this would be "economically wrong and counterproductive”, as well as running counter to the German constitution.

"It's not a bold prediction to say that in Brussels most eyes – all eyes – will be on Germany yet again,” she lamented at a conference in Berlin. "I say quite openly: when I think of the summit on Thursday I'm concerned that once again the discussion will be far too much about all kinds of ideas for joint liability and far too little about improved oversight and structural measures.”

Merkel argues strenuously that Berlin can only agree to underwrite the debts and deposits of eurozone countries if Paris, Rome and Madrid agree to hand over much more budgetary and banking control to Brussels – a move they are reluctant to make. "Liability and control have to be in balance,” she stressed again overnight. "The goal has to be a political union in which the standard is whatever is the best, not mediocrity.”

Berlin will no doubt feel that its hardline stance is vindicated by a leaked internal report from the 'troika' – officials from the European Union, the European Central Bank and the International Monetary Fund – that highlights the desultory efforts that debt-laden Greece has made to reduce its bloated public service.

According to the report, published in the Greek weekly To Vima, the previous Papandreou government did not stick to the formula of only hiring one new public servant for every five retirees (changed to one for 10 in June 2011) that it agreed to in exchange for receiving its first bailout. Had it done so, there would have been 8,000 new recruits in the Greek public service. Instead, there have been 16,711.

According to the report, Greece had 692,301 salaried public servants in 2010, and 668,035 in 2011 – a reduction of only 24,000 even though 40,000 public servants retired in the period. What's more, the report says this figure only includes those on a monthly salary, and doesn't include those on fixed-term contracts, those being paid by the hour, political appointees and elected officials working on specific projects.

The Papandreou government's efforts to save money by merging local governments were equally ineffective. The reforms resulted in an extra 4,500 people working in local administration – an increase of 5 per cent. The report notes this was "a remarkable result”, given that the mergers were supposed to generate €1.5 billion in savings, partly from reduced staff costs. Similarly, Greece's Ministry of Culture – which has cut the opening hours of many archeological sites because of staff shortages – saw its staff levels rise by 2.7 per cent, as Greek railway workers were transferred across.

The publication of the report comes at an unfortunate time for Athens, which is scrambling to find a replacement for its finance minister, Vassilis Rapanos, who resigned for health reasons overnight. The new finance minister will be charged with the task of trying to negotiate the austerity regime imposed on Greece in exchange for the country's latest €130 billion bailout. The new Greek coalition government wants "at least two years” more to achieve its budget reduction targets, and a freeze on further public sector layoffs.

Meanwhile, the gloomy mood now blanketing Europe has been captured by the German publication der Spiegel, which is running a cover story "Wenn der Euro zerbricht” in its latest edition.

According to der Spiegel, "investment experts at Deutsche Bank now feel that a collapse of the common currency is "a very likely scenario." German companies are preparing themselves for the possibility that their business contacts in Madrid and Barcelona could soon be paying with pesetas again. And in Italy, former prime minister Silvio Berlusconi is thinking of running a new election campaign, possibly this year, on a return-to-the-lira platform.”

According to the article, economists at the Dutch bank ING have calculated that output in the eurozone would crash by 12 per cent in the first two year's after the euro's collapse – a loss of more than €1 trillion. But a study commissioned by Germany's finance minister, Wolfgang Schuble, came up with an even grimmer forecast. The German finance ministry calculated that in the first year after a euro collapse, the German economy would shrink by up to 10 per cent, while more than 5 million people would be unemployed. "The officials were so horrified by their conclusions that they kept all of their analyses under lock and key, for fear that the costs of rescuing the euro could spin out of control,” der Spiegel notes.

Der Spiegel highlights the invidious choice facing Berlin. "German citizens haven't recognised yet what an abyss they are facing. If the euro collapses, not only will many people lose their livelihoods, but German retirement pensions will also be threatened. The economic success of the last few years would be destroyed, and Germany would fall back into the crisis status of the 1990s.”

But, it adds, "if the German government gave in to the Southern Europeans' pressure to communitize debt, the risks could even be greater. Instead of an uncontrolled euro crash, Germany could be confronted with an uncontrolled transfer union. Year after year, the Germans would have to transfer sums in the double-digit billions to Southern European countries.”

Der Spiegel concludes that saving the eurozone is possible, but it is a massive task. It requires European politicians agreeing to surrender power to Brussels, and for Italy and Spain to prove that they can reform and modernise their economies.