Europe's future: division or unity?

The eurozone is on the brink of a new recession as Italy and Greece are engulfed by a crisis which is now threatening the core of the single currency area – leaving European Union leaders to consider the very future of monetary union. But though they are united in calling for closer cooperation in the eurozone there appear to be divisions about how to achieve the goal and whether a two-speed Europe could function.

The European Commission said today that the eurozone could face recession next year, and downgraded its growth forecast for 2012 to 0.5 per cent from 1.5 per cent. Italy, with debts of nearly €2tn, has been plunged deeper into crisis as the yield on government bonds soared above the 7 per cent mark that led Greece, Ireland and Portugal to seek an international bail-out. And the ongoing political uncertainty in both Italy and Greece, with both prime ministers Silvio Berlusconi and George Papandreou stepping down, has caused turmoil on markets.

Italy, as the world's eighth largest economy, is considered too big to rescue and Reuters has reported that officials in Germany and France are making theoretical plans for some countries to leave the eurozone and for the remaining members to cooperate more closely – though both countries have denied this. Chancellor Angela Merkel has described the current state of affairs as "unpleasant" and called for a "breakthrough to a new Europe". She said: "Because the world is changing so much, we must be prepared to answer the challenges. That will mean more Europe, not less Europe." She is thought to favour treaty changes giving the EU more powers to enforce fiscal rules and prevent countries from building up massive debts and deficits.

A two-speed Europe is the inevitable outcome of the crisis, according to French President Nicolas Sarkozy. During a debate with students at the University of Strasbourg, he said that a single currency required economic convergence and integration. But he warned that federalism within the wider EU was not possible, particularly when in the coming years western Balkan countries join. "I imagine that nobody thinks that federalism, total integration, is possible at 33, 34, 35, countries," he said. There would be "two European gears," Sarkozy predicted, "one gear towards more integration in the eurozone and a gear that is more confederal in the EU."

France's triple-A credit rating has been under pressure as the debt crisis has spread towards the eurozone core, and Sarkozy accepted that there had not been enough convergence among countries that joined the single currency from the outset. "Frankly, the single currency is a wonderful idea, but it was strange to create it without asking oneself the question of its governance, and without asking oneself about economic convergence," he said. "Honestly, it's nice to have a vision, but there are details that are missing: we made a currency, but we kept fiscal systems and economic systems that not only were not converging, but were diverging."

However, a "split union will not work" and the EU remains "our best chance of prosperity" – in the view of commission President José Manuel Barroso. "To create the idea that we have two unions means disunion. It means separation of the members of euro area from those who are not yet members of the euro area," he said, adding that the challenge was to deepen euro area integration without creating divisions between the ins and outs. "One thing we don't need in Europe is more institutions and more agencies and more entities to manage the euro". Barroso said that deepening convergence must involve deeper democracy.

"European democracy must be furthered by enhancing the relationship between national democratic processes and the European democratic process. This will be the best way to involve our citizens in the decisions we take." The president laid out a grim future in the event of the EU breaking apart. "The costs have been estimated at up to 50 per cent of gross domestic product in an initial phase. It is estimated that Germany's GDP would contract by 3 per cent and it would lose one million jobs if the euro area were to shrink to a few core member countries."

Barroso's counterpart at the European Council, Herman Van Rompuy, said in a speech in Switzerland yesterday that the EU was "dealing with the remainder of an ill-managed past". He insisted that the aim was to keep all 17 members of the eurozone "on board". Without committing to either side, Van Rompuy said there was a "real debate about the way forward: some member states seem willing to accept a further pooling of sovereignty, in particular in budget oversight, in order to create a more stable financial environment for all of us".

Non-euro countries are concerned at being left out of key economic decisions if those that use the single currency create a "club within a club" – as British Deputy Prime Minister Nick Clegg called it in a speech in Brussels yesterday. Although supporting fiscal integration in the eurozone, he warned: "As the eurozone restructures, we may need to consider safeguards. And decisions that affect the 27 must always be taken by the 27. We must continue to use the community method, guaranteeing a voice for every member state and retaining the role of the commission as the guardian of the treaties." He said the greatest danger for the EU was division.

But simply creating stricter rules to enforce discipline will not solve the problem, a new study by analysts at the Centre for European Reform claims. In a report published today Simon Tilford and Philip Whyte argue that the crisis not a result of the "errant behaviour" of a few countries and that monetary union held together by a set of rules rather than full fiscal union is "deeply unstable". They write: "The eurozone will remain an unstable, crisis-prone arrangement unless critical steps are taken to place it on a more sustainable institutional footing. But it is equally clear that European politicians have no democratic mandate in the short term to take the steps required.

"The reason is that greater fiscal integration would turn the eurozone into the very thing that politicians said it would never be: a transfer union, with joint debt issuance and greater control from the centre over tax and spending policy in the member-states." Maintaining the "fiction that confidence can be restored by the adoption and enforcement of tougher rules" will "condemn the eurozone to self-defeating policies," they warn. Instead some rules should be broken in the short-term, they argue, allowing the European Central Bank to buy as much Spanish and Italian debt as necessary – so far it has made only limited bond purchases to control bond yields.

Meanwhile in Italy the appointment of Mario Monti, a former European commissioner, as senator for life has been widely interpreted as a signal that he may be asked by President Giorgio Napolitano to lead a transitional government once Berlusconi leaves office. And in Greece a new administration led by former vice-president of the ECB Lucas Papademos will be sworn in tomorrow following days of tense negotiations.

After accepting the post Papademos said: "Greece is at a crucial crossroads. The choices that will be made and the policies that are enforced will have a decisive impact on the well-being of Greeks. The days ahead will not be easy but the problems can be solved and will be solved if there is unity, cooperation and consensus."