The driving force of Europe's economic policy is the "European project" of political integration. That goal is reflected in the EU's current focus on creating a "fiscal compact", which would constitutionalise member states' commitment to supposedly inviolable deficit ceilings. Unfortunately, the compact is likely to be another example of Europe's subordination of economic reality to politicians' desire for bragging rights about progress towards "ever closer union".
The plans for a fiscal compact have evolved rapidly in recent months, shifting from a politically unpopular "transfer union" to a dangerous plan for fiscal austerity and, finally, to a modified version of the defunct Stability and Growth Pact of 1997. In the end, the agreement that will emerge this year will do little, if anything, to change economic conditions in Europe.
Angela Merkel, the German chancellor, initially proposed the "transfer union", in which Germany and other strong euro-zone economies would transfer funds year after year to Greece and other needy countries, in exchange for the authority to regulate and supervise the recipient countries' budgets and tax collections. The German public rejected the idea, while Greek officials and the Greek public rejected the idea of German control over their country's fiscal policy.
The next step was the fiscal plan that was agreed on in Brussels at the end of last year, which abandoned a transfer union in favour of an agreement that each euro-zone country would balance its budget.
But how, exactly, should the balanced-budget requirement be defined? Jorg Asmussen, the German member of the European Central Bank's executive council, stressed that a balanced budget meant just that. Even if a country ran budget deficit because a cyclical downturn caused a fall in tax revenue and an increase in social transfers, it should be required to raise taxes or cut spending to restore a balanced budget.
Fortunately, this recipe for creating future European depressions was rapidly dropped.
The most likely form of the fiscal compact now seems to be a mild agreement requiring each country to "balance its budgets over the business cycle". Failure to comply would in principle lead to automatic financial penalties, but it is difficult to imagine how such failure could be determined in a country such as Spain. At what future point would Spain, with a persistent unemployment rate of more than 15 per cent, be required to raise taxes and cut social transfers? Ordering Spain to do so might rest with the European Commission, making it a political decision, rather than the "automatic" technical requirement that its proponents promise.
If this is the essence of the fiscal compact that is eventually agreed on, it will have no predictable effect on euro-zone countries' behaviour. Its only effect will be to allow the euro-zone's political leaders to claim that they have created a fiscal union and moved Europe closer to the political union that is their ultimate goal.
But a fiscal union conceived in this way is completely different from how most people understand the term. In the US, the central government collects about 20 per cent of the country's GDP and pays out a similar amount. That centralisation of taxes and spending creates an automatic stabiliser for any region that experiences an economic downturn.
There is no similar process in the euro zone. Although the current European political process will not create strong fiscal discipline, financial markets are likely to force euro-zone governments to reduce their sovereign debts and limit their fiscal deficits. In the single currency's first decade, private investors' belief in the equality of all euro-zone sovereign bonds kept interest rates low in the peripheral countries, even as their governments ran up large deficits and accumulated immense debt. Investors will not repeat that mistake.
Financial markets will now enforce what the euro-zone political process cannot achieve. The EU's fiscal compact, whatever its final form, will be little more than a sideshow.
Martin Feldstein, a professor of economics at Harvard University, was chairman of president Ronald Reagan's council of economic advisers and is a former president of the US national bureau for economic research
* Project Syndicate