Europe’s chaotic political landscape is doing an excellent job of exposing a fundamental flaw in the euro area: the lack of a mechanism to revive growth in hard-hit economies.

Recent elections in Greece, France and Italy, where anti-austerity candidates made major gains, have demonstrated the failure of policies that seek to solve the euro area’s debt problems through spending cuts and tax increases alone. Economic strife has brought Greece to the brink of a political breakdown and exit from the euro ― a move that could trigger contagion throughout the currency area and have dire repercussions for the entire European project.

Economists have long warned that the euro area would be prone to such disasters. The member states’ economies are too out of sync to be considered an “optimum currency area.” Prices, wages and the flow of people across borders are not dynamic enough, a shortcoming that can be fatal unless the currency union has a powerful shock absorber. In the currency area known as the U.S., for example, federal transfers such as income-tax credits help struggling states catch up, cushioning as much as 40 percent of the blow of economic downturns.

The obvious remedy for Europe’s deepening problems, then, is to restore the growth needed to bolster tax revenue and reduce budget deficits, thus making debts more sustainable. The victory of Francois Hollande in France’s May 6 presidential election suggests that many Europeans, in their own way, recognize this. Sadly, talk of a new “growth pact” among European officials has so far lacked the necessary substance.

Some of Europe’s leaders, particularly in Germany, think the pact should be mainly a recommitment to stalled structural reforms. They have a point: The region’s lagging economies need to make it easier to fire workers, so businesses can restructure more quickly and prices and wages can fall to competitive levels. In France, for example, businesses are often afraid to hire because it can take years to get rid of unwanted employees.

Such reforms, though, will only inflict more pain in the near term unless they are combined with stimulus measures. Officials have signaled a willingness to ease the harsh deficit targets set out in Europe’s recently forged fiscal pact, and to boost public-works spending through the European Investment Bank. These temporary measures will have only a limited effect, and won’t help fix the euro area’s flaws.

It would be folly to expect Europe to build a full system of federal transfers, like that in the U.S., in time to save the common currency. But a new proposal by two economists ― Jacques Delpla of France’s Conseil d’Analyse Economique and Pierre-Olivier Gourinchas of the University of California, Berkeley ― suggests a way forward: Euro-area countries could create a common unemployment-insurance fund, which would give struggling members an economic boost as they liberalized their labor markets.

The system would funnel money precisely to the people and countries that need it most, and precisely when they need it.

Countries that chose to join would make an annual contribution equivalent to roughly 1 percent of their gross domestic product, while countries experiencing high unemployment could tap the fund for much more than that amount. Delpla estimates that net payments to Spain, where the unemployment rate is approaching 25 percent, could be as much as 2 percent to 3 percent of GDP. That might be enough to lift the economy out of recession.

Crucially, the system wouldn’t be another form of budget support, or a return to the European welfare state. Rather, it would circumvent dysfunctional national bureaucracies by offering a new, voluntary European labor contract directly to workers. Employers throughout the euro area could simply download the contract, which would represent ― and require ― a radical change in most countries’ employment laws.

If workers signed up, they would immediately be easier to fire, and, if fired, would have to enter a retraining program or demonstrate persistent efforts to find a new job. In return, they would be guaranteed severance pay commensurate to seniority and receive European unemployment benefits on top of what their national governments provide. An unemployed Greek store clerk, for example, might get 1,000 euros a month from the insurance fund in addition to Greek unemployment benefits, which are less than half that.

To provide an immediate boost, countries could allow the unemployed to sign up right away. The payments from a unified fund could sharply change attitudes toward the European Union among the hardest-hit Greeks, Portuguese and Spaniards, providing the political glue needed to hold the European project together.

There is, of course, a catch: Germany and other relatively well-off countries will balk at the idea of direct transfers to stricken nations. So far, their support has come almost exclusively in the form of loans. Monitoring job searches and training programs in recipient countries could also be a challenge. But the fund pays nothing unless workers sign up for labor reforms, and the cost is reasonable ― about 26 billion euros a year for Germany, or about 320 euros per German. Beyond that, the system works both ways: At some point, Germany and other northern European countries could find themselves on the receiving end. In the long run, rich countries should contribute no more, as a share of GDP, than do poor countries.

Eventually, Europe will have to forge some kind of fiscal union if it wants the common currency to survive. Given the imminent risk and potentially devastating cost of a euro breakup, the region’s leaders would be wise to take a step in the right direction now.

(Bloomberg)