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Four scenarios for Europe - scenario 4: 'Two-speed' Europe

Economic Report


More cooperation, but less Europe

To overview page future scenarios for Europe

  • The Member States decide amicably to change the composition of the eurozone
  • Some countries leave in a process controlled by the ECB, but retain access to the Single Market
  • The remaining countries intensify their cooperation economically, politically and militarily and form a ‘core union’
  • Initially, economic growth slows in the Netherlands and unemployment rises, but ultimately economic growth is higher and unemployment lower than in the muddling through scenario

Keynote: less unity leads to more diversity

Following the negative result of the Brexit referendum, a resounding electoral victory for the Five Star movement in Italy in the second half of 2017 and a strong rise in popularity by the communists in Portugal and Greece, we have a parting of the ways. The Member States decide to break-up the EU, but they work together to minimise the damaging consequences of this. The EU therefore splits, but is reborn as a two-speed union: a core union with the euro and continuing economic and political integration and a more informal periphery in which the only remaining common denominator is the Single Market. This outer layer will offer more room to join (or leave), but it will also have fewer rights.

After rather dramatic events in 2016 in many respects, the Member States of the EU decide to initiate a one-off intensive review of their cooperation. Those regretting their decision to join the eurozone will be given a one-time opportunity to leave the euro in a controlled manner. They will once again have their own currency, while with targeted interventions the ECB will ensure that the new currencies settle into the financial markets and then gradually depreciate. Most of the new currencies will have a loose link to the euro via an exchange rate mechanism, but there will be no tight bandwidths. After a narrow defeat of Marine Le Pen in the presidential elections, France in the end decides to maintain its link to Germany and remains in the eurozone, the core union. Certain South-European Member States (Italy, Portugal, and Greece) will on the other hand voluntarily leave the euro and introduce their own currencies. These currencies will ultimately depreciate substantially against the euro, but this will happen in a controlled manner due to interventions by the ECB. The core euro will also depreciate initially against the other international currencies. This will certainly be the case if the losses from written-off obligations such as the Target2 balances are recognised. All this will support economic growth in the peripheral countries, after a period of economic turmoil and high volatility. This will help them to consolidate their budgets. There will also be an end to deflation in these countries from higher import prices.

The remaining core euro will become relatively strong over time, which will seriously damage the competitive position of the Member States in the core union. There will be a risk of serious slowing of growth with deflationary tendencies, also because import prices will fall sharply. In response to this, the governments of countries running large current account surpluses in particular will pursue an expansive budgetary policy. This will be in addition to the already extremely accommodative monetary policy, while the European Investment Bank (EIB) will launch a large additional investment programme. The current account surpluses of Germany and the Netherlands will thus be reduced, but as a group the core countries will maintain an external equilibrium (in the current account of the balance of payments). The ECB will cease its quantitative easing policy, but it will not sell the securities it has bought back to the market in order to avoid serious shocks. The policy interest rate will remain low, market interest rates will return to moderately positive levels and the yield curve will acquire a more positive slope.

The differences of opinion will not be restricted to the economic cooperation. In other areas as well there are countries that will intensify cooperation and others that will not participate. The Baltic states, Scandinavia, Finland, Poland (which will after some time introduce the euro), France, Germany, Belgium and the Netherlands will decide to intensify their military cooperation. Schengen will continue, but its area will contract. France, Belgium and the South-European countries will leave; the Netherlands, Austria, Poland, Germany, Ireland and Finland will remain in. Denmark and Sweden will join the euro in due course, but not Schengen. Schengen’s border controls will become more intensely organised at European level, especially for people from the new periphery.

The new euro (core euro) will remain generally stable against the dollar and will appreciate against the other European currencies, but by less than the D-mark/guilder block in the ‘disintegration’ scenario. There will be a risk of slower economic growth, mainly due to contracting exports. Inflation will decline due to lower import prices. Pension funds in the core union will incur heavy losses on their foreign assets in the exiting countries and on their bond portfolios. As stated above, this will be offset by an easing of budgetary policy, which will mitigate the negative effects on economic growth to some extent. Ultimately the capital losses will remain limitid. On the other hand, public debt will rise. Due to the higher interest rates, despite the initial capital losses there will on balance be some recovery in the coverage ratios of Dutch pension funds.

Budgetary policy in the core countries will be centralised and closely coordinated. The core countries will wish to maintain their social systems and standard of living, but the growth trend here will be pressured due to the relatively rapid ageing of their populations. They will thus pursue an active immigration policy, whereby people from outside the core countries will only be permitted to enter with a work permit, either temporarily or permanently.

There will be an active effort in the core countries to grow into an optimal currency area. This means that there will be free movement of labour within their borders, that budgetary policy as already noted will be centralised to some extent and that the Single Market will be strengthened, mainly due to further liberalisation of the international trade in services. The Banking Union will be completed within the core countries, including a common deposit guarantee system or DGS with a prefunded and well-capitalised resolution fund. The core countries will also form a capital markets union. The peripheral countries will no longer participate in this: in their case, the ECB will return responsibility for banking supervision to national institutions.

Although the competitive position of the core countries will initially deteriorate as a result of the higher euro, the easier budgetary policy will keep the growth rate more or less up to standard, after a temporary lapse. On balance, there will eventually be a clear acceleration of growth. Good and enforceable agreements on budgetary policy will give the surplus countries sufficient confidence to allow some temporary easing of their budgetary discipline. Spain and France will feel the negative effects of the strong euro more than those countries that had already tied their currencies closely to the D-mark before the euro era, the traditional DM bloc. The core countries will enter into a compromise tax treaty, but competition and disunity with respect to corporate income tax will continue. This will cause internal squabbles.

While the countries in the periphery will still be part of the Single Market, the further integration and expansion of the market (in the services sector) will pass them by. The peripheral countries will continue to suffer from protectionist regulation and lagging structural reforms, meaning that they will not benefit from the Single Market as much as they could. Higher inflation and higher expectations regarding inflation and relatively weak currencies will lead to rising interest rates in these countries. The gap between the two blocks will gradually widen and over time therefore, it will become increasingly difficult for countries on the periphery to join the core countries and the euro. The admission criteria will be formulated so that only countries that have demonstrated over a longer period of time that they are in a position to become a full member will still be able to join.

For a country on the periphery therefore, joining the core will become increasingly difficult. The periphery will therefore also gradually move apart, with more countries following the UK’s example and leaving. Greece will be the first, falling into stagflation. Italy will also lag, but will continue to be linked at a distance as it was previously in the EMS. The new lira will depreciate, but the country will keep going. The same applies to Portugal. Most of the former Eastern bloc countries will increasingly fall behind, apart from Poland, the Czech Republic and Slovakia.

As a result, solidarity between the core and the periphery will gradually wane. The core union will be able to assist the peripheral countries in an emergency, for example with the ESM funds, but to a very limited extent and subject to strict conditions. The ECB will intervene from time to time in the currency markets to stabilise the currencies of the peripheral countries, but this will also be limited.

The group of core countries is smaller and more homogeneous than the present EMU. Power will move from the European Commission back to the Member States. The European Commission will no longer have a political agenda: its only role will be to execute the decisions of the Council of Ministers. The same will apply to the European Parliament, which de facto will no longer have influence. The EU will restrict itself to main issues, but many powers will be returned to national level.

Russia will benefit from the stagnation in the periphery by playing these countries off against each other and the core countries in order to increase its influence. The EU’s alliance with the US will come under pressure because the US will no longer hear Europe speaking with a single voice. Under the leadership of President Trump, it will focus increasingly on the countries in the core union, especially the countries which have intensified their military cooperation. There will also be differences between the core countries: for example, between a cautious Germany and a proactive France. Russia and China will benefit from this fragmentation.

The Common Agricultural Policy will weaken further because little common ground will be found in this area, even in the core union. This will result in a renationalisation of agricultural policy.

Box: How a two-speed Europe will lead to the end of the CAP

In a two-speed Europe, there will less readiness to assemble the resources for a European agricultural budget. This will lead to a renationalisation of income policy in agriculture. There will be agreement in the core group to prevent national income support leading to distortion of competitive relationships. Nonetheless, the current income support will mostly remain in place in countries such as France and Germany, since the strong rural/agriculture lobby will be able to resist any move to diminish it. Like the Scandinavian countries, the Netherlands will largely cease the current aid per hectare system, replacing this with the normal social safety net. The limited budgetary flexibility in the periphery will also lead to reduced income support for agriculture. These Member States simply do not have the resources to fund this. The Single Market will remain more or less intact. But few Member States will be able to allow themselves to leave it, either so that they can dispose of surpluses or so they can cover shortages in the provision in agricultural products. Countries such as Romania and Bulgaria will however shift their focus and turn their attention increasingly to the East (Russia, Ukraine, Turkey) for their external trade in agricultural products.

In the core countries, popular dissatisfaction will wane. Nationalist populism will still be there, but it will not significantly increase. The situation will be different in the periphery, where people will realise that many of the problems that were formerly attributed to ‘Europe’ have other causes, such as the failing economic policy of national politicians. Return to the core will however rapidly become almost impossible, since the difference in policy and development will become greater and the core countries will have little incentive to admit ‘dubious cases’. All this will lead to increasing dissatisfaction and political unrest in the periphery.

Summary of the ‘two-speed’ scenario

  • The EU Member States decide to review their cooperation
  • Some countries (the ‘periphery’) will leave the eurozone in a process controlled by the ECB; they will remain in the Single Market; depreciation of peripheral currencies will remain limited, with no bankrupt governments
  • The remaining countries (the ‘core eurozone’) intensify their cooperation economically, politically and militarily
  • The core eurozone will strive to become an optimal currency area; the Single Market will be expanded
  • Schengen will continue, but its area will contract.
  • After an initial depreciation against the dollar, the core euro will increasingly strengthen
  • Slower growth and a deflationary shock in the core euro area will lead to budgetary easing
  • The EU Member States outside the core eurozone gradually fall behind, making it increasingly difficult for them to join the core eurozone
  • The European Commission will increasingly become an executive body, and political power will rest with the Member States
  • Dissatisfaction will decline in the core countries; in the periphery it will rise

Consequences for the Netherlands

  • Economic growth slows initially, but will ultimately be higher than in the muddling through scenario
  • Unemployment rises initially, but will then fall by more than in the muddling through scenario
  • The Netherlands continues to be the gateway to Europe. Especially for the core union
  • Pension fund coverage ratios rise due to slightly higher interest rates
  • Currency losses on foreign assets, but less than in the disintegration scenario


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Wim Boonstra
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 5128 1405
Martijn Badir
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
Elwin de Groot
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 1389 2916
Carlijn Prins
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 1929 6455
Daniel van Schoot
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
Maartje Wijffelaars
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 2257 0569
Nic Vrieselaar
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 2216 2257

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