Europe's Bankrupt Welfare State

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The euro survived 2012 intact, and once again Europe's leaders are declaring victory in the fight to preserve the single currency. In a speech in Portugal Monday, European Commission President Jose Manuel Barroso said the existential threat to the euro was a thing of the past. If only.

Mario Draghi's offer last summer to buy unlimited quantities of government bonds to keep yields under control has certainly calmed down the bond markets in Spanish and Italian debt. The ECB President has achieved this even without so far having to act on the promise.

But the euro-zone unemployment numbers out this week are a reminder that the euro crisis is not so much over as quiescent. Joblessness in the single-currency bloc hit a record 11.8%. Youth unemployment stands at 24.4% and is above 50% in Spain and Greece.

Some observers will blame the joblessness and lack of growth in the euro zone on the austerity supposedly being imposed on the Continent by Berlin. But the real story is more ominous.

Europe's vaunted social model has struggled to generate growth or jobs for decades. Prior to the creation of the euro, national governments masked this problem with a combination of deficit spending and devaluation. The borrowed money would help pay for generous welfare benefits for those driven out of work by inflexible labor-market rules and economic stagnation. Currency devaluation would ease the burden of all that borrowing by allowing governments to pay back debt with devalued lire and francs while offering a short-term boost to wage-cost competitiveness.

The euro closed off that release valve for Europe's most sclerotic welfare states. But because it also lowered their borrowing costs initially, it facilitated a spending binge that kept the party going for a time. More sober economic observers warned that if the euro was to survive, reforms were necessary in countries for whom beggar-thy-neighbor devaluations had become a way of life. But until Greece stopped the music in late 2009, political leaders in most countries largely disregarded the warnings.

Germany was a notable exception, pushing through painful reforms of its tax system, labor markets and welfare benefits in the euro's early years, and it is now vilified for its trouble, even as it outperforms its neighbors and helps keep the euro zone afloat.

The discovery of Greece's serial budget deceptions also helped close off Southern Europe's other main release valve—permanent deficit spending. It is commonplace to say that Europe can't afford to keep borrowing and spending the way it's done in recent years, but it's closer to the truth to say it could never afford it. What's changed is that the biggest spenders have run out of palliatives.

And this is Europe's present and continuing danger. Budgets are being cut in places like Greece, and there are halting, reluctant signs of reform around the edges of the welfare state. But there remains no clear consensus, at least outside Germany, that the European way of welfare itself is bankrupt, that it never worked as well as its defenders pretended, and what we're witnessing is the coming due of all the checks kited over decades to keep it afloat.

The euro zone may be enjoying a respite. But the economic evidence shows how little has been fixed. Mr. Draghi's blank check addressed the symptom, but not the cause, of the euro zone's economic woes. And unless those are addressed—with more flexible labor markets, a smaller state and lower taxes—the crisis will be back in the form of social unrest, political populism and a generation of young Europeans who don't know what it is to be able to find a good job.

A version of this article appeared January 12, 2013, on page A12 in the U.S. edition of The Wall Street Journal, with the headline: Europe's Bankrupt Welfare State.