We have been waiting for what seems like an eternity for Europe's leaders to get their act together and deliver a credible plan to deal with the sovereign debt crisis.

It is, to be fair, a problem of fiendish complexity, with a lot of moving parts.

But perhaps the most sobering thing about it is that Europe could be seen as a microcosm of the world economy, some of the factors which have rendered the issues so intractable exist on a global scale as well.

We are, in any case, more than disinterested bystanders.


The "illustrative" downside scenario sketched by the Treasury in Tuesday's pre-election economic and fiscal update is one in which European leaders fail to contain their sovereign debt challenges, leading to a spike in risk aversion in global financial markets that sends funding costs in the financial markets upon which our banks rely through the roof.

Because governments and central banks have little ammunition left, compared with 2008, a protracted global recession ensues.

Even mighty China's growth slows to 6 per cent, versus an average of more the 10 per cent over the past 10 years.

The effect on New Zealand is to cut a cumulative 3 per cent from the growth outlook, compared with the central scenario, and to cut a cumulative $14 billion from tax revenues over the next five years.

Nor should this be considered a worst case scenario, the Treasury warns.

Based on its past forecasting performance there is a one-in-five chance of outcomes worse than its downside scenario envisages.

It has been clear for quite some time that the Greek Government is insolvent. It will never be able to repay all the debt it has racked up. And the austerity measures imposed by its creditors have plunged Greece into a gruesome depression.

More of the same would be futile and risk some kind of political eruption that could trigger a calamitous disorderly default.

So the issues are how much of Greece's debt needs to be written off and how to ensure that the process does not trigger the failure of systemically important banks elsewhere in Europe, and with it another financial panic, credit crunch and global recession.

In addition there is the need to carve out a fire break around Greece wide enough to prevent the conflagration engulfing other vulnerable sovereigns, including Spain and Italy.

In other words, how the funds committed to the European Financial Stability Facility, the bailout fund, can be leveraged to the sort of 13-figure sum that might be needed to prop them up if the markets turn on them. Even if all that can be done, there still remains the task of making the structural changes needed to guard against similar problems arising in the future.

What has made the issue so difficult to deal with is that it exposes the fundamental tension at the heart of the European project itself.

The Europeans want the benefits of a single market and a single currency, removing barriers to commerce within a community of, in the case of the wider European Union, over 500 million people.

But at the same time it is a voluntary association of 27, or in the case of the euro area 17, sovereign and democratic states, where the power to commit taxpayers' money rests in the member states' capitals, the fundamental prerogative of national parliaments.

Managing that balance, that division of labour between national governments and the still-evolving pan-European institutions is an ongoing challenge.

European Commission President Jose Manuel Barroso when talking to the Herald two months ago argued that the grand historical trend is clearly and irrevocably towards greater European integration.

That is also what the financial markets want, he said, and they would just have to be patient and accept that the political processes of democracies are messy and time-consuming.

The contrary view would be that European monetary union was a fatal overstretch. It yoked together economies that are just too far apart in terms of economic performance.

The weaker members ended up with interest rates too low and a currency too strong for their national circumstances, undermining competitiveness, inflating real estate bubbles in Ireland and Spain which have messily burst, and facilitating a blowout of public debt in Greece and Italy.

It was a Faustian bargain. That inflow of money was so abundant and cheap precisely because monetary union meant they had given up the option of reducing the burden of excessive debt through inflation and currency devaluation.

Unfortunately the problems cannot all be laid at the door of monetary union.

There is a similar tension at the global level between economic interdependence and the fact that economic policy is still made at the national level and driven by national self-interest.

The past 20 years have seen China, India and the former Soviet bloc rejoin the global economy, enabling hundreds of millions of people to escape from poverty.

World trade has grown even faster than the global economy reflecting multinational supply chains.

And technology has enabled global financial markets to transact on the scale of trillions of dollars a day.

But political institutions have not kept pace.

Multilateral bodies wax and wane.

Apec's Bogor goals are almost forgotten; now the East Asia Summit is the place to be. The G7 gives ground to the G20. The Doha Round is in a profound coma and the United Nations' climate change negotiations have a rather sickly pallor. Only national self-interest is constant.

If the countries of Europe, with so much in common and decades of experience in intimate collaboration, cannot muster the solidarity and collective political will to deal with their sovereign debt problems, what hope does the world have if systemic issues arise at the global level?

And they may well do.

There is of course no global equivalent of European monetary union.

But there is at the heart of the world economy a kind of conjoined twin relationship between the two largest national economies, created by China's effective pegging of the renminbi to the US dollar. Many of the major oil exporters are also part of this dollar bloc.

If Chinese exporters benefit from an artificially low exchange rate, the same might be said of German exporters, to the extent that the euro has been weaker than the Deutschmark would have been.

Both countries run large current account surpluses, effectively lending their trading partners money with which to buy their goods in what has been called the greatest vendor finance deal in history.

It is not, as Europe's current woes demonstrate, a sustainable model.

But just as it is mathematically impossible for every country to run a trade surplus, it is only possible for the current account deficit countries (including New Zealand) collectively to reduce their deficits if the surplus countries reduce their surpluses.

We need to rebalance in the direction of less spending and more saving, less consuming and more investing, less importing and more exporting.

They need to adjust in the opposite direction and pull their weight as consumers.

So far there is little evidence of a commitment to do that.