Europe needs a new deal that trades less austerity for more structural reform. It can be done without costing Germany a euro cent.

The contours of this shift are starting to emerge, with Spain leading the way. To persuade the European Commission to relax its budget deficit targets for 2014 to 2016, the government of Mariano Rajoy this week set out plans to overhaul pension systems and reform labor markets, service sectors and fiscal management.

Officials in Brussels are likely to be receptive to these ideas, because they see that current policies risk tearing apart the European Union. EU Commission President Jose Manuel Barroso warned this week that politically Europe is pushing against the limits of austerity.

Barroso is right that the euro area’s crisis-fighting mix needs to change: In Spain, unemployment reached 27 percent, and a new government being formed in Italy will need to offer carrots to secure the structural changes that will help its economy grow again. Despite the anger of some German politicians about Barroso’s comments, relaxing deficit targets shouldn’t be seen as a bad thing. Austerity doesn’t necessarily increase the periphery’s cost competiveness, which is the sine qua non for ending the crisis. Structural reform is better suited to that task.

Populist Politics

Austerity applied during a global slump creates suffering that is exploited by protest parties and unscrupulous politicians such as Italy’s Silvio Berlusconi, who are fanning anti-German and anti-euro sentiment to gain votes.

So far, structural reforms, such as improving the efficiency of labor markets by jettisoning laws that protect certain professions, have been hard to carry out in the euro-area periphery. The main reason is that those changes require taking on elites -- labor unions, taxi drivers, pharmacists or others -- that fiercely defend their privileges. This resistance made labor reform elusive for Mario Monti, Italy’s caretaker prime minister.

Mapping an acceptable path to soften or relax austerity in return for more structural reform could allow governments of Europe’s periphery to secure the public support they need to take on such vested interests and win. It could also help politicians who are serious about fixing their nations’ problems to marginalize the likes of Berlusconi.

The initiative would have to come from countries that want their budget-deficit targets relaxed. The commission could rule on each case, and decide whether the proposed reforms warranted a concession. The European Central Bank also could deploy its Outright Monetary Transactions bond-buying program if a country’s bond market is attacked as a result of the policy change.

Most likely, as has been the case so far, the very threat of ECB intervention would be sufficient to keep markets calm. The rebalancing effort wouldn’t have to cost northern governments a single additional euro.

This would be a good deal for southern countries such as Greece, Portugal and Ireland. Because of their renewed commitment to structural reform, they could get ECB support for their debt and, at the same time, get the lending countries to soften their austerity programs.

It also should appeal to Germany, and not only because it would help tame the noxious anti-German sentiment. A little more than a decade ago, Chancellor Gerhard Schroeder’s Agenda 2010 transformed Germany from what the Economist magazine called “the sick man of Europe” into Europe’s sole competitive economic power.

Sincere Effort

For Germany to abandon its view that the periphery countries will change only under austerity-imposed duress, however, it will need to see that structural reform efforts are sincere. Germans will be on board once they realize that this doesn’t mean giving the periphery a free ride but encouraging a more effective mix of reform.

German Finance Minister Wolfgang Schaeuble’s comment Thursday that France can take more time to cut its budget deficit as long as the government doesn’t slacken its structural reforms suggests that officials in Berlin may be open to changing the reform mix.

Skeptics will argue that money in exchange for structural reform always has been part of Europe’s crisis-fighting strategy, and that it hasn’t worked. What’s different now is that bailed-out periphery economies may have reached a level of suffering that forces national politicians and electorates to get serious about structural changes and begin combating privileged elites in exchange for relief from punitive deficit targets.

If these countries offer creditable plans for structural reform, why not take the chance? If the softer approach doesn’t work, harder policies can be restored. Spain has taken a constructive step that should be supported by Germany and the European Commission.

(Melvyn Krauss is an emeritus economics professor at New York University and a senior fellow at the Hoover Institution at Stanford University. The opinions expressed are his own.)

To contact the writer of this article: Melvyn Krauss at melvynbkrauss@gmail.com.

To contact the editor responsible for this article: Marc Champion at mchampion7@bloomberg.net.