A cynic would be tempted to compare the eurozone to Ryou-Un Mara, the rusty Japanese ghost ship that floated across the Pacific after last year’s earthquake. Some wrecks surprise us by staying afloat for a long time, but that does not make them less of a wreck.

Right now, Spanish leaders are finding out that one successful bond auction does not mean the country is out of the woods. It is difficult to keep the trust of investors, especially if it requires constant support from the increasingly reluctant European Central Bank. As a result, at last week’s bond auction, the Spanish government was only able to sell $3.3 billion worth of debt maturing between 2015 and 2020, compared with the original ambition of selling up to $4.6 billion.

The Spanish are trying to stabilize their public finances. Spain is running on what is generally recognized as the most austere budget since the country’s transition to democracy. In one year, the government has promised to reduce the deficit from 8.5 to 5.3 percent of GDP. While this is still high, it is a significant adjustment.

The problem with Spain, as with the rest of the eurozone, lies not in the unwillingness of political leaders to reduce public deficits. If anything, politicians on the eurozone’s periphery were more than willing to engage in quite suicidal stunts in order to bring public finances under control. The problem is that a true fiscal consolidation requires economic growth, and growth is nowhere to be seen.

The most optimistic of forecasts predict that the eurozone will stagnate until the fourth quarter of 2012. Hardly consolation for the 17 million people who are out of work in the eurozone - the highest level since 1997 – with the highest rate of unemployment, at 23.6 percent, in Spain.

Deep reforms such as an across the board liberalization of the labor market, cuts in marginal tax rates, a reduction of red tape, or thorough reform of European welfare programs could spark growth. However, these are not the measures being adopted in the ailing economies of Mediterranean. This is due to the combination of a focus on immediate deficit reduction mandated by Brussels (and by the bonds markets) and power of local interest groups.

Policymakers in Greece or Spain have very little room to do an overhaul of the social security systems or labor market regulation. First, such measures would do little to bring public finance under control now, and they would face well-organized opposition from trade unions. As a result, Mediterranean governments are cutting in areas where they will meet little opposition and where substantial savings can be achieved instantly – public investment, R&D, tourism, and so on.

But not all public spending is created equal. By trying to simultaneously appease fiscal hawks in Brussels and union leaders in Madrid or Athens, policymakers are likely to cut most significantly portions of government spending which serves as a useful input for private sector entrepreneurs, while keeping the various entitlement schemes unchanged. The 2012 Spanish budget, for instance, envisages the deepest cuts, of the order of 30 percent, in areas such as infrastructure, transportation, or R&D, while increasing the total spending on pensions by 3 percent.

The future of Europe hinges on whether its leaders are able and willing to overcome the power of interest groups and put in place reforms needed both for growth and sustainability of their public finances. Unlike the Japanese ghost ship, the eurozone can choose not to be a wreck. But to do that, European politicians and central bankers ought to do pretty much the opposite of what they are doing right now.

Dalibor Rohac is an economist at the Legatum Institute in London.

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