In 2011, Europe’s financial and banking crisis escalated into a sovereign-debt crisis. A problem that began in Greece ended up raising doubts about the very viability of the euro – and even of the European Union itself. A year later, those fundamental doubts remain undiminished.But, if one compares the EU with the United States or Japan (where public debt equals 200% of GDP), the Union’s current poor image is unjustified. Indeed, employment in the EU as a whole remains high, as do private savings rates. Moreover, the Union’s trade is in balance with the rest of the world.One reason for doubt about the euro and the EU is that, since the spring of 2010, Europe’s leaders have rushed from one crisis summit to the next, each time devising supposed solutions that provided too little and arrived too late. Europe’s leaders have never fully deployed their economic and political firepower. On the contrary, rather than taming the financial markets, as they once intended, Europe’s leaders continue to be besieged by them.It should come as no surprise that, with national governments’ parochialism impeding joint EU action, financial markets are using what the communists used to call "salami tactics” to slice away at the Union by attacking its member countries one by one. Indeed, the European Parliament and the European Commission have been sidelined, while a new management model for Europe has emerged: Germany makes the decisions, France gives the press conferences, and the rest nod in agreement (except the British, who have chosen isolationism once again).This management structure is neither democratically legitimate nor justified by its performance (which appears to consist of mere reactions to pressure from financial markets). Indeed, some estimate that, by 2050, Europe will produce only 10% of the world’s GDP, and will comprise just 7% of its population. By then, not even Germany’s economy will be significant in global terms, to say nothing of the other European economies.As early as 2012, when the world economy is expected to grow by only 2.5%, the battle for shares of the global pie will become fiercer. Europe is fighting for its economic survival, but it does not seem to know it.So, do we Europeans intend to remain relevant in the twenty-first century, which means strengthening our position? Or are we prepared to undergo a painful decline brought on by nationalist infighting and complacency?I advocate a strong Europe that embraces the challenges of a relentlessly changing world. We need a new contract among European nations, generations, and social classes, which implies difficult choices. We must bid farewell to national egoisms, vested interests, dirty tricks, and assumed certainties. If Europe wants things to remain as they are, things will have to change dramatically.First, the EU must become a true democracy – with a directly elected president and a stronger parliament – if pan-European decisions are going to have full legitimacy. The fiscal pact to which EU members (except the United Kingdom and the Czech Republic) agreed in December 2011 cannot be left to bureaucrats and courts alone. The European people, the true sovereigns, must ultimately gain the right to make Europe’s policy choices via elections.Second, we must close the income gap. The growing divide between rich and poor, stagnating real wages, and deep regional disparities in unemployment are both morally unacceptable and economically counterproductive. The EU’s increasing income inequality misallocates the purchasing power that its economy desperately needs for growth and employment.Finally, the welfare state needs a serious overhaul. Today, the EU allocates a large part of its public spending to pensions and health care for the elderly, while education suffers from underfunding. A welfare state that focuses mainly on the elderly, and does not provide sufficient opportunities for younger generations, is not sustainable. Moreover, the inequities created by privilege, such as public-sector pension schemes and discretionary advantages for vested-interest groups, must be addressed.In order to make these changes, higher taxation of wealth and capital income is inevitable. But, while these additional tax revenues would improve Europe’s public finances, they would not obviate the need to reform the welfare state. Indeed, at best, they could facilitate a socially responsible transition to more efficient forms of social protection.It is also a mistake to believe that austerity measures – the prime focus of Europe’s leaders up to now – will consolidate public finances. Europe is on the brink of recession. Governments should therefore restrict spending cuts to those that will not cause the economy to contract. Likewise, they should increase only those taxes that, when raised, do not reduce consumption, investment, or job creation.In addition, a "European Marshall Plan” that provides investment in infrastructure, renewable energy, and energy efficiency is needed. Such an initiative would not only foster growth, but would also lower current-account deficits (because expensive fossil-energy imports could be reduced). Public finances would be consolidated only by growth, not by austerity.The European Central Bank must adapt to the fiscal pact’s new rules. National governments’ vulnerability to the financial markets and their exaggerated interest rates must be reduced. Only the ECB, by taking on the role of lender of last resort, can stop the eurozone’s capital outflow and restore confidence in Europe’s capacity to solve its own problems.Europe is running out of time. The EU’s institutions must exercise their creativity to the fullest – conventional thinking will not be enough to save the Union. Only when the EU has its head above water again can we embark on the difficult but necessary path of framing and adopting a new treaty for a new Europe.Alfred Gusenbauer was Federal Chancellor of Austria in 2007-2008. Copyright: Project Syndicate, 2012