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Speech of Secretary General for Int’l Economic Relations & Development Cooperation Papadopoulos at the Euromoney Conference (Vienna,18-19 January 2011)
Is joining the Eurozone a desirable strategy for CEE countries?
The 6½ years that have gone by since the 2004 eastern-southern “Big Bang” enlargement of the EU allow a first cautious evaluation of the characteristics, economic progress and “euro-compatibility” of the new member states.
It was just a few days after the EU’s biggest enlargement had become official – on May 1st, 2004 – that I gave a talk in Greece on the benefits of enlargement.
I said at the time:
“Because the accession countries are much poorer on average than the EU15, the addition to the EU’s economic output will be considerably smaller, in percentage terms, than their 20% addition to the EU’s total population.1Total GDP will rise by around 5%, or the equivalent of adding an economy the size of The Netherlands. The per-capita GDP of the EU will actually fall by 13%.”
The next four years saw quite dramatic changes, namely, in the form of a pronounced convergence between east and west. By 2008, the 10 new members’ combined GDP was 36% higher than The Netherlands’. The Polish economy, which is by far the largest in the region, was similar in size to Denmark’s in 2004; by 2008 it had overtaken Belgium’s, a country with twice Denmark’s population. In 2004 Slovakia had an economy just bigger than Luxembourg’s. By 2008, the Slovakian economy was almost twice as large as that of the Grand Duchy.
Still, high growth did not manage to totally eliminate the income gap, only to narrow it.
More interesting from our perspective is the fact that the recent economic crisis had no substantial effect on the relative position of individual CEE Member States. Only Slovenia and the three Baltic States slid backwards a little in terms of relative GDP per capita in the period 2008-2009. Poland went up 5 points (from 56% of the EU27 average to 61%).
That is because the recession of 2009 spared no-one, and the pain was distributed roughly equally between east and west, north and south – though, admittedly, the suffering in the three Baltic States was of a different order, and Poland escaped outright recession. But all in all, the majority of new entrants proved to be very normal European countries, further evidence of how closely integrated their economies have become with those of their peers in the EU Single Market.
The recovery of 2010 – such as it was – also did not treat any particular region preferentially. Some countries are coming out of the trough faster than others, but with no systematic correlation between the depth of the recession at national level and the rate of recovery. (Actually, a country none other than Germany may be an exception to this observation: Germany last year experienced its most dramatic economic turnaround since the country’s reunification in 1990. GDP expanded 3.6%, compared with a 4.7% contraction in 2009, which happened to be the fourth worst performance in the whole of the Eurozone that year.)
So, apart from the differing income levels, and apart from the Recession itself – and we’ve just seen that the latter did not discriminate between European countries – what other phenomenon could theoretically impact differently the East from the West? The answer is: the crisis in the Eurozone. For example, if it could be shown that the opt-outs (Britain, Denmark, Sweden) suffered less, or more, from the crisis than the Eurozone per se, or rebounded faster, then potentially there could be lessons to be drawn for the CEE countries.
However, a closer study of how individual countries fared during the crisis suggests that whether countries were inside or outside the Eurozone had little to do with their resilience or their vulnerability to the crisis. For example,Denmark and Sweden, too, saw their economies contract in 2009, in fact, by more than 5% (viz., -5.2% and -5.3%, respectively). That’s 25% more than the EU (-4.2%) or Eurozone average (-4.1%) for that year. Britain’s economy contracted by -4.9%, also above the average.
True, the fiscal crisis in Greece triggered the sovereign debt crisis in the rest of Europe; and the first countries to be hit were, indeed, other Eurozone member states. This led to fears of contagion and therefore systemic breakdown first and foremost in the currency union itself. But the fact that Ireland was hit first, with other, southern, Eurozone countries being seen as next in line, had little to do with their status as Eurozone members as such (and their lack of a national currency), and more to do with other underlying problems, such as real-estate bubbles, banking-sector problems and competitiveness problems. Some have claimed that these can be traced back to the very existence of the euro itself and the rapid decline in interest rates it brought about. I prefer to blame classical human failings and ineptitude, such as massively irresponsible government behaviour in the fiscal domain, or good old-fashioned capitalist excesses, such as oversized real-estate booms, and banks running wild in the boom years with the authorities’ acquiescence, not to say tacit concurrence. In fact, one could turn the anti-euro argument on its head and argue that, were it not for EMU and the new stability mechanisms that have been set up, countries such as Ireland, Portugal and Spain, not to mention Greece, would be in a much worse state now, being exposed potentially to massive currency crises and skyrocketing inflation, even bank runs and capital flight in some cases – not to mention the sentencing to death of any serious attempt at fundamental structural reform.
Ironically, the fear of phenomena such as these were probably behind the British Government’s decision to introduce the recent draconian austerity measures – and the U.K., need I remind you, is not in the Eurozone! But its fear of being contaminated – or seeing its creditworthiness questioned – evidently overwhelmed the implied security of having an independent currency with a fully-flexible exchange rate and the adjustment capacity normally associated with it.
I say this because the British example is also useful as a case study of the actual effectiveness of currency devaluation, seen by many economists as the key to restoring competitiveness and escaping the spectre of protracted depression – a tool no longer available to individual Eurozone members! The latest UK data indicate that the trade deficit in November 2010 rose to £8.7bn, the highest monthly deficit since 1980. The deficit in merchandise trade also increased 4.5% in Sept-Oct-Nov 2010 compared with the previous 3 months.
This is despite the fact that the pound has fallen vis-ΰ-vis the U.S. dollar since January 2010 – not much: a little over 3% (though it is 8.3% higher compared with January 2009). Sterling’s value vis-ΰ-vis the euro, the currency of its main trading partners, is now only 4% lower than it was a couple of weeks before Lehman Brothers (and has actually appreciated in relation to the lows of 2009)2 – which goes to show that nominal exchange-rate movements don’t always go in the direction, or as far as, you’d like them to, once you’ve kept your national currency and opted-out of the euro for strategic considerations linked to your competitiveness. That’s because others can devalue too.3
Meanwhile, Germany is experiencing an export surge, while Sweden, whose currency is actually appreciating, is enjoying one of the better growth performances in Europe. Even Greece saw exports of goods increase 6.3% in the period Dec 2009-Nov 2010 compared with the same period a year earlier. In November alone, exports increased 39.8%, compared with November 2009 – notwithstanding the fact that the rest of the economy is still contracting!
But let’s go back to Central and Eastern Europe. What has been happening on the EMU front there? Two countries – Slovakia and Estonia – joined after the outbreak of the crisis, on 1/1/2009 and 1/1/2011, becoming respectively the 16th and 17th members.4 Slovakia in the first three quarters of 2010 had average growth of 4.2%, while Estonia’s 3rd Quarter growth reached 5.1% y-o-y. These are among the highest growth rates in the EU, and essentially put paid to theories that say that belonging to the euro circumscribes one’s ability to enjoy export-led growth, as this is what both countries are doing today. And if these exports go to other EU countries likeGermany, well, so much the better for the EU, its Single Market and the often-repeated need for a re-balancing of the German economy away from its netexport- dependency!
So to sum up, what we’ve seen is, first, that the new entrants have behaved much like the other Member States, both over the good years and the bad. And one of the similarities is the diversity that exists within each group, as our Eastern partners never cease to remind us. The second thing we’ve seen is that the new Member States’ progress toward joining the euro, or even adopting the euro itself, has not in itself adversely affected their economic recovery, and on balance has probably benefited it: the euro as credible “anchor” appears to be a far more potent strategy than any policy of devaluation, especially in an integrated economy where the import-content of exports is so high. In the longer run, the euro will benefit their economic progress even more – certainly when the new Eurozone governance architecture, now under construction, is put in place. And not so much because of the existence of a European Stability Mechanism as such (i.e., funds), but because of the more rigorous ex ante monitoring of national economies that’s in store.
So, is EMU accession the right strategy? Apart from the minor detail that, legally speaking, there is no other choice, countries such as Estonia clearly did the right thing by resisting the siren calls to “devalue, devalue, devalue”.5 That’s because the standard arguments in favour of membership apparently still hold – making full use of the Single Market, eliminating exchange-rate risks and transaction costs, and owning one of the world’s more stable currencies. At the same time, in a highly-integrated economy like the European one the effects of devaluation are vastly overrated, if not perverse, especially for small, open economies such as the CEE countries. For exactly the same reasons, I would be less enthusiastic about countries that did not belong to the EU unilaterally adopting the euro, countries that did not share the same Internal Market, did not have freedom of cross-border movement, and did not share the same structural and macroeconomic policies. But for countries that do share these advantages, the benefits of joining the euro, in my opinion, outweigh the costs. Don’t just take my word for it: ask the newest members, Slovakia and Estonia.
1 Up from 381m to 455m.
2 The pound has appreciated by about 4.8% vis-ΰ-vis the euro since a year ago (6.6% since 16/1/2009).
3 Meanwhile, the Danish crown has remained pegged to the euro since the latter’s inception. The Swedish Krona has appreciated 14% since Jan 2010, and 23% since Jan 2009 vis-ΰ-vis the euro. In any event, devaluation only works when your main trading partners’ and competitors’ currencies remain stable.
4 Slovenia joined on 1/1/2007 and Cyprus and Malta on 1/1/2008.
5 According to Estonia’s president Toomas Hendrik Ilves, all three Baltic countries were under great pressure to abandon their pegs to the euro in the early days of the euro crisis. See, Financial Times, 3/1/2011.