European Affairs

With the Euro, the EU Put the Cart Before the Horse     Print Email

Daniel GuéguenWhen countries that are part of a coherent economic zone come together to create a single currency, it is vital that they do so at a time when their competitiveness is comparable. Under such circumstances, economic synergies and coherence can lead to convergence rather than disparity.

Considering the extent of the commitment required for countries to pool their currencies, it appears logical that participants respect a certain number of guidelines and criteria. In the case of the 12-nation euro zone, this set of criteria is called the Stability and Growth Pact, an instrument intended to ensure that the economic coherence generated by the common currency brings continued benefits.

Ten years since the Pact was agreed, however, and contrary to expectations, the economies of the euro zone are diverging rather than converging. In fact, cohesion is breaking down, with the emergence of a virtuous avant-garde (Ireland and Spain), characterized by high growth rates, low inflation and flexible work forces, and a rag-tag band of laggards (France, Germany and Italy) suffering from low growth and rigid labor markets.

The most alarming problem facing the Stability and Growth Pact today is that three of the four largest euro zone countries are knowingly, willingly and deliberately violating the rules and undermining coherence between the euro economies. Such a situation hardly seems viable in the long term. The question today, therefore, is whether the euro is in danger; whether a participating country could leave the single currency, and under what circumstances.

In order to ensure that countries would be ready for euro membership, the EU adopted, largely at German insistence, a series of strict convergence criteria that a country must meet in order to join the single currency. These are:

1. An annual budget deficit of less than three percent of GDP.

2. Public debt no higher than 60 percent of GDP.

3. An inflation rate no higher than 1.5 points above the average of the three best-performing countries.

4. Long-term interest rates no more than two points above the average of the three countries with the lowest rates.

5. Two years of uninterrupted participation in the exchange-rate mechanism of the European Monetary System with no devaluation or severe tensions.

Eleven of the then 15 EU member states decided to become founder members of the euro in 1998. Denmark, Sweden, and the United Kingdom chose not to participate. Greece met none of the five criteria, but eventually joined on January 1, 2001. In fact, only Luxembourg originally fulfilled all five conditions. The other participating countries made choices based on a perceived short-term political or economic need to join, while completely disregarding the long-term fallout.

Belgium, France, Germany and Italy, for example, cut their budgetary deficits to three percent, not by reducing public expenditure but by increasing, sometimes massively, direct or indirect tax burden. In addition, exceptional revenues were used to reduce the budget deficit artificially for the 1997 reference year (gold sales in Germany and Belgium, and a big payment by France-Telecom to the French state). In several countries, the three percent budgetary deficit criterion was met by increasing debt.

At the current stage in its development, the European Union is facing major inconsistencies, of its own making. The very nature of the euro makes it a federalist instrument that requires fiscal and employment harmonization, since only these can foster economic convergence. Both, however, still fall within the ambit of national politics, so member states can do whatever they please, without bothering to coordinate their policies.

Without the federalizing vision of a common fiscal, employment, and economic policy, national economies continue to develop at their own pace, constantly diverging. One of the most troubling developments of recent years is that France, Germany and Italy, among others, keep running deficits in excess of three percent per year, and amassing debt, without incurring the penalties provided for in the rules of the system.

Worse still, it is now known that Greece and Italy freely manipulated economic data to join the Pact without any consequences, then or now. The reason behind this laxity is that while monetary policy is controlled by the European Central Bank (ECB), sanctions for non-respect of the budgetary rules are decided by the member states in the European Council of Ministers. States participate in discussions regarding their punishment, although they are not allowed to vote on them, and their fellow member governments, which may one day find themselves in a similar position, are likely to be more lenient than the ECB.

A common currency requires balance. If some participants are virtuous and others are not, the less virtuous members will constantly and consistently lose competitiveness vis-à-vis their partners. In the long run, their economies will be plagued by high unemployment and rising budgetary problems, as a result of accumulated debt and deficits, possibly leading to a monetary crisis.

In the absence of coherent economic coordination, the euro will be overvalued for these countries, possibly forcing them to leave the euro to ensure economic survival. We need not look too far back to find an example of monetary union gone wrong: Argentina’s monetary problems stemmed from the peso’s enforced parity with the dollar. The peso was driven up on currency markets by the strength of the dollar, whereas the two currencies would have gone very different ways had they been left to their own devices. Such a scenario for the euro may be far-fetched and improbable, but EU leaders need to examine the possibility seriously, with cool heads. They should think about the general architecture of the pact, rather than merely reacting to current pressures, and establish ways for countries to exit, if and when required.

The euro may have come too early in the process of European integration. The history of monetary cooperation suggests that a single currency requires three basic conditions: a common market, a federal state, and common citizenship.

None of these elements exist in the euro zone today. The single market is still impeded by non-tariff barriers, and the recent economic downturn has led governments to be more protective of their political prerogatives, perhaps hoping to distance themselves from an unpopular European Union, and to reap the political benefits if and when recovery comes. Aside from the largely symbolic European passport, the only tangible aspect of common citizenship is the euro.

In essence, the euro countries have put the cart before the horse; they should have completed the single market, built a federal state with common citizenship, and only then introduced the euro.

Daniel Guéguen is CEO of Clan Public Affairs, a leading European public affairs consultancy. He is also Chairman of the European Training Institute and has written extensively about the European Union. He is the author of The Euro: Europe’s Construction or Destruction?


This article was published in European Affairs: Volume number 6, Issue number 4 in the Fall of 2005.

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