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Euro-Expansion: Whither the Prospects?

Euro-Expansion: Whither the Prospects?

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This policy brief looks at the future of expansion for the European currency.
This policy brief looks at the future of expansion for the European currency.

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Categories:Types, Research
Published by: German Marshall Fund of the United States on Sep 20, 2011
Copyright:Attribution Non-commercial


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Euro-expansion is aliveand well, despite widespreaddoubts about the future of thecurrency. For a small Europeancountry with an open economydependent on trade with the big economies on the continent, itmakes sense to have a currencypeg and economic and monetaryunion with the rest of the conti-nent. But to reap these greaterrewards, candidate countriesmust become leaner and more
efcient, by rst implementing 
underlying structural reforms in their economies, which would put them on a path to greater conver-gence with the current eurozoneeconomies.
Economic Policy Program
Euro-Expansion: Whither the Prospects?
by Miguel Rodrigues
September 2011
1744 R Street NWWashington, DC 20009T 1 202 745 3950F 1 202 265 1662E info@gmfus.org
Euro-expansion is alive and well,despite widespread doubts about theuture o the euro should contagionspread rom Greece to Italy and Spain.Tis paper builds upon views expressedat a recent roundtable gathering o experts and embassy representativesheld under the Chatham House ruleat the German Marshall Fund. Publicenthusiasm or joining the euro variesby region in Europe: Te Baltic coun-tries are euro-enthusiasts, inspired by Estonias successul adoption o the euroon January 1, 2011, and euro-accessionremains a strategic goal or Latviaand Lithuania. For a small Europeancountry with an open economy depen-dent on trade with the big economieson the continent, it makes sense tohave a currency peg and Economic andMonetary Union (EMU) with the resto the continent, as this would elimi-nate currency risk, lower borrowingcosts, and open up access to liquidity rom the European Central Bank. Butto reap these greater rewards, candi-date countries must become leaner andmore ecient, by rst implementingunderlying structural reorms in theireconomies, which would put them ona path to greater convergence with thecurrent eurozone economies.Te Eastern Europeans are requiredto adopt the euro under the termso the treaties governing their entry to the EU, but the treaties, whilerequiring that these countries meet theMaastricht convergence criteria, donot speciy a deadline by which they must do so. Joining the euro wouldbe a good thing, both or the currenteurozone and the acceding countries.It would demonstrate that the dreamo greater European unity is alive andwell, and that the European project iscapable o weathering adverse circum-stances. It would expand the collectiveexperience in good governance (inthe case o the Baltics) to the currenteurozone, and it would make Europe alarger, more competitive economy onthe world stage.o successully join the euro, however,it is critical or a country to keep itseconomic house in order. Tis is whatthe Baltic countries did in responseto the East European nancial crisiso 2008-09, when, during the suddencredit crunch ollowing the excesscapital inows o the boom years,they reduced their budget decitsby 8-10 percent o GDP in 2009 by slashing wages and costs and tacklingdicult health and educational sectorreorms. Te lack o liquidity avail-able rom abroad also spurred higherdomestic savings in these countries.Teir currency boards helped oster
Economic Policy Program
decline. Its path to the euro will not, however, be withoutchallenges — ination is at 4.2 percent and the budgetdecit, expected at 5-6 percent o GDP this year, is stillabove the 3 percent Maastricht cut-o. Te Polish govern-ment hopes to decrease the budget decit to 2.9 percentin 2012. Other large Eastern European countries, such asHungary and the Czech Republic, are more or less in thesame boat as Poland, but their positions and prospects vis-à-vis euro-accession lie beyond the scope o this paper.By their successul reorms and the hard choices they madeduring the nancial crisis, the Baltic countries showedthat the economic targets under the Maastricht criteria areachievable. Western European nations — including Greeceand Portugal — need to embark on similar overdue reormsto their health sectors, state enterprises, and tax adminis-trations. Indeed, or more than ten years, these countrieshave not played by the rules. Greece, or instance, wasaccepted to the euro even though its public debt at the timewas “only” 95 percent o GDP, exceeding the Maastrichtcuto (the criterion requires that public debt should notsurpass 60 percent o GDP). And Greece has hardly beenthe only oender within the eurozone — Belgium and Italy entered with excessively high public debt levels, at 117 and115 percent o GDP respectively. Germany in 2002-05 andFrance rom 2002-04 exceeded the Maastricht budget decitceiling o 3 percent o GDP. In 2006, Lithuania was deniedentry to the eurozone because its ination rate was just 0.1percentage point above the reerence value, although inthe same year, EMU members Portugal and Ireland bothexceeded the Maastricht budget decit ceiling o 3 percento GDP.Greece has taken steps to rectiy its situation, promisinga scal adjustment o 6 percent o GDP a year, but many question whether this is enough. Tey suggest that Athensmay need to take bolder steps, including more signi-cant structural reorms than those currently proposed.Tis includes more cuts to public expenditure rather thanincreases in revenue intake to reduce its scal imbalance.Currently, the Greek ratio is 50/50. Tis is quite dierentrom the Baltic countries’ example o a 75/25 ratio o cuts in expenses to revenue augmentation, a ratio recom-mended by experts or decit reduction. Greece’s actionshave consequences or the decisions o other countrieswatching rom the sidelines. Unless Greece and other crisis-scal discipline and structural reorm as the best way totackle their budget decits. Te Baltic governments imple-mented austerity programs, and their publics went alongwith the shared sacrice involved, viewing this as the costo enjoying hard-ought reedoms in their now-sovereign,independent countries. Estonia, Latvia, and Lithuania thusconsolidated and improved their public nances and publicsector balance sheets. As a result, Estonia met all the Maas-tricht convergence criteria and was admitted to EMU onJanuary 1, 2011.Lithuania is also doing quite well, having set euro-accessionas its ocial goal or 2014. Its budget decit is down to 2.8percent o GDP rom 5.3 percent in 2009, and it expectsto continue meeting the 3 percent Maastricht budgetdecit criterion in 2012. It has achieved these metrics by severe budgetary cuts to pensions and other outlays, andlike Estonia and Latvia, is sustaining its public nancesby implementing important reorms in the healthcare,pensions, and social security sectors. Te Lithuaniannance ministry orecasts 5.8 percent growth or 2011 basedon new export markets and growth in the manuacturingand service sectors, and this will surely strengthen thecountry’s scal position. Latvia’s progress was particularly impressive. It aced severe problems at the time o the nan-cial crisis, with a total decline in GDP o 25 percent, and acurrent account decit o 23 percent o GDP in 2007, whichit turned into a surplus o 9.4 percent o GDP in 2009.However, in the larger Eastern European countries, such asPoland, the situation is somewhat more complex. Duringthe nancial crisis, Poland, with its oating exchange rateand ination-targeting monetary policy, was the only Eastern European country to record positive growth in2009. Te Polish government, the current holder o theEU presidency, supports euro-accession, viewing the euroas an instrument to achieve greater European integra-tion, but avors a less enthusiastic approach, as suggestedby recent comments rom government authorities. Polandconsiders the current crisis o the euro to be a byproduct o the diculties associated with European integration, and isoptimistic that the euro will survive the current turmoil andthat Europe will be strengthened as a result. Buoyed alongby GDP growth o 3.8 percent, which is orecast to increaseto 4 percent this year, Poland’s public debt is at 55 percento GDP, below the Maastricht threshold, and is expected to

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