The appeal of the euro
Joining the euro is still attractive to some
HAS the euro crisis dissuaded other countries from adopting the single currency? Not a bit of it.
Since 2009, when euro-zone GDP shrank by 5%, four countries—Slovakia, Estonia, Latvia and Lithuania (let’s call them the “SELLs”) have joined. Their experience suggests that the euro still has its benefits, but also some familiar risks.
Many thought that joining the euro would spur the SELLs’ foreign trade, by removing the friction of exchanging currencies. The Slovakian central bank, for example, predicted a boost of 50%. That was wildly over-optimistic: the euro has made little difference to Slovakia’s imports and exports. The problem may have been a confusion of cause and effect. Growing trade between nations is likelier to lead to the formation of a currency union than vice versa.
Baltic firms, meanwhile, have not significantly increased exports to the euro zone, even though the closure of its largest market, Russia, thanks to sanctions in 2014-15, forced many to search for new trading partners. Instead they have exported more to places like the United Arab Emirates and Saudi Arabia.
Happily, a perceived downside of adopting the euro was also overblown. The worry was that shopkeepers would use the changeover as an excuse to put up prices, particularly if doing so got them to a price ending in a “99”. But the changeover in Slovakia seems to have boosted inflation by just 0.3 percentage points. In Estonia large retailers joined a snappily titled campaign, “The € will not increase the price”. (In fact, a prod to inflation would have been no bad thing for the SELLs, which have fallen into deflation in the past year, thanks to cheaper prices for energy and food.)
The euro does seem to have helped the SELLs’ financial stability. Their banks and central banks now have access to emergency funding from the European Central Bank. They are also less vulnerable to turmoil associated with “currency mismatch”. On average, roughly 70% of their private-sector debt was denominated in foreign currency (largely euros) prior to joining.
Any depreciation of their currencies would have made those debts much harder to bear—a risk the adoption of the euro has eliminated.
Rimantas Sadzius, Lithuania’s finance minister, says euro membership also allows his government to borrow more cheaply. Debt-interest payments have indeed fallen. But had Lithuania joined a decade ago, Mr Sadzius would have been even happier. In the early 2000s, according to the IMF, euro membership was associated with a two-notch improvement in the credit ratings handed out by Standard and Poor’s. Since the crisis this premium has shrunk dramatically.
Even as some benefits have dwindled, some drawbacks have got bigger. As a condition of joining, the SELLs are supposed to contribute to the euro zone’s bail-out funds. For the man on the street the thought of rescuing Greece is an unwelcome one: its minimum wage is 70% higher than Slovakia’s and it is richer than the Baltics. In fact, for the most part members of the euro zone do not pay directly for bail-outs; instead, they guarantee loans or provide collateral for them. And the bail-out funds have benefits as well as costs. The SELLs could turn to them too if they ran into trouble.
The big question for the future is whether the SELLs can avoid the mistakes made by other euro-zone countries. In the 2000s low borrowing costs helped inflate a credit bubble in southern Europe.
Happily, the SELLs are not on a borrowing binge, as the Baltics were in the 2000s. Their current accounts are more or less in balance. Private-sector debt has actually fallen since the crisis. Their big banks are now supervised by the ECB. Local management has improved too, says Erik Berglof of the London School of Economics.
Despite this, the SELLs face a familiar problem: declining international competitiveness. Ageing populations and emigration are creating a shortage of skilled workers. The population of the SELLs is expected to decline by 4% by 2030. The result is that wages are rising faster than productivity. In the past year the minimum wage across the SELLs has risen by 9% on average. Joining the club may have contributed, by inducing workers to push for wages more in keeping with the rest of the euro zone, says Robert Juodka of PR1MUS, a Lithuanian law firm.
Governments in the SELLs say they are trying to respond by bringing in structural reforms, such as freeing labour and product markets, to boost productivity and thus maintain competitiveness. With devaluation not an option, such reforms have assumed new importance.
There is still plenty to do.
Much of Lithuania’s labour code is inherited from Soviet times, says Rokas Grajauskas of Danske Bank, which makes hiring and firing difficult. The Slovakian labour market has in recent years become considerably less competitive, according to the World Economic Forum, in part because of misguided tax changes. The euro zone’s newest members may avoid the same problems that befell southern Europeans in the 2000s—but the single-currency club still makes its members pay their dues.