Brian Ardy

Adjusting to EMU

List of Tables List of Figures List of Boxes Abbreviations Acknowledgements Preface Notes on the Contributors Introduction PART 1: ADJUSTMENT AT THE EU LEVEL Macroeconomic Policy in the EMU The EMU Constitution Policy Co-ordination under EMU Structural Policies as a Means of Adjusting under EMU PART 2: ADJUSTMENT AT THE NATIONAL LEVEL The Early Years of EMU: Convergence but Uneven Adjustment Germany: Painfully Adjusting to EMU? Ireland: Adjusting to Life in the Euro Area without the United Kingdom? Finland: Membership to Encourage Change Sweden: Not Yet or Not Ever? The United Kingdom: Prospering Outside the Euro Area? The New Members - Big Bang or Slow Transition to Stage 3 Adjusting to EMU: Conclusions and Policy Implications Notes Bibliography Index

How will EMU affect cohesion

The new policy environment of EMU affects economic, political and social cohesion in different ways: the policy mix and menu will be reconfigured; it will provide for more macroeconomic stability in cohesion countries; economic competition will intensify and change patterns of specialisation; and comparison of living standards will become easier, which puts pressure on policymakers to reduce inequalities. This article assesses the significance of these effects and their likely consequences in the short, medium and long run. Then the salient cohesion issues as regards eastern enlargement are discussed. Finally, policy conclusions are drawn, mindful of the considerable uncertainties that warrant further research.

Germany: Painfully Adjusting to EMU?

Without Germany there simply would have been no monetary union. The pre-eminence of its economic policy framework during the post-war period made the Deutschmark the natural anchor currency for the Exchange Rate Mechanism and the Bundesbank provided the institutional blueprints for the ECB. Today Germany is much the largest economy in the euro area, accounting for roughly one-third of its domestic product. Although the advantages to other Member States of adopting Germany’s credibility and stability approach to monetary policy are well documented, it is a little more difficult to pinpoint what Germany took from the bargain. There were few macroeconomic advantages and some potential disadvantages for Germany, which would be trading-in a stable macroeconomic policy tailored to the needs of the German economy, for one based on the needs of the euro area as a whole. The effect of this change would dominate in the short term over the microeconomic advantages, which relate to the improvement in efficiency stemming from permanently fixed exchange rates and a common currency.

The New Members: Big Bang or Slow Transition to Stage 3?

The ten new members that joined the EU in 2004 face a tantalising dilemma: should they aim to participate fully in Stage 3 of the euro as soon as possible, or retain monetary autonomy until their economies have adjusted more fully to the challenges of full EU membership? Plainly, their circumstances differ and, in many ways, these circumstances reflect the challenges of adjustment analysed in previous chapters. Six of the new members are very small economies which can expect to becoming increasingly open as they integrate, three are medium-sized, while Poland has a population comparable to Spain of 39 million. However, collectively, the GDP of the new members, measured in purchasing power terms, is barely 5% of the EU25 total.

The United Kingdom: Prospering Outside the Euro Area?

The most distinctive feature of the UK’s approach to EMU is its reluctance to participate. This ambivalence about the political and economic benefits lies behind the concession of an opt-out1 giving the UK the option not to join until it is ready to do so, negotiated as part of the December 1991 Maastricht agreement that paved the way for EMU. By contrast, the two other EU-15 Member States which are not part of the euro area, Denmark and Sweden, have had governments committed to membership, but have been prevented from going ahead by the results of referenda. The current UK government has expressed its political agreement to membership (HM Treasury, 1997a) provided that the economic conditions are right, and put forward five economic tests by which that stipulation was to be judged. While these tests have been portrayed as being purely about the economic case for UK accession to the euro area, in practice they are also political, not least in requiring that the case for membership be ‘clear and unambiguous’. All major parties have also pledged to call a referendum on membership, which will be a tough test given that support in the UK for European integration in general, and monetary union in particular, is consistently the lowest in the EU.

Adjusting to EMU: Conclusions and Policy Implications

The achievement of EMU has been a slow and tortuous process. It has had to overcome significant political and social opposition, changing views on how to effect the shift from national currencies and policy systems to what is now in place, and vacillation over the institutional design. Today, the euro is taken for granted and the debate has moved on to the no less complicated questions of how to manage the economic policy system and whether and/or when reforms of particular instruments are needed. With poor economic performance compared to aspirations, this has been generating some quite severe tensions recently, as people look for something to blame.

Sweden: Not Now or Not Ever?

Sweden has chosen a unique approach to joining Stage 3 of EMU, which is to agree to the principle of membership but to postpone actual entry until economic circumstances are appropriate. The other two countries among the EU members that have not joined Stage 3, Denmark and the UK, both have an opt out. They can stay out permanently if they wish. Sweden cannot. Furthermore, many of the countries that joined the EU in 2004 have expressed a wish to proceed to EMU membership rapidly thereafter. This chapter explores whether there are some unique reasons for Sweden’s choice, particularly in the light of the referendum in September 2003 rejecting membership.

Macroeconomic Policy in EMU

Our aim in this chapter is to set out the principal challenges facing macroeconomic policy in Stage 3 of EMU and to consider progress in meeting them thus far. The context for this evaluation springs mainly from the ‘Lisbon Strategy’ that was propounded at the Lisbon special European Council in March 2000 and re-launched at the 2005 spring European Council, which requires a quantum leap forward in the economic performance of the EU. Much of that improvement is expected to come from the closer integration of markets and removal of barriers, which should of itself intensify competition and spur firms to greater innovation, efficiency, effective investment and hence growth. Some of it will stem from co-ordination of policies, particularly in the fields of structural reform and employment through the BEPGs (see Hodson and Maher, 2001). Much of the remainder is expected to arise from Stage 3 of EMU itself, both with the single monetary policy and the enhanced co-ordination of fiscal policy implied by the SGP.

Policy Co-ordination under EMU

One of the most important and novel features of EMU as a policy system is the extent to which it relies on policy co-ordination. As explained in Chapter 1, this is a deliberate choice, motivated by a reluctance to push more powers upwards to the Community level in the wake of monetary union. EMU, however, means not just integration of the currency, but also a furthering of the single market and the reduction or elimination of barriers that segment factor markets. It follows that economic policies implemented by one Member State increasingly affect those in others, so that the common interest in the impact of national policies is evident, as is the need to ensure that policies are mutually consistent. Co-ordination therefore has to steer a course between allowing Member States to exercise their discretion, while restricting disruptive policy divergences. Initially, the focus was on co-ordination of fiscal policies and on ensuring the smooth functioning of the single market, but subsequently, machinery for co-ordination has developed for a range of other policies, notably employment.

Finland: Membership to Encourage Change

Of the five Nordic countries only Finland has chosen to go into Stage 3 of Economic and Monetary Union from the outset. Sweden and Denmark, as members of the EU, could have joined if they had chosen, as they had no problem meeting the convergence criteria in 1998. Norway and Iceland of course were not eligible, as they were not members of the EU but just the EEA. It is easy to put forward a list of economic and political factors that have contributed to these differences in choice. With its large asset base from North Sea oil and gas, Norway cannot merely afford to take an independent line but finds that it is subject to different exchange rate pressures. With extensive fishing industries, Iceland and Norway have something to lose from entry into the Common Fisheries Policy of the EU that the others do not. Finland with its long common border with Russia has stronger incentives to embed itself very firmly in an alternative grouping. One can go on.