Taking on the euro
A consortium of economists and political scientists from the EU and Acceding countries is investigating the complex decisions and impacts facing the new Member States as they move towards adopting the single currency. Interdependencies between labour markets, inward investment, monetary policies and political realities make it essential for the whole EU that the right choices are made. The project is looking for ways to minimise financial and systemic risk in the context of existing social and cohesion policies.
The ECB cannot fine-tune interest rates for individual eurozone members, despite their differing labour costs, tax regimes, capital markets and industry structures. For economists the eurozone is not an ‘optimum currency area', because it is heterogeneous in national economic priorities and responses – making it less flexible to crises. Acceding countries' relatively low productivity, low incomes, underdeveloped financial institutions and heavy dependence on flighty foreign capital imply increased risks, but responses are limited by EU social policies. Critically, the EU as a whole shares these higher risks as economic failure in one Member State will have cost impacts across the continent.
Rocks and hard places
Building the consortium was a learning process, says coordinator Professor Michael Bolle. “We only knew each by reputation, so it took time to gel. Mixing political scientists and economists to study interdependencies was difficult at first, with opposing views strongly held. But our belief in the project's importance held us together on the major issues. We all brought relevant experience – the Finns in research design, Lisbon in spatial modelling of trade, Bologna in exchange rate models. It is an effective mix.”
The project combines theoretical analysis with empirical research structured in three stages. First, the reshaping of markets for the eurozone is analysed. Then policy analysis and the social dimension are added. Finally, low-risk strategies are developed to reduce the overall adaptation cost of extending the eurozone.
“Take central and eastern European capital markets,” says Bolle. “They are still imperfect, and information asymmetry produces caution, reducing domestic lending. We call it credit rationing. So business depends heavily on foreign capital that is only available when investors have confidence in the accession process. A missed accession deadline could trigger a flight of capital, forcing currency depreciation and precipitating an economic crisis. This is a real risk in the transition period between accession and entry into the eurozone, with costs that all Europe will bear.”
Once in the eurozone, Acceding countries will not be able to mitigate economic shocks through monetary policy. Labour markets need to be deregulated and flexible so that crises can be managed through reductions in unskilled wages. Deregulation implies short-term pain for long-term gain, and the alternative is higher structural unemployment. But political pressures may intervene. Should a government compensate the newly unemployed, or further increase market flexibility and thereby place additional pressure on the least wealthy?
Ezoneplus considers such scenarios in depth. Clearly in the medium term the economic convergence of Acceding countries will require additional financial resources, and much of this will come from the EU. There are many possible paths through the transition to the eurozone, however, and Ezoneplus aims to define those with the lowest net cost and the lowest risk to the EU as a whole.
The project has further ambitions, Bolle says. “All the consortium members learnt a tremendous amount from each other, and these are influential institutes in their home countries. We recently made presentations in Bulgaria, Romania and Turkey, and want to extend our network to these countries under FP6 to look at wider and deeper issues of convergence.”
The eastward enlargement of the eurozone (EZONEPLUS)
FP5: Human potential
Jean Monnet Centre of Excellence, Freie Universität Berlin, Germany
University of Bologna, Italy
Institute for Economic Research, Slovenia
Government Institute for Economic Research, Finland
Warsaw School of Economics, Poland
University of Tartu, Estonia
Universidade de Évora, Portugal