Abstract
The founders of the European Union and European Monetary Union foresaw or assumed that the monetary union would only be sustainable if there was a convergence of living standards across member countries, and that the endogenous convergence in living standards was only possible if there was sufficient institutional and structural convergence. However, their view that there may be a kind of endogenous institutional-structural convergence process within a monetary union with structurally heterogeneous member countries has not proved well founded. Convergence (in living standards as well as in institutional and structural development) seems possible only if this process is accompanied by conditional aid from those more developed member countries and with a strict surveillance of the implementation of these conditionalities. Without these preconditions, convergence in living standards across member countries in the European Monetary Union will occur only if higher debt ratios are accepted in the member countries. Over-indebtedness in some member countries, however, can lead to a sovereign debt crisis and create contagious effects on other, even further-developed, member countries. This has become apparent in the European Monetary Union during the past few years.
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Notes
- 1.
Another conclusion of this paper is that the larger the development (real convergence) gap between an accession country and the incumbents of a monetary union, the greater the danger of ending up with low or even negative net real growth effects from accession, at least for some period of time. This has proven true for some euro area countries like Greece and Portugal, and may also prove true for other less developed member countries.
- 2.
This requirement does not apply to Great Britain and Denmark; these two countries negotiated early on an opting out clause so that they do not have to join the euro area.
- 3.
See, for example, Papademos (2006).
- 4.
Here I treat GNI and GNP the same measure. GNI is identical to GNP as previously used in national accounts generally (Eurostat’s Concepts and Definitions Database).
- 5.
Various convergence hypotheses have been developed and tested econometrically (see Sala-i-Martin 1996, Galor 1996, Barro and Sala-i-Martin 1995, Chap. 11). Here, catching up is understood to decrease the dispersion of real GNP per capita in the EU countries (see also Grosser 1992, p. 404; European Commission 1996, p. 175). This measure serves as a rough indicator for the alignment of standards of living, an aim of the treaties on which the EU is based. A necessary condition for this convergence is that the “backward” countries grow faster than the richer countries. In the terminology used by Sala-i-Martin (1996) this means that β-convergence is a necessary condition for σ-convergence.
- 6.
OCA theory was originally developed in the 1960s; however, it now requires further development against a background of the globalization process that has occurred since then. For a survey of the theory of OCA see, for example, Mongelli (2008).
- 7.
The term acquis communautaire is used in EU law to refer to the total body of EU law accumulated thus far.
- 8.
See Wagner (1997).
- 9.
This can be seen in the development of bond spreads after the (announcement of the) establishment of the euro area in the mid- to late-1990s. See Fig. 4.
- 10.
The compulsion of a restrictive fiscal policy means that in certain circumstances a high level of unemployment and the fact that important infrastructural investments cannot be financed must be accepted to fulfil the interest parity condition of a monetary union.
- 11.
This discipline is seen as particularly important on the road towards an European Monetary Union. See Wagner (2005a).
- 12.
The establishment of the European Monetary Union means the separation of monetary and fiscal policies in the member states. The opportunity to autonomously procure revenues from seigniorage disappears. Within the monetary union there will still be profits from the creation of money, but these will go to the ECB, which will return the profits to the individual states. However, the profits for those countries that previously had high rates of inflation will probably become significantly lower, because an independent ECB will be likely to considerably restrict the possibility of seigniorage revenues. This could result in substantial budgetary policy problems for some of the less developed member states. This loss of revenue will have to be compensated for by tax increases or reductions in expenditure. However, as a result of the general reduction in rates of inflation in the 1990s this problem appears now to be considerably lessened for the present circle of member states. See Wagner (2006).
- 13.
At this stage most politicians and economists consider that the benefits would outweigh the costs of European monetary integration (the question is however, is this the case for all members, and at which time horizon).
- 14.
Another potential counter-argument to the long-term real effects of monetary integration is, however, misleading, and refers to the hypothesis of neutrality of monetary policy (see Wagner 2001).
- 15.
NMS-10 represents the ten former post-communist countries that joined the EU between 2004 and 2007, and the EA-17 currently includes 17 member countries in the euro area.
- 16.
This may be disappointing for GIPS if compared with NMS-10. However, the level of GNI per capita is still higher in GIPS compared with NMS-10 (see Table 4 in the Appendix).
- 17.
In sum, empirical evidence appears to advocate in favor of convergence during the initial stage of becoming a member of the European Monetary Union. Once a country has joined the common currency, the process of convergence slows down.
- 18.
This nervousness could also be explained by the risky actions taken by the incumbents by allowing less developed EU members (such as Greece and Portugal) prematurely into the euro area. There were concerns not to overload the newly-founded European Monetary Union and particularly the ECB with uncertain or risky challenges.
- 19.
On fiscal issues of post-communist NMS-10, see Wagner (2006).
- 20.
The counter-argument is often based on the endogeneity hypothesis that an exchange rate instrument would in any case not be as necessary within a monetary union because the typical cases for its application would endogenously tend to disappear or be reduced. First, the increasing integration resulting from the founding of the European Monetary Union would lead to changes in industrial structures in the sense of greater turnover and investment relations within industries. This means that most countries will both export and import the products from many branches (“intra-industrial trade”). As a result, sector-specific shocks will hit different countries more similarly than previously. Second, a credible monetary union would influence the behavior of both sides of industry to the extent that they would pay more attention to remaining competitive, because the alternative of devaluation no longer exists. Thus, wage and price flexibility becomes greater, which reduces the significance or the benefit of exchange rate adjustment as a shock absorption instrument. Third, the European Monetary Union will eliminate an important category of country-specific shocks that have their origins in exchange rate movements themselves and in an imperfectly coordinated monetary policy. See Emerson et al. (1992), p. 24.
- 21.
Another critical point or cost associated with premature accession is that the accession of less developed emerging economies into an economic and/or monetary union that consists mainly of more highly developed industrial countries increases the asymmetries in the macroeconomic structures of the union. These asymmetries create challenges or strains for common central banks as the common monetary policy (one-size-fits-all policy) then creates different adjustment reactions in individual member countries. Different business cycles and tensions within the union are then predetermined.
- 22.
See Wagner (2002a).
- 23.
The International Monetary Fund (IMF), for example, emphasized that accession aspirations should “help these countries maintain the momentum of progress that is needed with fiscal reforms, privatization, other structural improvements, and environmental clean ups” (IMF 2002, p. 39).
- 24.
Or as the European Commission pointed out: “the priority should remain on improving the functioning of the budgeting process, carrying out structural reforms, implementing the acquis communautaire, and supporting catching up” (European Commission 2002, p. 126).
- 25.
- 26.
For further details see, e.g., Darvas and Szapary (2008).
- 27.
- 28.
Latvia, for example, increased its external debt to 139% of GDP in 2008. Domestic lending relative to GDP expanded between 2000 and 2008 from 23% to 89%. In Estonia, domestic lending was also boosted from 34% of GDP in 2000 to 98% in 2008, where most of the expansion was not covered by domestic savings. Therefore, external debt also increased from 45% of GDP in 2000 to 108% of GDP in 2008. Despite these high external imbalances, Estonia (in contrast to Latvia) then managed to keep domestic overheating within tolerable limits due to a sound fiscal policy with budget surpluses between 2002 and 2007.
- 29.
The debt crisis in the euro area may also be contagious for newcomers if capital flows are drying up and countries with large current account deficits rely on these.
- 30.
Moreover, in some euro area countries interest rates or spreads on government bonds may increase due to country-specific risk premiums, as the current development shows.
- 31.
Due to space limitations I will not replicate the model here and shall only highlight the results of the model analysis.
- 32.
If, however, the incumbents also follow strategy (2), and moreover if the NMS are assumed to be “large” countries there may also be a strong(er) negative growth effect in the core countries (for more on the fiscal issues and challenges in NMS under globalization see Wagner 2006). But even then the goal of “real convergence” is violated if we regard it as a combination of different convergence sub-goals, also including convergence to an absolute level of living standard.
- 33.
A set of formal entry criteria was supposed to serve as a useful test of prospective members’ ability to follow disciplined policies. One of the rationales for fiscal entry criteria or constraints has been that spillovers of fiscal policy may be strengthened within a monetary union due to fiscal free riding. Such free riding tends to generate too expansive fiscal policies. This imposition of restrictions on government deficits and debt is to be seen against the background that, in contrast to monetary policy, fiscal policy has remained a national competency within the European Monetary Union.
- 34.
These criteria are contained in Article 109j of the Maastricht Treaty establishing the European Community and defined in Protocol 6 of that treaty.
- 35.
“The Union …[as well as] A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public under-takings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.”
- 36.
This is laid down in Protocol No 4 of the Treaty of Lisbon.
- 37.
In particular, Germany was scared that the constraints of the European treaties would lose their bite once a country was admitted into the monetary union, as no member country can be forced out again.
- 38.
However, it should be noted that, ironically, it was Germany that first violated the Stability and Growth Pact in the first decade of the 2000s.
- 39.
Particularly the “New OCA Theory” emphasized the endogeneity of cyclical correlations with respect to the decision to join a monetary union (cf. Frankel and Rose 1997, and Frankel 2005; see also de Grauwe and Mongelli 2005). However, others have emphasized the endogeneity of structural and institutional convergence in a broader sense (see Wagner 2012a).
- 40.
And even this solution would likely be a weak compromise. As we often experienced, it is unlikely that reform decisions will eventually be completely implemented. There will be pressure from lobby groups as well as a natural slowdown of reform efforts as soon the crisis weakens.
- 41.
And also other emerging member countries were affected via contagion.
- 42.
That is, the more heterogeneous an economic union is with respect to the development stage of its potential members, the more dangerous or costly is the step towards establishing a monetary union.
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Wagner, H. (2013). Is the European Monetary Union Sustainable? The Role of Real Convergence. In: Kaji, S., Ogawa, E. (eds) Who Will Provide the Next Financial Model?. Springer, Tokyo. https://doi.org/10.1007/978-4-431-54282-7_17
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