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Why Eastern Europe Doesn’t Want to Join the Euro

By Leonid Bershidsky

Czech Prime Minister Andrej Babis thinks he found some useful data to explain his opposition to the euro: A recent report from the German think tank Center for European Policy that says only Germany and the Netherlands have benefited substantially from the common currency since it was introduced 20 years ago. But Babis is wrong, and not just because the report’s findings are being disputed.

“I don’t want the euro,” Babis tweeted on Tuesday. “And all of you who want it, come see the analysis of the German CEP, which does long-term analysis and assessment of EU actions. Which countries have gained from the euro and which haven’t? I think you’ll be surprised.”

The paper in question, by  Alessandro Gasparotti and Mathias Kullas, was published by the CEP last month. It analyzes the euro’s  impact on the prosperity of seven of the earliest-adopting countries between 1999 and 2017. It’s based on a counterfactual analysis – a scenario for the countries’ development if they hadn’t dumped their national currencies for the common one. The scenario is based on the performance of a group of economies that didn’t adopt the euro and that exhibited similar economic trends as the seven countries before the European currency came into existence. Prosperity is defined as per capita gross domestic product multiplied by the pre-euro consumption rate.

The most obvious surprise here isn’t that the biggest countries by net exports among the seven (and the wealthiest in terms of nominal GDP per capita) profited the most; it’s that the effect on Greece’s prosperity is positive. But Gasparotti and Kullas wrote that Greece only benefited in the common currency’s initial years and then suffered enormous losses. They calculate that the euro’s effect on Greece’s 2017 GDP was a negative 41 billion euros ($46.3 billion).

The other rather surprising finding is that France, with a strong export-oriented economy, has borne such big losses. Expect France’s nationalists from Marine Le Pen’s National Rally party to shake the CEP report at their opponents next.

How useful is the study? The CEP’s results have been disputed by various German economists, both pro-euro and anti-euro, who argue a convincing counterfactual cannot be drawn from other countries’ trends because their economies are too different from the euro zone ones. But Babis is wrong to  adopt the CEP analysis for other reasons.

The views of Nobel prize winner Joseph Stiglitz and like-minded economists, who cast Germany as a beneficiary and southern European countries as victims of the euro, acquired quite a following long before the CEP arrived at its highly quotable conclusions. Strong counterarguments have been made by believers in the common currency, however.

The biggest problem with the euro, according to its detractors, is that it makes it impossible for adopting countries to devalue their currencies in response to economic shocks, so they could boost their competitiveness. Presumably, had the governments of Portugal, Italy or even France had this ability, they wouldn’t have sacrificed growth to the euro zone gods. But European Central Bank Mario Draghi has argued that the formation of EU-wide value chains has “blunted the short-run benefits of competitive devaluations.” When a country’s exports contain a large share of imported inputs, it’s not clear if much can be gained by driving down the exchange rate.

That’s a particularly powerful argument for eastern and central European countries such as Hungary, Poland and the Czech Republic. Much of their growth came from inclusion in regional value chains (the car industry’s growth in these countries is a prime example of this inclusion). The “ultimate production partners” in these chains are mostly German, but other euro zone countries such as France and Italy are also amply represented.

Given this high degree of integration with the euro zone, a major devaluation of a national currency won’t do much for competitiveness. That’s  evident from the example of Slovakia, which is part of the same value chains and which has adopted the euro after years of pegging its currency to the common one. During the global economic crises, neighboring countries’ floating currencies depreciated by about 30 percentagainst the euro-pegged Slovak koruna, but their economic performance was no better than Slovakia’s.

The Czech Republic set a lower bound for the Czech koruna’s  exchange rate to the euro for three and a half years before abandoning it in 2017. Since then, the koruna has appreciated by about 5.7 percent. It’s not clear what kind of economic advantage the country gained from it beyond a slight tempering of inflation; it’s certainly not led to a competitiveness improvement.

Central and eastern European governments are fiscally conservative, bent on keeping debt low and distrustful of inflationary financing for their economies. They are also aware that, given the EU’s free movement of labor, a sharp devaluation would probably lead to increased emigration; for the region’s nationalist governments, that’s highly undesirable.

For all these reasons, eastern European governments aren’t planning to play the devaluation card. So why do they choose to bear the costs and risks of maintaining their small currencies, exposing themselves to speculative attacks and feeling intensely uncomfortable about their foreign currency-denominated debt? One plausible reason could be that the euro zone isn’t without its problems: Absent fiscal policy harmonization, it’s not clear it can deal with shocks that are larger than Greece-sized. But that isn’t the real reason Babis and others are opposed.

The main obstacles are political above all else. Support for adopting the euro is low in the Czech Republic – just 33 percent, compared with 69 percent in Romania, 59 percent in Hungary and 48 percent in Poland. Czechs like the vestiges of their sovereignty. Babis should just say so straight out. As the European economy continues integrating, joining the euro, as all EU members except the U.K. and Denmark are legally obliged to do, will eventually feel natural to Czechs, too; as a politician, Babis can openly choose to follow the polls rather than push them in that logical direction.

Bloomberg

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