Euro Membership: gain or loss?

(TAKAHASHI Yoichi, PPPC Chairman)

Economies of Eastern European countries have shown fairly good performances lately. Poland will likely record more than 3% of economic growth rate in FY 2014. Similarly, the Czech Republic’s prospected economic growth rate in 2014-2016 will mark 2-3%. Both economies have shown a remarkable performance despite concerns caused by negative growth in Ukraine. On the other hand, Greek economy is yet to get out of uncertainty.

Within Europe, many Euro-member countries have marked low growth while non-Euro-member economies have accomplished economic growth. The author thinks it is not coincident because such an incident could be predicted by a famous theory in international finance.

A Nobel Prize winner Robert Alexander Mundell is known for his theory on optimal currency area, whose essence can be summarized as conditions for using common currencies such as euro.

First, in order to utilize common currencies, it is required that fluctuations of economy and inflation rates in each country accord with each other. Second, trade inter-dependencies must be high among the member countries in order to standardize the economies. Third, economic flexibility and open labor markets are required so that structural coordination is available and people can move across the boundaries.

Because same interest rates are applied in member countries under the common currencies, any monetary policy would not work as long as there are varieties in economic fluctuation and inflation rates in each country. The three conditions above are thus required to make macro-monetary policy function.

Given the conditions, there would not be much problem if it was just the major countries such as France and Germany that use the common euro currency, but economic performance would automatically decline by enforcing the minor countries such as Greece to join the membership.

Nonetheless, as result of political intensions of France and Germany to expand the euro currency irrespective of such economic calculation, the current euro has expanded beyond Mundell’s optimal currency area.

To note, there was a political calculation to support Greece as fort against Islamic countries. Greece has historically confronted with Turkey and invested a lot in military expenses. There are illegal immigrants flowing from north-African countries and Greece has served as front-gate to prevent immigrants from spreading all over Europe. In the bottom line of the Greek tragedy there was such a political intension behind the euro-expansion orientation.

At the same time, there is a gaining for the major member countries such as France and Germany by increasing the peripheral member countries. As the ECB’s interest rate is set at relatively-lower to accord with that of France and Germany that dominate majority of price indexes of euro.

Among the euro member countries, while prices of export goods can be controlled in the slowly-inflating economies such as France and Germany, export goods of quickly-inflating economies such as Greece would lose the price competitiveness. Consequently, France and Germany have enjoyed the fruits of increasing exports; they were the beneficiaries of euro-expansion.

Now the euro has come beyond the optimal currency area and will turn into decline as a whole. The positive sign of East-European economies seems to be the other side of that coin.

Let us confirm by siting the data. The graph below shows the average economic growth rates in the euro and non-euro countries since 1999 when the euro was established.

　　　　　Economic Growth of euro-member countries and non-euro countries in Europe

Non-euro countries have performed better in most of these years. It seems not to be promising to join the euro which is now beyond the optimal currency area.