Living with the Euro. The CEE Experience

The common currency should not be easily pictured as the cause of problems or a guarantee of success. The Euro is awarding those who are well prepared.

The twentieth anniversary of the Euro currency should be a moment for reflection. Next, to the US dollar, the Euro is the second most important currency in the world, which is used—on average—by more than 70% of the citizens who live in the Euro area. This is the strongest support ever in history. Aimed at avoiding the fallacies of Europe’s southern countries, the Euro has been undergoing a process of reform for many years. Some- times called “the Euro 2.0”, although still on the development path and far from being perfect, it now creates a complex integration project that consists of the former monetary and currency union supplemented with new institutions such as the European Stability Mechanism, the Banking Union, and the Capital Markets Union. The Union of Social Standards is in the plan in the future.

Furthermore, in the projected following EU multiannual financial perspective 2021-27, there is a separate fund for the eurozone countries. Over time it could transform into a separate eurozone budget, which will clearly privilege those countries who are inside. Soon it may appear that the full benefits of membership in the EU are linked to membership in the euro area. This was already clearly stated by the European Commission President, Jean-Claude Juncker, in his State of the Union speech of 2017. This perspective has also begun to prevail in the entire discourse on the future of the EU.

Assuming that Brexit finally happens, the eurozone would comprise 85% of the EU GNP. Additional countries are knocking at the door: Bulgaria, Romania and Croatia. At the same time the mood in Poland, the Czech Republic and Hungary is quite contrary. None of them is in a rush to fulfil their old obligation arising still from the 2003 accession treaties to the EU and consequently implementing the Euro currency. They still view the Euro through the prism of the global financial crisis that began a decade ago. Their societies are reluctant to abandon their national currencies and are afraid of the rise in prices and a decrease in the standard of living as a result of accession to the Euro. The negative benchmark was introduced by the vivid memory of excessively indebted countries of the EU South, who experienced years of shallow economic growth and high unemployment rates.

Additional countries are knocking at the door: Bulgaria, Romania and Croatia. At the same time the mood in Poland, the Czech Republic and Hungary is quite contrary. None of them is in a rush to fulfil their old obligation.

Looking, however, at the countries who committed mistakes in economic policy and bore some heavy consequences should not be the only perspective (it is worth mentioning, that none of those countries is willing to exit from the eurozone).

Good lessons from the CEE4-ins

There is no doubt that every economy must be well prepared in order to be a solid member of the eurozone. The good lessons here are offered by the four CEE countries who are already in: Slovakia, Estonia, Latvia and Lithuania. Let’s call them CEE4-ins. They have been jumping into the euro area in different moments of time. This was Slovakia in 2009 during the outbreak of the global financial crisis, which had its roots in the US, but soon approached Europe; Estonia in 2011—in the midst of the crisis; Latvia and Lithuania just after the crisis, in 2014 and 2015 respectively.

The CEE4-ins did not copy the mistakes committed by the South of Europe. Over the long-term, each of them experienced a drop in unemployment.

A common feature of these countries was a very low level of public debt before the accession, although they all had problems with too high inflation. Lithuania, for example, failed twice with its accession due to excessive inflation. In the case of the CEE4-ins, entry to the eurozone did not trigger deterioration. The CEE4-ins did not copy the mistakes committed by the South of Europe. Over the long-term, each of them experienced a drop in unemployment (except Slovakia, where the unemployment has risen for a short time similarly to the rest of Europe in consequence of the global crisis).

After entry to the eurozone, the economic growth in CEE4-ins was moderately positive. In the case of Slovakia, since 2009, the cumulative GDP growth reached 20% while in the case of Poland, the Czech Republic and Hungary (CEE3-outs) it was 18% on average. Slovakia surely did not become impoverished due to the eurozone. Slovakia had a much stronger growth of industrial production in 2010-17, around 60%, while in the Czech Republic and Hungary it was 40% and Poland 46%. According to the recent IMF forecast, over the next five years, Slovakia will be the fastest developing economy from among the entire Visegrad Group. In the case of Estonia, since the entry to the eurozone, the cumulative GDP growth hit 28%, while in CEE3-outs 19% on average. Lithuania and Latvia, since the entry to the eurozone, are growing at a similar tempo to the average of CEE3-outs.

Higher prices are not a consequence of accession to the euro

Slovakia achieved unprecedented economic success after it joined the eurozone, which resulted in a general satisfaction observable in the opinion polls. For the Baltic states, who were interested in fast accession mostly for political reasons, the entry has also contributed to a better economic situation.

Before accession, the Baltic states all had a fixed exchange rate towards the Euro. The Baltic states GDP per capita was 4 times smaller than that of the other eurozone countries in 2004. This difference is only twice as big at present. They had a meaningful inflow of FDI from the eurozone and a rise in the share of export and import with the eurozone in trade. The unemployment rate in Lithuania, Latvia and Estonia was also smaller than in the other eurozone countries. Surely, the Euro is not the only reason for this success, but the conclusion is very simple: the CEE4-ins did not copy the mistakes of the EU South. Therefore they achieved tremendous success.

Before accession, the Baltic states all had a fixed exchange rate towards the Euro. The Baltic states GDP per capita was 4 times smaller than that of the other eurozone countries in 2004.

One of the popular myths present in public opinion is the supposedly high growth of prices in CEE4-ins in consequence of accession to the eurozone. It is simply a false statement. In 2009 (the date of the Slovakian accession to the Euro) the inflation rate in Slovakia was 0.9%, i.e. it was lower than in the past. The growth of prices in Poland reached 4%, the Czech Republic and Hungary 6% at the time. Since the accession to the eurozone, prices in Slovakia have grown cumulatively of about 12%, while in CEE3-outs 18% on average. There was also no mythical levelling of prices with Germany. The prices in Slovakia decreased relative to Germany from 65% to 61% from the moment of eurozone entrance.

The common currency is not the cause of problems or a guarantee for success

Thanks to strong performance in preparation for changing the currency, the introduction of the Euro was not followed with an acceleration of inflation. Nonetheless, the rise in prices on some goods has strongly contributed to the fact that perceived inflation was much higher than the real one. It can be explained by the so-called “cappuccino effect”. People tend to notice much stronger the rise in prices of goods that are bought by them in cash (for example a coffee in Italy). Another explanation is that people tend to observe more closely a rise of prices, not a decrease in them, while the statistical inflation rate is an average from both the rise and drop of the prices of goods.

In the public perception, the further popular “argument” symbol- izing the rise in prices and the impoverishment of Slovakia and Lithuania after entry to the eurozone is the fact that their citizens prefer to shop in Poland instead of their own countries. This is, however, a rather false interpretation that arises from a misreading of economic mechanisms. The citizens of Slovakia are not poorer after joining the Euro. Since 2008 (the last year of existence of Slovakia’s corona), the average Slovak salary has nominally risen 35%, after deducting inflation 20% in real terms. It equals an additional amount of money in people’s pockets. Additionally, due to holding a strong and resilient euro, Slovak wages did not drop as they have been calculated in Euro, in contrast to the wages of Poles, Czechs and Hungarians.

The weakening of the Polish zloty in 2009 automatically triggered the drop in prices in Polish shops. While in 2008 the prices in both countries were almost identical, in 2017 the average Slovak could buy in Po- land 20% consumption goods more than in Slovakia. All in all, Poles have been impoverished due to a depreciation of their currency (they had to pay more for imported goods or for all goods that were bought abroad). Slovaks also enriched themselves in comparison with Poles—in their home country thanks to a much stronger rise in wages relative to prices, and even much more on shopping in Poland as the prices were very attractive to them.

Slovakia’s performance vis-à-vis the Czech Republic was also remarkable. As of 2008, when Slovakia experienced the very strong effect of anticipation before joining the Euro, the average GDP growth was 1.4%, while in the Czech Republic 0.4%. The gap in GDP per capita between the Czech Republic and Slovakia has dropped from 21% in 2008 to 7% in 2016.

The experience of CEE4-ins, and CEE3-outs demonstrates that the common currency should not be easily pictured as the cause of problems or a guarantee for success. The Euro is awarding those who are well prepared.

One of the popular myths present in public opinion is the supposedly high growth of prices in CEE4-ins in consequence of accession to the eurozone. It is simply a false statement.

It can create problems for those countries who do not undertake appropriate reforms and make grave mistakes in economic policy. Worth remembering, whether they are in the Euro or out of it, is that countries who do not commit reforms will always have difficulties.

None of the CEE3-outs reject the eurozone by principle

Thanks to the Euro, the CEE4-ins also received obvious political benefits. The Baltic states are members of the informal but highly influential “Hanseatic League” (sometimes called the Northern League), which is one of the most important groups leading the debate on the future of the eurozone. It often directly and successfully contradicts the views of Germany and France. Slovakia closely cooperates with the League. The Slovak Minister of Finance, Peter Kažimír, was one of the favorites to chair the so-called Euro group (a group of countries who hold the Euro currency), while Latvia’s former Prime Minister, Valdis Dombrovskis, as Vice-President of the European Commission, is responsible for the reforms of the entire eurozone. Furthermore, it can be easily assumed that membership in the Euro will create an additional advantage during the negotiations on the next EU multiannual financial framework.

Thanks to strong performance in preparation for changing the currency, the introduction of the Euro was not followed with an acceleration of inflation.

For the CEE3-outs, the situation is not simple. In Poland, the Czech Republic and Hungary the choice of not entering into the eurozone seems to be mostly linked to a political factor and the ideologies of the governing parties. This also strongly affects public opinion as the mood towards Euro entry is rather gloomy in all CEE3-outs. Characteristically, none of these countries rejects the eurozone by principle. They all argue, however, that the Euro must reform itself as its current shape is still incomplete and does not ensure sufficient safety in times of crisis. The argument is partly true, but does not take into account how volatile the currencies of CEE3-outs are currently. Monetary sovereignty is much different today than it was in the past. The EMU is currently the largest project since the creation of the Single Market, and it must move forward. The rules clearly will be decided without the participation of CEE3-outs and one way or another it will impact them. Therefore all these three countries keep open a small window for a change of option.

I had the privilege on several occasions to exchange views with the Czech PM, Andrej Babiš. Although he by principle rejects the idea of a common currency, it seems that he would be very much pragmatic if the circumstances change. This is also the case with the Hungarian PM, Viktor Orbán, whose government has already suggested a willingness to reconsider its position. The Polish PM, Mateusz Morawiecki, has introduced the conditions for the entry to the eurozone that practically makes it impossible to project in the years to come. In all three cases, the attitude would probably change if the idea of the introduction of the eurozone budget becomes real and would not be small. Objectively, the eurozone needs it. It may additionally trigger a new impulse for the CEE3-outs.