GMF - The German Marshall Fund of the United States - Strengthening Transatlantic Cooperation

An old Chinese proverb has it that we should be careful what we wish for. As the European Union’s new accession countries from the former communist world scramble to drop their national currencies for the euro without even the semblance of a debate about the potential risks, it is a warning they might want to bear in mind.

The crux of the matter can be summed up in the following question: what are the potential consequences for economies growing on a long term basis at between 5 and 10 percent a year of entering a currency zone whose central bank interest rate policy is geared towards managing economies growing on a long term basis at between 1.5 and 2.5 percent a year?

That question echoes the debate in the mid to late 1990s over euro adoption in Britain, where a large majority of the public became convinced that, to use the idiom of the day, "one size doesn’t fit all". With the British economy growing by an average of 3 percent in the four years between 1996 and 1999, it was argued, there could be real dangers for the country’s future economic stability in adopting an interest policy appropriate for France and Germany whose economies were growing in the same period at an average of 2.5 percent and 1.7 percent respectively. Those two countries’ relatively weaker economic performance, and their much higher unemployment rates, was a product of their inability to enact the kind of radical reforms Britain went through in the 1980s. Why, asked many Britons, should we be lumbered with an interest policy -- and all the attendant implications for inflation, mortgage rates, house prices and budget deficits -- made for economies that had doggedly refused to reform?

Moreover, since much of the euro zone faces a looming pension system crisis, which will inevitably have knock on effects on state spending and, in the end, interest rates, why take the risk of importing even bigger problems in the future?

Such questions could well be asked, and with considerably greater emphasis, by the new batch of euro zone candidates many of whom want to be in by the end of the decade. Bearing in mind eurozone economic growth in the first quarter of this year of 2.0 percent, consider the following growth rates among the eight CEE countries. Hungary came in last place in the first quarter of 2006 with 4.6 percent growth followed by Slovenia -- which is set to adopt the euro next year -- with 5.1 percent. Poland grew by 5.2 percent, Slovakia by 6.3 percent and the Czech Republic by 7.4 percent. The best three performers were the Baltic states with Lithuania on 8.8 percent, Estonia on 11.6 percent and Latvia topping the group with a whopping 13.1 percent.

Many of these economies are in what must appear, from the euro zone perspective, to be the enviable position of facing serious dangers of overheating and are adjusting interest rates accordingly. Latvia and Slovakia, for instance, recently raised rates by 50 basis points to 4.5 percent and many economists expect further hikes in the future.
Since the European Central Bank’s key rate stands at 3 percent, joining the euro tomorrow could have serious inflationary consequences.

No-one, of course, is saying that these countries should adopt the euro tomorrow. So the big question for the future must be this: What is fundamentally going to change about the relative dynamics in central and east European economies compared to eurozone economies by the time euro adoption is actually expected to have taken place in the next 4-6 years?

The answer, one hopes, is very little. The key aim of all governments in the region, after all, is to bridge the wealth gap between western and eastern Europe caused by more than four decades of communist misrule.

In order to achieve this aim, the people of central and eastern European have spent much of the last decade and a half enduring painful, radical reforms.

Now that those reforms are bearing fruit, the last thing anyone in the region wants is to see growth rates slowing back down or to revisit the kind of economic dislocation -- particularly the high inflation which had such a devastating impact in the early stages of the transition -- they are only now beginning to put behind them.

In order to make high and stable growth rates sustainable, central banks will need to manage interest rates in a manner which is appropriate to the very specific needs of a transitional economy. And with growth powering along at such a robust pace it is hard to make a rational case for taking a leap into the unknown. There must, therefore, be a serious question mark over whether early adoption of the euro, and the interest rate regime that goes with it, is really in the region’s best interests, at least at this stage of its economic development.

It also seems, that for one reason or another, many people in central and eastern Europe are skeptical about joining the euro in any case.

According to a Eurobarometer survey released in June, those people in the three Baltic states saying they were unhappy about swapping their own currency for the euro outnumbered those saying they would be happy with such a change by an average margin of 60 percent to 31 percent. In the Czech Republic 52 percent opposed the euro compared to 39 percent supporting it. Even in those countries where sentiment was more positive, the results hardly indicated overwhelming support.

Poland, Slovakia and Hungary scored euro-positive readings to the tune of just 50 percent, 54 percent and 56 percent respectively. Slovenia was the only country in the entire region where support for euro adoption could in any meaningful sense be described as strong with positive responses outgunning the negative by 64 percent to 30.

Upon joining the European Union in May 2004, all countries in the region signed up to a nominal commitment to join monetary union. And most leading political parties, whether of right or of left, take it for granted that they should do their utmost to fulfil that undertaking as soon as they possibly can.

However, in view of the weakness of popular support and the size of the risk they could be taking on board it is now surely time to rethink this whole issue and and begin a meaningful debate.

Robin Shepherd is a senior transatlantic fellow of the German Marshall Fund of the United States.