Should European Nations Avoid Adopting the Euro to Provide an Economic Advantage?
Introduction and Context
Driving east along the M3 out of Budapest as you head towards the Hungarian mountains near Gyöngyös, the landscape is filled with rolling hills and small settlements. In a post-communist country such as Hungary there is still potential for development that perhaps was stalled under Soviet rule. But just as you make your way towards the town of Hatvan, about 90 minutes outside the capital, the farms and small country homes become overshadowed by a large and imposing structure. The amount of time it takes to drive past the building is significant and shows the scale of its size. Deep red and definitely placed to be noticed, the logo of the Bosch electronics company clearly denotes the entity responsible for the man-made feature occupying the landscape. With some research it was revealed that the factory is responsible for automotive parts and is actually, “the biggest production site of the automotive division within the Bosch-group” (Bosch). The company has furthered its investment in Hatvan and in Hungary with the completion of a training centre in early 2015 that, “will help the plant become one of the biggest employers in the region” (Hungary Today, 2015). But why Hungary? Why not in Germany where Bosch is headquartered? Gonzalez Pareja, the head of Bosch Hungary has even stated, “the company was in Hungary for the long term. Hungary will become a strategic hub for global innovation and R&D efforts” (Hungary Today, 2015).
On the surface the answer to those questions may be difficult to determine. Surely Germany, a highly developed nation, has the infrastructure and talent to produce the same quality of good at the same speed as a factory in Hungary. However, ultimately in business it comes down to the bottom line. The effects of globalization, where firms set up factories in countries where it is less expensive to produce a good is well documented. The example of an American company shifting production to China is used as a typical illustration. But Hungary is located much closer to Germany than America is to China. Perhaps the same principle can apply to geographically adjacent nations?
After World War Two, in response to the volatile global monetary system, the Bretton Woods exchange rate system was established. It “saw all currencies linked to the dollar, and the (United States) dollar linked to gold” (Economist, 2014). This created some stability, however it was abandoned in the early 1970’s as a result of the U.S. adjusting its monetary policy so it would not be tied to the price of gold. After this occurred the World was now engaged in a floating foreign exchange rate system. This system can best be described as the influence of supply and demand on a currency in the foreign exchange market. The forces of supply and demand determines the relative values of global currencies. This is a contributing factor to the phenomenon of globalization. Countries with a lower valued currency can supply exports to countries with stronger currencies and enjoy the economic benefits that arise.
As a result of the 1992 Maastricht treaty, European leaders had agreed to move forward with a single European currency, later to be named “the Euro.” Many of the European Union countries were in favor of this and began the work that would eventually lead to the creation of a new currency and the infrastructure necessary for it to operate. As the Euro was something that had not been previously attempted on this scale there were no examples to look back on to provide feedback. So far the implementation itself has been a success and at this point, nineteen of the twenty-eight European Union nations have adopted the currency, including the large economies such as France and Germany. However, there are a number of European Union nations that do not currently use the Euro, including the country mentioned above, Hungary.
Is there a connection between the foreign investment in Hungary and the use of its own currency, the Forint as opposed to the Euro? Should European nations avoid adopting the Euro to provide an economic advantage?
Advantages to Adopting the Euro
The original basis for adopting the Euro was part of the vision to create a single internal market within the European Union. The idea was to create an economic entity that would be the most efficient and would leverage the potential of its members to create a global economic power. A pan-European currency was determined to be a key factor in the single internal market which would assist in greater market efficiency.
Before a country can adopt the Euro it must meet certain criteria that will allow it to easily adapt to the single currency and also ensure that it will integrate into the euro area monetary union. Named “Convergence Criteria,” in a nod to the incorporation that is to be completed, the criteria is essentially a method to ensure a country that wishes to join the Euro has a base of economic indicators that will allow the existing members to have full confidence in their inclusion. The criteria, once achieved will allow the potential member to adopt the Euro.
With public financing being a crucial measure of a country’s economic stability, it would make sense that it is one of the key metrics by which a country is judged to be worthy of adopting the Euro. In order to meet this criteria, countries must have an appropriate level of Government debt as a percentage of GDP. This is the ratio of a country’s national debt to their GDP, “which indicates the country’s ability to pay back its debt” (Investopedia). It must also meet a certain threshold of Government deficit as a percentage of GDP, which is a ratio of Government expenditures and revenue that shows if a government is fiscally sound.
Price stability and keeping inflation low is also an important convergence criteria for Euro adoption. Using the Harmonized Index of Consumer Prices (HICP), a consumer price index, overall inflation or deflation can be measured. Once a country has a stable inflation rate of “Not more than 1.5 percentage points above the rate of the three best performing Member States” (European Commission, 2015), then they will have met the criteria. The main objective of achieving price stability is for the benefit of consumers which, “allows them to make well-informed consumption and investment decisions and to allocate resources more efficiently” (European Central Bank, 2015).
And finally, if a country wishes to adopt the Euro it must first participate in the Exchange Rate Mechanism. The ERM is also a significant element of the Convergence Criteria as the mechanism works as a monetary stabilizer that assists the nation towards adopting the euro, “A central exchange rate between the euro and the country’s currency is agreed. The currency is then allowed to fluctuate by up to 15% above or below this central rate” (European Commission, 2015). Once the country has achieved this for at least two years then they are deemed to be in good standing and may adopt the Euro.
What the criteria are, in essence, are signals. They signal that a country has reached an agreed upon level of economic soundness. With the stability of a large monetary union there is significantly reduced risk of exchange rate volatility or, the tendency for foreign currencies to appreciate or depreciate in value. This coupled with the outcome of meeting the convergence criteria provide, “stimulation of investment and growth due to the reduction of risk and uncertainty arising from joining the currency union” (Panos, 2000).
Given there are clear benefits to joining the Euro, one would think a country like Hungary would be banging down the door to enter the Currency union. However at present, “a move to the single currency is no longer of “immediate interest,” according to the Hungarian government’s international spokesperson, Zoltan Kovacs” (CNBC, 2014). If there are is no urgency from Hungary to join, then surely there must be a number of factors driving this decision.
Drawbacks of Adopting the Euro
When a country decides to adopt the Euro as its unit of currency, they actually stand to lose a significant amount of independence. “When a Member State enters the euro area, its central bank becomes part of the Eurosystem made up of the national central banks of the euro area and the European Central Bank, which conducts monetary policy in the euro area independently from national governments” (European Commission, 2015). This shift towards the common Central Bank also shifts the decision making to an entity with the concerns of 28 member states versus the concerns of the single nation. Viewed in that way, there is a definite loss of sovereignty and independence in the decision making of the euro-adopting nation.
When a country devalues its currency its value will decrease relative to other foreign currencies, for a number of reasons. If the value of their currency is much lower than previous, it will lower the price of the country’s exports and increase the demand for their goods and services among importing nations. When exports are increased there is a corresponding increase in economic growth that would not have been possible had the country not devalued its currency. However, when a country chooses to adopt the Euro it loses the ability to devalue its currency. The process of joining the euro involves ceding a nation’s central bank authority to the European Central bank. So for example, if a country such as Greece was undergoing a period of economic malaise, it could potentially devalue its currency which would aid in making its exports more competitive in the global marketplace. And it would make it less expensive for foreign travelers to experience what Greece has to offer. However, Greece would not be able to perform this action as it currently uses the Euro.
The concept of Seigniorage and the potential revenue that is forgiven can also be seen as a loss to joining the common currency. When a country produces new money it has an associated cost to it. The difference between the value of the new money and the cost of producing it is said to be the Seigniorage. A positive seigniorage can be “used by governments to finance a portion of their expenditures without having to collect taxes” (Investopedia, Seigniorage). Again, when a country joins the Euro it is unable to see the potential revenue from this as it has been transferred to the European Central Bank.
Interest rates are another method in which a Central Bank can influence a country’s economic performance. By setting the interest rate, either by purchasing or selling securities such as Government Bonds, the Central Bank can influence how different actors behave in an economy. An example would be in response to the 2008 global financial crisis the United States’ central bank, the Federal Reserve, undertook a period of quantative easing (the purchasing of securities) that helped keep interest rates low and “(got) households and businesses to spend more than they otherwise would, boosting economic activity” (BBC News, 2014). In the case of a European nation looking to implement their own form of interest rate manipulation, they must have their own currency and not be associated with the Euro.
The loss of independence of giving up central bank authority is something that a country must accept if they wish to join the European currency union. Currently there are a number of countries that although initially had the intention of joining the Euro have given up for the time being. Now that over fifteen years has passed since the Euro was implemented, some comparisons can be made.
Economic Comparison of Euro/Non-Euro Nations
The world standard for measuring economic growth is what is called Growth Domestic Product, or GDP. Gross Domestic Product, “represents the total dollar value of all goods and services produced over a specific time period” (Investopedia, GDP). This can be used to measure the economic growth of a country over time and although it is not perfect as it does not take into account factors such as debt and hidden output, an example of which would be unpaid work performed in a household. However, we can still use it to measure a country’s economic performance over time and in this case since the Euro was introduced in 1999 till the present day.
Using the available data from the World Bank and Population figures from Nations Online using the continuously compounding formula for growth rates I was able to do a comparison of GDP growth for six countries since the Euro was adopted in 1999. Three countries were selected due to their initial adoption in 1999; Spain, Portugal and Belgium. And three countries of similar size to each of the previously mentioned countries were selected due to the fact they have yet to adopt the Euro; Poland, Hungary and the Czech Republic. The data from the year 2000 till 2014 was used due to the fact the Euro was introduced in 1999 and I felt it required a one year grace period to reflect the changes in the economies.
Please refer to Appendix 1 for the calculations.*
What the calculations showed in terms of the GDP growth rate, is that all three non-Euro nations have a higher percentage of GDP growth since the year 2000. Spain with a 2015 estimated population of forty six million and Poland with an estimated population of thirty eight million are relatively close in population and can be compared with each other. The data showed that since the Euro was adopted by Spain its average GDP growth was 6.13% whereas Poland’s was 8.28% over the same period. Belgium and the Czech Republic, both around eleven million people have Euro adoption era GDP growth rates of 5.78% and 8.6% respectively. And the final pair of countries, Hungary and Portugal, each around ten million were found to have Euro-adoption period GDP growth rates of 7.6% and 4.73%.
Once again, using GDP to measure a country’s economic performance is not perfect. However with that in mind there is a clear premium for the non-Euro countries. And if the growth rates of each set of three are averaged, the Euro nations come in at 5.54% average whilst the non-Euro nations are higher, at 8.16% GDP growth over the 14 year period.
Based on these numbers one can infer that similarly sized nations individually and as a whole have performed better than their comparatively sized non-Euro counterparts.
Conclusion
There is a loss of independence that arises when a nation adopts the Euro. Their currency can no longer be devalued at their convenience, which would allow for more competitive exports and a mitigation of negative economic forces such as a recession. The ability to set interest rates and spur investment which is also performed by the central bank would also be lost through adoption of the Euro as would the potential revenue from Seignorage.
However, by joining the currency union and meeting the “Convergence Criteria;” Government deficit as a percentage of GDP, price stability and employing the Exchange Rate Mechanism stabilizer, a more solid economic bedrock is achieved. And having achieved the criteria, the signal is sent that there is less risk to investment and could spur further economic growth.
Instead of driving on the M3 past the Bosch factory on the outskirts of Hatvan what if one drove out of Budapest southeast on the M5. Eventually the city of Kecskemét would appear on the horizon and most likely an even larger factory, this one for the luxury automaker, Mercedes Benz. The factory, completed in 2012, was “expected to produce up to 120,000 cars a year, (and) is one of the largest-ever direct investments in Hungary.” Given the data on GDP growth revealed that Hungary and the other non-Euro economies had a larger increase than their Euro adopting counterparts over the period of existence of the currency, it is clear that more investments such as these are to be expected. And although the Euro does include 19 members of the European Union, perhaps the countries that have not adopted it would be wise to continue with their currency, or at the very least hold off until further information can be gathered.
Thanks for reading :)
*Give me a shout if you want my calculations. TBH they should probably be reviewed by a legit economist.
