Rheinisch-Westfälisches Institut für Wirtschaftsforschung 1 Wim Koesters Is EMU Sustainable? Wim Koesters Ruhr-Universitaet Bochum and Rheinisch Westfaelisches Institut fuer Wirtschaftsforschung Essen

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 2 Wim Koesters Contents 1.Motivation 2.EMU - Some Basic Facts 3.Economic Conception of EMU 4.Fundamental Requirements for the Sustainability of EMU 5.Critical Assessment on the Basis of Actual Policy

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 3 Wim Koesters 1.Motivation „EMU is unique in history. It is one of the great success stories in the long standing process of European integration that started immediately after the end of World War II.“ O. Issing (2005), p. 31 (Chief economist of ECB)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 4 Wim Koesters Motivation (2) ● Speaking as from a soap box politicans and others take the lasting success of EMU for granted mainly by pointing to the stability of the Euro. ●In their daily politics, however, they intentionally or unintentionally act to the damage of the working of EMU which in the extreme could lead to the failure of it. ●Since recently those threats grew markedly it is high time for a discussion on the sustainability of EMU pointing to the dangers in the hope that they then will be fully recognized and avoided by policy makers. ●There exists a good tradition in Germany and Europe that academic economists act in such a way by reminding and warning in public (see e.g. the manifesto „The Euro comes too early“ signed by more than 170 university professors of economics and published in the Financial Times on February 9, 1998)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 5 Wim Koesters Motivation (3) ●The failure of EMU would endanger the European integration project alltogether. ●This would hurt the world economy much more then e.g. the East Asian Crisis some years ago and would, therefore also have a negative impact on Korea and other economies in this part of the world.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 6 Wim Koesters 2.EMU – Some Basic Facts Chronology of European Integration 1957Treaty of Rome (European Economic Community, EEC) 1979Establishment of the European Monetary System (EMS) 1987Single European Act (SEA) 1992Signing of Maastricht Treaty on European Union 1993Single European Market comes into effect Chronology of European Monetary Union July 1, 1990 Start of Preparatory Phase (Stage 1) January 1, 1994 Start of Phase of Convergence (Stage 2) December 13/14, 1996 Agreement on “Stability and Growth Pact” January 1, 1999 Start of Monetary Union (Stage 3) January 1, 2002 Distribution of Euro Notes and Coins

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 7 Wim Koesters EMU – Some Basic Facts (2) Source: ECB

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 8 Wim Koesters EMU – Some Basic Facts (3) Source: RWI Essen

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 9 Wim Koesters EMU – Some Basic Facts (4)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 10 Wim Koesters EMU –Some Basic Facts (5)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 11 Wim Koesters EMU –Some Basic Facts (6)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 12 Wim Koesters EMU- Some Basic Facts (7)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 13 Wim Koesters EMU- Some Basic Facts (8)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 14 Wim Koesters EMU – Some Basic Facts (9) ● Thus, up to now EMU was quite successful in creating a stable currency. In spite of that, the Euro is not yet fully accepted by Europeans („Der Euro ist ein Teuro“). ●With respect to growth and employment EMU on average falls back behind the rest of EU und other countries. ●For several reasons the seemingly easy solution of trading off price stability for more growth and employment is not possible.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 15 Wim Koesters EMU – Some Basic Facts (10) ● Among others, it would raise existing acceptance problems for the new currency and neglect the fact that mainly big member states (especially Germany, Italy, France) underperform whereas mainly smaller ones (notably Ireland) do well. ●My proposition is that it is not EMU per se that creates the differences in performance but the way how the challenges put by its new framework for economic policy are taken up by the member states.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 16 Wim Koesters 3.Economic Conception of EMU EMU and the European Single Market (ESM) for goods, services, capital, and labour have to be looked at together since their success is dependent upon each other. EMU is seen as „natural“ supplement of ESM, since by removing exchange rate risks, simplifying comparisons of prices etc. it enhances competition. It will be shown, that EMU needs a working ESM, since the loss of at least two policy instruments on the national level requires more wage and price flexibility. Thus both EMU and ESM constitute the new framework for economic policy in Europe challenging prevailing structures.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 17 Wim Koesters Economic Conception (2) The monetary constitution of EMU can be described in short by -the mandate of the ECB in article 105 of the EU Treaty “The primary objective of the ESCB is to maintain price stability.” -the independence of ECB (article 108 of the EU Treaty), -the prohibition of monetary financing of public budget deficits (articles 101 and 102 of the EU Treaty), -The no-bail-out clause (article 103 of the EU Treaty) and -the fiscal provisions (article 104 of the EU Treaty) and the Stability and Growth-Pact

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 18 Wim Koesters Economic Conception (3) The German monetary constitution served as a model for the European monetary constitution -The first three characteristics just described were taken from the German monetary order -The organizational structure of the ECB resembles that of the Deutsche Bundesbank very closely -Just like the Deutsche Bundesbank the ECB publicly announced a monetary policy strategy: The Two Pillar Strategy (economic and monetary analysis) -By all this part of the high reputation and credibility of the Deutsche Bundesbank was transferred to the ECB -All these factors explain the continued price stability within EMU

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 19 Wim Koesters Economic Conception (4) The stability orientation of European monetary policy is, however, not guaranteed in the long run, because an important element of the German monetary order was not transferred to the European level: the system of checks and balances securing an accountability of the Deutsche Bundesbank. A possible substitute for this was not introduced into the European monetary order. Therefore, one still has to wait, whether the bureaucracy ECB in the long run will stick to its mandate strictly.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 20 Wim Koesters Economic Conception (5) The European Single Market (ESM) aims at removing all non tariff barriers and guaranteeing the free movement of goods, services, capital and labor within EU. By this not only goods and services markets but also factor markets will be open within EU. Capital and labor (human capital) mobility thus increased strengthening their options for „voice“ and „exit“. In addition, the country of origin principle enables an evasion from national jurisdictions and regulations even without factor movements.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 21 Wim Koesters Economic Conception (6) All this, in combination with yardstick competition should bring about more competition on the economic markets as well as between national regulatory systems. This in turn should put pressure on the member states to enact the badly wanted structural reforms of labor markets, social security and tax systems etc. By that wages and prices should become more flexible to make EU and EMU economies more adaptable. This is absolutely necessary to balance the loss of national adjustment instruments :

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 22 Wim Koesters Economic Conception (7) -Monetary policy is no longer a national economic policy instrument but a European one assigned to the goal of price stability in the Euro area -Exchange rate policy is no longer a policy instrument within EMU -Fiscal policy remains a national policy instrument but its use is limited by the Stability and Growth Pact (3 % deficit and 60 % debt criterion). Thus it can not serve stabilizing purposes as much as in the past but has to be used more for allocative ones. -The fight against the high unemployment in many EMU-countries has to be done mainly by wage policy. Trade unions and employer federations have to bear more responsibility for the goal of high employment. -This is not a Keynesian but much more a neoclassica assignment approach founded by institutional economics.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 23 Wim Koesters Economic Conception (8) In sum the deliberations before show that the success of EMU and ESM is interdependent. For EMU this means that the danger of its failure will grow the less ESM works. In case, however, the economic conception just described would be realized fully, EMU member countries would meet the challenges of globalization better and by adjusting faster than other countries would get a lead over them.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 24 Wim Koesters 4.Fundamental Requirements for the Sustainability of EMU The Euro area is a monetary union without a fully fledged political union. How much of a political union is necessary to make a monetary union sustainable? The answer follows right from our reflections on the economic conception of EMU: The monetary constitution of EMU laid down in the Maastricht Treaty should be fully respected and the European Single Market (ESM) should be completed as soon as possible and its rules should be strictly observed.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 25 Wim Koesters Fundamental Requirements for Sustainability of EMU (2) More specifically this means (see also Issing 2004) -that the independence of the ECB, its mandate for the goal of price stability as well as the prohibition of monetary financing of public deficits is fully accepted, -that the rules of the Stability and Growth Pact (SGP) limiting national sovereignty over budgets are fully observed, -that, by completing ESM, badly needed structural reforms on the level of member states are enforced and factor, goods and services markets are made more flexible. By this, in fact, an elementary political union is described.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 26 Wim Koesters Fundamental Requirements for Sustainability of EMU (3) To turn the argument on its head, this means that the sustainablity of EMU is put at risk by -challenging the core elements of the monetary constitution like independence, prohibition of monetary financing of public deficits, Growth and Stability Pact etc. -not completing the ESM and instead introducing minimum wages limiting the free flow of capital within EMU etc. There are quite some instances recently!

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 27 Wim Koesters 5.Critical Assessment on the Basis of Actual Policy Actual economic policy did not rise to the challenges just described: -In June 2005 the Italian minister of labor, Roberto Maroni, demanded that Italy should leave the Euro area and return to the Lira. -Although the independence of ECB and ist mandate for price stability were not touched directly yet, there were attempts to do so. -In the first draft of the European Constititional Treaty price stability was no more among the goals of the EU, but instead was degraded to an objective of ECB alone. -There were demands (mainly from the French and the Italian government) to add growth and employment as goals for the ECB. -In 2005 it turned out that Greece was admitted to EMU on wrong terms: the budget and debt figures were forged again and again. The same seems to be true for Italy.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 28 Wim Koesters Critical Assessment (2) Germany and France did not comply with the budget deficit criterium since 2002 year after year and Greece, Italy as well as Portugal recently failed too. Mainly on demand of the big countries the SGP was „reformed“, i.e. watered down (Table) France and Spain try to prevent takeovers of home firms by enterprises from EMU countries clearly violating a constitutive criterion of a monetary union, the free flow of capital and full convertibility. These instances show that the monetary constitution of EMU laid down in the Maastricht Treaty is not fully accepted by now. Its efficient working is put at risk since the pressures for introducing structural reforms to make wages and prices more flexible are thus lowered.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 29 Wim Koesters Critical Assessment (3) Important Elements of SGP – Old and New Sources: ECB and Gros (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 30 Wim Koesters Critical Assessment (4) The fact that the implementation of national reforms is very sluggish especially in the big EMU countries like Germany, France and Italy is also due to delays in the completion of ESM. A very important actual example is the rejection of the first draft of the services directive of the European Commission which was based on the general validity of the principle of origin just like in European goods markets. On the demand of Germany, France and other countries this was watered down to the point that in the new draft the principle of destination is the rule and the principle of origin is the exemption. This would have the effect of lowering the intensity of competition (less „Polish plumbers“ in France and less „Polish butchers“ in Germany) thus preventing more flexible wages and prices. By this a possible source for growth is locked: services contribute on average about 70 percent to GDP of EU countries but its share in EU intra trade is only about 40 percent.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 31 Wim Koesters Critical Assessment (5) In addition, there are many instances or national measures against the spirit if not the letters of ESM limiting competition even more, e.g. -Germany is planning to introduce minimum wages by law which then would have to be payed also by foreign service suppliers. -The French prime minister demands economic patriotism, declares some firms to be strategically important so that they cannot be taken over by non French and is planning on constructing national champions by merging firms under French leadership. -The Spanish government tries to prevent the takeover of Endesa (energy supplier) by the German Eon -The Polish government tries to block the merger of Unicredit and Hypo-Vereinsbank as well as their Polish subsidiaries Pekao and BPH.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 32 Wim Koesters Critical Assessment (6) - Italy`s minister of finance disappointed by the French rejection of the takeover of Suez by Italian Enel was in public even comparing the present situation in Europe with that just before the outbreak of WWI in 1994 and less dramatically showed deep concern that the EU could fall back to a „Zollverein“ (customs union).

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 33 Wim Koesters Critical Assessment (7) -After the failure of the European Constitutional Treaty in the referenda in France and the Netherland many policy-makers not only in these two countries are demanding that Europe should not be left to free markets and big business. The „European social model“ should be saved instead. -The German government just declared, that it will prevent free migration of labor from the 10 new EU member states as long as possible.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 34 Wim Koesters Critical Assessment (8) All this together has the effect that structural reforms in EMU member countries are not taking place faster than in the rest of OECD (see following figures and tables). Because of the loss of national adjustment instruments they are however, badly needed as shown before.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 35 Wim Koesters Critical Assessment (9) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 36 Wim Koesters Critical Assessment (10) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 37 Wim Koesters Critical Assessment (11) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 38 Wim Koesters Critical Assessment (12) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 39 Wim Koesters Critical Assessment (13) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 40 Wim Koesters Critical Assessment (14) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 41 Wim Koesters Critical Assessment (15) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 42 Wim Koesters Critical Assessment (16) Source: Pisani-Ferry (2005)

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 43 Wim Koesters Critical Assessment (17) Conclusions -EMU was introduced on the premise of a completed ESM. -A common currency in connection with factor mobility should create a higher dregree of competition on goods, services and factor markets pushing for more structural reforms to make wages and prices more flexible. -This would have made the economies more adaptable and adjusting faster to the challenges of globalization. -At the moment the EU is in a dilemma: the ESM project is not made ready to deliver and the rules of EMU are discussed or even broken by policymakers in the attempt to overcome these deficiencies.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 44 Wim Koesters Critical Assessment (18) The success of EMU comes not automatically about but has to be earned politically: It is only sustainable if ESM is completed with the highest priority and the monetary constitution of the Maastricht Treaty is fully accepted and supported by all member states. The processes of ongoing globalization and aging of European societies will not wait until European policy is finally ready.

Rheinisch-Westfälisches Institut für Wirtschaftsforschung 45 Wim Koesters