The monetary union has proved to be a highly sensitive area of European Integration, as there are several Member states who decided to opt out or have not yet adopted the euro as their currency. Especially during the international banking and financial crisis which later turned into the eurozone crisis, monetary union has been discussed fiercely to the extent that there have been calls to expel Greece from the euro (Reuters 2010). The crisis in the eurozone has revealed a major incompleteness of the architecture of the euro as a single currency for 19 countries of the Eurozone each with their own style of economic policy making. As Andrew Moravcsik puts it, the nature of the eurozone was a ticking time bomb (2012, p. 57). Even Mario Draghi described the incomplete financial integration as the “Achilles’ heel” of the Economic and Monetary Union (Draghi 2014). During and after the crisis, however, the Member states have implemented a number of institutions and instruments, trying to solve the current crisis and to make the monetary union more sustainable.
The question of this essay is whether the monetary union is likely to fail if there is no further political integration. The essay is structured as follows. In the second chapter I outline the main causes and consequences of the crisis. In the following chapter I demonstrate the theory of Optimal Currency Areas and discuss to what extent the EMU fulfils the criteria. The fourth chapter points out institutional adjustments that have been introduced since the beginning of the crises and suggest further steps. On this basis, chapter five and six discuss the need for political integration and debate measures such as a budgetary union.
2. Causes and Consequences of the Crisis
As Fritz Scharpf argues, the international financial crisis, which emerged in consequence of the subprime mortgage crisis in the United States, has had three impacts on the European economies (2011, p.21). The crisis triggered chain reactions in Europe, which turned the vulnerabilities “into a systemic crisis” (ibid.). First of all, some Member states such as Germany and Ireland were forced to bail out banks that were considered to be system-relevant (Scharpf 2011, p. 21). Thereby, their government faced wide budget deficits themselves. Secondly, due to the amortisation of toxic assets of banks, there was a money shortage which resulted in declining economic activity and increasing unemployment (ibid.). The GIPS countries were hit most by this recession, as their economies are heavily depending on “the availability of cheap credit and massive capital inflows” (ibid.). Moreover, the burst of the property bubbles in Spain and Ireland caused another banking crisis and in effect let to high budget deficits, even though both countries’ public debt was way below the limits of the Stability and Growth Pact pre-2008 (ibid., p, 48, Figure 16).
Thirdly, as rating agencies questioned solvency of some member countries, most notably Greece, their interest rates increased dramatically and made refinancing virtually impossible (ibid., p. 22). In 2012 interest-rates on ten-year government bonds were five times lower for Germany compared to Greece (Jones 2009, p. 42).
However, to understand the present nature of the EMU it is necessary to recapitulate the causes for the crisis and the reasons for the vulnerabilities of the monetary union. In the article “Europe After the Crisis: How to Sustain a Common Currency” Andrew Moravcsik points out the main reasons for the crisis and reforms he considers to be necessary (2012).
The architects of the monetary union expected the European economies and behaviour to converge so that a single monetary policy is financially justifiable (Moravcsik 2012, p. 54). Therefore, surplus and deficit countries would have had to align their macroeconomic behaviour (ibid.). Their expectations did not fulfil. Moravcsik considers a “fundamental disequilibrium” within the eurozone, “which applies a single monetary policy and a single exchange rate to diverse group of countries”, to be the main problem of the crisis (ibid.).
He suggests that the private sectors and the surplus countries should be bearing the burdens of the crisis, not the public sectors and deficit countries (ibid.). He demands surplus countries to change their domestic macroeconomic behaviour, as they mostly benefit “from the current system, in which deficit countries must do nearly all the adjusting”, while Germany and others being also the main creditors (ibid., p. 64-65). He states that a lack of regulation of the private sector was another cause of the crisis, resulting in the destabilisation of the economies in the GIPS countries (ibid., p. 57-58). However, the main causes of the instability of the euro lie in the “contradictions within the euro system itself” (ibid., p.58). One example for this is the German trading behaviour, making up for forty percent of the surplus in the eurozone, made possible because the euro functions as an undervalued currency for Germany (ibid., p. 59-60). On the other hand, the GIPS countries are pressured to austerity policies to offset the backlog to the surplus countries (ibid.). Moravcsik assesses the future of monetary union to be dependent on the ability of European countries to converge their macroeconomic behaviour, thereby becoming somewhat like an optimum currency area (OCA) (ibid., p. 67). In the following chapter I will critically demonstrate the theory of OCA.
3. Is the Eurozone an Optimum Currency Area?
I. The Theory of OCA
The theory of optimum currency areas (OCA) has been built up by R.A. Mundell (1961) and supported by the works of Kenen (1969), McKinnon (1963), and others. The basic principles of the theory are that in an OCA economic shocks affect member countries symmetrically and labour and capital can move freely across the area (Eichengreen 1990, p. 1). According to Frankel and Rose, there are four jointly endogenous criteria that determine whether a common currency is appropriate or not:
a) the extent of international trade across member countries and openness of the currency area; b) the symmetry of shocks and business cycles; c) labour and capital mobility; d) risk-sharing through e.g. fiscal transfers (Frankel and Rose 1997, p. 3).
The more distinct these criteria across a region, the more suitable a common currency. The degree of international trade and openness both affect if a currency area constitutes an OCA as they reduce the transaction costs and risks (ibid., p. 4). Trade integration also affects the correlation of business cycles between the member states (ibid., p. 5). They point out the importance of similar business cycles: If they are mostly similar, country-specific shocks can be converted into “internationally co-ordinated business cycles” (ibid., p. 4-5). Thereby, member countries would circumvent the impact of asymmetric shocks even though they renounced independent monetary policy, which is an important stabilising tools (ibid., p. 1).
Yet, it is important to stress that the theory of OCA is not uncontroversial. Paul de Grauwe points out, that the costs of joining a currency area might not be as high as suggested, since the advantage of independent exchange rate and monetary policies is more limited than expected by the theory (de Grauwe 2012, p. 52).
In their paper “The Optimum Currency Area Theory and the EMU”, Jennifer Jager and Kurt Hafner evaluate if the EMU can live up to the expectations of an OCA (2013). For this reason, they analyse several case studies and data. They distinguish the criteria of an OCA into two groups. On the one hand, there are criteria that determine the ability of member states to endure asymmetric shocks: “the similarity of economic structure”, openness, internal trade and the degree of specialisation (Jager and Hafner 2013, p. 316). On the other hand, the possibilities to readapt the currency union to asymmetric shocks: e.g. “homogeneity of preferences”, factor mobility (which includes both the free movement of workers and capital) and fiscal transfers (ibid.).
The better a currency union does in the criteria of the first group, the less vulnerable it is to asymmetric economic shocks and the better suits a uniform monetary policy. The second group of criteria is required for an efficient crisis management and to fight the effects of a recession in some parts of the currency area.
II. Is the Eurozone an OCA?
In the first group of criteria, according to the analysis of Hafner and Jager, there are several evidences that indicate that the eurozone does not constitute an OCA. Regarding the similarity in economic structure, the member countries of the eurozone vary widely in all respects. There are huge differences in GDP per capita, GDP growth rates and unemployment rates, and the gap is widening even further (Jager and Hafner 2013, p. 318). In terms of the competitiveness there are also strong distinctions, e.g. labour in Germany has become more than twice as productive as labour in Portugal (ibid.).
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Figure 1: Labour productivity in 2011 (GDP per hour in USD) (Jager and Hafner 2013, p. 318)
When it comes to openness, the eurozone compares very well, “as the euro area’s average share of imports and exports is almost three times as high as the corresponding share in the US” (Jager and Hafner 2013, p. 318). The interregional trade in the EU has always been high and even increased since the euro was introduced, even though some scholars expected the boost to be bigger (ibid.).
The degree of specialisation should be low in order to minimise “the impact of sectorspecific shocks” (ibid., p. 316). According to a study by Kristoffer Persson, the Member states of the EU increased their degree of specialisation, resulting in the eurozone becoming a less stable currency area (ibid., p. 318-319).
Regarding the second group, the authors argue that the interests of Germany compared to those of the periphery countries differ with regard to ideas like a budgetary union or Eurobonds (ibid. 319). There is also an interesting paper by Madeleine Hosli in which she demonstrates the very diverse preferences in the negotiations of the single currency (Hosli 2000; see also: Claeys 2017, p. 1).
The labour mobility in the eurozone and even within countries is very low, making the European labour markets one of “the most inflexible in the world” (Jager and Hafner 2013, p. 319). There are case studies that suggest that a harmonisation of labour policy such as professional standards can increase the labour mobility in the EU and thereby improve regions’ ability to adjust to asymmetric shocks.(see: Bloomfield et al. 2015).
Even though EMU increased FDI inside the eurozone and the integration of capital markets is described as “fully developed”, capital flows cannot balance asymmetric economic shocks as much as the US (Jager and Hafner 2013, p. 320). And finally, in the eurozone there is simply no system of fiscal transfer payments like a budgetary union, which could help to “re-establish economic equilibrium” (ibid.). All in all, the authors assessed that the EMU is not an OCA as it lacks several features such as transfer payments. Moreover, the analysis reveals that in a number of criteria the eurozone is not as integrated as it needs to be. Additionally, in terms of the degree of specialisation EMU even made the eurozone economies more vulnerable to asymmetric shocks than before.
4. Institutional adjustments since 2008
The Brussels-based thinktank Bruegel recently developed a thorough analysis of the systemic reasons for the crisis, the adjustments that have been introduced since 2008 and suggests several institutional adjustments to address the monetary union’s instable architecture (Claeys 2017).