1 Is it easier to join EU or EMU? Why? Are the Criteria Good?

2 Today’s Agenda  EU enlargement -Benefits and costs for new members -Benefits and costs for old members  EMU enlargement -Benefits and costs for new members When should they join? -Benefits and costs for old members  Euro crisis and the future of EU

3 EU Enlargement  Several enlargements over the history of EEC/EC/EU -The ones in 2004 and 2007 different from previous GDP/capita much lower in the new countries Large number of countries at once

4 Benefits for New Members  Credibility, attractiveness -EU membership signals political and economic stability -More foreign investments technology diffusion -Subsidies from EU budget  Better opportunities for trade -Technical barriers removed (free trade agreement already before membership, though) -Competition and scale effects

5 Costs for New Members  Transitional costs -Conforming to EU rules  Currency appreciation -Demand for domestic currency increases Decreased exports  Increased inflation -Price level well below EU15 -Productivity (and wage) increases in export sector Wage increase demands in other industries as well (”Baumol’s disease)  ”Dependence” from foreign investments -Deep recession in when investments stopped

6 Benefits for Old Members  New markets, more trade  More labor (to compensate the now retiring baby boomers)  Uniting Europe -Political stability  More political power globally?

7 Costs for Old Members  Potential unemployment -Migration, firm relocation  Pay more, receive less from the budget  Reduced decision-making power -As more countries join, the weight of any one country in the DM process is diminished  Institutional and administrative issues -Voting schemes, official languages, etc.

8 What has happened since 2004?  Economic growth in the new members was strong until late 2008; since then big problems  Migration has not been a huge problem -More migration from outside EU -Some countries apply restrictions  Some problems with Romania and Bulgaria

9 Next Enlargements?  Croatia, Turkey and Iceland officially candidate countries -Turkey’s membership debated a lot  Macedonia submitted an application  Others yet to come (Bosnia, Serbia, Kosovo, etc.)  Similar issues apply to the forthcoming enlargements as with the previous ones -”enlargement fatigue”

10 EMU Enlargement  All new EU members are required to join EMU at some point -Only UK, Denmark (and Sweden) have the option to stay out  The question is then, when can the EU countries join EMU, and when should they do it

11 Cost and Benefits of EMU Enlargement  The costs and benefits of EMU membership are essentially the same as discussed in sessions 1 and 2 -larger union more likely to experience asymmetric shocks -The weight of one country in ECB’s decisions grows smaller New voting rule of ECB council  In addition, the transition to EMU can create problems for the new members!

12 Catching Up  The EU12 are in a catching-up phase -Productivity and price level behind EU15  Increased trade increases productivity and prices in the export sector -Wage increases in all sectors  inflation -Real currency appreciation due to inflation Trouble for export industries  More foreign investments  nominal currency appreciation -Trouble for export industries, increased imports  Leads to trouble with the Maastricht criteria!

13 Convergence Criteria Once More  Public debt <60% of GDP  Budget deficit <3% of GDP  Long term interest rates  Inflation  Membership in ERM II  Compatibility of national legislation to that of EMU treaties Based on previous analysis, we should expect trouble here

14 Convergence Criteria in 2014 (figures from 2013) Source: Convergence Report 2014 (European Central Bank) Price Stability (inflation) Budget deficit (% of GDP) Debt (% of GDP) ERM IILong term interest rate Bulgaria-0,8-1,518,9No3,5 Czech Rep.0,9-1,546,0No2,2 Croatia1,1-4,967,1No4,8 Hungary1,0-2,279,2No5,8 Lithuania0,6-2,139,4Yes3,6 Poland0,6-4,357,0No4,2 Romania2,1-2,338,4No5,3 Reference value 1,7%-3,0%60,0%2 yrs6,2%

15 Criticism and Discussion on Criteria  CEECs don’t understand why they have to fulfill all the criteria even though most current members didn’t  Discussion if new criteria should be added -E.g. health of financial sector  However, difficult to change criteria (requires unanimity)

16 Future Developments  Slovakia joined in 2009, Estonia in 2011, Latvia in 2014 and Lithuania in 2015  Others at an undetermined date later -Financial crisis and euro crisis made matters more complicated  The financial crisis made EMU membership more attractive to Sweden and Denmark, but the current debt crisis has made them wary again

Current Euro crisis – a threat to the future of EMU? 17

Foundation for the crisis is laid with the inception of EMU  Advent of EMU brought down inflation levels in the south to historical lows Record low interest rates and access to capital Increased borrowing, investments and consumption  Also governments borrowed money increasing the debt ratio already years before the financial crisis and the recession 18

Private and public debt 19

Wage increases above productivity increases 20

Loss of competitiveness leads to current account deficits (devaluation of currency is not possible) 21

When the financial crisis hit…  Banks were in trouble first, which meant that borrowers were soon in trouble -Real estate buble caused by borrowing and investments burst  Financial crisis lead to a recession, which together with supporting banks forced the governments to create large deficits in a situation when the debt ratio was already high (except Spain)  Credibility of governments was lost and interest rates on bonds increased (also the ”default” of Greece increased doubts for others) -The revelation that Greece had falcified statistics undermined credibility even further 22

What has been done?  The EMU countries have lent money to the countries in trouble (without a guarantee to get any money back) -The money comes with conditions, though  ECB has bought government bonds  Both of these acts were forbidden (”no bailout” clause of the Treaty) to make sure that governments would behave responsibly and that the credibility of the whole union would not be at stake if one country is in trouble 23

What next?  No one knows -EMU is unique in the history of economics, and so is the current crisis -There is no mention of how to leave the EMU in the Treaty (the membership was assumed irrevocable)  The disintegration of EMU would lead to great losses an instability for all members, so even the ones with sound finances have an incentive to help the others 24

25 Final Group Work  In your group, draw a new mindmap to organize your thoughts on economic integration, the EU and the EMU -Again, you don’t have to restrict yourselves to only economic aspects

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