Central Europe and the Eurozone

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Central Europe and the Eurozone

• EURO - Social conference
• 25 May 2007, Bratislava

Bela Galgoczi European Trade Union Institute for
Research, Education and Health and
Safety http//www.etui-rehs.org
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The context of Eurozone accession for the new
member states major questions

• How the agenda of the Eurozone accession fits
  into the mid and long-term development strategies
  and national priorities of the individual NMS-s
• Is the race for the Euro matching with other
  objectives, as Lisbon Strategy, European
  Employment Pact, real convergence
• It is taken for granted that an early entry into
  the Euro zone is beneficial for the development
  of all these countries...
• It appears on a mere technical level, how
  governments manage the process
• Only question is how to push the bitter pill of
  fiscal and monetary adjustment down the throat
  of the population - is this really so simple?

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Two major mismatches, why the SGP criteria do
not fit NMS-s

• 1. Different macroeconomic framework in NMS-s
  compared with steady, slow growing EMU countries
• 1.1. Higher dynamism of CEE with cca. 10 nominal
  growth rates..
• As a result, 4-5 government deficit would be
  sustainable (in order government debt in of GDP
  does not grow)
• 1.2. Fast and uneven productivity growth gt
  Balassa Samuelson effect gt large gap in
  productivity growth between tradeable and
  non-tradeable sectors of the economy gt
• Push effect on wages from tradeable to
  non-tradeable sector Distorted price and cost
  structures, wages below potential levels gt
  adjustments still underway
• Result higher inflationary potential

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Illustration for the different macroeconomic
profile
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Comparative price levels (EU25100), 2005
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Change in nominal yearly compensation per
employee in Euro, 1999-2006 ()
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Illustration Uneven growth of wages and
productivity (Hungary between 1995 and 2005)
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Second mismatch gt fiscal pressures

• 2. Fiscal pressures due to welfare deficit and
  public investment needs
• 2.1. Welfare deficit due to forced modernsation
  and structural change (see social risk index)
• Low employment rates, high unemployment rates gt
  more active LMP gt more spending needed
• 2.2. Need of public investments (infrastructure
  development, environment protection, research
  development, education training in line with
  Lisbon agenda) gt more spending
• The fiscal issue is not just a question of
  pushing deficits down, it is a policy choice and
  a choice of priorities (ESM, Lisbon ??)

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Social spending in NMS and OMS (2005) (ESM
spending, GDP)
output per capita, 000 PPS
Note Luxemburg excluded, data not available for
ES, PT, US
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At-risk-of- poverty rate and needed social
transfers

• Source Eurostat Yearbook 2006-07118

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Employment rates, 2004
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Social risk indicators for EMU accession (2003)
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Major social concerns of a fast track EMU
accession

• On basis of an aggregation of of the above social
  risk indicators into a social risk index taking
  also fiscal positions into account, country
  groups were identified
• Group 1 Hungary (and Malta and Cypus)
• Hungary has a high debt, a high deficit and an
  intermediate level of social spending, and a
  relatively low position on the welfare stress
  index. This would suggest that while EMU will be
  constraining, the social consequences could be
  managable.
• Group 2 Poland, Bulgaria and Slovakia
• For this group, EMU public expenditure
  constraints pose a problem, demanding
  retrenchment and cuts that may prevent a level of
  social expenditures in line with relatively high
  levels of welfare stress.

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Major social concerns of a fast track EMU
accession

• Group 3 The Czech Republic and Slovenia
• The Czech Republic has a low-to-moderate debt,
  medium level of deficit intermediate level of
  social expenditure, a relatively high employment
  rate and a low level of welfare stress.
  Slovenia is in even better condition, with low a
  low deficit and debt, high employment and low
  welfare stress, alongside a relatively high level
  of social spending making it the best performer
  of the wider CEE group.
• 4) Group 4 Lithuania, Latvia and Estonia
• This group of countries has medium levels of
  employment, low deficits and debts but medium to
  high levels of welfare stress, alongside low
  levels of social spending. Even within EMU, these
  countries (with their largely residual welfare
  states) could embark on a path of welfare catch
  up in line with the EU 15.

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Major concerns of a fast track EMU accession

• The general concerns are thus
• SGP criteria in their present (rigid) form do not
  fit with the NMS-s
• Due to different macroeconomic framework
  conditions
• NMS-s would have a higher equilibrium inflation
  rate as a result of the BS effect, the
  distorted price and cost levels, and the
  productivity reserve..
• Moreover due to low debt rates and higher growth
  (in nominal terms up to 10) higher than 3
  deficit rates are sustainable (4-4.5 are
  estimated) the 3 deficit ratio was designed
  for other framework conditions (Belgium, Italy)
• If non-fitting criteria are applied in a forced
  way they have a downside effect price stability
  at fixed exchange rate is a burden and would not
  be sustainable

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Major concerns of a fast track EMU accession

• If the present SGP criteria are rigidly applied,
  sacrifices in growth, employment, real
  convergence, wage convergence, with knowlege
  based economy targets are unavoidable
• This would cause substantial welfare sacrifices,
  given the welfare deficit already there,
  aggravated by low employment rates in most
  countries, high unemployment rates in several
  countries (special risks Pl, SK where both of
  these are present)
• Would Maasricht become a means to maintain
  social dumping?
• Would hamper strategies for breaking out of the
  low wage profile (Hungary started this and has
  got under constraints, for Slovakia and some of
  the Baltic states it might be a major ambition in
  the future..)
• Lisbon goals, convergence would need higher
  public investments

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Example of Lithuania

• Lesson on basis of constructed arguments on the
  inflation criteria, LT was rejected
• Message low income fast growing countries not
  welcome
• Eurozone a club of slow-growing rich countries?
• GDP/capita a hidden criterion?
• Official comment sustainability of the inflation
  criteria is not guaranteed (prognosis also a
  criterion?)
• Lesson inflation is the major problem
• Question, what is the optimal path?
• How could LT wages of cca 400 EUR converge to
  2500 within the Eurozone
• How could Baltic welfare system be consolidated
  within the EMU

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The case of Hungary

• The case of Hungary with the social-political
  turbulences in the autumn of 2006 in the wake of
  the announcement of the latest Maastricht
  convergence plan with the necessary austerity
  measures, delivers lessons from another angle.
• In the period 2001-2005, Hungary has launched a
  welfare correction programme accompanied with a
  comprehensive infrastructure development.
• This programme has responded to real expectations
  of the society, but due to political
  irrationalities did not respect basic realities
  of sound public finances and led to a crisis of
  government finances culminating in a government
  deficit close to 10 of the GDP in 2006.
• The case of Hungary has thus demonstrated how
  basic European priorities, as the Lisbon Agenda,
  the Stability and Growth Pact criteria and the
  principles of the European Social Model get into
  conflict with each other in the case of
  transformation economies. A chain reaction of
  political irrationalities has only magnified the
  contradiction.

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Conclusion

• In case of transformation economies there is a
  clash between EU objectives
• SGP Lisbon agenda European Social Model
• A forced fulfilment of Maastricht goes to the
  detriment of the two other objectives and might
  hamper real convergence
• A revision of the Stability of Growth Pact is
  unlikely, although several European think tanks
  propose to implement a Balassa-Samuelson rebate
  for CEE at the inflation criterion.
• Each country needs a proper societal debate on
  its central national priorities and needs to
  embark on an optimal EMU accession agenda
  accordingly.