Is the euro worth the risk?

Given the current turmoil in the EU’s smaller economies, an Irish economist warns eurozone aspirants to be careful what they wish for

Michael Stein 10.12.2010
Ireland’s decision to adopt the euro hasn’t sat well with everyone | na serveru | aktuální zprávy Ireland’s decision to adopt the euro hasn’t sat well with everyone | foto: © ReutersČeská pozice
Ireland’s decision to adopt the euro hasn’t sat well with everyone | na serveru | aktuální zprávy

The Irish ordeal contains some significant warnings for the EU’s newer members from Central and Eastern Europe (CEE), according to Moore McDowell, economic consultant formerly at the University College Dublin School of Economics. For him, the multifaceted economic problems facing Ireland have one common factor — the euro.

“The Eastern European EU members have a commitment to join the euro. It’s on paper, but the ‘when’ is not clear,” McDowell said, indicating a delay is the only remaining card these countries can hope to play. “If you don’t qualify you won’t be allowed in. I’m not saying Eastern European countries should never join, but they should go in with their eyes wide open.”

McDowell defines the current economic situation in Ireland as the convergence of three separate crises:  a competitive crisis based on the foreign exchange value of the euro since 2003, a fiscal crisis due to the country’s massive debt and a banking crisis resulting from the burst property bubble.

“I will be in the minority in this, but I absolutely believe that we made a decision in the ’90s after the Maastricht Treaty to enter the euro if we could. We were able to, and that has turned out to be a disastrous decision,” McDowell said.

At first, euro adoption seemed like a dream come true. “Ireland has never really lost from being on the periphery and from being a small economy, and even from being an agriculturally based economy. There was a big terms of trade shift in Ireland’s favor from going into the EU and that lasted for about 20 years. Ireland succeeded in getting a disproportionate share of, particularly American, FDI,” he said. In this respect Ireland was totally unlike an Eastern European or Balkan country.

Ireland’s strong trade relation with the US showed up another problem with the European currency. Unlike the US, the EU doesn’t represent an Optimal Currency Area (OCA), McDowell insists, unsure if the question of whether the EU was an OCA was ever seriously asked. “Eurozone countries have very limited capital mobility. They are not in lockstep in terms of monetary policy. Most of what we produce [in Ireland] is exported and most of what we consume is imported, and it’s not primarily in trade with other eurozone countries.”Irish economist Moore McDowell sees the current bailout effort as ‘gallant’ but doomed to failure.

The result was a steep drop in the euro’s value in relation to the US dollar, which in Ireland caused a huge depreciation in the real exchange rate. “The effect was as if we’d devalued our currency,” McDowell said. What followed was further demand being pumped into an already growing economy and then an asset price boom that resulted in the property price boom that ended in 2007.

What might have been a benefit of the whole process, a sudden, unexpected surge in tax revenues, was woefully mishandled by the government, who treated the temporary price boom as something permanent, raising public salaries, adding public sector jobs and increasing welfare. “It was like a household that won the lottery and decides to raise their expenditures by that amount every year. The peripherality problem for Ireland, in my view, was a failure to understand and adjust fiscal policy to the reality that this was a transient boom,” he said.

McDowell sees the current bailout effort as doomed to failure. “If we were just dealing with the deficit, the government austerity plan would work after four or five years. My view of what’s taking place at the moment is it’s a gallant attempt but it’s not going to work.”

Ultimately, countries looking to enter the eurozone have to understand exactly what they’re doing and should be wary of making a premature decision to lock their monetary decisions to what’s going on in Europe. “There is not a mechanism to exit the euro. It was designed to make it a practical impossibility. There is only one country that could conceivably leave the euro and that’s Germany. If France or Italy said they wanted to go back to the franc or the lira there would be a run on banks.”



Michael Stein

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