Friday, June 25, 2010

Euro, Ad Nauseum

Giovanni Angioni of the Estonian Free Press contacted me to request a comment. The text below is a response to that. Some of these points are recycled from previous articles on AnTyx and elsewhere.

1)      Estonia needs to enter the Eurozone for political reasons, not economic ones.

The country has maintained a peg to the Euro and the preceding Deutschmark at the same level for 18 years. Thanks to the currency board system, every cash kroon ever issued is covered by liquid assets. The peg is not volatile, it does not rely on market confidence, and it cannot be abandoned in a sudden sweeping move for legislative reasons. (I have seen a scenario for overnight devaluation without making the move public in the Riigikogu, but this relied on a very iffy loophole and would have almost certainly fallen to a constitutional challenge.)

In that sense, there is indeed no rush to join the Euro. Economically, Estonia could continue with the kroon, maintaining the peg, and would suffer very little penalties.

There are two main political reasons why Estonia is joining the Eurozone now. One is down to the government, the other is down to the people.

The government needs the Euro to justify its austerity measures. A balanced budget and a tiny public debt (indeed, still lower than the country’s reserve assets) have been a core value of Estonia since independence, but in a crisis this big, there is a natural desire to spend one’s way out of a hole: borrow money to support people who have fallen on hard times. Inevitably, this is what the opposition has been advocating. Instead the government has chosen to stay its course, slashing jobs and salaries in the public sector and raising taxes. In order to not get crucified, the governing coalition (which actually holds a narrow minority in the parliament and needs to negotiate with small parties to pass legislation) has explained away the need for these measures by the relatively clear numbers of the Maastricht criteria. The recession, high unemployment and lack of consumer confidence have put enough pressure on prices that inflation was actually negative in 2009; the last barrier to entry was the 3% budget deficit limit. Remarkably, the milestone was achieved with a comfortable margin (at only 1.7%).

The people of Estonia want the Euro because it is a mark of deeper integration. This is almost never spoken of aloud, but Estonia’s foreign policy is just about entirely driven by the desire to prevent another Russian occupation. Estonia is now a member of NATO and the EU, but that is not enough for Estonians to trust their allies. The country seeks a deeper integration – deep enough that European politicians will not be able to afford to surrender it in a chess game of interests with Russia. The Euro is a hallmark of that level of integration. Foreign readers may find it astounding, but remember that this is not a thing often said out loud. It is a nagging worry that lingers at the periphery of the Estonian psyche. Remember also that the war in Georgia two years ago reinforced this belief. We are, without question, paranoid. That doesn’t mean they’re not after us.

2)    Even if the Euro fails, it will not be disastrous for Estonia.

The best thing that could happen to Estonia, economically, is a massive crash of the Euro on January 2nd. The structural problems of the Eurozone as a whole do not scale down to Estonia, a tiny country with lower wage levels and living standards. If the Euro is devalued and the Eurozone itself holds, it will be an isolated market of 330 million consumers, who cannot afford imported goods, and desperately need to find cheaper labor domestically. Industrial investment will flow into Estonia, and its production capacity will skyrocket (in relative terms), as we steal back the jobs that went to China. This will stimulate a convergence of Estonian living standards with French and German ones far quicker than EU structural funds ever could.

If the Euro crashes and the Eurozone is disbanded, we simply go back to the kroon, re-pegging it against the Neue Deutschmark. The sum total of our losses is the collateral we’ve deposited at the European Central Bank, and the cost of re-printing the banknotes. This is a calculated risk that we just have to accept. The good news is that the forces that actually decide if the Eurozone persists, and control the resources needed to hold it together, have far more to lose in its disappearance than we do.

3)    Estonia cannot do anything truly useful with monetary sovereignty, anyway.

The ability to devalue at a snap is great for a large, self-sufficient economy. If Estonia is cut off from foreign markets, it can just about grow enough food for 1.3 million residents, maybe. Our value-adding manufacturing industry is actually bigger than most people imagine, but even stimulated by a cheap kroon, it will not be enough of an economic powerhouse. Exchange-rate penalties would price imports out of the consumer’s reach, and our real living standards would drop down to the level of the mid-90s, which is orders of magnitude worse than this recession has produced to date.

Beyond that, there is a tremendous amount of households that struggle with a mortgage denominated in Euros. Devaluation would trigger a wave of defaults that would devastate the Swedish banks that issued them, and leave Estonians without property. (The same goes for businesses which have taken out loans to expand and re-tool.) The embarrassment caused by that alone would negate any influx of investment capital interested in the decreased labor costs.

Meanwhile, Estonia’s most valuable assets – highly skilled professionals – either already have contracts that list their prices in Euros, or are mobile enough to simply pick up and move to where their talents will be better compensated. Decreased labor costs and the associated increase in competitiveness will either not apply to high-tech sectors at all, or the effect will be very minor.

We cannot abandon the Euro peg with any real benefit. Switching to the Euro on the eve of its crash will bring some short-term trouble, but far bigger long-term benefits. Continuing with a pegged kroon while the Eurozone is repaired will deny us some relatively minor, but potentially useful benefits.

Objectively, there is no reason not to join.

1 comment:

Giustino said...

I'd add that Finland is Estonia's second largest investor, and the adoption of the euro is, next to adopting the Swedish kroner, one of the best things Estonia can do to tie its domestic market to its northern neighbor's ... so that you have free flow not only of people but their money. Again, that has a lot to do with Estonia's "paranoia"-driven post Soviet security project, but it also seems like a legitimate goal for a country of 1.3 million located to a related, much wealthier country of 5.2 million with a diverse economy and a reputation for stability.


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