It is no coincidence that the recent EU summit to restate the European project was held in Bratislava: Slovakia is the poster child for the benefits of the Euro, says Unicredit’s Global Chief Economist, Erik F Nielsen.
Bratislava is the capital city of Slovakia; a notable success story of the EU and its shared currency.
Slovakia has seen robust growth after joining the Eurozone, whilst its neighbour, the Czech Republic, which decided to remain independent and keep its old currency has done comparatively less well.
Prior to 1992 they were part of the same country the two country’s serve as a useful study in comparing the relative benefits or negative’s of joining a monetary union.
Or so argues Unicredit’s global chief economist, Erik F Nielsen.
Part of the spew of negative rhetoric aimed at the EU and its various institutional spawnings is that the introduction of the euro has been a disaster for the countries employing it.
The argument is that the euro prevents countries from adapting their monetary policy and therefore their exchange rates during periods of boom and bust.
During a recession, for example, it is advantageous for countries to lower their exchange rates to support exports, so they can export their way out of their recessions.
The normal way of achieving this would be for the central bank of that country to try to manipulate the exchange rate, either by lowering interest rates or directly intervening.
However, by being a member of a currency union the country is not able to do so, since interest rates and market interventions are controlled by the European Central Bank (ECB) in Brussels.
Nielsen argues that this reasoning, whilst seemingly compelling on a theoretical level, does not hold up in reality.
He thinks that rather than being negative for its member states the Eurozone has actually been economically positive for them.
“European integration is good, and I’ll illustrate it with possibly the most controversial of topics, namely the Eurozone, which has been blamed for all sorts of European malaises,” says Nielsen.
He attempts to prove the Eurozone has been a positive by comparing the economic development of Slovakia and the Czech Republic.
Whilst the two countries were part of one large Czechoslovakia, in 1993 they split into the Czech Republic and Slovakia.
Nielsen sees the two as a test case for whether the Eurozone is beneficial for a country or not.
“Let me use the occasion of Bratislava to compare how Slovakia has been performing relative to its 'big brother', the Czech Republic - and specifically since 2009, when Slovakia joined the Eurozone while the Czech Republic decided to keep what they believe to be monetary independence (thereby preserving a tool which would make them out-perform.)”
Whilst the naysayers would say the Czech Republic made the right decision to stay out of the monetary union, Nielsen decides to look more closely at the numbers to decide which nation made the wisest decision.
First he provides us with some background context on the region:
“Czechoslovakia masterminded a virtually perfect separation in January 1993 into two independent countries, namely the relatively industrialized Czech Republic of a little more than 10 million people with a per capita income then of EUR 3,300 equivalent per year, which inherited the entire set-up of government institutions in the capital city of Prague, and the much more rural Slovakia of 5.4 million people with a per capita income then of EUR 2,200 equivalent per year, who turned the regional capital of Bratislava into the new country’s capital city.”
Nielsen says that the first five years of life for both countries was described as ‘mixed’ with per capita income rising about the same amount in each country.
In 2004 both countries joined the EU and were both given 2% of GDP a year in development grants from western EU countries to try to help them converge with western standards.
“Both countries joined the EU in 2004, and as preparation for membership started to take shape in the years before (and supported ever since by a bit more than 2% of GDP per year in funds from their Western European EU partners) convergence towards EU income levels accelerated – and the gap between Czech and Slovakia’s income levels began to narrow.”
Then in 2009 Slovakia adopted the euro and, “with their different FX policy during the last almost eight years, through the global crisis, growth and convergence, these two countries probably provide as good a case story as any on the wisdom of the euro,” says Nielsen.
He concludes that the euro has benefited Slovakia more than its neighbour without the euro.
Growth in Slovakia averaged 1.6% per annum in the eight years, whilst in Czech Republic it only rose 0.4%.
“As a result, the gap between Slovak per capita GDP and Czech per capita GDP shrank from 21% in 2008 to 7% last year.” Notes Nielsen.
Moreover, these years included major headwinds for the Eurozone, including the Great Recession and the more specific regional crisis in Europe.
Secondly, he argues that GDP growth has been more volatile in the Czech Republic than Slovakia, illustrated by the fact that the Czeck Republic fell into a recession in 2012-13 whilst Slovakia “skirted through he sovereign debt crisis with positive (if modest) growth rates.”
Part of the explanation can be put down to Slovakia attracting more foreign car makers which it was in direct competition for against the Czech Republic.
Nielsen also makes the distinction between the lesser independence but greater power of Slovakia over monetary policy by having a seat at the ECB governing council, and the greater independence by relatively little power of the Czech monetary authorities.
He concludes by citing Professor Helene Rey’s seminal paper, “Dilemma not Trilemma; The Global Financial Cycle and Monetary Policy Independence”, which argues that the global financial cycle, “constrains national monetary policies regardless of the exchange rate regime so long as capital movements are free.”