Eurozone Politics in 2008

in collaboration with Sebastian Dullien

One year ago, we forecast the economic and political developments of the Eurozone for 2007 on Eurozone Watch (see our ex-post analyses here and here). 2008 were are giving this forecasting challenge another go. This is the second part of our outlook on 2008 and deals with politics and governance issues for EMU. You can read our outlook on the EMU’s economic developments in 2008 here.

Will the French EU Presidency help improve EMU governance?

So far, EMU issues have not been named among the main topics for the French EU Presidency which will start on July 1, 2008 (these are Immigration, Energy, Environment and European Security and Defence Policy). However, early governmental statements issued on France’s EU Presidency did evoke initiatives to improve growth and employment. In addition, France’s President Nicolas Sarkozy on several occasions suggested summoning a Eurozone Summit. He has not repeated this idea since coming into office (but in June 2007 suggested he would come up with a proposal on EMU governance after the summer and the end of the German EU Presidency). Nothing precise has come up so far, but Sarkozy did provoke concerns on France’s commitment to the fundamental arrangements (monetary and fiscal policy) of EMU. At the start of this year, there is no clear indication that France will take any initiative on EMU issues in 2008. If there was anything serious in the repeated request to improve EMU governance, and given the fact that France will be followed by small (and non-EMU countries) in the EU Presidency, the political leaders should work on this idea (e.g. calling for a Eurozone summit) in 2008, as no other EMU country is likely to take the initiative. However, it is only if Sarkozy manages to gain preliminary support of his large EMU partners (Germany, Italy, Spain) that he can seriously hope to advance with this issue under his EU Presidency.

Will the German grand coalition hold and will it continue its beggar-thy-neighbour-policy?

Most likely, the German grand coalition will hold until the general elections in 2009. For none of the large parties, there is an alternative and there is little they would gain from early elections. Coming to the beggar-thy-neighbour-policy of Germany, there will most likely be no new initiatives in 2008. In the past years, this policy has not been intentional but rather a result of the idea that unemployment can best be battled by lowering labour costs. With unemployment falling and the surplus in the social security system having been mostly depleted by the recent cuts on the contribution rates, most likely there will be no push for a further cut here. More likely, there will be a new discussion on cuts in the income tax, a path which does not influence labour costs directly. Moreover, with the social democrats and public opinion shifting towards stronger wage increases, German wage dynamics will most likely improve somewhat. However, as the German wage bargaining system shows a large degree of inertia, wage increases in Germany will again lag the rest of EMU and relative price competitiveness will improve further.

What will Jean-Claude Juncker make out of his last year of Eurogroup Presidency?

2008 will be Jean-Claude Juncker’s last year of his second two-year term as the Eurogroup’s first permanent President. The Prime Minister and Minister of Finance of Luxemburg had signalled ambition and had raised high expectations when he entered into office on January 1, 2005. Since then, apart from some improvements to the functioning of the internal work of the Eurogroup and the recent EMU-Trias-visit to China, nothing spectacular has happened. The informality of the group, the rising number of participants (11 in the beginning, 15 as of 1 January 2008), the need to build consensus without votes will continue to limit the capacity of the Eurogroup’s President to exert a strong leadership within that circle.

Will further EU countries get the go-ahead for EMU membership?

The most likely next entrant into the EMU is the Slovak republic. In Spring 2008, it will have to prove that it complies with the convergence criteria laid down in the Maastricht Treaty. At the moment, it looks very likely that Slovakia will be able to meet all criteria. Inflation (which has been the main obstacle for the Baltic countries to join EMU) runs only at 2.3 percent, which in fact is higher only than inflation in the Netherlands (1.8 percent), the UK and Finland and is thus safely within the margin of 1.5 percentage points above the three best-performing countries in the EU. Even the increase in the excise taxes on cigarettes will most likely not push inflation into a territory which would endanger accession. In addition, neither the budget deficit of slightly above 2 percent of GDP or the government debt of about 30 percent of GDP come into conflict with the Maastricht treaty.

In contrast to Slovakia, the Baltic countries will further denied entrance for the foreseeable future. In 2006, especially Lithuania was very disappointed when it was denied entrance for marginally missing the inflation target. At that time, EU commission officials voiced the concern that inflation in the Baltic countries would increase and imbalances be too large for a quick accession. Looking now at inflation rates in Estonia, Latvia and Lithuania shows that these concerns were justified: According to the latest figures from November 2007, inflation reached 13.7 percent in Latvia, 9.3 percent in Estonia and a still impressive 7.9 percent, all coupled with current account deficits in double digits (with the Latvian current account deficit set to reach a whopping 21.6 percent in 2008 according to the EU commission’s forecast).

Will the opt-outs move any closer to EMU membership?

The UK will not become any more pro-European or pro-Euro in 2008 than it was in 2007. Gordon Brown is not only a Euro-sceptic after ten years of participating in the work of the Ecofin as a former Chancellor of the Exchequer. Politically weakened, he is also under increasing pressure by the Tory Party and other interested groups over his agreement to the Lisbon Treaty and his intention not to hold a referendum. He will have to put all his energy in getting the Reform Treaty ratified by a Parliamentary vote (which he didn’t even dear to sign along with his 26 EU partners in the official event, but did so later alone in order to get lesser public attention).

We do not think that Sweden will move on EMU issues, however, we think it is possible that the Danish Prime Minister indeed takes the risk to hold an EMU referendum once the Reform Treaty is ratified and politically out of the way.

Will the ratification of the Lisbon Treaty matter for EMU governance?

The Lisbon Treaty, if it enters into force, will not change the parameters of EMU governance practically. In the long run, the mentioning of the Eurogroup in a Protocol to the Treaty can serve as a basis for a further creeping institutional development of this informal forum vis-à-vis the other EU institutions and the ECB. But there will be no radical change on the day the EU is governed by the Lisbon Treaty. If, however, the ratification of the Lisbon Treaty fails (e.g. in the Irish referendum), there may be two possible consequences for EMU governance. The first, and more probable scenario in the immediate time horizon is, that the EU would fall back into some kind of helpless crises with a minimum of institutional reforms remaining unimplemented and a prolonged crisis of political leadership. This could negatively affect the Eurozone.

The second scenario would be “a moment of truth”, with some countries seeking further integration and an alternative to the Lisbon Treaty, while others would have to be serious about their reluctance to go ahead, and decide whether they really want to be “out” of the next step of integration. Depending on the constellation of member countries, this situation (not in 2008, but in the following years) could be used to deepen the political dimension of the EMU.

3 Responses to "Eurozone Politics in 2008"

  1. eparisi   January 10, 2008 at 5:49 pm

    Can a compelling case be made for the UK to enter the Eurozone?