Does Joining the Euro Come at the Cost of Growth?

Sweden’s Euro Debate

Euro proponents in Sweden are more confident that their country will join the euro in the near future. In December last year, renowned economist Lars Calmfors published a study commissioned by the Foundation for Free Enterprise on a potential Swedish euro accession. Calmfors concluded strongly in favor of abandoning the Swedish krona.

This past winter, echoing the Calmfors study’s conclusions, representatives of most parties in the Swedish parliament expressed one form or another of support for euro accession. Since then, the issue has vanished from the political radar, ostensibly because proponents know that support among Swedish voters remains weak.

The issue is likely to surface again after the election in September. Regardless of whether the incumbent center-right government wins re-election or the Social Democrat-led opposition takes over, there will be a solid parliamentary majority in favor of the euro. Since the ECB report places the Czech Republic and Sweden “close” to meeting the criteria for euro accession, it will essentially be up to the national governments of those two countries to make the leap into the currency area.

In other words, the big question regarding euro-area enlargement is not whether there are eligible candidates; the big question is to what extent – if at all – those candidate countries benefit from joining the euro.

The aforementioned Calmfors study, positive as it was about euro membership, devoted its 544 pages to relatively unimportant aspects of a nation’s economic performance. It failed to address major questions such as the decline in GDP growth that 90% of the pre-Bulgaria euro members have experienced. Bulgaria’s membership is too recent to be evaluated. war das andere falsch?

This decline in economic growth is easily identifiable in the relevant statistics. Before examining the numbers, however, it is worth briefly looking back at how the euro zone came about, as this provides important context for the statistical findings.

Why Convergence Was Supposed to Matter

When the European Union was formalized in the Maastricht Treaty of 1992, the euro was envisioned as a common currency for the whole union. The individual member states would abandon their national currencies for the euro, but to do so they would have to meet a set of convergence criteria. These required inflation to be no more than 1.5 percentage points above the rate of the three best-performing EU member states in terms of price stability. Government finances had to comply with the EU’s Stability and Growth Pact, while long-term interest rates could be no more than two percentage points above those of the same three member states.

The motivation behind these criteria was the theory of so-called optimum currency areas: when countries with different currencies shift to one common currency, their economies must align in terms of growth, inflation, employment and business cycles, or else the common currency will come under existential stress. The EU’s euro-zone convergence criteria were designed to serve this alignment purpose.

Ahead of the euro’s introduction at the turn of the millennium, aspiring members began adjusting their economies to the convergence criteria in the mid-1990s. Understanding how euro membership has affected their economies therefore requires examining GDP growth statistics going back 30 years.

Growth Before and After Euro Accession

The figures for each euro-zone member cover two periods: before and after accession. The length of each period varies depending on when the country joined.

When the euro was launched in 1999, 11 of the EU’s then 15 members adopted the common currency: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain.

Two years later, Greece became the 12th country to join the euro zone. Since then, with the gradual expansion of the EU, another nine countries have replaced their national currencies with the euro.

Bulgaria is excluded from the statistical review because its accession to the currency area is too recent to allow for any meaningful analysis of the transition.

For the remaining 20 countries, the pre-euro period begins in 1996, when the first prospective euro-zone members began aligning their economies with the convergence criteria.

The calculation uses inflation-adjusted quarterly national accounts data from Eurostat to compare GDP growth in each of the 20 countries before and after they joined the common currency. This provides a detailed picture even for relatively short periods such as 1996–1998.

The results are striking. The average annual growth rate for these 20 countries was 3.8% before they joined the euro, compared with 2.3% after accession.

At the country level, economic growth fell in 18 of the 20 economies.

This is by no means an exhaustive review of the economic effects of euro-zone membership. At the same time, this cursory review focuses on the most consequential of all economic variables in any evaluation of fiscal or monetary policy. It addresses one of the first and most pressing questions regarding the upsides and downsides of euro-zone membership: is it likely that an economy will become more prosperous under the common currency?

In 18 of the 20 countries examined – 90% – average real GDP growth was lower after euro accession than before. This historical pattern raises the question of whether Sweden and the Czech Republic would experience a similar slowdown after joining the euro.

Why One Percentage Point Matters

But is it really that important if economic growth is, for example, 3% instead of 2%? Does it really matter for the country as a whole?

Yes, it matters a great deal. A decline in GDP growth by one percentage point means at least a similar weakening of wage growth: workers find it harder to stay ahead of inflation. That same GDP growth decline also takes a toll on tax revenue: unlike government spending, tax revenue is closely tied to the economy as a whole. When GDP growth slows down, so does tax revenue – but not government spending.

In short: both households and governments suffer when the economy slows down. Since businesses sell their goods and services to households and governments, they, too, take a beating from a more stagnant economy.

A Hypothetical Growth Scenario for the Euro Zone

To illustrate the effect of slower growth after euro accession, each country’s post-accession growth rate is applied to its pre-euro period. By 2025, the resulting differences are in many cases downright staggering.

In eight of the 18 countries with simulated GDP losses, the loss exceeds 10% for the period 1999–2025. Latvia and Slovakia would have lost more than 30%.

This is, of course, a purely hypothetical experiment; several of the current euro-zone members were not yet EU members in 1999. However, the purpose of this experiment is not to be backward-looking, but to raise valid concerns about both the economic future of the euro zone as a whole and the consequences for the non-euro EU states if they were to abandon their currency independence.

According to this simulation, the GDP of the euro zone as a whole would have been 3.8% or €465bn ($531bn) smaller in 2025 than it actually was. Among many other things, that would have resulted in roughly 3.5%–4% lower wages – at a time when households are already fighting an uphill battle against inflation and taxes. Furthermore, it would have resulted in €200bn ($229bn) less in tax revenue for euro-zone governments, the vast majority of which are continuously struggling with budget deficits.

For countries still weighing accession, meeting the criteria should therefore mark only the beginning of the debate: surrendering monetary independence requires convincing evidence that the benefits outweigh the potential cost to growth.