What's New in the EU: The euro after 10 years - successes and challenges

While the European Commission states that the euro is a success, so far it has fallen short of some initial expectations.

By ARI SYRQUIN
eu flag biz 88 (photo credit: )
eu flag biz 88
(photo credit: )
In less than two weeks from today the euro will celebrate its 10th anniversary. The move to the last phase of EMU - Economic and Monetary Union - on 1st January 1999, marked a watershed in European integration. Although economic in substance, it also sent a political signal to European citizens and to the rest of the world that Europe was taking far-reaching decisions to create a common future for the continent that had all too often suffered from wars and economic and political instability. The number of countries that share the single currency has increased from the original eleven to fifteen at the beginning of 2008 and is set to increase further. While the European Commission states that the euro is a success, so far it has fallen short of some initial expectations. A number of significant challenges which had not yet emerged or were only starting to become apparent when EMU was devised are now more pressing. While the progressive enlargement of the euro-area could add dynamism to its economy, it might also increase the diversity of EMU, making stronger demands on its adjustment capacity. At around 2 percent per annum, potential growth remains low. Although employment has risen, productivity growth has slowed from 1.5% in the 1990s to around 1% this decade. As a result, the euro area's per capita income has stalled at 70% of that of the United States. While most of the smaller euro-area economies have done well, potential growth should have been significantly higher in some of the largest member states. The tendency for persistent divergences between euro-area member states has partly been the result of a lack of responsiveness of prices and wages, which have not adjusted smoothly across products, sectors and regions. This has led to accumulated competitiveness losses and large external imbalances, which in the EMU require long periods of adjustment. In accordance with a report published by the Commission, citizens in some countries believe that prices significantly increased because of the euro. Indeed, even if overall inflation was only marginally affected at the time of the changeover, occasional abusive price increases in specific sectors and countries have tarnished the image of the euro and continue to do so. At the same time, the lack of development of the economic leg of the EMU, compared with the monetary leg, has also fed the concern that the euro area is incapable of addressing the key challenges facing it, further weakening its public image. Globalization offers major opportunities for market growth, yielding lower prices and greater choice for consumers, and efficiency gains for producers. However, it also puts strong demands on the adjustment capacity of the euro-area members as new activities will need to replace declining industries, and as research, innovation and human capital become ever more important drivers of economic dynamism. Moreover, globalization further compels the euro-area to take an effective role in global economic and financial governance. The population of the euro-area is rapidly ageing. As a result, the portion of the population dependent on pensions will increase, simultaneously reducing the economic growth potential. Indeed, the ratio of working-age to older people is projected to halve over the next four decades and on unchanged policies, the potential output of the area will slow to just over 1% per annum from around 2% at present. Ageing will also make relatively large demands on public spending, and unless reforms are made to pension and health systems it will increase the share of public expenditure in GDP by an estimated 4 percentage points over the next four decades. Ageing populations pose a serious challenge to the euro-area's capacity to adjust and put the sustainability of its public finances and, more generally, its welfare systems at risk. These longer-term trends, whose effects are increasingly being felt, will pose challenges for the performance of all advanced economies in terms of growth, macroeconomic stability, adjustment capacity, the sustainability of social security systems and the distribution of income and wealth. But they will produce policy challenges that are particularly compelling for the euro-area considering its relatively low growth potential, its weaker adjustment capacity, high public indebtedness and the strong interdependence of its economies. syrquin@013.net Ari Syrquin is the head of GSCB Law Firm's international department.