The Challenge Comes After

5^th January 2007

The Malta Independent - Friday Wisdom

Saving unforeseen events, this time next year we should all have crisp euro notes in our pockets. Assuming there will be no surprises on the inflation front, Malta should together with Cyprus become the 14th and 15th member country of the eurozone as from 1 January 2008.

Member countries have had different fortunes with the euro. While the Irish thank their good sense of joining the euro, the Italians doubt till this very day whether the 1999 decision to join the euro made sense in their circumstances. The Germans on the other hand had a very hard time adjusting to the switch from the deutsche mark to the euro, but are now roaring ahead confidently.

These different experiences by countries in different circumstances make it pretty evident that joining the euro on it own is no panacea. The competitiveness of a country does not depend on joining the euro. It depends more than anything on having a flexible and efficient economy capable of competing on price and quality to win on world markets. If then a country that has reasonable competitiveness in its base economy decides to join a monetary bloc sharing its monetary sovereignty with other countries with whom it has a free trade agreement or an economic union, then the success also depends on joining the monetary bloc a rate which preserves and enhances its competitiveness.

Ireland fared best as it joined at a competitive rate and restructured its economic base well following the ordeal of 1992 when the Irish punt was thrown by the markets along with the pound sterling and the Italian lira out of the then European Monetary System. When Ireland delivered the efficiency gains and attracted waves of FDI, its membership in the euro protected its competitiveness. Out of the euro, Ireland would have seen the punt soar in value against other currencies to reflect its economic advancement and thus tamper its competitiveness.

Germany on the other hand joined the euro system at a rather uncompetitive rate which did not take into account the continued high cost of integrating the Eastern part of the country following its nearly fifty years of communist economics. Germany thus needed time to regain its competitiveness by restructuring its economy at the base. This process was given further impetus by the challenge of new members since 2004 which forced the German Unions to make concessions for labour flexibility which were unthinkable till a few years before, in order to prevent factories from relocating to less expensive new EU members on Germany’s doorstep.

Both Chancellor Schroeder and Chancellor Merkel forced the economic restructuring at the base and this has currently rendered the German economy an export powerhouse. It is leading to a fall in German unemployment levels which until recently were stubbornly at double digits levels.
Italy on the other hand joined the euro ill-prepared. It window-dressed its economic performance to come technically but not substantially in line with the Maastricht criteria. Worse still, after joining it did pretty little to re-structure its economy.

With a cost base running higher than that of its competitors, the Italian economy found the euro system quite suffocating as it did not permit recourse to old habits of occasional devaluations to restore competitiveness lost due to inflexibility of its base economy.

What experience awaits us after the pomp of the changeover gets replaced by the challenge to preserve and enhance our competitiveness under the new rules of monetary union? Will we emulate the Irish, the Germans or the Italians?

The true challenge for making success of the euro will not be 2007. It will have to be a few years down the road when we can draw some conclusion about the success or otherwise of our euro project. Unlike what many might think the euro challenge is not the preparations for smooth changeover, which will be largely forgotten a few weeks after the event. It is the process of the unfolding years after the event that will decide whether the euro has enabled us to accelerate the restructuring in order to preserve our competitiveness.

2007 is pretty much a transitory year. Being the last full year before the latest date for holding fresh elections, governments tend to go soft on the restructuring process. Such issues like restructuring of the health services and a thorough overhaul of our fiscal system will have to wait till after the next election.

The government has no tools to manage the economy in 2007. Fiscal policy needs to remain restrictive to pass the ultimate euro test. Monetary policy has effectively already been ceded to the ECB who cannot be expected to fine-tune its monetary stance with Malta in mind. Exchange rate policy has never been used to manage the economy since 1992. It has been rather meant to deliver an anchor of stability to our external trade.

All in all therefore 2007 will be a cruising along year. The real challenge comes after. Making success of our joining the euro depends on our determination to continue restructuring to avoid waste, as is currently inherent in our public services, and accepting that there is no such thing as a free lunch. The euro is certainly no free lunch. It is a veritable challenge.