Estonia Joins the Euro Area

Could be a short membership!

Geography sometimes matters. Since breaking free from the Soviet sphere of control, Estonia has developed strong economic ties with Finland – probably one of the most fiscally disciplined members of the EZ and certainly among the better governed. The Scandinavian and Baltic states are locking themselves into the economic and strategic thrust of a German Europe to which it appears the Netherlands, Luxembourg and Austria have also signed up – as well as some of the smaller new entrants such as Slovenia, Slovakia and the Czech Republic.

This leaves Britain and France with their fading notions of grandeur, Belgium and Italy traditionally indulged by the EU to maintain some semblance of national unity, Poland & Hungary with their historical national identity issues, the Balkan states struggling to up their game and, finally, the peripherals.

I think that looking at the EU in the terms of the varying extents of economic and strategic cohesion and integration helps to place the challenge facing Ireland and the other peripherals in some sort of context. We are looking from the outside in and grumbling about how beastly these core country politicians and their institutions are being to us. But if one looks from the inside out, one may get a sense of the extent to which Ireland and the other peripherals have gone into an orbit of their own.

@Michael H,

You make valid points about the hard fiscal and political decisions the new easterm members have made and, continuing my analogy, the efforts they have made themselves to avoid going into orbit, unlike the peripherals. (Only the Hungarians, isolated in a sea of Slavs, seem to be having serious difficulties.) And there have to be concerns about the extent of the rule of law and the nature and quality of governance, but a failure to achieve some fiscal and economic stability would have made any problems in these areas immeasurably worse.

The peripherals have accumulated so much garbage that, if they were to crash and burn, they would do serious damage to the core economies. The challenge for Ground Control (spread across Brussels, Berlin and Frankfurt – with some input from Washington and Paris) is to decide how – and how much treasure to expend – to bring the peripherals into a sustainable orbit and prevent them crashing and burning.

@Rory O’F,

Are you contending that, because you think I might have mislocated Hungary, my general contention about the varying extents of strategic and economic cohesion and integration in the EU is invalid? (Believe me, there is a distinct historical, cultural and ethnic Magyar identity that has related and continues to relate in varying ways to the cauldron of Teutonic and Slavic (and Islamic) tensions in which the Magyars have found themselves for the last 1000 years.)

What we are considering here is the extent to which small nations like Estonia are prepared to lock themselves into this German Europe strategic thrust – and relating this to the extent to which small peripheral nations such as Ireland seem to be excluded and have excluded themselves.

The questions are: do we wish to engage effectively? And if we do, how should we go about it?

@ Paul Hunt

I think we are moving towards a more German-centric EU, and I think Hungary is in a good position for this. I think a German centric Europe is inevitable as they are the biggest economy, now are geographically in the centre of the EU, are a sort of bridge between East and West in terms of rail/road etc. Also the pro-French bias of the EU is much reduced because of less WWII angst and the French language is fairly irrelevant to most Eastern Europeans (except Romanians).

I think to engage effectively we should improve our knowledge of German. 4 times more students study French than German. Of course French is useful, but I strongly doubt it is 4 times more useful than German (and the standard to which both are learned is fairly low by European standards).

@Rory,

I am pleased that you see some merit in my contention. I think it provides a useful basis on which to frame consideration of the future development of the Irish economy. And I agree with your point about language-teaching, but it involves much more than this. We need to leverage our traditional ability to operate effectively in the economic space defined by the US and the UK to engage effectively with the German strategic vision for the EU in a world inreasingly dominated by the non-EU and non-Anglo Saxon members of G20.

@Paul Hunt

Ireland is not a peripheral economy in the EU. It is very much at the centre of it. This can be seen in the level of imports and exports to and from Ireland. Tens of billions of export and import orders flow between Ireland and the rest of the EU every year. Proportionally, Ireland is one of the most active trading nations in Europe and both our exports and imports as a % of GDP far outstrip truly peripheral economies like Portugal and Greece.

Ireland’s centrality can also be seen in FDI flows. Billions of euro come in from the US to Ireland as it is the gateway to the EU Internal Market. Ireland receives a vastly larger share of US FDI receipts than its size would imply. This is because we are the conduit between the US and EU. Hardly a role of a peripheral economy.

Hundreds of companies have established European headquarters in Ireland which further underlines our role at the heart of the EU economy.

We are also deeply enmeshed in EU capital flows. This could be seen at the time of the EU/IMF bail-out talks. France, the UK and Germany had huge exposure to the Irish financial markets. One of the dictionary definitions of peripheral is, “unimportant”. Ireland was hardly unimportant at the time as a default by us would have caused havoc for these three countries’ financial positions. Tens of billions would have been lost. The urgency with which the bailout was agreed demonstrates how important and therefore non-peripheral Ireland was to the stability of the EU economy.

Ireland is in trouble and requires a good few years of sound economic management to restore us to the fortunes we enjoyed in the Nineties but it certainly is not peripheral to the EU economy. It is a small, but vital cog of the European machine.

@Cathal: “Ireland is in trouble and requires a good few years of sound economic management to restore us to the fortunes we enjoyed in the Nineties …”

Sound economic management is not currently available Cathal. Modern economies are a complex aggregate of finite physical resources, infinite credit and political ideology. The canons of modern economics have little to say (yet) about energy and debt. Debt is real entity and it grows exponentially (absent any physical restraint or nutrient) until it is capable of consuming both all present and future incomes – these being derived from our finite (and diminishing) physical resources. Human ingenuity is no match for thermodynamics.

Its not sound economic management we need, its an entirely new economic model. We need to hand-pick our future economists ‘off-the-tree’ not ‘out-of-the-barrel’.

BpW

Now that those in the political class who lead the wrecking of Ireland will soon have time on their hands, we should send them to Estonia to explain how not to run a country within the Euro zone.

Change is the constant, Ireland changed, Germany will change. We emerged from poverty, then we prospered after which we entered a fantasy stage where we appeared to be prospering and then we ran our economy over the cliff. There is not a country in Europe that has not blown bubbles that burst. It is the aftermath that we managed abysmally, too slow, lacking competence at every level, stumbling, fumbling and bungling.
Germany became a federation in 1869 this was followed by the Franco-Prussian war 1871-72, WW1, hyperinflation 1920s’, WW2 1938-45. Four disasters in less than a century had a sobering effect on German behaviour. They have managed their affairs intelligently since 1945 and are now the most stable country in Europe. Germany is no more immune to mismanaging its economy than Sweden or GB. We have had indications in the last twenty five years that Germany is vulnerable to wage levels eroding its competitive edge. Ireland’s low corporate tax which was and still is our one trick pony has its mirror in Germany in its competitive wage levels. As Clausewitz said “Nations do not have friends, they have interests.”. Prepare yourselves for changing circumstances as allegiances change within Europe as they have done for millenia. Todays kissing cousins will be tomorrows mortal enemies and vice versa. Countries like Ireland have to hoe their row alert to changing circumstances. Presently the EU and Eurozone is still our best bet and is protection against a wave of protectionism which will erupt if America cannot improve its productivity relative to China.

@Cathal,

We could argue semantics until the cows come home. However, in this context, I am using ‘peripheral’ to some extent in a geographical sense, but also, and more relevant to the strategic direction in which Germany seems to be pushing the EU, using it to describe the extent to which I perceive Ireland is not sufficiently integrated in this exercise.

I agree that Ireland, particularly during the ’90s, operated very effectively in the intersection between the economic space defined by the US and the UK and that of continental Europe, but much of this ‘conduit’ has become clogged with toxic banking and financial sludge that could cause serious damage to the EU’s financial system. And the headquartering of many international firms in Ireland is seen, rightly or wrongly, by many in Europe as a tax dodge.

Unfortunately, the Irish ‘conduit’ is seen by many in Europe as a toxic drain that needs to be flushed, but mounting the effort and securing the necessary chemicals will be time-consuming and costly.

@Peter,

It is disappointing that your perception of our ‘carefully-worded, highly-loaded rhetoric’ is upsetting you so. Hang in there, I’m sure some academic intellectual masturbation about optimal currency areas and the Maastricht criteria will surface eventually.

In my view, what is interesting about Estonia is its willingness to hitch its wagon to the German locomotive and to acept whatever discipline might be required to stay on the rails. The principal focus of heavywwight EU politicians and Eurocrats over the next year or two will be on keeping the EMU show on the road. The requirement for the survival and strengthening of the system will overwhelm any academic nit-picking about optimal currency areas and the Maastricht criteria will be revised to meet this requirement.

In this context, efforts will be made to get the Irish wagon back on the rails, but Ireland will have to demonstrate a willingness to assist this effort and, more importantly, to accept the necessary disciplines if it is to be hitched to the locomotive.

@Pete the Greek,

You’re not related to Phil the Greek by any chance? 🙂

I think the GANG (and the smaller gang members) is keeping on eye on the big picture, but I suspect they would like to rejig the EMU’s institutions and mechanisms at a more leisurely pace than the sovereign bond market is prepared to allow. Dodgy EZ banks that are exposed to peripheral public and private debt and that may require public support and, possibly, recapitalisation are imposing the risk of impairing future sovereign debt service throughout the EZ and beyond. The sovereign bond market will not tolerate this risk and uncertainty and will force matters to a head sooner rather than later. The peripherals may then get some relief.

Interesting comment here:
http://namawinelake.wordpress.com/2011/01/02/an-garda-siochana-%E2%80%93-a-police-service-unfit-for-purpose/

And story here:
“It is also intended to place a legal obligation on banks and other institutions to provide a proper index and certification for material being handed over for use as evidence in court.

In recent investigations, such as the Anglo case, large numbers of documents have been provided to gardai without any effort to index the material or to certify it, to make the material admissible in court as evidence without the need for witnesses to prove them.

According to gardai and senior justice officials, the volume of documentation has been a source of considerable delay.”
http://www.independent.ie/national-news/witnesses-must-give-evidence-or-face-prison-2480269.html
If only the government controlled Anglo Irish.

@Eureka,

Ireland joined the EEC on the basis of what it could get out of it. This included (a) the potential to escape from Britain’s shadow, (b) access to a huge market and (c) significant fiscal transfers that would lift the performance of the Irish economy. Having sat out WWII and wallowed in economic despondency during the ’50s when the original institutions were being formed, Ireland had little understanding or appreciation of what the founders (and their successors) were attempting to achieve.This is not to suggest that national self-interest did not motivate the other members, but I think, in Ireland’s case, the pursuit of naked self-interest was more blatant than most.

All this was fine while Germany was happy to be the principal net contributor and gain benefits from rising prosperity throughout the Community in return. In the last decade, Germany’s political and strategic stance (and that of other economically alligned members) has altered subtly, but quite significantly. It should not surprise anyone that Germany increasingly believes that other members, whose economic boats have been lifted on the rising tide, should take more responsibility and contribute more to the heavy-lifting. And if they were not capable of dischargng their responsibilities appropriately, they should be prepared to shoulder an appropriate share of the cost of the necessary remedies.

Germany, as a model modern democracy for the last 60 years and pursuing an overwhelming political desire to integrate itself fully in the European polity, was prepared to contribute to lift new members (such as Ireland, Spain, Portugal and Greece) out of backwardness and dictatorship. But once lifted, Germany had a not unreasonable expectation that these members would govern themselves sensibly. This, of course, has proved not to be the case, and a Germany, pursuing a much greater global strategic objective for itself and similarly well-governed EU members, is loth to divert time and resources until these errant members have demonstrated sufficient commitment to mend thier ways. However, the timescale has been foreshortened and Germany (and other core EZ members) will be forced to act because the sovereign bond market will push for a resolution.

It possible to make a plausible case that it would be in Ireland’s self-interest to plan for default, exit the Euro and devalue, but my view is that it is better to take the medicine and cheer on the sovereign bond market.

@Pete the Greek,

It is good to hear the views of people in the heartland of Europe – in particular from Germany. What you are saying is similar to what I hear from my contacts in Germany. Too often here we have the crying into our pints and lamenting how terrible these beastly foreigners are to poor, liitle Ireland. The German people, in general, have worked hard, taken some economic pain and contributed proportionately more than most to build the EU we have today. It may not be perfect, but it is better than any conceivable alternative.

Having put in the effort to rescue the peripherals from self-imposed backwardness and dictatorship I can well understand why they are reluctant to put in further effort to rescue them from the fruits of their own misgovernment – and especially when they sit there, refuse to reform their system of governance and blame everyone else for their problems.

@Joseph Ryan,

I agree that the German strategy is not without risk, but then what strategy is. Germany (and the EU) has to engage with the world as it is and seek to propogate its governance, values and processes; not how it would like it to be. Hiding in ‘fortress Europe’ is a recipe for managed decline. I would, however, contend that its strategy has more substance than the ‘super-knowledge economy’ of FF policy and taskforce fantasies.

@JR
“There is a strong argument that without the ruling elite paying a sufficient price, ‘Ireland’ will not learn any lessons. To date pain has been distributed amongst the lower orders. That neither the EU/ECB or IMF deemed it necessary to exact a price from those that caused the disaster was surely a major error and an opportunity missed.”
+1

I will be the first to admit that I am often guilty of “straying off topic”. However this time I will try to bring the comments back to the topic .
While I recognise that this is an Economics portal I also recognise that “we are all economists now” so it may help to examine the political factors behind the reason why Estonia joined the Euro. In fact IMHO the reasons behind this were all political : Domestic, Geo-political and Pan-European.

1)Domestic:The general opinion in Estonia about joining the Euro has moved from indefference in early summer (following the Greek crisis) to emotional in the wake of the Irish crisis. Estonians do not identify much with Greece but feel that they know and understand a lot about Ireland. Indeed when a referendum was held in 2003 ahead of EU accession the Irish “experience” was cited as the main reason why membership (of the EU) would be a good thing.

Estonians who oppose currency conversion can point to an opinion poll last month which indicates that 75% of the population “regret the passing of the Kroon”. Those who favour EZ membership point to earlier polls which indicate that roughly 50% of the population believe “on balance” the Euro “may be a good thing”.

The recent impetus for joining the Euro came from the Estonian Reform Party which is the larger of the two ruling coalition parties. (The junior party is a reluctant Christian Democratic Party with strong nationalist leanings but which no longer enjoys the populartity it enjoyed in the 90ś). The Estonian Reform Party (which also supples the EU Transport Commisioner of Icelandic Volcano fame) allies itself with the ALDE in the European Parliament as does, ironically, the main opposition party.

The Estonian Reform Party describes itself as a Liberal Party but it is probable fair to describe it as a Neo-Liberal party which has been unable to achieve the full extent of itś ambitions because of the constant necessity to form coalitions. As with the main opposition party the Reform Party (including the Prime Minister) is led by former Communists. In a classic case of “smoke and mirrors” the Reform Party has “re written” very recent history by concealing the fact that it as the ruling Party in it vehemently opposed joining the Euro in 2006-7 as they would have to “stop serving drinks” in order to dampen inflation.

The renewed application for EZ entry (which was approved last July) was prompted by the Latvian crisis, ahead of the Greek and Irish crises, and in light of the economic downturn was deemed a necessary pre-election policy. The “4-yearly” Estonian general election will be held ,on schedule, on March 6th. Domestically the EZ entry was a “PR stunt” which has gone a bit pear shaped thanks to the 2010 crises and the forecasted crises in Iberia, Belgium and Italy.

2)Geo-Politics: Sweden and Finland are playing a major role behind the scenes. Estonia is not in danger of having a banking crisis simply because Swedish banks own most of the banks. Sweden is also not a member of the EZ but enjoys ” a peg” just as Estonia has enjoyed until December 31st. Up to recently Sweden was in-different to whether Estonia joined the Euro or not as long as the Estonian Economy remained upright and Estonian society remained stable (There are complex historical reasons,which also suprisingly involve Ireland, behind the latter).

Finland on the other hand is very interested that Estonia joins the Euro. In recent weeks this “interest “has appeared to border on “desperation” with Olli Rehn becoming a household name and frequent visitor.

Why is Finland so interested? Again the Irish crises provides the clue.

Following the recent “bail-out” talks and opportunistic “corporation tax” moves by Finland many people in that beautiful country woke up to a terrible truth. This “terible truth” was the realisation in Finland that if Ireland could be “stitched up” why should Finland which is much more isolated than Ireland and which suffered a banking crisis in the early 90ś be treated any differently in different circumstances. The fact that Sweden, Norway, and Denmark are not EZ members and that Denmark and Sweden quickly jumped into the Irish crisis talks with the offer of bi-lateral loans was not lost on the Finns.

While Finland is viewed from Ireland as a similarly (populated) and similarly sized economy the situation is not veiwed in the same way from the North Eastern part of Europe. Finland exercises a lot (but no more than Sweden) of economic influence on Estonia but is also aware that itś other EU and EFTA neighbours are not in the EZ and do not share the same historical , cultural and linguistic ties as the other Nordic states.

Finland is also aware that Ireland has strong links with the UK and US which it can never hope to match.

Finlandś “realisation of isolation” was best illustrated by recent absurd “public mutterings” that Latvia should also join the EZ as quickly as possible. In short Finland which has very deep memories of WW2 and how it was left to fend for itself needs the extra flags around the table that Estonia (and perhaps, if the Euro survives the next few years, Latvia) can provide.

While Estonia can pose no risk, because of itś size, to the EZ Finland is aware that it is taking a risk. If the EZ collapse Finland will have to be the central bank (it has actually minted the new Estonian Euro coins) for both economies if the Euro collapses. Such a burden would pose a bigger challenge to the Finnish economy than re-unification did to West Germany.

3) Pan European :In an effort to understand why Estonia has actually joined the Euro many economic commentators in (and on) Estonia have analysed it differently from, IMHO, political scientists. Most have entertained the notion that Estonia may “strenghten the German wing in the ECB” by promoting the concept of “austerity” .

This of course is just spin! Particularly so when one considers that it was precisely the fear of mild austerity in 2007 that made the ruling Reform Party (with the same cabinet members) reject joining the Euro.

The only way that Estonia is strenghtening the “German wing” by joining is by adding a “no risk” flag to the EZ club at a very vulnerable time. The propogation of this “spin” also benefits Finland as it struggles to find some favour and influence around an ECB table which has revealed a ruthless side in the recent Irish crisis talks. From the Finnish point of view Ireland has options which Finland does not if Europe reverts to itś “bad old ways” (and days).

Germany with its Chancellor who was once a citisen of the DDR can resonably be assumed to view Europe in a different way than its North Western partners in London and Dublin. London still has legacies of an Empire which(except for Ireland) functioned out of Europe, Dublin struggles with the notion of “Boston or Berlin” and Berlin has only recently become the capital of a united Germany.

In light of the above it is easy to understand why Germany feels more passionate about the survival of the Euro than the practical reasons behind the concerns of the UK, France and Italy. It is also easy to see why people in Tallinn are confused about why they are joining the Euro at this time and why people in Helsinki know that Ireland never has to face the worst fears that they may have to face if their country ever finds itself “left out in the cold”.

A “2 tier Europe” does not mean the same thing in many parts of Northern and Eastern Europe as it does in North Western Europe.

All above is IMHO of course.

@Paul Hunt
Germany’s future has been set by its demography—as has most of Europe: Ageing fast.