Economics Update (January-March 1997)

European Monetary Union Status Uncertain,
Says German Banker

T he implementation of the European Monetary Union (EMU) is feasible in 1999, but it is not yet a foregone conclusion, says Gerd Hausler, a member of the Board of Managing Directors of the Dresdner Bank. Hausler believes that, at the present time, it is impossible to predict the outcome of decisions concerning the EMU's fate—decisions which must be made by early 1998.

Importance of Convergence

The concept of convergence—achieving relatively similar economic status among all of the potential members of the European Monetary Union—is an important one, in his view. Hausler, speaking recently to directors of the Atlanta Fed and local business and community leaders, noted that economists and politicians who say that such convergence is not necessarily important point to the example of the United States, which is a functioning monetary union "despite the fact that fiscal policies and economic structures in the individual states are not fully harmonized. In fact, prosperity may differ considerably," says Hausler, "from one area to another within the United States," and under the same currency—the U.S. dollar.

Comparison with the United States

But the comparison of the planned European Monetary Union with the United States is "inappropriate," believes Hausler, for several reasons. "For one thing, the level of debt of the American federal states is extremely low compared to that of the European countries, and thus there is little risk of one state being held liable for the debt of another."

In addition, Hausler continued, neither the European Union nor the European Monetary Union will have a central budget, which helps to ensure (as in the United States and in Germany) that living conditions will be fairly uniform. He believes that "such a central budget would not be particularly desirable."

But most importantly, he continued, the labor market in the United States is "far more flexible than the labor market in Europe. Not only is the mobility of job-seekers far greater than in Europe, but also the differentiation of wages and salaries meets with hardly any problems of acceptance" in the United States.

Some may find that relation coincidental, says Hausler; he, however, finds it "quite interesting." Without a central budget or a highly mobile labor force "to act as a buffer between areas of differing prosperity the degree of convergence between European countries must be very high to compensate for the loss of the exchange rate," which, Hausler notes, "is the natural mechanism to balance such disparities." This is why, he believes, the Bundesbank and other German institutions "are insisting on a very high level of convergence prior to entering into the EMU."

In addition, consumer spending is fairly weak in Germany, partly because of fiscal consolidation processes and partly because consumers have become wary of their government's promising tax cuts and then proceeding to take money away from them in various other ways, in Hausler's opinion.

German Unemployment

In addition, unemployment in Germany rose in January to unprecedented highs—owing partly to seasonal factors like the very severe winter that plagued most of Europe this year but due more importantly, Hausler noted, "to the continuing erosion of Germany's industrial base"—something that the United States experienced a decade or two ago.

Smaller European countries such as the Netherlands, Sweden, Finland, Ireland, Denmark, and even Portugal, Hausler says, "have quietly and almost unnoticeably undergone massive structural reforms, and are, in this respect, further ahead than Germany."

What all this means for Hausler is that for the last two years neither France nor Germany would meet the convergence criteria in their strictest interpretation. Criteria in the Maastricht Treaty require that each single member country have no more than 60 percent debt in relation to its GDP. Germany's ratio is above this mark and is still rising. The treaty allows for a country's ratio to be above 60 percent, but it must be falling, which is not the case with Germany's ratio.

More important than this ratio, says Hausler, is that the governments in Bonn and Paris promise that their deficit levels in 1997 will not exceed 3 percent. Hausler believes that Germany (and possibly also France) will exceed this 3 percent criterion because export performance is not currently sparking investment or private consumption. Hausler points out that "the German business cycle has always followed the same pattern: exports first, investments second, and then consumer spending," but that cycle is not currently in play. "The corporate sector is unsure where Germany is going—unsure as to whether the government will really be able to put through economic reforms." Hausler says that politicians and forecasters in his country "base their assumptions too much on previous business cycles, whereas today high unemployment numbers and the fear that many more people have that they might lose their jobs is slowing down consumers' propensity to spend." And, although recent wage settlements were fairly moderate, entrepreneurs in Germany "are still not yet convinced that Germany will achieve the promised turnaround in terms of cost and taxation."

Tax Revenues and Growth Rates

Continental Europe is experiencing what Hausler sees as a substantial decoupling of tax revenues from growth rates. "Historically," he stated, "once growth rates pick up, almost at the same time, the cash register of the German Treasury will ring because the taxes come in. This is no longer true, because the decoupling from underlying growth is related to the globalization of taxable revenues: multinational companies (and also smaller companies) can make sure that they are being taxed in the countries they want to be taxed in and not necessarily the country in which their headquarters are located."

In addition, the value added tax (VAT) in Germany is also being circumscribed, Hausler suggests. "Exporters are being reimbursed for the VAT that they pay for the domestic components that they put into their exports, but they are reimbursed by the government once their exports leave the country." Consequently, he concludes, "exports do not contribute to the revenues of the Treasury."

Political Commitments to EMU

Concerning issues related to convergence, Hausler notes that some people in international financial markets believe that no one will pay attention to the convergence criteria once the EMU is in place, insisting that political commitments will compensate for any variations in convergence criteria.

While acknowledging the strength of this commitment, Hausler says that the decision will belong, to a large degree, to the German voters as to whether or not admission into the EMU takes place. And, "taking into account that the German public has been promised time and again that the convergence criteria are more important than time tables, and keeping in mind that Germany will experience general elections in 1998"—the year when the decision whether or not to join the EMU will take place—Hausler believes that "the political leeway of politicians towards a looser interpretation of the criteria is fairly limited."

The outcomes of these discussions on the interpretations of the Maastricht convergence criteria will determine "whether the future euro becomes a single currency, whether it will be a hard currency, or a soft one," says Hausler. The reason, Hausler says, may be a simple one: "Deutsche mark holders all around the world—and there are more than one thousand billion deutsche marks—will decide if they consent to shifting their assets from deutsche marks into euros, or if they want to sell their deutsche marks."

Europeans—and Germans in particular—must move decisively and quickly, Hausler concluded, if they hope to establish the EMU as the viable economic entity envisioned and hoped for by so many.

Return to Index