Convergence Criteria without Convergence

A major role in the Euro’s early history was hence played by admission requirements, or convergence criteria. The Maastricht Treaty listed four relatively lenient requirements together with the public sector deficit not exceeding 3 of GDP to be fulfilled in order for states to become members of the EMU. However, as criteria written into the EU Treaty, they showed to be impossible to change at a later stage. Furthermore, the Treaty required that EU countries that did conform to the convergence criteria had to adopt the common currency.

Hence, an unfortunate situation arose in which interests of France and the EU Commission, who both wanted as large a membership as possible, coincided with the interests of the weaker EU economies, for whom membership of the ‘European currency’ was considered a ‘seal of approval’. For the weaker countries, membership of the EMU became a matter of national prestige. From their perspective, only successful economies would be admitted, while they perceived failure to be admitted as demotion to second-class status in the EU. Unsurprisingly, the question of membership thus became a politically sensitive issue. In this game of political prestige, the theoretical question of a country becoming a part of a European OCA slid into the background, with the result that all the ‘old’ EU countries that wanted to join the EMU duly became members.

The main criticism of the convergence criteria was that it only required fulfilment in a single year, entailing that any government so desiring could make the figures add up without much difficulty. Even the German finance minister, Theo Weigel, suggested that, when the German budget deficit surpassed the 3 per cent of GDP, the Bundesbank could sell off parts of its gold reserves. Such a sale would be registered as a resource for the German state, resulting in a reduction of the German budget deficit.

Hence, considerable creativity was demonstrated by many countries to comply with these rather soft and unsatisfying criteria, which furthermore only had to be fulfilled in a single year (except for membership of EMS). The example of Germany illustrates the absurdity of the definition of the budget requirement; the selling off of public property was considered to be on equal terms with raising taxes. The inadequate and arbitrary definition of how the public sector budget deficit should be calculated has continued to haunt the Euro member states since the very start of the project.

However, the tendency for states to fulfil the convergence criteria in only a single year was not the only criticism levied by the Euro-realists. Let us briefly review the four principal criticisms one by one. ^[1]

The objection here is that competition within the EU internal market itself ensures that the tradable part of consumer goods will at least resemble each other. However, in relation to the good function of the EMU, this point is trivial compared, for instance, to the importance given to the ability of cost levels to develop in parallel in order to secure profitability. To put it another way: just because a hand blender costs the same all across the Eurozone does not mean that the cost inflation of every country is convergent.

2. Stable currency: Each member state must respect the normal limits of fluctuations in the exchange rate (±15 percent) within the European Exchange Rate Mechanism (ERM) for at least 2 years.

As mentioned earlier, ± 15 percent comes close to a floating exchange rate. However, this is hardly a test, and a far better criterion would have been to focus on the balance of payments; for instance, with no deficit or surplus exceeding 3 percent of GDP and foreign debt remaining smaller than 40 percent of GDP.

3. Stable long rate of interest: Within the test year, member states may not, on average, have had a long-term interest rate deviating by more than 2 percentage points compared to the three best-performing member countries.

This was mainly a test of the expectations of the financial markets. If membership were the dominant expectation, then the exchange rate risk would disappear. At that time, government bonds (without exchange rate risk) were rated AAA; hence, if the other criteria were met, then speculators would consider any government bond to be almost as safe as a German one. However, this assumption was wrong, although it was not proved as such until after 2008. Until then, speculation on the European capital markets mirrored conventional wisdom.

4. Sustainable public finances: The annual public deficit should not exceed 3 per cent of GDP. Likewise, the public debt should not exceed 60 per cent of GDP.

A standard number of 3 percent was arbitrarily chosen, although no one could explain where this had come from. Some critique focused on the inadequate procedure of lumping all expenditure and revenue together, as though they were on the same footing. For example, unemployment benefits, the selling of gold and the construction of new infrastructures were all taken to add up to just a single figure, as if old age pension, education and new railways were to be handled as the exact same product when reductions of expenditures were required. A concrete example of this is the Greek government currently being required to sell off some of its islands to make them the private reserve for the rich/private property of wealthy private owners.

The focus on public sector balance is an outcome of the euro-monetarist way of thinking, where the private sector is taken as self-adjusting via the market mechanism and competition. Hence, any public sector imbalance will obstruct the processes of private sector adjustment. A realist economist would instead examine empirically where the cause of macroeconomic imbalance should be found. The answer, as we shall see, could equally well be that the balance of payments, over-saving in the private sector or lack of effective demand in the labour market spills over into the public sector via automatic budget stabilisers.

As we shall see, the only worry seriously expressed by the Euromonetarists (and the German Bundesbank) was the risk of politicians not keeping the public sector budget below 3 per cent of GDP. By the end of the 1990s, the requirement was therefore the introduction of the so-called Stability and Growth Pact to be part of the EU Treaty (Amsterdam Treaty). This will be explored in the next section.

Despite the critique from Euro-realists and the prolonged financial crisis, which has vindicated that the Eurozone, in its present form, does not come close being to an OCA, the convergence criteria have not been changed. Although it is obvious that the new member states are, in many respects, non-convergent, Brussels has continued to welcome them into the Eurozone. On the other hand, countries such as Sweden, Poland and the Czech Republic without a formal euro-opt out clause have deliberately avoided being members of the EMU by not fulfilling all five convergence criteria. They have simply not applied for membership of the European fixed exchange rate system, ERM (formerly called EMS) and just led their currencies float against the euro. These countries did so for at least two principal reasons. First, the political leaders realised that the popular resistance to the Euro was so strong that it could jeopardise the countries’ membership of the EU. Second, they considered the common currency to be just a stepping stone to further political integration. Accordingly, it was not the ruling political class that held these reservations, but rather the citizens. In Sweden and Denmark, a referendum was held in which the government strongly recommended an acceptance of the Euro, but a majority of the people voted against it.¹

• [1] Price stability: The rate of inflation of consumer goods in themember states should not exceed the inflation rate in the threemember countries that have proved best at keeping prices stable bymore than 1.5 points.