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Benefits of the euro? Let’s watch Slovakia

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Many representatives of the industry, car manufacturers and exporters have been recently convincing the Czech public vehemently that they would be better off with the euro.

Leave aside the fact that the same people are asking for various types of subsidies and car-scrap bonuses, which would mean a further increase in the public finance deficit (and would inevitably postpone the possible eurozone entry date), and look at how euro adoption influenced their counterparts in Slovakia.

A comparison of developments in the Czech and Slovak economies definitely does not bring too many arguments supporting the statement that euro adoption would benefit exporters and industrialists.

Economists versus “practitioners”
The debates about the impacts of euro adoption on exporters and the industry demonstrate pretty well the disputes between so-called “managers – practitioners” and economists.

Economic theory leads to conclusions that are the opposite of what the practitioners expect: Entering a single currency zone should result in a full transposition of negative demand shocks into the Slovak economy (that means demand and output, for instance) that, by switching to the euro, lost its ability to adopt itself by means of currency weakening. By contrast, the “practitioners” have always argued that eliminating exchange rate swings will enable companies to focus on production itself. It will make it easier to plan investments and introduce measures raising labour productivity and will in general bring effects boosting the development of industry and growth in exports.

Practice and measurable results usually serve as a good arbiter in such disputes. Moreover, the Slovak economy is similar to the Czech one: the share of the automotive industry is big, therefore the proportion of industry in GDP is big too; its banking system is stable regardless of financial turbulence, and its monetary policy before euro adoption was very similar to that implemented in the Czech economy.

We can therefore expect that the global decline in demand has had a similar impact on both economies, so their different development at the present time can suggest a lot about the influence of euro adoption. But data in monthly time series suffer from many kinds of short-term noise. For this reason, I will use three-month averages of year-on-year growth for the comparison.

Slovakia was the leader last year…
Regarding the initial conditions, Slovakia’s eurozone entry was approved in the summer of 2008 in the instant that the country’s economy grew (mostly thanks to reforms implemented earlier and to the ensuing foreign investments) at a considerably faster pace than the Czech economy.

The difference in GDP growth was 4.4 percentage points in 2007 and 3.3 percentage points in 2008. That, of course, meant adequately higher growth not just in the industry and exports, but also in retail sales. In the third quarter of 2008, the difference in three-month averages of year-on-year export growth equalled 7 percentage points and the difference in industrial output growth was 6.1 percentage points (6.2 percentage points in the manufacturing industry) in favour of Slovakia.

Slovak economic output grew faster until the end of last year. Still in the last quarter, Slovak GDP growth was 1.8 percentage points higher on the year than Czech GDP. And until recently, the forecast for Slovak 2009 economic growth was for around 2 %, while a moderate decline of some 1% was predicted for the Czech economy.

However, the latest data from the monthly time series are starting to indicate a significantly less favourable scenario for the Slovak economy.

When we look at the growth in industry and exports in the last three months (data till February 2009 are available for both economies), we can see that the differences in year-on-year growth – respectively decline – in both indicators have shown a turnover to the benefit of the Czech economy.

…but the tide turns from January
The average year-on-year drop in exports is 3.4 percentage points lower in the Czech Republic compared with Slovakia. Likewise, the average year-on-year drop in industry from December to February was 2.8 percentage points (2.7 percentage points in the manufacturing industry) lower in the Czech economy.

The fall of the global economy has hit both economies heavily, but the latest monthly figures suggest that fixation of the exchange rate of the Slovak crown (which de facto came in the summer of 2008) is provoking a deeper fall in exports and industry in Slovakia than in the Czech Republic. If representatives of our automotive industry were right about the impacts of the car-scrap subsidies, then Slovak data should at least partly reflect the favourable effects of the aid that Czech manufacturers are missing so much.

Maybe it is worth reminding that also Slovak retail sales in the said three months were 2.5 percentage point lower than in the Czech Republic. (This is also the reason behind the revised forecast of Slovak GDP for this year. The National Bank of Slovakia expects a 2.4 % economic decline for 2009.)

Let us summarize the facts. The first – and of course preliminary – monthly data from the end of last year and the beginning of this year do not suggest at all that eurozone entry would protect Slovak exporters and industrial producers from experiencing the impacts of the global economic downturn.

Where has the beneficial effect gone?
If we compare in what condition both economies were in the middle of last year, we could even say that the forecast of the standard economic theory is being met. In other words, that the overly strong exchange rate, with which the Slovak economy joined the eurozone, is starting to pose an increasingly apparent burden for this economy. I would regard it as helpful if representatives of industry and exporters started to realize this fact in their recommendations regarding the euro.

The author is vice-governor at the Czech National Bank.

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