Is the Euro Good for Europe?

Sunday, Sep. 26, 2004 By PETER GUMBEL
Illustration for TIME by MAX ELLIS
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People in the German border town of Passau probably don't think of themselves as champions of the euro. Yet this August they scored a victory for Europe's single currency. On a warm Friday afternoon, about 500 people, led by Mayor Albert Zankl, drank beer, ate bratwurst and — for almost five hours — blocked a road into neighboring Austria. Their target: the price of gasoline in Germany which, at about j1.15 per liter, is about 20% more expensive than in Austria. Every day since the beginning of this year, an estimated 2,000 German motorists have filled their tanks at a new BP station on the border, built on the site where national passports and customs controls used to be. The Austrian gas station's success has come at the expense of its 17 rivals in Passau, some of whom have laid off staff, and has provoked the ire of local authorities because traffic clogs the narrow streets of the district near the border. Mayor Zankl is demanding that the German government reduce gasoline taxes or at least give Passau residents a subsidy. Zankl estimates the nation now loses about €1 billion in gasoline tax revenue annually from motorists in border areas. "Only more pressure will make a difference," he says.

What does this have to do with the euro? Passau is a textbook example of what is supposed to happen after a monetary union. Long before the euro became legal tender in 12 European countries on Jan. 1, 2002, many economists and policymakers pledged that one of its biggest benefits would be the ease with which prices could be compared across borders. That, so the theory went, would lead to greater price competition for goods, and increase the pressure on national economies to become more competitive with one another.

Such "price harmonization" was but one of the many economic virtues that the euro was supposed to usher into reality. As well as making life easier for travelers, the euro was also touted as a major boost for business: it would eliminate many transaction costs and put an end to the currency devaluations of the past that were often bruising for governments and companies alike. Savers and lenders were supposed to benefit from a bigger capital market. And overall, the euro was supposed to be a shot in the arm for growth, investment and employment because countries that joined it were bound by strict rules that aimed to limit inflation and deficits. There were many skeptics, of course, some of whom went so far as to predict that monetary union would never get off the ground. Who was right? After nearly three years in our wallets, has the euro made much of a difference? What are its true economic effects — for good or ill — so far? Time put those questions to a range of economists, business leaders, consumers and trade groups across Europe. Here's the euro scorecard.

[ECONOMIC GROWTH] One of the optimistic projections about the economic impact of the euro was made in 1992. A panel of economists chaired by Michael Emerson, then the European Commission's chief economist, estimated that the elimination of currency transaction costs alone would boost gross domestic product of between 0.5% and 1%. But since 2001, Euroland has experienced a protracted period of subpar growth, even as budget deficits in half of the 12 nations have soared beyond the 3% of GDP that is technically allowed under the monetary union's rules. Germany has suffered the worst downturn, but France, Italy and the Netherlands have also had virtually no growth. Meanwhile, Ireland, Greece and Spain have boomed — if not overheated. Some believe that the euro has exacerbated these differences because of its one-size-fits-all monetary policy, with the same interest rates set for all by the European Central Bank. "In the short term, monetary policy is driving economies apart, not bringing them together," says Mike Taylor, a European economist for Merrill Lynch in London. But the Center for European Policy Studies' director, Daniel Gros, who also served on the 1992 panel, continues to stand by the growth prediction, although he adds that "this is now impossible to prove."

A recovery of sorts is under way, but it's a weak one compared with Britain and the U.S. In its latest forecast issued last week, the Paris-based Organization for Economic Cooperation and Development (OECD) predicted that Euroland's economy will grow by 2% this year. That's a big increase on the 0.4% growth it posted in 2003, but less than half the growth — of over 4% — that the OECD expects for the U.S. and Japan, and well below the 3.4% it's predicting for Britain. Economists have numerous theories as to why growth is so sluggish, ranging from a chronic lack of labor mobility to massive overregulation. Whatever the causes, it's clear that the euro has not been enough to overcome what many economists see as a key weakness: productivity, which has remained flat in Euroland even as it has soared in the U.S. And central bankers and business leaders worry that, if the rules for monetary union laid down in the E.U.'s Stability and Growth Pact are diluted, as some governments including France and Germany now want, the economic cost will be huge. "Everything that damages the credibility of the euro is inherently bad," says Jürgen Strube, president of the European employers' association, unice.