Georgi Angelov, Senior Economist with the Open Society Institute – Sofia,argues that the ESM and the Pact for the Euro are a real burden for the poorer EU member states and they significantly decrease their incentives to join the Eurozone.

The background

In the first decade of the existence of the euro, there was a very interesting phenomenon. The Eurozone candidate countries had to meet strict criteria, while the Eurozone member states in practice had no such conditions (normatively, such rules existed but were not observed). There was a remarkable case, when a candidate for the Eurozone was not admitted as it had inflation rate just 0,01% above the required level. At the same time, many countries of the Eurozone did not meet the requirements for a government debt for years on end, but no action was taken against them.

The Eurozone rules were not only unjust – they were counterproductive too. Common sense requires respecting the rules within the Eurozone in order to ensure stability of the euro. As this was not done, now many Eurozone member states are on the verge of default. At the same time, the goal of imposing the euro as a global currency required the quick accession of the new member states of the EU, at the time when they were willing to enter the Eurozone. This was not done.

Paradoxically, the countries with a better fiscal and economic policy were outside of the Eurozone, while the countries within the Eurozone had worse fiscal policy. For example, in 2008 all new EU member states had a government debt below 50% of GDP, excluding only Hungary, while in the Eurozone the government debt was over on average 70% of GDP. What is more – seven of

the ten countries with the lowest level of government debt in the EU were outside the Eurozone in 2008. They were outside the Eurozone mostly because they were not admitted to it. The Eurozone did not admit countries with a good economic policy, while the Eurozone itself had a weak fiscal policy as a whole. It is hard to believe, but it is a fact.

The current state of affairs

From the perspective of the countries outside the Eurozone, the situation in recent months did not change for the better. It is just the opposite. After they created the mess with the Eurozone fiscal problems, the big countries came up with a "solution" - a bailout fund for rescuing the defaulted states – although bailout of bankrupt countries is illegal under the current legislation of the EU. Now the change in the Lisbon Treaty is put forward, aiming at legalizing the bailout fund, the so-called ESM (European Stability Mechanism).

The rescue fund itself (ESM) will have a capital of 700 billion euro of which 80 billion euro will be effectively deposited and the rest will be provided when necessary. The initial proposal was to allocate the capital on the basis of population and GDP – meaning that the poorest countries will pay the most as a share of GDP, while the richest will pay least. It was only after strong opposition by the new member states a small and temporary concession was made – during the first 12 years of Eurozone membership for the countries with less than 75% of average GDP, the weight of population will be 12,5% instead of 50%.

However, even under the new system the poor countries will pay more as a share of GDP, and this problem will exacerbate after the 12 year transitional period. Twelve years are not enough for the poor to become rich. Rather paradoxically, the poorest member of the Eurozone will pay the most as a share of GDP - and this money will save one of the richest countries in the EU such as Ireland, Belgium, Spain, etc. It will be even more paradoxical if poorer countries enter the Eurozone – such as Romania, Bulgaria and Latvia. The poorest will come to the rescue of the richest!

The financing mechanism of the ESM is in no way linked to the risk of one country needing assistance. In fact, the countries with the smaller government debt as Estonia and Bulgaria (which are least likely to default) will pay most as a share of GDP in the rescue fund. I.e. the allocation of capital is not only unjust to the poorer countries – it punishes the prudent countries, which have to increase significantly their debts in order to contribute their share to the fund. At the same time, the counties with the largest government debt will pay the least.

And we are not talking about some trivial sums here. For example, the share of Bulgaria in a 50-50 weight of population and GDP is about 6,1 billion euro – or about 17% of GDP. Countries such as Luxemburg, the Netherlands, Austria, Belgium and Finland will have a 3% to 5% share of GDP. In practice, this is an "entry fee" for Eurozone membership, i.e. an additional criterion to the candidates, which are already facing higher requirements. The candidate countries, which have nothing to do with the problems of the Eurozone and have always have had a better fiscal policy, will have to participate with a larger share in saving the defaulted Eurozone member states.

What is the responsibility of Bulgaria for non-compliance with the Eurozone rules in the last decade so that it has to pay for it? Bulgaria holds the European record for government debt reduction for the last decade – but will not be rewarded for it, but it will be "fined" to pay the most in the ESM when it enters the Eurozone. The payment in cash, together with the promise for future payments when necessary will put a burden on the cost of financing of the country, i.e. this is a real burden for the economy.

It is unclear why the ESM is being established, when the International Monetary Fund can adequately fulfill this role. Moreover, the rescue fund of the Eurozone is being used for political goals, e.g. the pressure by France against the low corporate tax in Ireland.

Poor and low debt countries to pay the most in ESM

Estonia and Bulgaria have a minimal government debt – with a minimal share in the common debt of the countries in the EU, Their share in the ESM capital however is about 15 times higher than their share in the EU gross debt. On the contrary, Germany, France and Austria will pay less to the ESM than their share in the debt. The poorest and least indebted countries will pay much larger share in the ESM than they are entitled to.

But the ESM financing is not the only problem. In parallel, the Pact for the Euro is being developed and the countries outside of the Eurozone were not invited in the discussions in any way. Despite this, there is a huge political pressure on them to announce that they "voluntarily" join the Pact for the Euro. Apparently, the Pact for the Euro breaches the principles of equality in the EU, because the opinion of the new member states was not taken into consideration. It is also used for imposing policies that are harmful to the poor states and detrimental for achieving high economic growth. The Pact for the Euro includes coordination and harmonization of taxes, which has nothing to do with the stability of the euro, and is promoted mainly by France with its wish to prohibit low taxes. But the low taxes are the key element of the policy for encouraging higher economic growth and convergence – if the poor countries have the same high taxes as the rich, there will never be high growth, prosperity and wealth.

We already have an experience with the harmonization of the indirect taxes, which demonstrates clearly how the same minimal rate is appropriate for a rich country as Germany, but it is extremely heavy for a poor country as Bulgaria. For a German, a 30-40 cents tax on a liter of fuel is negligible, while for a Bulgarian this is a huge sum with an average salary of 300 euro per month. It is not coincidental that the high excise duties on fuel and cigarettes create problems with smuggling and grey economy in the poor countries.

In addition, the Pact for the Euro talks about assessment of competitiveness, which will be done through comparison in the dynamics of salaries. The Pact claims that the big and steady increases in wages bring about erosion of competitiveness. However, there is no exemption from the rule for the poorer countries. It is obvious that if a country is poor and achieves high economic growth, the levels of prices and levels of salaries in this country will increase at a faster pace that in the richer member states – this is the whole logic of convergence. The poor countries can never become rich if they don't achieve a high growth of incomes.

It is not surprising that the Pact for the Euro does not include the point of view of the poorer countries – after all, they didn't participate in its negotiation. This is an evidence that policies dictated entirely by the "old" Memeber States are not the best for everyone, especially for the poorer member states. Even before the crisis Brussels was displaying lack of understanding for the economic circumstances in the new member states. Then, it was often claimed that the big current account deficit is a problem, although the latter was a direct consequence of the intensive FDI flows. We have to thank only the financial crisis because as a result the big current account deficits quickly disappeared, thus invalidating the assumption that they would cause problems during the crisis.

In short, both the ESM and the Pact for the Euro are a real burden for the poorer EU member states and they significantly decrease their incentives to join the Eurozone. The new member states are gradually taking Sweden's route – according to Eurobarometer surveys popular support for joining the Eurozone is dwindling in these countries, while trust in local currencies is rising (especially if it's a stable one like in Bulgaria and the Czech Republic). For years we have been warning that the Eurozone has to enlarge rapidly while the new Mmeber States are still willing to join, because the time will come that they will no longer be wishing to do so. It appears like this moment is approaching and introducing new burdens such as the ESM and the Pact for the Euro will only aggravate anti-Euro tendencies.

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