Why monetary union may derail Germany

April 3, 1998

The Royal Economic Society held its annual conference at Warwick University this week

FAR FROM being the engine of the Maastricht convergence process, Germany is in danger of being derailed by it and should be exempted from some criteria, a paper presented to the Royal Economic Society conference argued this week.

Germany's position for most of recent history as the largest and strongest economy in the European Union and Chancellor Kohl's desire for closer European integration have made the Federal Republic the main political force behind the drive towards European Monetary Union.

But John Driffill of Southampton University and Marcus Miller of Warwick write that incorporating the former German Democratic Republic has made this process an extremely difficult one.

The Maastricht debt and deficit criteria are hamstringing the transition, they stay. Criteria intended to stop governments borrowing irresponsibly in fact stop the Germans - whose debt ratio and borrowing level are at the Maastricht limits - from using capital markets to finance transition.

"This forces the costs on to current taxpayers, and destroys new jobs in the process. Instead of treating her as a special case to be exempted from the Maastricht criteria, however, Germany's neighbours are looking to her to set the pace in fiscal rectitude," write Driffill and Miller.

"Like the wronged heroine of some Victorian novel, Germany is destined to bring her offspring into the world without any relaxation in the strict straitjacket of utter respectability."

It is unclear how long the east German transition will take. Driffill and Miller quote early, over-optimistic suggestions that there would be wage convergence between east and west by 1994. A recent Organisation of Economic Cooperation and Development report found wages in the former GDR were 73 per cent of western levels but productivity was only 52 per cent.

The federal government expects to go on subsidising the east heavily until 2002 at least, though it projects lower expenditures after that. Subsidies cost between 3.5 and 4 per cent of Germany's gross domestic product - equivalent to 30-50 per cent of the east's GDP - a gigantic burden.

Unemployment has risen in both east and west, with around two million jobs lost in manufacturing in the former GDR.

This puts pressure on wage rates, but Germany's relatively generous social security system - unemployment-related benefits average around 70 to 80 per cent of previous net earnings - makes it expensive for the state,leading to higher taxes which hamper job creation.

Driffill and Miller argue that subsidies to the east are "precisely the kind of large but relatively temporary investment expenditures which would normally, in the absence of Maastricht treaty ceilings, be financed by borrowing, with the accumulated debt serviced or repaid from higher future incomes".

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