20 September 2023

SUERF's Boonstra: Leaving the eurozone but staying in the EU. Can it be done? And is it wise?

Such proposals share with each other that they usually are poorly substantiated by sound economic arguments and that hardly any attention is paid to the transitional and structural costs of such a step. A cost-benefit approach to such a step is almost always absent.

From time to time the idea is launched that a country should have the opportunity to leave EMU while at the same time remain member of the European Union. 

To fill this gap, and to illustrate the irresponsibility of such proposals, I will discuss exit-scenarios for two scenarios, viz. the exit of respectively a financially weak country and a strong country. All countries, be it rich or poor, will face substantial transitional costs, as a currency conversion is a large, time-consuming and complex process. For a financially weak country, the structural costs for both the private and public sectors will be huge. It is less damaging for such a country to default on its sovereign debt than to leave the eurozone. A strong country will also face transitional and structural costs. Such a country has much more to gain by staying in the euro area and strive to make it work better. The conclusion is that all countries, both weak and strong, will experience that leaving the eurozone is a very expensive and painful process, even if the exiting country can remain in the EU. Therefore, it would be a good thing to stop this pointless discussion and put more energy in improving the working of the eurozone.

Introduction

Since the introduction of the euro in 1999, support for the European currency among the European population has generally been strong. Nevertheless, from time to time, discussions arise about the possibility of a member state voluntarily leaving the eurozone or expelling a country from it if it does not comply with the policy agreements made.1 During the euro crisis, some German and Dutch politicians have expressed themselves along these lines. For example, among others, former Dutch Finance Minister De Jager, following the example of his German colleague Schäuble, at the time proposed removing Greece from the eurozone. With this thoughtless utterance, they managed to further fuel the euro crisis at that time. Today, there are still politicians in the Netherlands who would like to see that a country that does not comply with the policy rules of the Stability and Growth Pact (SGP) can be expelled from the euro. They also hold the view that a country should be able to choose to leave it.

The consequences of such a move would be severe, as the European treaties do not provide for the possibility of leaving the eurozone without also leaving the European Union (EU) and thus the single market. It is theoretically possible, however, for a member state to leave the EMU and the EU, while at the same time applying for new EU membership. But the first question this raises, of course, is whether this is feasible in practice.2 There is not much reason to be optimistic here. For example, the United Kingdom’s (UK) experience with the Brexit has shown that leaving the EU is a lengthy, painful and very costly process. It is completely unrealistic to assume that it could be possible, in parallel with the exit negotiations, to already renegotiate rapid EU accession. So the probability that the exiting country will not be a member of the EU and the single market for some time, perhaps several years or even decades, is extremely high. If a country exits from the euro, the transitional costs of a currency conversion and the structural losses of a euro-exit would come on top of the costs of the exit from the EU.

The conclusion is that, under the current legal framework, it is virtually impossible for a member state to leave the EMU without also having to leave the EU at the same time. This realization has for example sharply reduced the already low enthusiasm for a possible Nexit in the Netherlands. The price of an exit from the EU for an extremely open, highly EU-oriented economy like the Netherlands is probably significantly higher than that for the UK. But one now occasionally mentioned new option is that it should be possible for a member state to leave the eurozone, but remaining within the EU. Within Eurosceptic parties, such as the Dutch party as JA21, this option appears to have some support.

However, such proposals usually fail to include a thorough estimate of the financial costs and benefits of an EMU-exit. Especially the costs of such a step are usually completely ignored. Such costs basically have two components, viz. the transition costs, which have an incidental character but, as we will see, which may already be prohibitive, and the structural economic consequences.

In this Policy Note, I therefore will discuss the financial and economic consequences of a scenario of an exit-from the eurozone, in combination with a continued membership of the EU. Because as far as I know, no one has so far seriously considered the practical consequences of a euro exit, although I cannot rule out the possibility that some member states have already done some homework on this issue behind the scenes during the euro crisis. I first discuss the consequences that would occur for all countries, regardless of whether their new currency is weak or strong after the euro exit. I then provide two scenarios, one for a hypothetical country with a weak new own currency relative to the euro (Weakland) and one for a country with a relatively strong new own currency (Strongland). Finally, I briefly discuss how to create a stronger euro area. In this case, by "strong" I mean a eurozone with stronger market discipline than is currently present. Strengthening the policy discipline eurozone is important because of the existing moral hazard created by the fact that policymakers in weaker member states know that if they are in danger of getting into trouble, the European Central Bank (ECB) will ultimately come up with a bailout anyway. Removal of this moral hazard is essential in any scenario, regardless of the outcome of the hypothetical exit-scenarios discussed here....

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