Policies Adjusting to EMU: Idiosyncrasy and Democratic Institutions. ACES Cases No. 2007.3

[From the Introduction] In May 2004 the European Union (EU) was enlarged to include ten new member states. Romania and Bulgaria followed in 2007. Although so far Slovenia is the only new member state that has adopted the EU's single currency (the euro) the other eleven of these twelve countries will do so at some point in the future, after two years of membership in the Exchange Rate Mechanism (ERM) mark II, and after their levels of public debt and deficit, inflation and interest rates were brought to the standards of Economic and Monetary Union (EMU) set by the Maastricht treaty. However, EMU was associated with substantial economic and political strains within and among EU member states in the 1990s. In addition, in recent years leading member states have breached the rules governing fiscal policies in the EU, which are part of the EU's monetary regime. Eventually these rules were made more flexible. Perhaps more worryingly, competitiveness of industries in some of the member states, notably the Mediterranean ones, has been continuously eroding since they joined the euro zone. Unable to devalue their currencies to regain this lost competitiveness these economies face significant potential imbalances. All of this suggests that potential or even actual membership of various EU member states in the third stage of EMU should not be taken for granted. The purpose of this study is to develop a quantitative indicator of the economic and political adjustment burden of EMU to its member states' societies and to argue that proper domestic political institutions can reduce this burden for the member states by enhancing cabinet duration. 1 This is not a financial cost-benefit balance of EMU. Rather, this study attempts to measure how large are the adjustments that a member state's society would have to bear after joining the union. The adjustment burden indicator is based on optimum currency area theory, adjusted for political variables. Other things being constant a higher adjustment burden makes a currency union less sustainable and must be compensated for by other factors to make it sustainable