Devaluations fail to dent single market

Date: 19/10/1995

By Tim Jones

IT'S official - or it will be soon.

While northern European textile and car companies and some of its border regions have felt the strain of the devaluations of the Italian lira, Spanish peseta and UK pound over the past three years, the Union's economy as a whole has coped well.

That is the conclusion of a long-awaited report from the European Commission into the effects of currency fluctuations on that most-prized of all the EU's achievements: the internal market.

The study, to be adopted as a communication at the 31 October meeting of the full Commission, was prepared at the request of EU finance ministers amid growing unease about the effects on the single market of wild currency swings.

It was not meant to be like this. The single market, which abolished fiscal frontiers and liberalised the movement of goods, services and capital between member states, was meant to coexist with a stable Exchange Rate Mechanism (ERM).

When sterling and the lira left the ERM in September 1992 and the peseta went through a series of controlled devaluations, the rules changed. From mid-1992 to mid-1995, the lira lost 33&percent; of its value against the mark, the peseta 28&percent; and the pound 21&percent;.

Suddenly, companies who had long competed in the sure knowledge that their governments could protect them against devaluation were having to sink or swim in an open market against rivals with an instant 20-30&percent; cost advantage.

For monetary union enthusiasts, this shows a single currency is needed more than ever.

“It proves what we said back in 1988,” insisted former Economics Commissioner Henning Christophersen. “You can't have a single market without capital controls and with 14 separate currencies.”

Before finance ministers requested the report, the Commission realised it had a political challenge on its hands. In its annual report on the working of the single market, the Commission said: “For our citizens and European business, the completion of the single market and the steady improvement of its operating effectiveness are crucial to the competitiveness and political credibility of the Union.”

In the spring, Economics Commissioner Yves-Thibault de Silguy sounded a warning. “It is already clear that a number of sectors and border zones are suffering significant difficulties,” he said. “If these persist, there is a danger that the resulting political pressure could prejudice the single market.”

The report, overseen by de Silguy and Internal Market Commissioner Mario Monti, concluded that large-scale macro-economic effects from the currency swings had been marginal, long-established trading patterns had not been impaired and markets had not been permanently lost by companies in strong currency countries.

The report sees “no evidence of damage to strong currency countries”, a Commission official said. The Commission's growth forecast for the EU will be revised down only slightly for this year from the 3&percent; rate expected in the spring, but this is likely to bounce back next year, de Silguy predicted last week.

Nevertheless, sectoral and border problems have been real.

Border areas, especially in southern Austria and northern Italy and south-west France and Spain, have experienced trading distortions. French farmers have destroyed cheap Spanish strawberries and car-sale franchises have declined to sell vehicles to people without proof of residence in Italy and Spain.

Some of Europe's biggest companies have felt the pain. Daimler-Benz AG, Germany's second largest industrial group, said at the end of June that it would face a “severe loss” in 1995 and could lose 20,000 jobs in its DASA aerospace division, largely because of the soaring mark.

Fokker, the Dutch regional plane-maker in which DASA holds a controlling stake, has come close to failure and needs a capital injection of as much as 950 million ecu to survive. For DASA and Fokker, the problem is the same: aerospace pricing is in dollars while their costs are incurred in marks and guilders.

As the dollar falls and the mark and guilder rise, profits are squeezed. Daimler-Benz even threatened to start shifting production abroad. Its car-making unit, Mercedes, intends to build 10&percent; of its cars outside Germany, up from the current 2&percent;.

Yet much of this has been exaggerated. The experience of Siemens, Germany's power generating and electrical engineering giant, shows there is much more to relocation than currency shifts.

The company did break precedent by agreeing to build a 1.3-billion-ecu new plant in north-east England. But low corporate tax rates and telecommunication costs combined with low non-wage costs and a skilled workforce were the deciding factors rather than short-term shifts in the mark exchange rate.

Moreover, economic data fail to bear out the theory that Germany is finding it difficult to sell abroad because of the strength of the mark. German exports grew 9.1&percent; in 1994 and the German chambers of commerce (DIHT) expect them to increase by another 5&percent; this year. In 1994, western Europe accounted for 73&percent; of Germany's exports despite the weakness of three of its major currencies.

“Exports pulled the economy out of recession last year. In 1995, they will admittedly lose some of their locomotive power but will not, in any way, slow down growth,” said Franz Schröder, president of the DIHT.

Again, it is certainly true that some areas of northern Italy have benefited from the cost advantage of the weak lira, but the gains have not been uniform. Exporters whose products have a large proportion of Italian content have done well, but firms that rely on imported raw materials have seen much of their advantage wiped out.

For example, computing and telecommunications firm Olivetti pays for its raw materials, such as chips, micro-processors and software, in dollars and yen while the “added value” in its products from Italian production is relatively modest.

None of these conclusions will be music to the ears of some of the big industrialists in northern Europe. The most vociferous of these is Jacques Calvet, the president of PSA Peugeot Citroën, who warned his shareholders during the summer that: “Europe will not hold together for long if there is not a rapid solution to the problem of competitive devaluations.”

Every one per cent fall in the value of the lira or sterling, he said, stripped Citroën's pre-tax profits by between five and 20 million ecu. He called for compensation for companies harmed through no fault of their own except for operating out of a strong currency country.

The Commission started to worry that this kind of idea would gain momentum and really threaten the single market. The idea had already been floated by Belgian Finance Minister Philippe Maystadt.

In May, he warned that the “hard core” of the European Monetary System (Germany, France, Belgium, the Netherlands, Denmark, Austria and Ireland) could protect themselves against devaluers.

“If a country like Italy continued on the path of competitive devaluation - a path which is anyway very dangerous for itself eventually - it cannot be excluded that members of the hard core would collectively invoke the safeguard clauses envisaged in the treaty,” Maystadt said.

His suggestion that industries which have suffered harm should be allowed a temporary reduction in social charges will be ruled out by the Commission as incompatible with the single market.

The Italian government is keen to prove Germany wrong. By advocating an early return to the ERM for the lira and pursuing a stable exchange rate, he sets on the record his desire for Italy to be among the first tier of countries going into a monetary union.

With the UK and Spain keen to avoid a resurgence of inflation, the “hard core” may well find that economic logic is doing the job of stabilising currencies for it.