Domestic battles of Slovakia threatening euro

Slovakia is the last member of the eurozone to agree to expanding the powers of EFSF (European Financial Stability Facility). Slovakia's prime minister Iveta Radicova (left on the picture) is finding it hard to reach an agreement with her coalition partners who oppose EFSF. Richard Sulik (right on the picture), leader of Slovakia’s libertarian Freedom and Solidarity (SaS) party last week agreed to supporting the EFSF only if Slovakia would not participate in ESM (future substitute of EFSF) and only if Slovakia would have a veto of how the funds would be used in EFSF. The prime minister refused the offer.

Slovaks have publicly opposed helping heavy borrowers and those who don't follow eurozone rules. Let's see how Slovaks themselves manage in that area.

Slovakia has been running a huge budget deficit for the last two years (-8% in 2009 and -7,9% in 2010 - Eurostat). Maastricht criteria require it to be under 3% of GDP. In former years Slovakia has done well in that area. Slovakia plans to run a 4,9% deficit this year and has a budget drafted for 2012 which foresees a 3,8% deficit.

Slovakia doesn't have as much debt as the problematic countries in the eurozone do. It had a debt burden of 41% of GDP in 2010 which is bound to increase in current and next year.

Slovakia isn't the best performing country in the euro area. Yet it is possible that it will be the only one not supporting the EFSF legislation. And it is not because Slovakia has a lesson to teach to rest of the Europe about how to balance the budget but it's because Slovakia has power-hungry politicians not willing to do the right thing.

What about Maastricht criteria?

Every country part of the eurozone has to fulfill certain economic conditions (referred to as Maastricht criteria). The country that is not obeying these criteria can be punished by the ECB. The criteria go as follows:

1. Price stability. The inflation rate should be no more than 1.5 percentage points above the rate for the three EU countries with the lowest inflation over the previous year; 
2. Budget deficit. This must generally be below 3% of gross domestic product (GDP);
3. Government debt. The national debt should not exceed 60% of GDP, but a country with a higher level of debt can still adopt the euro provided its debt level are falling steadily;
4. Exchange rate. The national currency's exchange rate should have stayed within certain pre-set margins of fluctuation for two years (no re- or devaluation of currency);
5. Interest rates. The long-term rate should be no more than two percentage points above the rate in the three EU countries with the lowest inflation over the previous year;

Maastricht criteria were the reason why my home country Estonia didn't join the euro in 2007 as planned because of the inflation criteria was not fulfilled even though Estonia is fiscally the toughest and best performing country in Europe (Estonia is part of the eurozone from 2011). That's OK because rules are rules... or are they? Greece, Italy and Belgium (the heart of EU - really?) joined the euro even though their debt was exceeding 100% of GDP. Greece was running the biggest budget deficit with one of the highest inflation rates. Check the following graphs.

So far the criteria have been important for countries willing to adopt euro since it's a precondition for joining (this statement is conditional itself as seen from history). For joining countries it is a good motivational exercise to get their finances in order. Once already in the eurozone motivation quickly disappears.

So how should we deal with that? Shall we fine the countries that are not capable of cut their spending (read: living within their means)? That's like asking for money from a beggar so it probably wouldn't work. There are still couple of things that could be tried.

Make it political! The main reason for not cutting spending or increasing spending for politicians is the support of their voters. Political promises can often lead to overspending so there is motivation for politicians to spend more than possible. So why couldn't it be possible to force the government step down if two out of five criteria are broken for example?

Another idea is to keep away the cookies. Today a lot of countries are receiving structural funds and richer countries are participating in other mechanisms like Framework Programme. Would it make sense to cut funding for countries that aren't fulfilling their duties? Since all of the EU countries aren't in the eurozone it would be impossible, but approach as such would serve its course (as can be seen in Greece today).

I would prefer stabilizing the eurozone with political measures which reduces populism, the mother of all wrongdoings. We should remove the motivation to behave badly, fines and nagging doesn't work here!