Grokking Latvia

The EU and the ECB formally recommended that the euro area finance ministers approve Latvia to join the monetary union on January 1. They will do so next month. The small Baltic country will become the 18th member of EMU, a year after Estonia. Barring an unexpected setback, Lithuania will become the 19th member at the start of 2015.   Perhaps by the end of the decade, Poland and/or the Czech Republic may also join.  

The expansion of the monetary union confounds the numerous forecasts for its demise.   Greece's exit was thought inevitable and imminent one and two years ago.  Then Cyprus's departure was foretold and some even suggested capital controls were tantamount to the introduction of a new euro.  Even now there are many pundits, mostly seemingly located outside of the euro area, who advocate an exit from monetary union as the solution for all that ails the periphery, including Portugal, Spain and Italy.

Many critics simply dismissed Estonia's ascension, and will do the same for Latvia (and Lithuania) as irrational or incomprehensible and, therefore, render any understanding and analysis superfluous.  Yet there is important insight to be had by thinking more thoroughly about the motivation of the new members.

The claim that the monetary union is not an optimal currency zone is quite beside the point.  Surely the US was not an optimal currency zone when thirteen colonies formed their political union.  It might not have been a optimal currency zone even when banks and the government joined forces early in the 20th century to create the Federal Reserve and nationalize the currency.  Those who predict the demise of the EMU because it is not an optimal currency zone often seem more dogmatically economic determinists than the crude marxists.  

We argue that monetary union is first and foremost about politics.   The integration of Europe is about creating the conditions for peace on the continent that has both led and bedeviled the world for the last millennium.   It was understood by the architects of the EU after the Great War that integration would happen by crisis;  crises help lift countries over the (nationalistic) obstacles.  

This crisis is a doozy, not to put too fine a point on it.  And it has, as the founders anticipated, led to greater integration, not less   European officials have innovated to build institutional capacity where it did not exist before.  To be sure, it remains a work in progress, but certainly, it is not same monetary union that sailed through its first decade (1998-2008).  

Frustratingly though, it remains more an elite project.  Broad and deep popular support is lacking in most countries.   While no anti-EMU party has come to power, risk of such may have also encouraged officials to soften the seemingly endless demands for austerity and offer some (token?) measures to address the high unemployment and promote public investment.  

The inclusion of the Baltics into western European security and economic institutions is part of the post-Soviet Union evolution.  Joining the monetary union is a logical extension of joining NATO and the EU.  It offers insurance against Russia trying to cobble together some form of the Soviet Union.  It solidifies and ensures the Baltic integration with Europe, which has been a powerful popular aspiration. 

The integration of Europe is also understood to be increasingly important given the rise of China and Pacific Basin economy.  Indeed for more than 30 years now, more goods go over the Pacific than the Atlantic.  Europe, especially, the numerous small countries, would be increasingly marginalized in a Pacific Century.   In addition, the new members will help shape EMU going forward.  

One can bemoan that five members are receiving international assistance.  Perhaps the only thing worse is if they did not.  The EFSF and ESM show the ability of Europe to still evolve.  Spain's aid was limited to banking assistance and that too shows an evolution of how European officials are trying to address the crisis.    Contrary to the doom and gloom prognostications, EMU is here to stay and it will continue to evolve and grow.