Poland without the euro A cost benefit analysis 2 Polityka Insight Poland without the euro Index EXECUTIVE SUMMARY 2 1. POLAND’S INTEGRATION WITHIN THE EURO AREA – THE CONTEXT 6 How to adopt the common currency? 8 Survey of social opinions and political positions on euro adoption 14 Analysis of probability of euro being introduced in Poland by 2030 15 2. COSTS OF DELAYING EURO ADOPTION 16 Measurable costs 17 Potential costs 21 Non-measurable costs 25 3. BENEFITS OF DELAYING EURO ADOPTION 28 Measurable benefits 29 Potential benefits 30 Non-measurable benefits 37 4. BALANCE OF COSTS AND BENEFITS OF DELAYING EURO ADOPTION 40 Balance of measurable effects 41 Balance of potential costs and benefits 42 Balance of non-measurable costs and benefits 45 SUMMARY 47 REFERENCES 49 A cost benefit analysis Polityka Insight 1 Executive summary This report deals with the question of adopting the euro in Poland. It differs from previous such works in two respects. First, our ques- tion is not “should Poland adopt the euro?” as the EU Treaties oblige all Member States who joined the EU after the Maastricht Treaty came into force to join the eurozone. Hence, we focus on the implications of Poland's decision to delay its adoption of the common currency. Second, in contrast to previous studies we distinguish between different types of costs and benefits – we identify those which are measurable, those which are po- tential and those which are non-measurable, i.e. are of socio-political nature. In our view such a distinction is required to assess the effects of adopting the euro on the Polish economy in a way which incorporates the possible differenc- es in the preferences of decision-makers and public opinion. Further, we should not treat in the same way those consequences of monetary integration which are certain and easily measurable (e.g. the reduction of transaction costs) and those which are less certain and can only be roughly estimated (e.g. the in- crease in investment activity or reduction in cost competitiveness of exports). Our cost and benefit analysis does not yield an unequivocal answer to the question of whether and to what extent the Polish government should forego preparations for monetary integration. Our objective is to provide an overview of the relevant literature and to make the debate more systematic, thus devel- oping a dynamic framework for further research. While the ratio of measurable costs and benefits suggests that adopting the euro could give Poland an additional growth stimulus, such an effect would be small (0.7 per cent of GDP), i.e. within the margin of growth forecast error. Most significant costs and benefits are the only potential, which are contin- gent on the institutional framework. Premature and badly prepared monetary integration could result in economic losses significantly exceeding the measur- able benefits of early full EMU membership – our estimates suggest that that long-term GDP loss could reach even 7.5 percent. On the other hand, monetary integration preceded by sound institutional preparation would bring Poland an additional growth stimulus for the next decades - GDP could be higher by as much as 7.8 percent. This would be the case in particular with improved regulations of labour and financial markets, a relatively weak conversion rate of złoty to euro, additionally supported by a responsible and non-populist fiscal policy, i.e. budgetary discipline also at the peak of the economic cycle. 2 Polityka Insight Poland without the euro Executive summary Measurable consequences of delayed euro adoption higher transaction costs in the economy higher interest rates on loans higher public debt servicing costs no one-off costs of currency conversion Potential consequences of delayed euro adoption slower domestic demand growth slower export growth no share in the ECB profit disbursement lower probability of a house price bubble higher cost competitiveness of the economy lower price level smaller amplitude of business cycle fluctuations Non-measurable consequences of delayed euro adoption limited influence over political decisions concerning the European Union’s future higher social and political risk resulting from foreign currency denominated or indexed loans higher susceptibility to speculative attacks and risk of crises no access to funds from the euro area budget higher independence of economic policy lower susceptibility to euro area crises A cost benefit analysis Polityka Insight 3 The report was produced in partnership with The Friendly State Foundation. The report is impartial and objective; the partner had no influence over its thesis or content. All rights reserved. The Friendly State Foundation was created in 2013 by private founders. NGO's statutory objectives include carrying out research and analysis concerning regulation and economy, promotion of economic liberties and entrepreneurship growth, educational activity, encouraging civic and social activity, increasing the effectiveness of government and local government activities. All reports, analyses and publications of the Foundation are available at przyjaznykraj.pl. Polityka Insight is the first platform of knowledge in Poland designed for business CEOs, politicians and ambassadors accredited to Poland. It was founded six years ago and currently consists of three business lines: analytical services (PI Premium, PI Finance and PI Energy), tailored research services (e.g. reports, presentations and workshops prepared for companies, administration and international organisations), as well as high-profile events and conferences. www.politykainsight.pl/en Warsaw, March 2019 4 Polityka Insight Poland without the euro AUTHORS Adam Czerniak Chief Economist Agnieszka Smoleńska Senior European Affairs Analyst EDITOR Adam Puchejda GRAPHIC DESIGN Anna Olczak A cost benefit analysis Polityka Insight 5 1. Poland’s integration within the euro area – the context 6 Polityka Insight Poland without the euro This section reviews the institutional architecture of the euro area – that is, the set-up within which the decision to delay or speed up integration with the common currency area is made. Monetary integration within the European Union was foreseen as part of the European integration project since its inception. It was hardly – as is sometimes depicted - the cost borne by Berlin for France not to object to the unification of Ger- many in 1990s (Mody, 2018). Early reports of the European Commission consider monetary integration as the pinnacle of the internal market project – the final step of removing barriers between Member States. The necessary economic convergence was to be supported by the antecedents of cohesion policies introduced in 1980s by the then President of the European Commission, Jacques Delors. Economic and Monetary Union finally came into being with the 1992 Maastricht Treaty, and the common currency (euro) entered circulation in 12 Member States of the Union on 1 January 2002. These countries were: Belgium, Germany, Spain, France, Greece, Italy, Ireland, Luxembourg, Netherlands, Austria, Portugal and Finland. In 2007 they were joined by Slovenia, followed by Malta and Cyprus in 2008, Slovakia in 2009, Estonia in 2011, Latvia in 2014 and Lithuania in 2015. Currently 19 of the 28 European Union Member States use the euro. The financial crisis of 2008, which two years later in some of the euro area Mem- ber States transformed into a sovereign debt crisis, was the first real test of the EMU. It has brought to the surface the shortcomings of the European Monetary Union construction that contributed to aggravating the economic crisis in some countries. These included the lack of safety mechanisms or common supervision over the banking sector (Padoa-Schioppa, 2005), which led to disintegration of Eu- ropean financial markets (a decrease in cross-border transactions, divergence in risk assessment of different Member States (Draghi, 2018)). Euro area reforms since the crisis had as their objective the reintegration of banking systems of the euro area under single supervision, the introduction of risk-sharing (via financial markets as well as stabilization mechanisms) and greater synchronization of busi- ness cycles. New economic governance mechanisms and institutions were intro- duced (Pisani-Ferry, 2014; Sandbu, 2017), the most significant of which we describe below. These reforms have importantly changed the ratio of costs and benefits of Poland adopting the euro. A cost benefit analysis Polityka Insight 7 How to adopt the common currency? EU Treaties define the eurozone as an area where a common monetary policy is pur- sued. A distinct institution was created to this end – the European Central Bank (ECB) – whose objective is to maintain price stability and, without prejudice to this objective – to support economic policies of the Union in accordance with the principle of an open market economy with free competition (Art. 119(2) TFEU and Art. 127 TFEU). All Member States of the EU, apart from Denmark and – until it leaves the EU – the United Kingdom, are members of the Economic and Monetary Union. Countries which joined the European Union after the Maastricht Treaty was signed in 1992 have the status of “Member States with a derogation.” These are (in the order of joining the EU): Sweden, Czechia, Hungary, Bulgaria, Poland, Romania and Croatia. These countries do not participate in the final (third) phase of the EMU, but are part of some of the institutions of monetary integration, such as the European System of Central Banks. In accordance