”The yes-campaign has misinterpreted its trade guru”


By Bo Malmberg[1]


(The article was published as an op-ed piece (DN Debatt) in the Swedish daily morning paper Dagens Nyheter (www.dn.se), Saturday 2003-08-02)



Klas Eklund (chief economist at SE-Banken) does it. Lars Leijonborg (leader of the Swedish Liberal Party) does it. Hans Karlsson (minister for labour market affairs) and Gunnar Lund (deputy minister of finance, responsible for financial markets and international economy) do the same. Ulf Jakobsson (professor of economics, head of The Research Institute of Industrial Economics), Assar Lindbeck and Mats Odell (economic spokesman for the Christian Democratic Party) do it. Yes even Göran Persson (prime minister) and Carl Bildt (prime minister 1991-94) do it. All of them claim that if Sweden joins the euro it will boost growth of trade and thereby act as catalyst for increased material wealth-creation.


That conclusion is based on research initiated by Berkeley-economist Andrew K. Rose.  Rose has studied how membership of a monetary union affects the trade of nations being members. According to Rose trade can increase by as much as 300 % for countries that form a monetary union.


The problem is that the examples studied by Rose are hardly relevant when one tries to asses possible effects on Sweden, should we decide to say yes to the euro. The nations that constitute the euro-zone are relatively large and located relatively close to Sweden. The positive effects on trade analysed by Rose however rely on analysis of trade flows that occur  over larger geographical distances as well as between countries that are smaller than Sweden.


If one instead looks at trade flows between countries that are of similar size to Sweden, and takes into consideration the geographical distances between Sweden and the dominant EMU-countries, the effects on trade from forming a monetary union are actually negative.


The conclusion that can thus be drawn is that it is not credible to rely on Roses research when one argues that membership in the euro-zone will boost Swedish trade and thereby become a vehicle for more job-creation. One of the most important lines of reasoning adopted by the yes-campaign can thus be refuted.


The shallowness of the empirical results that the yes-campaign relies on can be detected simply by studying the database that Rose himself has constructed and which is available on his personal website. In that database there are data on all in all 40 000 trade flows of which around 400 pertain to countries having the same currency.


When Rose quantifies the effect of being member of a monetary union he compares the actual trade flows between two countries with the expected trade flows after taking into consideration the geographical distance between the countries as well as size of GNP. He then draws the conclusion that a common currency can boost trade by as much as 300 %.


One line of critique that has been levelled against Rose, for example by the British Department of Treasury, is that trade flows within currency unions making up that analytical base usually take shape between very small countries. Another deficiency is that monetary unions that form the bulk of the research done by Rose comprise countries that are relatively far way from each other. The average distance is 180 mil[2] and more than half of the member-countries are located more than 100 mil from each other.


Most of Sweden’s trading partners that are, or might become, members of the euro-zone are closer to us than 100 mil. That is true for Finland, Germany, Netherlands, Belgium/Luxemburg, Austria and Ireland as well as UK, Poland, Czechoslovakia (yes Malmberg uses that label even though that former country is now split into two separate nations), Hungary and the Baltic nations.


It is therefore relevant to pose the question if a monetary union is likely to exert the same positive effects on trade flows over shorter geographical distances.


It is easy to look into this by relying on the database Rose himself has provided. The only analytical step that needs to be done is to make separate analysis between actual and expected trade flows for large and for small countries. Furthermore one has to look separately into the trade that occurs within monetary unions where the geographical distances are large and trade taking place within monetary unions characterized by small geographical distances.


It then transpires that the positive effects from forming a monetary union mostly materialize for trade flows over large distances and for trade involving small nations. For trade that takes place over shorter distances and between countries of the same size as Sweden, or larger, the effect on trade from forming a monetary union become negative.


This does not necessarily mean that trade would decrease if Sweden joins EMU (yes Malmberg here uses the term EMU and not euro). But it shows with necessary clarity that research presented by Rose cannot be used to argue that Swedish trade would increase.


The literature on economic geography can explain how it comes that the effects of monetary unions are different depending on whether member countries are big or small and whether they geographically are close or far away from one another. This literature demonstrates that large trade flows on the whole tend to be less sensitive to higher transactions costs. Transaction costs are costs associated with, i.e., finding a supplier, draw up contracts and secure means of payment. For smaller business deals people however tend to want to avoid high transaction costs. The higher transaction costs that come with the use of multiple currencies are thus more burdensome on relatively minuscule trade between small nations  geographically far away from each other. The existence of different currencies is less of an obstacle for countries with geographical proximity where trade flows are large.


The reason why Rose has been able to detect such large effect on trade from a monetary union lies in the fact that his research has been heavily focused on trade flows over large geographical distances between comparatively small nations. Such trade flows start from a very low level, which is one reason why they respond very positively to the lowering of  transaction costs. The fact that such flows also tend to be small in absolute numbers means that the effects measured as increase in percentage become very large. This visual effect remains the case even when increase in volume of trade is not very large.


Switzerland and Iceland are two illustrative examples of how small nations that maintain their own currencies rather than being members of a monetary union can achieve high trade and a high level of economic well-being. In the latest international rankings of GNP per capita, published by Confederation of Swedish Enterprise (Svenskt Näringsliv), Switzerland ranks as number 5 and Iceland as number 6, far ahead of EMU-members like Finland, Spain and France.


Swedish politicians often refer to such rankings as a reliable indicator of successful economic policy. If one uses such an argument one should admit that Sweden’s possibilities to climb to the top of that ranking are as favourable whether we keep our own currency or join the euro.


In the future we will be able to make more reliable assessments of the economic effects of EMU. We will have access to robust studies on the relation between EMU and trade. Such studies are being produced but have not yet been published. Nevertheless they are often referred to by campaign makers.   


Here one would wish that the Swedish debate would have been characterized by the same reflective attitude as the British Department of Treasury. To quote “Such estimates are surrounded by a number of insecurities and risks. It is of vital importance to bear that in mind when one tries to asses the effects on trade, such an assessment being part of a wider assessment of the likely costs and benefits of a British EMU-membership.”


That such insecurities are significant has been confirmed to me when I was in contact with the author of one of the publications that representatives of the yes-campaign refer to. The author acknowledges that the report contains parts that are not scientifically satisfactory. He is therefore in the process of working on a new up-graded version. But that report is not yet published.


Now that is can safely be said that the proposition that membership in a monetary union boosts trade neither applies to Sweden nor the EMU-area at large, it is time for Göran Persson and others who campaign for a yes to ponder their way of arguing.


Especially Göran Persson ought to give serious consideration how large a weight to assign this trade-related argument. There are reasons to believe that the excessive focus on this aspect has meant that the social democratic yes-campaign has become more detached from classical social democratic economic policy.


With the euro trade will increase, larger markets provide more jobs and more jobs mean higher tax revenues to finance public sector expenditures. This is a summary of the arguments that prime minister Göran Persson uses in the brochure “My reasons for saying yes to the euro” (“Mina skäl att rösta ja till euron”)


What is puzzling here is that Persson seems to subscribe to a narrow-focused and rather outdated analysis of the relationship between economic growth and the well-being of society. According to this attitude the male dominated export companies are the engines of wealth creation. The public sector is treated as a cost. Investments in education, health care and other related – mostly female dominated - activities are not considered.


If one compares this with last years campaign for the general elections when Persson was very explicit in his endorsement of the public sector as the key vehicle for wealth and Swedish competitiveness, one can notice a shift of emphasize. Might this be a reason why it has been so difficult for Göran Persson to make euro membership seem attractive to female voters as well as social democratic rank and file?


Göran Persson admits that his positive attitude towards euro membership has been influenced by the economist Assar Lindbeck, associated with The Research Institute of Industrial Economics (Industrins Utredningsinstitut, www.iui.se), which is sponsored by Confederation of Swedish Enterprise. I regard this as reason in itself to scrutinize the argument put forward by Göran Persson that increased trade paves the way to a more robust welfare state.


Assar Lindbeck is hardly someone who has made himself a name as a strong proponent of the welfare state. In his latest economic research Lindbeck singles out Sweden as an example where the welfare state has become overblown. One reason why this is so, according to Lindbeck, is the fact that there are today so many transfer recipients in Sweden that it has become politically almost impossible to get a majority for proposals to downsize the welfare state. As long as Göran Persson continues to use Assar Lindbeck as his economic mentor it is likely to be very difficult to convince voters that a yes to euro will lead to larger funds channelled to higher public sector expenditures.      


The central challenge facing Göran Persson and others on the yes-side is to make a convincing case how Sweden in the future will be able to achieve full employment and an ambitious welfare-state policy if we, by becoming part of the euro-zone, lose the possibility to tackle economic crises with an active independent monetary policy.


During the coming 20 years Sweden will face great economic challenges when the large cohort of people born in the 1940s retire from active labour force participation. Research conducted among others by us at the Swedish Institute for Future Studies illustrate that this can lead to severe macroeconomic challenges.


One important factor that needs to be borne in mind, when one balances the pros and cons of adopting the euro, is that none of today’s EMU-members has an age-pyramid that resembles ours. There is therefore a great likelihood that Sweden might have to face different types of economic disturbances than EMU-members like Germany, Italy, France and Spain, who do not face large flows of retirements at the same time as Sweden.


As I see it there are therefore compelling reasons why Sweden needs to retain the possibility to pursue an economic policy that can adapt to the specific disturbances that are likely to confront Sweden.


Our experience during the last 10 years teaches us that with the help of our own currency we have been able to conduct a very successful economic policy. Especially we can see that we have obtained a much wider scope for a well functioning democratic process. This stands in contrast to the 1980s and beginning of the 1990s when the only variables that parliament could decide about were taxes and public expenditures.


Had Andrew K Rose’s argument that the formation of a monetary union would lead to substantial increases in trade been relevant for Sweden or the EMU-area at large, it would have been compelling to consider that argument as a serious case for pondering a yes to euro. The data provided by Andrew K Rose do not however provide an argument that by remaining outside Sweden risks forgoing trade. Weighing the pros and cons an independent Swedish currency seems to be the best tool to secure a stable economic development in Sweden.             






[1] Bo Malmberg is Associate Professor at the Swedish Institute for Future Studies (Institutet

för Framtidsstudier, http://www.framtidsstudier.se/eng/index.htm) and Uppsala University,

Department of Social and Economic Geography. 


[2] 1 mil = 10 km. 1 km = 0,62 mile.