How the Credit Crunch has affected Scandinavian countries' relationship with the EU

The three Scandinavian countries (Denmark, Norway and Sweden) together with Iceland (itself part of the Danish crown territory until 1944) have traditionally had an ambivalent attitude towards the EU. There has been a host of theories put forward to explain this phenomenon, ranging from relative geographical isolation from Central Europe to concern over the effects integration would have for the region's renowned welfare state.

Differences Within the Region

There are though subtle differences between the traditional attitudes of the various countries. Denmark was the first country to become a member of the EU (then EEC) joining with the UK and Ireland in the 1973 expansion. Since then, though, public support has been lukewarm with the Treaty of European Union (Maastricht Treaty) voted against initially which lead to several opt-outs being negotiated. One of the opt-outs was in relation to the Euro and the Danish people voted against joining in a referendum in 2000.

Sweden was the next country to join the EU in 1995 although, as in Denmark, a referendum to join the single currency resulted in a no. Norway has never made the leap to joining the EU, although it has been a long-standing member of the EEA (and previously of EFTA).

Iceland is perhaps the most interesting case. As a small country with a population of around 300,000, it would seem to have most to benefit from joining the EU. However, it has not worked like this in practice with the EU's complicated fishing quotas being a particular turn-off for Icelandic voters and politicians alike.

Effect of Credit Crunch

The traditional positions are now being challenged following the recent global financial turmoil and its consequences. The Icelandic people still have little love for the EU as an institution, and its fishing quotas in particular, but there is now one specific and concrete advantage in joining the EU - namely that only by joining the EU would Iceland be able to adopt the Euro.

The financial meltdown in Iceland has hit large-scale investors hardest but it has also been felt by ordinary people. In recent years, with the economy expanding quickly, interest rates in Iceland were in double digits. This encouraged many borrowers (often ordinary individuals) to take out loans at vastly lower interest rates in the major carry trade foreign currencies, like the Yen and Swiss Franc. Thus, when the Icelandic krona went into freefall this autumn it hit some individuals like a sledgehammer. Not only had these people to pay significantly more for imports (and as a small economy Iceland is heavily dependent on imports) than they did just a month before but the liabilities side of their personal balance sheets suddenly shot through the roof.

How differently things would have worked out had Iceland been in the Euro is a moot point. Certainly, the interest rates would have been set in Frankfurt rather than Reykjavik and would have been vastly lower, thus discouraging the borrowing in different currencies which has created such a problem (although there is an argument that the ability for a country to control its monetary policy itself is positive overall). In any case, with the Euro being seen as a solid global currency, the massive increase in prices of imports would not have happened and, having seen that Iceland's size means that it is difficult to fight against global pressures on their currency, many see joining the Euro, and thus coming under the wing of a global currency, as financial common sense.

The Debate in Denmark

In any event, the above has made joining the EU a live debate again in Iceland, and it is not the only country in the area which is reconsidering its relationship with the EU. The Danish Prime Minister, Anders Fogh Rasmussen, made clear a year ago that he would like to hold a referendum on Denmark's various opt-outs. With the revised Lisbon Treaty being voted against in Ireland, the situation was put on the back-burner for a while but, as in Iceland, membership of the Euro has suddenly become a live issue again.

After Denmark voted no to the Euro the government decided to tightly peg the Danish krone against the single currency. Whether the end result was optimal is open to question given that Denmark, by choosing to peg the krone, ceded its monetary policy independence to a large extent but did not gain the full advantages of joining the Euro. Up until September 2008 though, there was little discussion of the issue as the krone was spectacularly stable against the Euro, with the rate more predictable than the English Premier League, and Danish base rates would generally follow the ECB's lead. Although Danish rates were slightly higher, with the Danes effectively paying a premium for maintaining their own currency, the difference was generally around 0.25% and therefore not significant enough to become a political hot potato.

This, though, changed in September as investors sought the safe havens of the global currencies amidst the financial turmoil. This meant that currencies of smaller economies came under pressure and the Danish krone, despite the fact that in current account and national debt terms the Danish economy is on a sound footing, was not immune. Accordingly, the Danish National Bank was obliged to raise interest rates to protect the krone. At one point the gap between the Danish base rate and the ECB exchange rate was 1.75% and although the difference is now down to 1%, the gap is still significant. This meant (and continues to mean) that Danish borrowers were paying significantly more than they would had Denmark been in the Euro and there is not even an argument that the higher interest rates were justified from a macroeconomic perspective - on the contrary the global economic downturn would justify an expansive monetary policy to encourage consumption and investment.

The pro-Euro camp had previously claimed that Denmark was missing out on financial advantages by not being part of the project but their argument were dismissed by opponents as more relevant in ivory towers than on the shop floor. The after-effects of the credit crunch gave a clear and unambiguous example of how not being part of the Euro can be a significant disadvantage for Denmark.

There have been signs that the general public have shifted slightly. A recent opinion poll showed 49.8% in favour of Denmark joining the Euro with 44.6% being against (the remaining 5.6% had not made up their minds) with men viewing the project particularly favourably. From the (pro-Euro) government's point of view the time would therefore seem right to call a new referendum, although they may be reluctant to call it so soon after the credit crunch, thus risking being seen as opportunistic and making political capital out of severe financial problems.

What About Norway and Sweden?

Sweden choose to take a different path than Denmark following its no vote, and allowed the Swedish krona to float. Likewise, the Norwegian krone is not pegged against the Euro. This has allowed the Swedish and Norwegian national banks much more scope for manoeuvre to reduce interest rates than was available to their Danish counterparts.

The reduction in interest rates (whilst justified by the macroeconomic outlook) have led to one particular consequence: namely that the value of both the Swedish krona and Norwegian krone has fallen by over 15% against the Euro. Of course, the effect of a depreciation of a currency can be debated, and there is a particular argument that it is positive overall during challenging economic times, but the depreciation has led to a change in nuance in the debate.

Swedish and Norwegian consumers are aware that they are paying more for their imports and, when travelling abroad, will have diminished purchasing power. Therefore, as in Denmark, it has become clear that there can be significant consequences in being outside the Euro.

Whilst every country has its own particular take on the issue and local circumstances, the credit crunch has undoubtedly had a significant difference to the dynamic of the European debate in Scandinavia. It is too early to predict the changes that are in store but the issue, which had been almost dead, now looks to be the main political question of 2009. This blog will follow matters closely and report on significant events.