Internal EU exchange rate stability would be achieved once and for all. With advantages for investment, and improvements in the productive capacity for European industry.
The introduction of a single currency would eliminate certain speculation against individual European Currencies. An example of this is when the currency crisis threw the Pound out of the EMR, causing a cost of billions in lost foreign exchange reserves. This type of risk would completely disappear.
The single currency of Europe, the Euro, would become a leading world currency, alongside the dollar or yen. This would lead to increased interest world- wide.
It would also make it easier to achieve and sustain more growth-orientated macroeconomic policies.
The arguments put forth for membership of the "Euro zone" (countries that have adopted the Euro as their currency) are split into two groups: political and economic.
A move towards a Federal Europe (Churchill's ideal of a "United States of Europe") that is governed in a similar way as that of the U.S.A. is the primary political argument. A Federal Europe would be governed as a whole with member countries retaining a few powers but losing almost all-political sovereignty. It is argued that this reason is one of the driving reasons for the setting up of the Single European Currency. France and Germany in particular want to integrate the core European economies more closely and move towards a single European Economy.
A single currency will eventually produce a European GDP, which is higher than that of the USA or Japan and thus will be extremely powerful in economic terms.
The economic arguments are further sub-divided into three groups: transaction costs, trade competition and investment. Ultimately, abstaining from the Euro means higher costs (as far as transaction costs are concerned) than if we joined. The commissions involved in buying the Euro when trading with European countries will remain and the uncertainty arising from a floating exchange rate will also continue to be apparent. Whilst this is unlikely to make a significant difference for UK businesses buying continental European exports, it could well affect the number of UK exports being purchased by continental European companies. Basically, UK exports will be more expensive to Euro zone countries compared to exports of other Euro zone countries due to the changing cost of buying the pound. The UK's membership in the Euro zone would eliminate these costs.
Trade competition refers to the fact that if exports from Euro zone countries are all priced in the same currency then it is easier for companies to see price differences between companies across borders, ultimately increasing competition between companies. In effect, with the lack of tariffs or quotas for import and export between Euro zone countries, it is almost like an integrated single European Economy as buying from a company in a fellow Euro zone country is exactly the same as buying from a company in your own country. This is called price transparency: it will become far easier to compare prices across the markets of the Euro zone. This has the advantage of creating competition between countries (which leads to prices leveling out), perhaps even providing competition for existing monopolies. For example, with borders being opened up between Euro zone countries, the traditional telecom monopolies that plague most European countries could be opened up to include foreign competition as networks expand across borders.
The removal of transaction costs associated with exchanging currency has another effect. Intra-European investment flows would likely increase. This means that companies across the Euro zone would benefit from increased investment from other Euro zone countries.
Ultimately a Single European Currency goes one big step further to the completion of the Single European Market, by opening up the markets of each member and linking them with one currency. Labour markets are also linked and the economies of the Euro zone can become more synchronized, lending themselves to full-on integration. The completion of a Single European Market has one major advantage - there will finally be a major competitor to the U.S.A. in the global economy. Economists predict that the U.S.A. and Euro zone Europe will become the two major players with Japan as a junior partner in the world economy. This has particular relevance now, since many economies at the moment, particularly our own, hinge on the US economy. If it slows down, like it is about to, then those other countries are likely to do the same. With another competitor to the US, the global economy can become much more balanced and with it brings possibly more stability.
Disadvantages For UK adopting the euro
One of the main advantages of staying out of the EMU would be retaining the use of the exchange rate, as a macroeconomic tool. The UK would also lose the ability to set it's own interest rates to suit her domestic economic conditions. The ECB would conduct monetary policy to stabilize prices in the EMU are as a whole. If the UK's economy were in line with the rest of the EMU area, then the ECB's monetary policy would be suitable. But if the UK's economic conditions were contrary to those in the rest of the EMU area, then the interest rate would be unsuitable for the UK's economy, and it would possibly destabilize the economic conditions
Those who oppose the EMU, argue that it will threaten our sovereignty, impede growth and employment, reduce our purchasing power, and dangerously split the EU into two tiers, and eventually collapse leaving an economic mess.
With regards to the question of sovereignty, "Where a parliament is sovereign it has an unlimited authority, recognized by the courts, to make any law or to amend any law made. " In Europe, abandoning the national currency in favor of the proposed Euro appears to many, to signify a loss of nationhood. By joining an EMU a nation will hand over its monetary policy to the ECB, and consequently loss its control over national money.
There will also be change over costs, including the process to change from national currencies to one single currency which will effect both business and trade, these are essentially short term costs, but are of some significance.
The main cost associated with the EMU is the loss of monetary independence, and adopting to a, "one fits all" approach. Accepting a single currency requires giving up the use of the nominal exchange rates as a tool for macroeconomic adjustment and as a means of gaining competitiveness. Exchange rate adjustments can help to stabilize economies through the booms and slumps of an economic cycle, or unusual shocks, but once a, "one fits all," policy is implemented this will not be possible. Asymmetric shocks could lead to deep regional recessions and increasing unemployment, creating social burdens that is politically unacceptable to many governments. Consequently alternative mechanisms in adjusting to asymmetric shocks in EMU will need to be found. In the case of asymmetric shocks where there is a shift in demand from country A to country B, then an aggregate demand would go up in country B and down in country A.
If there is a shift in relative demand across countries, and real exchange rate does not adjust, there will be unemployment in the country where demand has been reduced unless there is migration towards the country where demand has increased. However labour movements across EU countries are very limited. And while it might be argued that labour mobility might increase as economic and monetary integration proceeds, it should be acknowledged that numerous historical, cultural and linguistic differences in European countries would prevent migration. Thus due to low labour movements and mobility migration will be an extremely limited tool to cope with asymmetric shocks in EMU.
If labour markets are flexible then this problem will resolve itself quickly, e.g. if wages were flexible, country A would lower its wages thereby allowing prices to fall, which would make its products more competitive and consequently stimulate the demand required to restore equilibrium to the economy. However wages and prices are not flexible enough to cope with asymmetric shocks in the EC, and therefore Fiscal policy would be used to control the situation, by either raising taxes, or cutting government spending. But evidence shows that national governments pursuing active demand management policies have often conducted poor measures, making the economies far more volatile. "Fiscal austerity in, 'good times', would thus be price to pay to be able to exercise fiscal flexibility in, 'bad times'
The arguments against the UK's membership in the Euro zone are also split into political and economic arguments.
Political arguments include the loss of Britain's individuality as a separate country, as well as the loss of nearly all control over the UK economy. Furthermore, adopting the Euro more or less ties Britain into any future plans of a Federal Europe. It would be hard to back out of such plans with so much integration already set in motion. This, of course, would mean the loss of political sovereignty for Britain.
It is the economic arguments against the Euro that are the most important and in many ways the most compelling.
Economic theory states that the macro objectives for a government are as follows:
- Low unemployment
- Low inflation
- Economic growth
- Balance of Pay Equilibrium
In order to succeed in these objectives, governments use policies to control various aspects of the economy:
- Monetary Policy
- Fiscal Policy
- Supply-side Policies
- Exchange Rate Policies
In the analysis that follows, it will be shown that three of these policies would be rendered unusable to control the UK economy:
1. Monetary Policy
Monetary policy involves the raising and lowering of the base rate to control aggregate demand. For example, if aggregate demand is rising too quickly and raising prices (demand-pull inflation):
In this situation, the government could increase the base rate. This would have the effect of lowering consumer expenditure since there would be a higher incentive to save and a higher cost of borrowing.
AD = C + G + I + X – M
The introduction of the Euro in the UK would make this policy unusable because interest rates for Euro zone members are set by the European Central Bank (ECB) and is the same for all member countries. Of course, the ECB is able to operate Monetary Policy over the whole Euro zone, but an increase or decrease in aggregate demand might have a positive effect on one economy but a negative one on another. Economists argue whether the economies of the Euro zone are suitably synchronized to allow policies such as this to be used universally.
2. Fiscal Policy
Fiscal policy is closely linked to monetary policy and is also used to control aggregate demand. However, it does so by controlling the amount of government spending and taxation. Increasing government spending will increase aggregate demand:
AD = C + G + I + X – M
Increasing taxation means that incomes are lowered, which causes consumer expenditure to go down which means that aggregate demand, goes down (see above). Of course, both can be applied vice versa as well.
Fiscal policy becomes more or less useless with the adoption of the Euro, since one of the convergence criteria for joining the Euro zone is a low government debt. This means that the government cannot increase government spending to increase aggregate demand.
3. Exchange Rate Policy
Exchange Rate Policy is the devaluation and revaluation of a currency in order to deal with a balance of payments deficit. Little needs to be said here, since obviously with membership of the single currency this will be out of the control of the British government and in the hands of the ECB.
This leaves only Supply-Side Policies, which are rather limited in their applications. They involve deregulation to lower costs of production for businesses, and increasing labour productivity to increase growth rate (by promoting competition, privatisation, reducing strikes, etc.)
The main reason behind setting the Euro in the first place is to promote economic growth within Euro zone countries. As you can see from figure 6.1 overleaf, this would not appear to be the case.
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However it must also be considered that by staying out could pose serious risks to the British economy.
It would deny Britain the chance to enjoy any of the aforementioned benefits of EMU.
A successful EMU should promote more investment, not just in the UK, but for the whole of Europe, as it is believed that low inflation, along with stable exchange and interest rates leads to more investment. This coupled with the European Single Market will lead to reductions in transaction costs and exchange rate uncertainty, along with price transparency will promote competition and reduce costs. EMU is also expected to offer benefits to the UK's financial sector, by increasing competition and reducing costs.
Hazards from staying out of the single currency:-
· UK based banks could lose a competitive edge if they do not have access to the Euro target payment system.
· UK may be blocked from Euro markets by loopholes in the, current single market legalisation laws.
· Staying out of the EMU could make it much harder for Britain to finance it's spending and to stabilise it's chosen exchange rate.
The UK may also lose direct foreign investment in the long run. Advocates in Britain are worried that by isolating themselves from Europe, may produce another case of, "missing the boat," as British politicians have done in the past, and consequently losing to some extent, the it's international influence.
Whether joining would create better conditions for long-term decision making
Obviously, decision making with regards to controlling the economy will be hindered by the removal of most government policies. However, Britain's economy can be more effectively controlled to fit in with Europe, providing a more substantial base upon which decisions can be made. Once the economies of the Euro zone are suitably synchronised, the European Economy can then be improved which could ultimately be more beneficial to Britain.
Whether joining would be good for employment
Ultimately this would be true as the larger labour market would, in theory, increase competition and the number of jobs and hopefully increase demand. This would therefore increase the number of jobs and lower unemployment. In addition, if Britain abstained from the Euro for a long amount of time then businesses could move towards Europe for its workers (due to the larger labour market and the removal of transaction costs). This could lower the number of jobs in Britain and cause higher unemployment.
Conclusion
In conclusion it can be seen that Single currency does have many benefits for the UK and the European Union as a whole, if the project is successful. Employment, investment and growth could rise as a result. However, Monetary Union also has its costs. There seems to be uncertainty as to which is greater, but it should be noted that the cost/benefit ratio is not likely to be equally favorable in all the EC countries, since there are important structural economic differences among them.
Having analysed both the pros and cons of membership in the Euro zone, I conclude that at this time it probably is not beneficial to join. This is for two main reasons.
Firstly, the UK economy is at its strongest at the moment and has still has prospects despite opting-out of the Euro for the moment. Capital inflow is likely to continue even if we stay out of the single currency and the UK still has attractive supply-side factors in both product and labour markets for foreign investors. Particularly, the UK will remain attractive for Far Eastern countries such as Japan and the so-called tiger economies.
Secondly, I think that currently the risks outweigh the advantages that would be gained. As mentioned before, the UK economy is at its peak and is doing considerably better than other Euro zone members. If the UK joined the Euro then it is highly possible that the less fortunate countries will drag the UK down with them, as it were. Furthermore, the ECB will likely have to take relatively drastic action to keep some of the poorer economies in the Euro zone in check. This could have adverse effects on the otherwise sound economy of Britain. The problem is that the economies of the Euro zone are not suitably synchronised to allow economic control to be universal over all of them. Universal measures are the only option with a single currency. If Britain opts-out for the time being until the single currency has had a chance to both synchronise and improve the economies of the Euro zone, then it might be in a better position to offer advantages that outweigh the risks. On the other hand, if the Euro fails miserably and its economies go into recession, then we will be suitably distant from it to avoid unnecessary damage to our own economy.