There are inherent differences between the British and Euro-zone economies. Its pattern of external trade links is still different, though progressively assimilating, and the transition mechanism joining the financial system to the real economy is also different. The British economy is invariably out of phase with other European countries, entering recession and recovery at different times to that of most of her EU partners and historically Britain has been more in-line with the US trade cycle.
Business Cycle diagram-lack of convergence page 1 Potts
One important factor to note is that since the introduction of the Euro Germany, which was once heralded as the model for future economies, continues to slip into abyss, while on the other hand Ireland is experiencing a boom. This only serves to prove that there have been problems with the Euro and convergence. This is one of Gordon Brown’s five economic tests, that the UK must converge with euro zone countries before joining the Euro, enabling the UK to be comfortable with Euro interest rates. But it is fair to say that convergence may be temporary and that the UK could easily fall out of sink with the other countries.
Fiscal policy is closely linked to monetary policy and is a major tool also used to control AD, however it does so by controlling the level of government spending and taxation. A rise in government spending, with the price level constant, will increase AD, pushing the AD curve to the right as shown in Fig 1.2. Equally, a cut in taxes will affect AD, such a cut could be on income tax or national insurance contribution, this will lead to a rise in the level of disposable incomes to households. As households keep a greater proportion of their income in such a situation, this would lead to greater consumer spending and hence an increase in AD, shifting the AD curve to the right as shown in fig 1.3. Of course, both can be applied vice versa as well.
There are no firm plans at the moment for the harmonization of taxes within the euro zone however; with the adoption of the Euro the fiscal policy is greatly limited. One of the convergence criteria for joining the Euro-zone is low government debt especially in respect to achieving a required budget deficit figure of 3% GDP, hence, not enabling the domestic government to increase public spending as it would acquire debt.
This also leads to Blair’s government’ second test. This is whether there is sufficient flexibility in the economy and it refers to how well the economy could cope with problems and how quickly the Euro system could act in order to deal with a setback.
Insert Anderton diagrams page 235
Furthermore, the loss of competitive devaluations as an economic tool in respect to other European countries would further hinder a government’s ability to manage its own economy and we would also lose the capability to change our balance of payments. This power would be handed over to the ECB. This leaves only supply side policies, which are limited with regards to their applications. This would involve the deregulation to lower costs of business, and increasing labour productivity all effectively increasing growth rates.
The strength of the euro was supposed to be guaranteed by ensuring that the economies of all the participating countries were in a healthy state and had significantly converged at the time of joining by insisting that they met strict entrance criteria. In reality most of the countries failed to meet the stipulated targets (especially in respect to achieving the required budget deficit figure of 3% GDP) but with the exception of Greece (initially), were allowed to join anyway due to the fudging of the convergence criteria. The subsequent poor performance of the euro on the international currency market could be an attribute this. In the short period after the launch of the euro, the euro fell against the pound. The pound was strong and this greatly affected the number of exports leaving the UK. This would effect Gordon Brown’s third test which is the euro’ impact on Foreign Direct Investment (FDI).
The cost of a change over to the euro would have to be borne by all businesses in the UK, regardless of whether they trade with the Euro-zone countries or not. It is likely that we would experience higher levels of unemployment following the inability to continue to match economic efficiency with the euro zone.
It is important to note that a large majority of British companies, especially smaller ones, survive by selling to local markets. However, these firms would still incur the costs of conversion e.g. new accounting and payroll systems. I believe, the concept of greeter price transparency is a fallacy, since even if consumers become more aware of price differences they are still more likely to buy in their local high street rather than make the effort to buy from another country. Price comparison is already straightforward; all that is required is a calculator.
Also, one of the UK’s concerns is that countries such as Germany and France are not yet as deregulated as the UK especially in the Labour market. They do not hold a hire and fire policy, which again questions the flexibility within the euro system.
In contrast, however, there are many advantages to the euro the first of these is that 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 an uncertainty of rising from a floating exchange rate; it is likely that this could affect the number of UK exports being purchased by continental European countries. In short, 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. Membership of the Euro-zone would eliminate these costs. We would also gain greater price transparency, which would inevitably lead to greater allocative efficiency in the fact that we obtain greater freedom of information and in a sense, perfect competition. This would lead in the long-term to economic growth. The introduction of the euro will lead to the development of a truly a single European market resulting in improved competition between companies across the euro-zone area. This will ultimately lead to leaner, more competitive industries and to lower prices and better value for consumers.
In this diagram we can see what would
happen to Aggregate Demand should
we not join the euro the value of the pound is
strong against the euro and UK goods are
expensive. Fewer goods are exported and AD falls.
By joining the single currency British businesses will enjoy the benefit of a fixed exchange rate with Britain’s biggest single trading partner i.e. the Euro-zone. The benefit of a fixed exchange rate is that it provides companies with the ability to plan and budget for future activity and expansion since the value of a transaction will not have changed due to currency fluctuations during the time that elapses between the signing of a deal and the receipt of payment. At present, a British company selling goods or services to a Euro-zone customer runs the risk of eventually receiving payment in a currency, which has subsequently devalued against the pound. The euro makes it possible to more accurately predict the future costs of producing goods in the UK for European markets by removing the factor of a potentially volatile exchange rate between the pound and the euro.
The removal of separate national currencies across Europe will increase pressure on uncompetitive businesses to become more efficient. This would occur as cross-border investment will be more likely as apposed to the traditional reluctance of many investors to move their money into a currency other than their own, meaning that the level of investment received by a company would based on their competitiveness rather than their nationality. Additionally cross-border mergers and acquisitions will also lead to more streamlined and efficient businesses across the Euro-zone.
Insert diagram regarding investment effects on AD (to increase it).
Tourism and tourists as in industry would also benefit from the introduction of the euro. This would occur as holidaymakers and travellers would no longer incur the costs of currency conversion when travelling between Britain and other euro countries. Notes and coins issued in the UK would be legal tender in Europe, moreover, money which is not spent on holiday could be spent back in Britain, thus helping to reduce the amount of money leaving the country, thus benefiting our domestic economy as shown below in the circular flow of income cycle.
There are also two other economic tests put forward by Blair government: The impact of the Euro on financial services-This refers to how large corporations will benefit or not from joining the Euro. The lack of speculation on exchange rate could create stagnation. However, on the other hand, the new ease with which foreigners within the Euro zone could invest in UK corporations could benefit the stock exchange. A particular factor that has to be taken into consideration is the strong international financial service industry based in the city, Edinborough and recently Leeds.
The last economic test is 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.
Ultimately a single currency goes one 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 synchronised, lending themselves to full integration. One major advantage to the Single European Market is that it would be a competitor to the USA on a global scale. This would serve a few functions, which may benefit the UK. Firstly, at present, economies of the world follow the movement of the US stock market (namely the S&P and Dow Jones), should the Single European Market be a success then it may mean that should the US suffer a recession then the member countries wouldn’t be as adversely affected.
To end, the UK economy is at its strongest at the moment and has many 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. I believe that currently the risks outweigh the advantages that would be gained from joining the single currency. 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. 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 remains out of the euro zone 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. Inappropriate currency arrangements can certainly wreck an economy but paradoxically while a bad currency, such as the euro, reduces prosperity, a good currency does little directly to help an economy. In the long run, the economic health of a country is determined by fundamentals such as the rule of law, low taxes and good incentives to save and invest. UK membership of the euro could only get in the way and damage Britain’s current economic strength.
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