A place i Know well

Why should Britain join the Euro in reference to Economical and Political benefits will it bring as a consequence?

Many economists and politicians believe that in order to enhance Great Britain’s power and influence amongst the European community we must join the Euro, the single currency of Europe. The aim of my report into this hugely debated issue is to examine the advantages and disadvantages that joining the Euro has for Great Britain and to come to a justified conclusion.

Economical Advantages:

The economical benefit, for Great Britain, in joining the Euro and participating in business in the Euro zone are as follows:

-Transaction Costs:

There will be no longer a cost involved in changing currencies (frictional cost); this will benefit tourists and firms who trade within the Euro zone. It has been estimated that this economical gain will be equal to 1% of Great Britain’s GDP which is a significant benefit. There will also be a reduced need for companies to hedge against exchange rate fluctuations which adds both risk and uncertainty.

-Price Transparency:

With a common currency it will be easier to compare prices in different European countries because they would all be in Euros. This enables firms to source cheaper raw material and also enables consumers to buy cheaper goods. For example new car prices are much higher in the UK than elsewhere; a single currency could help reduce these price differentials.

-Eliminating Exchange Rate uncertainty:

Volatile swings in the exchange rate can destroy the profitability of exports. This weakens the confidence business’s have in investing. Therefore with a single currency business confidence should improve leading to greater trade and economic growth for Great Britain

-Improvement in Inflation Performance:

The ECB (European Central Bank) which sets interest rates for the whole Euro zone will be committed to keeping inflation low, countries with traditionally high inflation will benefit from this because by joining the Euro zone they adopt the inflation rate that is present within the Euro zone community. Although Great Britain does not traditionally experience high inflation on a regular basis, it will benefit from a steady and reliable level of inflation.

-Euro could emerge as a global trading currency:

With the Euro being an already established trading currency globally, it could emerge as the leading trading currency for the world with the inclusion of Great Britain, one of the worlds most active and established countries economically and politically.

-Inward investment:

Inward investment may increase from outside the EU as firms take advantage of lower transaction costs within the EU zone.

-The financial sector could benefit:

It would be easier to conduct banking and insurance with a single currency. For example, it would be easier to trade German shares on ...

This is a preview of the whole essay

-Euro could emerge as a global trading currency:

-Inward investment:

Inward investment may increase from outside the EU as firms take advantage of lower transaction costs within the EU zone.

-The financial sector could benefit:

It would be easier to conduct banking and insurance with a single currency. For example, it would be easier to trade German shares on the London stock market

-Conclusion of advantages:

Economically, British companies will not wreak the full benefits of the European single market as long as they are separated from it by a shifting exchange rate, which is currently present in our single pound orientated market. British business currently has no great motive to export, import or invest in the Euro zone due to currency fluctuations remaining an uncertain risk to future returns. As a result, British companies will be more likely to confine business within the boarders of their own segregated currency, instead of participating in a broader one which will include their European competitors. Equally, ‘Euro zone’ companies will have less interest in doing business in Britain, for similar reasons. Ultimately, by not joining the Euro soon British companies risk missing out on the economies of scale and profit offered by business in the European market and by Euro zone membership, which will in time damage the competitive nature of the British economy.

Economical Disadvantages

The argument against Britain joining the Euro is fueled mainly by the following economical disadvantages:

-Loss of Independent Monetary Policy:

On joining the Euro, interest rates would no longer be set by the MPC (Monetary Policy Committee, Bank of England). They would be set by the ECB (European Central Bank). The ECB look at the whole Euro economy and not what is best for the UK. Thus if the UK joined the Euro, interest rates would fall from MPC rate of 5.25% to the ECB rate of 2.25%. This fall in interest rates could boost the Housing market and cause inflationary pressures in the near future.

-Difficulty in getting out of a recession:

If the UK suffered a recession they would be unable to cut interest rates. It would be difficult to boost demand and get out of the recession. To an extent this occurred in 1992; the UK was in a recession but because they were in the ERM (European exchange rate mechanism) they were trying to maintain a high value of the £. Thus interest rates were far too high (15%) these high interest rates only made worse the UK’s recession.

-Sensitivity to interest Rates:

The nature of the UK housing market means the UK economy is sensitive to changes in interest rates. Unlike European countries most UK householders own their own house, their variable mortgage is a high % of their income. Thus even a 0.25% change in interest rate can significantly affect disposable income. If the UK were to join the Euro now and interest rates were to fall by 2% it would very likely because a further rise in the housing market which would only cause inflation rates to rise.

-Conclusion of Disadvantages:

The British economy is doing relatively well; by historical standards our economic performance is quite remarkable. The pound is stronger today than both the Euro and the American Dollar, and with inflation presently low, makes trading and business in Europe and the U.S.A an inviting prospect for businesses. Possible changes in interest rates could seriously harm the economy within the citizenry of Great Britain. Also high risks come with the Euro e.g. a recession - which would leave Britain in a far worse of state economically than we presently are in. Thus, when looking at the current state of British economy, there seems little incentive from an economical point of view for Britain to gamble its structured and steady economy on the minor benefits that the Euro might bring.

The Political consequences of Britain joining the Euro

Politically, Britain cannot become one of the leading countries in the EU so long as it remains outside the Euro. The opportunities for Britain to assume a leading role are great. Key relationships with other European nations must be strengthened if Britain wishes to emerge as a figurehead of European economy and politics. Both the French and the Germans are also ready to develop closer ties with the UK on specific issues. The French have looked to the British in the past for help in developing an effective EU foreign policy and on institutional reform. Germany likewise has asked for British support on economic reform and trade, in the past. But neither country is prepared to fully trust the British so long as they are outside the Euro and thus uncommitted to the common destiny of the Euro zone countries.

If Britain joined the Euro, a more fluid pattern of alliances within the EU would emerge. Instead of France and Germany distancing itself from Britain at some distance, there would be different alliances among the three dominant European nations on different subjects. The small countries, too, would find it much easier to ally with the British if they were in the Euro. The Dutch, for example, have long wanted Britain to take a more positive attitude to Europe, to diminish Franco-German domination. However, so long as Britain avoids the Euro, its voice on economic issues within Europe will count for less than it could and should do.

Despite the fact that some analysts worry that Frankfurt or Paris could replace London as Europe main financial centre if the UK stays out of the Euro zone London has retained its pre-eminence since the Euros launch in 1999. It is likely that regardless of whether the UK joins the Euro it will keep its top status, as its reputation rests primarily on its financial knowledge and experience rather than whether we adopt the single currency of the Euro.

CONCLUSIONS

British Business and the Euro

The CBI (Confederation British Industrial) is in favor of the Euro in principal and beliefs that the Currency can bring significant benefits. These advantages range from competing in a single market to the removal of the UK from volatile exchange rate swings. However, British business would like the Euro zone countries to be more like the UK e.g. lower taxes and less state intervention, as well as a more flexible labor market i.e. more inline with the UK and US economies.

Dollar to Euro Exchange Rate

Dollar to Pound Exchange Rate

The Maastricht treaty of 1992 laid down a number of criteria that had to be met before countries could join single currency. This primarily related to inflation rate levels, spending policy and debt levels. Clearly if there are weak economies within the Euro zone that do not meet the set criteria they will drag down the overall European economy and the strength of the Euro.

The current world currency situation is that the US economy is struggling and hence the dollar is weak against the Euro. Although the pound is also strong against the dollar this is primarily because of a weak dollar rather than a strong pound. More recently the pound has dropped significantly against both the Euro and the Dollar. These changes in exchange rate are based primarily on the fear of recession in the US and a weakening UK economy. Based on this one could argue that there would be major advantages currently for Britain to enter the Euro zone.

Overall it seems to me that the Advantages for joining the Euro for out way the disadvantages, many of which are unfounded. The adoption of a single currency should help stabilize currency fluctuations, ease trading within the European economy and protect the UK from the negative impact that the American Economy can have on the British economy. I believe that the UK will still be the financial center of Europe and that the adoption of the Euro will stabilize European economies removing the damaging impact of the ‘boom-bust’ cycle.

Ben Davisson