Should the United Kingdom join the single European currency?

In the United Kingdom at the moment there is a rather large debate taking place which asks “Should Britain join the single European currency? There are lot’s of advantages to joining the Euro but there are also many disadvantages and in this assignment I will critically asses as many as possible.

The main advantage of joining the single European currency is the fact that it would cause prices in the UK to be greatly reduced, this is known as price transparency. At present in the United Kingdom many consumers are angry at the frequent extortionate prices being charged for goods compared with the rest of Europe, and since Britain has been given the label “Rip-off Britain”. For example in the UK a Fiat Bravo car costs 76% more than in Europe and the Renault Laguna 60% more (see fig. 1).

If the UK opted to join the Euro overseas trading could take place more easily, without the need for exchange rates and currency commission etc. Also, goods would be able to be transported free between participating countries and this would enable the easy establishment of Trans National Corporations (TNC’s), which will create more employment and reduce the amount of people claiming benefits.

These factors would then have the benefit of creating more choice for consumers with foreign businesses trading in the UK but also create more competition in the UK forcing current companies to lower prices and become more efficient in order to retain their competitive advantage, thus creating more choice and a better deal for consumers.

With the lower prices in place consumers will have more money to spend on other goods and so the standard of living will rise.

However, many anti-euro/pro-pound campaigners argue that prices have nothing to do with the currency and that the price differences between Britain and Europe are driven by factors such as tax, transport costs and regulatory systems. For example in the UK alcoholic drinks are more expensive than in Europe because the government sets high taxes on alcohol.

These campaigners also believe that to freely trade with other nations there is no need for a single monetary union, an example of this occurring is in the North American Free Trade Area in which America, Mexico and Canada trade freely without the need for a single currency.

Also there is a danger that our trade with America may be damaged if we joined the Euro because it would de-stabilise our economy and also at the moment the Euro is extremely volatile against the dollar (see fig. 2) and so could bring greater instability for the majority of our trade and investment.

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Many people also say that joining the Euro would reduce transaction costs for businesses and consumers in the UK but the saving has been estimated to be only 0.1% of gross domestic product and this would be dwarfed by the cost of the changeover estimated at up to £30 billion and many people feel that transaction cost savings are trivial and not a good reason to join a single monetary union.

Another disadvantage to joining the Euro is that if we did join our economy would become unstable. At the moment investors are attracted to Britain because of the stable economic environment and joining the Euro would jeopardise this stability. Not only do we do less than half our trade with the EU, but figures from HM Customs and Excise from March 2001 showed that only 19% of goods exported are invoiced in Euros. However 27% of goods exported are invoiced in dollars and 52% in sterling. If Britain was in the Euro, the volatility between the Euro and the dollar (see fig. 2) would de-stabilise British trade far more than the fluctuation between sterling and the Euro does at present.

The main disadvantage to joining the Euro is that in many economists opinions we have already tried a single monetary system and in terms of the UK it failed.

In 1978, EC member states agreed to establish an Exchange Rate Mechanism (ERM) that would limit fluctuations in the currencies of members who chose to join, over time all member states except Greece joined. The idea behind the Snake in the Tunnel as the ERM became known was to provide relatively fixed exchange rates between member states. The Snake in the Tunnel allows currencies to move up and down over time (the snake) within fairly narrow upper and lower limits (the tunnel) (see fig. 3). The Central Bank of a country must take action to stop it’s currency moving out of the tunnel.

When the UK joined the ERM in the early 1990’s, it soon became necessary to raise interest rates to keep within the tunnel. This had the effect of prolonging the recession in the UK and in September 1992 the UK decided to suspend their membership along with Italy. As a result of the ERM 100,000 businesses were bankrupted and unemployment rocketed and stood at 9.6% and many people are fearful that this will happen again if we join the Euro. There is an advantage to the fixed exchange rates however because they are an effective anchor against inflation as the UK and Italy have realised.

From the ERM the Maastrict Treaty was set up in 1991, which set out to strengthen the European Community and provide movement towards economic and monetary union by setting timetables for the introduction of the single European currency.

If Britain was to opt to join the single European currency they would have to meet several convergence criteria set out in the Maastrict Treaty, this is because for a single currency to work all of the economies involved must be reasonably close economically. The five criteria are as follows:

Inflation – no more than 1.5% above the average inflation rate of the lowest 3 inflation countries in the EU

Interest rates – the long term rate should be no more than 2% above the average of the three countries with the lowest inflation rates

Budget deficit – no more than 3% of GDP

National debt – no more than 60% of GDP

Exchange rates – currency within the normal bands of the ERM with no

re-alignments for at least 2 years

One of the problems if the UK was to join would be that they would have to meet the convergence criteria and one of the criteria specifies that the budget deficit should be no more than 3% of the UK’s GDP. However Britain’s stands at 6% and to reduce this figure public expenditure would have to be cut by an astronomical £18 billion, or alternatively the government could increase income tax 9p to 33p per pound and/or raise VAT from 17.5% to 24.5% and the public would not appreciate these cuts, it is expected to raise unemployment by an estimated minimum of 500,000 and cause many more people to claim benefits from the state.

Another disadvantage to joining the single European currency is that the British government would lose, to an extent, control of the economy. Instead of our government controlling factors such as interest rates etc the European Central Bank or ECB would. The ECB have an inflation target of 2% or less and then set interest rates to achieve that target and at the moment it is true to say that the present rates in the Euro zone would have risked an inflationary boom in the UK. However if we joined the Euro the Bank of England would be involved in the decision and lower interest rates would certainly promote investment in the UK which will contribute to long term growth, if interest rates remain high investment in the UK will be discouraged.

Also a single monetary policy cannot deal with the differences, divergences and cyclical variations in the European economies. National currencies provide an adjustment mechanism, and allow governments to use interest rates to respond to events, a single European currency would remove these options. The single European interest rate creates the problem of how a participating country could adjust to a shock or economic development specific to that country. The recent terrorism attacks are an excellent example this problem.

Another disadvantage is that these decisions would be out of our hands, if politicians fail we have the power to remove them but in the Euro it would not matter what we think and decisions would be made for us in Brussels and/or Frankfurt by people not elected by the UK.

There are also many other disadvantages such as the moral aspects of joining the Euro, the loss of our currency would be a loss of heritage and freedom and would contradict the idea that Britain is independent, a little island separate from mainland Europe and also many people do not want the queens head removed from our currency.

Also, many people are sceptical about trusting foreign countries, for example BMW selling off Rover when they stated that they would not. Also the widespread confusion of adopting the Euro is incalculable and will cause many people to get very frustrated and also a single European currency needs a single European tax and this is estimated to cost £200 per household.

Other advantages include the easy travel for holidaymakers without the need for exchanging currency, which will give the air travel industry a boost that would be very beneficial since the terrorist attacks of September 11th. This would then have the disadvantage however of causing some unemployment in the bureau de change industry.

In conclusion I feel that on balance the UK should not adopt the single European currency at the moment mostly because of the cost of the changeover, estimated at £30 billion, not to mention the cost of reducing the public spending budget in order to meet the convergence criteria set out in the Maastrict Treaty. This money could be better spent on priorities such as the NHS and the transport system, which are in crisis at the moment.

In my opinion Britain should sit on the fence and wait to see if the single European currency does work in the long term before committing. Simply by looking into the media it can be said that the Euro has not met it’s first hurdles and is failing in many aspects including being very weak against the pound (see fig. 4). At the moment there is a great deal of variation between the economic cycles of the European countries involved and the process of reaching similar cycles would be very long and arduous and would probably involve high prices, high taxes and increased unemployment until these problems are rectified.

If Britain were to wait until all of the problems of the Euro have been ironed out we would be in a better position to make a decision on whether or not to join the single European currency.