Do the Benefits of Joining the Euro Outweigh the Disadvantages?

SALLY ROBERTS

DO THE BENEFITS OF JOINING THE EURO OUTWEIGH THE DISADVANTAGES?

Introduction

The changeover to euro notes and coins is now complete across a 'eurozone' of 300 million people, for the majority of British people the debate over whether to adopt the single currency is just getting started.

For most people in the UK the decision will not be an easy one. With those who have already decided, there will be people who argue that the introduction of the single currency is just the next step in the development of a truly single market which will lead to greater economic prosperity, stability and security for Europe's inhabitants, and that by joining the euro, Britain would get a part in what could eventually become the world's most powerful economic zone. Others believe that a successful common market is not dependent on the adoption of a single currency, which they see as merely another step towards the political union of Europe. This, they say, will lead to a loss of national sovereignty, weakening the voice of the British electorate.

By presenting some of the arguments put forward by both sides of the debate over British membership of the euro, my aim is not to promote one set of arguments over the other, but to introduce some of the key campaign issues, which are being promoted.

Research Methodology

To find out the views and opinions of the people living in Pembroke and Pembroke Dock, I carried out primary research in the form of a short questionnaire and gave it to a random sample of 40 people. A sample of the questionnaire can be found on page 1 of the appendix along with the results in figures alongside the questions, and graphs to illustrate the results on page 2.

I also got secondary information from the Internet. Samples of these can be found on page 3 of the appendix.

Advantages of joining the euro:

1. The first significant advantage which membership to the Euro brings is the fact that it will eliminate transaction costs of converting national currencies, with savings estimated at around £2 billion annually. The first implication of this is lower prices to EU consumers of products imported and exported within the EU. As a result of this, the rate of inflation should fall, relative to the percentage change of price in imported products. Reduced transaction costs for traders,

2. Firms will incur lower costs of production as a result of the elimination of transaction costs, making export and import markets more efficient. The next step of the decrease in costs to countries exporting products within the EU could be that prices of domestically produced products may fall to compete with cheaper imports from other EU countries.

3. Euro zone multinationals are likely to benefit from substantial economies of scale as many barriers to trade within the Euro zone are removed. The occurrence of economies of scale is attributable to a decrease in average cost resulting from an increase in output. As a result of a decreased average cost to Euro-zone firms, again prices will be lower to Euro-zone consumers.

4. Firms will no longer be able to segment markets and charge different prices in different currencies. Because of the relative price stability associated with the adoption of the Euro as a result of price transparency, it is unlikely that Euro-zone firms would be able to legitimately charge different prices to consumers in different countries, thus the producer surplus attributable to price discrimination would fall substantially.

5. As a result of price discrimination, competition within the Euro-zone is likely to rise, as firms will be encouraged to lower prices and work towards productive efficiency in order to increase profits.

6. The UK is likely to benefit from lower inflation often associated with Euro-zone countries as a result of the implementation of tight monetary and fiscal policy. As a result of this, The Bank of England monetary policy committee are likely to be able to decrease short-run interest rates in order to maximise economic growth as well as to increase investment by firms, resulting in a shift to the right in the economy's production possibility curve.

7. A loss of inward investment if we fail to join. This popular argument fails to distinguish between the loss of such investment due to the overvaluation of the pound, and the loss of it due to non-membership of the Euro. These are quite separate issues, and the former seems considerably more likely to be significant. In fact the Invest in Britain Bureau announced in March 2000 that Britain's stock of inward investment rose by 25% (to about £250b) in the first twelve months of the Euro. Although this investment represents decisions taken before 1999, it had been known for some years that Britain would not be in the first wave of members.

8. Exchange rate stability for over half of UK trade. This would encourage higher levels of trade, as exporters and importers realised that their profit margin could no longer disappear with an unanticipated exchange rate movement. Remember though that we have a major trade deficit with the EU, and that imports as well as exports will experience this new exchange rate stability. Remember also that 47% of our trade is not with the EU, and that the Euro itself has been unstable against other currencies. An appreciation of the Euro against the dollar subsequent to our joining would do the UK's important ...

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8. Exchange rate stability for over half of UK trade. This would encourage higher levels of trade, as exporters and importers realised that their profit margin could no longer disappear with an unanticipated exchange rate movement. Remember though that we have a major trade deficit with the EU, and that imports as well as exports will experience this new exchange rate stability. Remember also that 47% of our trade is not with the EU, and that the Euro itself has been unstable against other currencies. An appreciation of the Euro against the dollar subsequent to our joining would do the UK's important trade with the USA no favours.

9. UK firms would probably enjoy reduced borrowing costs, encouraging investment and growth, as British interest rates fell to European levels, and UK homebuyers would enjoy cheaper mortgages. It is true that industrial investment in this country has been persistently handicapped by the short term use of interest rates against inflation, but even the present level of interest rates in the UK appears to have set off house price inflation in the south.

10. Rip-off Britain: Those firms that currently price discriminate between different European markets would find it difficult to sustain this practice as price transparency increased. Some profits could be lost by UK firms, but consumers could benefit.

Disadvantages of joining the euro:

1. As with ERM membership in 1990-2, a major concern of some economists is that membership of the Euro would deprive the UK of an independent monetary policy, and subject it to a possibly inappropriate monetary regime. If Euro interest rates were lower than seemed appropriate for the UK, as according to the Bank of England's Monetary Policy Committee they are at present, an inflationary increase of the UK money supply could only be prevented by a tougher than desired fiscal stance, aimed at reducing the Public Sector Net Cash Requirement (PSBR).
Because the UK economic cycle tends to follow the USA, it is hard to see how the "one size fits all" monetary policy of the European Central Bank would be in the UK's interest.

2. As an abundance of economic data suggests, many interest rates in large European economies are far lower than the UK's rate. If the UK economy were forced into implementing a lower and arguably unsuitable interest rate, then this would most likely lead to severe demand pull inflationary pressures induced by excess aggregate demand. If the UK were granted no powers to intervene, the likelihood is that the UK government would have little choice but to leave the Euro in order to prevent the disastrous scenario of hyperinflation.

3. As with decimalisation in 1971, converting to a new currency offers an opportunity to retailers to round up prices and take advantage of the confusion. The depreciation of the pound required to secure entry at a viable exchange rate would also cause import price inflation.

4. In practice, it could be argued that the Euro is likely to be far less stable than many of the European currencies it replaces, including Pound Sterling. As a result of this, it would make it extremely difficult for British firms to make financial forecasts and plans because of the volatility of the demand for imports, as well as the demand for exports outside of the Euro-zone. If the demand for products produced by British exporters is price elastic, then an increase in price caused by fluctuations in the Euro exchange rate will lead to a substantial fall in demand, and a possible threat of insolvency.

5. One-off costs of converting IT systems and coin machines, and training staff, have been estimated at up to £36 billion. These costs would be encountered by UK firms after their competitors in the existing Euro-zone had bedded in the new systems, and thus UK firms would be at a competitive disadvantage for a couple of years after joining in addition to paying the capital cost. Although derided by Gordon Brown as "not worth the paper it's written on,” this estimate seems not unreasonable and no alternative estimate has been offered by the proponents of entry.

6. Stock market decline: It has been estimated that £300 billion could be moved from UK stocks into European stocks as a result of portfolio adjustments which will be required as a result of entry by market tracking funds. Such a decline would put upward pressure on interest rates and make it more difficult for UK firms to borrow in order to invest. UK fund managers will also have to follow the precedent of European fund managers who used to speculate in European currencies, before the creation of the Euro put a stop to that (except with regard to sterling) and forced them to conduct their arbitrage in other markets, thus involving the movement of funds out of the Euro zone. More funds would therefore flow out of the Euro zone and into the dollar and yen, putting more downward pressure on the Euro.

7. Fraud and crime: The Euro notes come in great variety and are not even all on the same paper. Detecting forgeries could be greatly complicated. At 500 Euros the largest note could be particularly attractive to criminals.

8. Higher levels of unemployment would follow an inability to continue to match economic efficiency with the Euro zone, and the UK could not, as in the past, be rescued by currency depreciation. Euro membership is legally irrevocable.

For more arguments for and against joining the euro, specifically regarding the economy, and business and trade, turn to page 11 of the appendix.

The Five Tests

The 1997-2001 Blair government established five conditions that must be satisfied before joining

1.Convergence of business cycles, enabling the UK to be comfortable with Euro interest rates
2.Enough flexibility in the Euro system to deal with problems
3.The impact on firms choosing to invest in the UK
4.The impact on the competitive position of the UK financial industry
5.The impact on growth, stability and jobs

It can be seen that the majority of these tests are subjective questions that perform a political rather than economic function; that is, they allowed the government to put off a decision that was likely to be unpopular. Several of the "tests" are unquantifiable matters of opinion, and will probably be subjected to anecdotal rather than scientific evidence in any referendum campaign.

Conclusion:

Overall, the benefits of United Kingdom joining the euro do outweigh the disadvantages. Plus the adoption of the Euro is likely to result in a stable trading climate within the Euro-zone, allowing firm's to make long-term decisions and realistic financial projections.
Implementation of the Euro is likely to mean that both the UK, and the collective Euro-zone will have increasing influence in the world economy, and this will reduce the volatility of the Euro, thus promoting long-term trade with countries external to the Euro-zone.
A further reason once more promoting the adoption of the Euro is the fact that British firms are likely to become more productively efficient as a result of the reduction in average cost arising from the incurrence of substantial economies of scale.

£ To euro – exchange rate