Economic and monetary union

Identify and discuss the costs and benefits of joining the Economic and Monetary Union (EMU)? Do the benefits outweigh the costs?

Thesis Statement

The Economic Monetary Union has been the centre of prolonged debates as to whether a country joining it will either create benefits or drawbacks. During the course of this analytical report, both costs and benefits will be identified and explained in order to judicate the feasibility of joining the EMU and a specific country will be chosen to illustrate this further.

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Introduction

To understand the concept behind the creation of the Economic Monetary Union, the overall objective of the European Union must firstly be understood. Since the end of the World War II, European political forces have been attempting to unite forces in order to escape the extreme forces of nationalism which were seen as unsustainable. Industries were evolving and beginning to compete globally, international trade throughout the globe expanded at an exponential rate and some felt it had to be regulated in order to maximise the gains achievabe. As a result, the European Union was set up in 1993 with X. Its primary principles are of a single market with no barriers to trade in goods and services or to capital and labour movements, competition and social policies, co-ordinated macroeconomic policy and a harmonised fiscal policy. In order to regulate these aspects effectively the EU set up a body named the Economic Monetary Union. This was seen as potentially a contender to the widely traded and valued US dollar and as the solution to deepening the integration of the European Union.

The EMU is characterised by the following policies, policy harmonisation to remove barriers to improve mobility, a common monetary policy which states there is one interest rate and exchange rate policy determined by the Central Bank, fixed exchange rates via the single currency and the pooling of foreign exchange reserves. The evolution of the EMU began in the late 1980s and was characterised by three stages set out by the Delors Report in 1993. The first stage was devoted to ensuring all member states participation in the Exchange Rate Mechanism and improved policy co-ordination and the removal of barriers to capital flows. The second stage consisted of the creation of the European Monetary Institute (EMI) and central banks becoming independent from their national governments (January 1994). Finally the last stage involved fixing the participating currencies and creating the European System of Central Banks which takes over the responsibility for monetary and exchange rate policies and finally the Stability and Growth pact came into force by January of 1999 to ensure member states that do not comply to the EMU principles are fined or sanctioned. During this evolution in 1992 twelve countries signed the Maastricht Treaty, which fundamentally was the root of the introduction of the Euro. During 1992 and 1997 the convergence criteria was set out which stated that in order for a country to join it must have a low and stable inflation, stable exchange rates and stable public finances and by 1999 the countries officially joined the EMU. However as the Euro could not be introduced overnight, there was a transition period in order to allow the member states to adapt to the new currency and after three years, by 2002, the euro was officially the single currency for all European union member states.

Initially the transition period was considered a triumph by European Union members, but as individuals (mainly economists) observed the evolution, many critics are still debating whether joining the EMU and endorsing the euro brings success or just adds to the ever amounting issues each member states are already experiencing. This topic will be thoroughly explored throughout the course of this analytical report and a balanced argument will be drawn from the information available as to whether the EMU carries with it primarily, benefits or costs to a member state joining.

The Economic Monetary Union is considered to be one of the major steps in integrating a before divided Europe, as people and businesses could begin moving and trading freely as trade barriers were removed, the currency becomes more stable, financial markets are integrated, the cost of exchanging currencies was eliminated, transaction costs reduced and theoretically increased competition between countries which is a driving factor in keeping prices low and productivity high which is both favourable for consumers and businesses. These benefits must be more deeply explored in order to comprehend the extent to which they have aided success or deepened the intricate network in Europe.

The success of the EMU has been difficult to quantify as its revolutionary principles have only been recently enforced, however the theoretical benefits are supposed to be more easily identifiable in the long run as more member states join and European integration is extended to particularly the eastern European community. Debra Johnson and Colin Turner state that one of the major benefits, the elimination of transaction costs in intra-EU trade, have only saved 0.5% of the EU’s GDP and that SMEs which predominantly serve local markets, will not benefit extensively from this. However as successful SME’s usually have high exports they can expect a favourable return from the introduction of the Euro.

The EMU is also responsible for the lowering of interest rates. Various studies suggest that decentralised fiscal policies cause a bias in inflation and public spending (Sibert 1992, Levine 1993, and Levine and Brociner 1994) and therefore are in favour of the co-ordinated fiscal policies in a monetary union.

The single European market can bring numerous benefits to a joining country such as the price transparency. It is still considered too early to quantify precisely the degree to which it has helped and many argue that the EMU must speed up the price convergence through enabling consumers to compare prices across member states more easily. This in turn could facilitate a lowering or raising in in labour costs and could change supply patterns resulting in a more stabilised and fair souricng of resources for firms and possibly improve equality throughtout the European union. These benefits are possibly achievable but have not yet been completely achieved as these processes take time and co-operation and some believe these are not present in todays European society as the recession has caused political and financial instability.

The EMU has the potential to create extraordinary gains for the member states but these will not be visible or quantifiable in the near future as it is a timely process of evolution, this therefore poses a risk of not only time consumption but also of resources both nationally and individually and along with the few drawbacks of joining the EMU, critics believe the EMU is not the optimum choice for certain countries in Europe.

The drawbacks of joining the EMU are considered to not outweigh the benefits by the majority of observers but still must be considered thoroughly before joining a revolutionary body which causes a country to enter a short-term of deflation, the loss of the exchange rate tool which is considered a tool of national economic policy, the potential problems related to a lack of ‘real’ convergence and potential policy conflicts and finally the inappropriateness of one monetary policy for many states. These will be analysed and explored in order to conclude whether these outweigh the benefits even considering the majority of parties disagree.

The main risk of joining the EMU is the differences in trade cycles between countries, this is one of the core reasons as to why the UK is yet to join. European countries have differing economic statuses and languages, which fundamentally are essential in permitting countries to maximise the gains achievable from a single currency. It is therefore argued that more attention needs to be given to how economies can enhance their factor mobility to balance out the differences found in differing countries. Cohesion funds are the possible solution to the problem but today there are still great differences across the member states in terms of economic performance and labour mobility. This raises the legitimate question whether one monetary policy can fit all member states.

The globe today is experiencing an economic recession which is highlighted one of the major issues with joiing the Economic Monetary Union as governments from member states are obliged through the stability and growth pact to keep to the Maastricht criteria meaning they cannot regulate or alter fiscal and monetary policies in order to alleviate the problems arising from a receeding economy. Countries would not be able to devalue to boost exports, to borrow more to boost job creation or to decrease taxes because of the public deficit criterion.

The most debated issue with joining the economic monetary union is the loss of national sovereignty. This would result in more established and developed states having to co-operate with the less stable and strong economic countries which are more tolerant to higher infation rates.

Finally, the last drawback of joining the EMU is the initial cost of introducing the single currency. This issue is mainly debated in the UK as the British Retailing Consortium estimated that British retailers will have to pay between £1.7 billion and £3.5 billion in order for the Euro to be introduced. However it is argued that the one off cost does not outweigh the long-term benefits obtainable from the policies and regulation and that if more countries join the EMU these benefits will be amplified even further.

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Robert Mundell and Abba Lerner(1960s) believed in a currency area. This is “a group of countries that maintain their separate currencies but fix the exchange rates between themselves permanently” (Nello, 2009:205). The optimal currency region (OCR) is the idealistic view that an entire region sharing a single currency can benefit extensively the efficiency of the member states’ economies. It states the optimal characteristics needed for a successful economic integration to occur. These are optimal labour mobility across the region, openness with capital mobility and price and wage flexibility across the region and an automatic fiscal transfer mechanism to redistribute money to areas/sectors which have been negatively affected by the first two characteristics.

Supportive Evidence

The UK has the world’s fourth largest economy and the EU’s second largest and is consequently one of the primary targets of speculation as to whether the benefits outweigh the costs of joining the EMU. In 1999, The Chancellor of the Exchequer, Gordon Brown said that although the government supported the principle of a single currency, Britain would not join. This decision was based on various factors that could have caused rifts in the country. In terms of trade it was seens as unfeasible to join because the UK has the lowest level of intra-EU trade and therefore is more vulnerable to fluctuations in external countries. The UK is vulnerable compared to the rest of the EU counties to potential unfavourable interest rates set by the Central Bank because it has one of the highest percentages of home owners potentially leaving British mortgage holders in a state of crisis. Another characteristic that lead the UK to not favour the joining of the EMU is its position as an oil producer and exporter meaning it is harshly affected by changes in oil prices, however as the quantity of oil diminuishes at an ever expanding rate and the gradual transition to more sustainable energy resources means that this is not as important as it was when the EMU was introduced a decage ago.

These issues are feasible arguments to the absence of the UK in joining the EMU however as the countries that have joined the EMU continue to attract foreign direct investments, the UK has been threatened by foreign investors that the Eurozone is becoming a more attractive zone to trade with because of its increased stability. The United Nations Conference on Trade and Development released information on the World Investment Report in the form of a bar graph clearly illustrating the downward trend of inward FDI of the UK compared to the general upward trend of the countries with the EMU.

As clearly illustrated by figure 1.0, the UK continued to attract FDI from 1992 until 2000, where it increased five-fold from 20 billion in 1992-1997 to almost 120 billion U.S dollars in 2000. However by 2003 this figure drastically fell to below 20 billion, which was less that it was almost ten years before. Whilst France, Netherlands, Spain and Ireland all either increased or stabilised by 2000 and resumed until 2003. This is further evidence that the UK should consider joining the EMU, in order to guarantee long-term success. As more countries join, currently 26 today, the EMU is ever closer to achieving an optimal currency area (Mundell, 1973) creating, idealistically speaking, a perfectly harmonized economy and resulting in countries flourishing.

Conclusion

In a perfect world, the EMU’s potential benefits would be endless but due to unforeseeable fluctuations in economies, labour mobility, and personal matters it is difficult to quantify the benefits and costs of joining the EMU. Especially with the recent economic downturn the risk of joining the EMU has been even more re-considered by certain countries especially the U.K. However these drawbacks are limited and do not outweigh the vast benefits achievable from embracing a single currency and single European market as it would guarantee to a certain extent the long-term success of a country as harmonization and stabilisation will cause consumers to be given better prices and businesses to trade more efficiently creating a, arguably, more competent country.

Establishment of the Maastricht Treaty which was signed by twelve countries in 1992, which set out the convergence criteria, ultimat

The Maastricht Treaty of 1992 established a single currency, the euro, and on January 1st 2002, the EMU began using the euro.The EMU was created in 1992 It has stringent conditions and objectives which countries have to meet via signing the Maastricht Treaty. With joining the EMU, the euro must be endorsed and therefore the monetary policies become the responsibility of the European Central Bank and national central banks of member states. Essentially they are co-ordinating the monetary and fiscal aspects of the member countries.

Sovereignty