Macroeconomics Environment of Business - Essay Example

Macroeconomics Environment of Business Q Discuss whether or not the foregoing means that the advantages of the Euro have failed to materialize. If not, explain why not. Ans: 1: Euro is the currency of twelve European Union countries, stretching from the Mediterranean to the Arctic Circle (namely Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland). Euro came into existence on 1st January 1999 when eleven (later twelve) EU countries established the conversion rates between their respective national currencies and Euro with formal circulation of bank notes and coins from 1st January 2002. It was in 1957 when a formal vision of Common European Market was set in motion by the Treaty of Rome, with the aim of increasing economic prosperity and contributing to "an ever closer union among the peoples of Europe". This vision materialized in 1999. But Bordo and Jonung (1999) report that some observers have started raising question marks on the future of Euro. They point out some ‘flaws’ in the construction and working of EMU (European Monetary Unit) like; i. The absence of a central lender of last resort function for EMU, ii. The lack of a central authority supervising the financial systems of EMU, iii. Weak democratic control (accountability) of the ECB, iv. Unclear and inconsistent policy directives for the ECB, v. The absence of central co-ordination of fiscal policies within EMU combined with unduly strict criteria for domestic debt and deficits as set out in the Maastricht rules and the Stability Pact in the face of asymmetric shocks, and vi. Euroland is not an "optimal" currency area. The list can be lengthened. The major benefit of a common currency that has been emphasized is that it facilitates trade (in both goods and services) and investment among the countries of the union (and hence increases income growth within the region) by reducing transaction costs in cross-border business and removing volatility in exchange rates across the union. The report points out that Europe is too large a geographical area to form a well-functioning monetary union. From European standards this could be true, but if we look around, we find that the countries like China, India etc. are much bigger in size and operating with one currency of their own. It is also pointed out that European labour markets are commonly described as rigid and labour mobility within the EMU members as limited. Well, this type of saturation in individual markets could prove to be blessing in disguise as no member country can blame other of excessive infiltration after opening up of borders. The report also argues that in a national monetary union political and monetary sovereignty can go hand in hand. Their question is why the need to abolish the currency of union members? To strengthen this argument, examples of British Monetary Union and Federal Reserve Bank of US are cited, stating that two types of currencies can indeed co-exist. Monetary unification of the US was not completed until long after its political unification. The US did not establish a central bank with a lender of last resort function until this century. Unfortunately this argument too doesn’t seem to hold much water. There were over 700 princely states in India at the time of its independence in 1947, but after independence all states became part of a federal government and a common currency (Indian Rupee) came into being in all the states. It’s been around 60 yrs now, the system is working absolutely fine. Moreover the population and area of India is much larger than the combined area of all countries under EU. On the other hand there is the example of USSR breaking up into 14 smaller countries. Ruble was the currency of a unified USSR, but now the newly formed countries have come out with their own currencies while still accepting Ruble. This system as working fine as well. In fact success of any unified currency depends largely upon the sincerity and integrity of member states. In the case of EU the member countries don’t have a history of fierce rivalry or enmity like between Israel and Palestine (or other gulf countries), India and Pakistan or the cold war between US and USSR. So far each member has displayed maturity and commitment towards the unification move, recognizing the potential of unity for all. Moreover these are early days and initial hiccups are bound to crop up. To think that there should’ve been multiple currencies only because there have been such an arrangement in past means we’re not taking lessons from history. Think about the multiplicity of efforts and resources that are required to maintain two types of currencies simultaneously. Under such circumstances, if all 12 member countries use their own currency together with EMU, at times the chauvinistic feeling also crop up which may bring up the thought of putting one’s country’s currency over that of the unified currency (which in totality means nobody’s currency). Thinking of the positive aspect in EU formation, it is worthwhile here to mention that the transitions of this magnitude, where 12 nations change their currency simultaneously, has been quite smooth and the mutual respect and trust amongst participating nations appears headed towards a sustainable relationship, which is bound to ensure the longevity of Euro. European Currency Bank (ECB) will be taking up the pivotal monetary role coordinating amongst member countries. Any new experiment brings with it a plethora of opportunities for learning, which is an evolutionary process. In this case also, problems are bound to come up, but when all parties will sit together and discuss the matter the outcome will devise newer methods of strengthening the Union. Q-2: .On the other hand, is the Euro threatened by the rigidities of the market and the policies of member government? Ans: 2: It is true that European labor markets are commonly described as rigid and labour mobility within the EMU members is limited. This holds equally good for EU nations as well. Due to this rigidity and inflexibility the unemployment figures are on the rise for couple of years now. Arthur Okun did a study for US administration in 1962 and found out that a 3 per cent reduction in GNP was associated with an increase in unemployment of about 1 per cent in the United States. This was quite intriguing finding, because it implied that a reduction in unemployment had a much larger than proportionate effect on output. Thus came into being the famous Okun’s law, which is considered as one of the most reliable empirical regularities of macroeconomics. But EU needs to take a cue from the fact that a nation with a flexible labor market, able to shift workers from one economic activity to another quickly, smoothly, and without social disruption, would have a substantial competitive advantage over countries unable to adjust smoothly to todays quickly changing demands for various working skills as technology progresses and consumer tastes vary. Factors like rising unemployment, fiscal transfer request and protective measures will result in mutual distrust and appears to threaten the credibility of EMU. For a well functioning monetary union, political understanding and cohesion are the key ingredients. But if we look towards the present global unemployment figures we find that the trend has been similar all around. In countries like US and UK unemployment is on the rise on account of the outsourcing phenomenon as well. It is worthwhile here to mention that the North American job market happens to be dynamic and flexible, which helps in lowering the unemployment figures and yet these economies are hard pressed for a solution for unemployment. One reason for this is that the United States has unusually weak provisions for job security, both in its labor legislation and in the contents of many collective-bargaining agreements. For decades, it has been common for U.S. employers to "lay off" workers for weeks or months during times of slack product demand, and then bring them back when business picked up. Therefore to just weaken or abolish job-security provisions is not really creating labor flexibility, but rather just labor expendability. EU nations like France and Germany too are not immune from the outsourcing phenomenon, which is slightly off-balancing the employment figures in these countries. But this is a temporary phenomenon, as most of outsourcing companies are on way to make quick profits by indulging in cost-cutting exercises. Overall the strength of a nation is determined by the GNP and GDP figures, which help in firming the belief of investors in these economies, which in turn helps in lowering the unemployment figures. A currency is like language. As a common language facilitates effective communication among people, a common currency could promote trade and investment among countries. More trade and investment means more job opportunities. In an environment of different currencies, transaction costs, including the costs of obtaining information about prices, would be higher. This may prove to be a disincentive to trade, commerce, and investment. To offset the major drawback of difficulty in maintaining employment when changes in demand or other "asymmetric shocks" may require a temporary reduction in real wages in a particular region. High labor mobility is thus required in order to offset such disturbances. Having gained enough confidence of each other, EU citizens will gradually open up to each other and this may trigger the intra-community movement. Recently during the Soccer world cup (Germany-2006), a large number of EU nationals took full advantage of being part of a European Union, when they made it sure that the on the day’s of the matches they happen to be in or around the stadium in Germany. In case they got the tickets they were inside the stadiums, if not they enjoyed the matches on the giant screen placed in the Fan clubs around the stadium. Their journey was hassle free and they were roaming the streets of Munch, Berlin, Dortmund etc. as if they are enjoying an evening walk around their backyard. Such type of events and confidence building measures will definitely result in more manpower movement across EU nations. Like any desirable thing, achieving labor-market flexibility costs money and effort, for which the EU nations need to sit-up and take stock. Q.3: Provide a satisfactory conclusion incorporating and summarizing your answer to the above two questions. Ans-3: Prior to January 2002, around 14.89 billion euro banknotes and 51.629 billion euro coins were produced throughout the euro area. The speed of changeover from existing national currencies to the euro varied from country to country depending on their respective national changeover plans. EU citizens were granted a changeover period for dual circulation from four weeks to two months. The changeover was therefore quite smooth. When someone readies to enter an alliance he first of all tries to convince himself about the positive aspects of the alliance and once satisfied, goes for the agreement. Later he tries to convince his near and dear one’s also to do business with the alliance, providing further strength to the alliance. Similar is the case with EU nations. In line with the existing tradition of agreements between France and Monaco, Italy and San Marino & Italy and the Vatican, these countries (i.e. Monaco, the Vatican City and San Marino) have each concluded monetary agreements with the EU Community. These agreements allow them to issue limited quantities of euro coins with their own national sides, while they use the same banknotes as the euro area. Similarly Andorra has never had an official currency or any formal currency regime, but uses euro notes and coins since they replaced the Spanish peseta and French franc, which previously circulated in the Principality. In May 2004, the EU Council approved a decision on the position to be taken regarding an agreement concerning the monetary relations with Andorra. Euro is also being used as the domestic currency in certain parts of former Yugoslavia, in particular Kosovo and Montenegro, without any official agreements, following the precedent set by the German mark which had previously been the de facto currency in these territories. Luxembourg-Belgium and Liechtenstein-Switzerland are also the examples where monetary authority is exercised entirely by the larger country i.e. Euro is the prevailing currency in these countries as well.. It is therefore quite true to say that in a national monetary union political and monetary sovereignty go hand in hand, but to conclude that the borders of the nations state must determine the borders of the monetary area will be a gross understatement in the era of globalization. It therefore appears quite certain that Euroland is here to stay, despite the pessimistic view expressed by some. These observers certainly have their own logics and historical evidences in support of their statements yet in this information age, when the world is bracing itself for a global village and global community, to say that one should remain limited to his cocoon will not be a correct position. There are cases like the Scandinavian monetary union, which had one common unit of account, the Scandinavian Krona, and three members: Sweden, Norway and Denmark. Each member maintained its own central bank, issued its own Krona currency which circulated freely within the other countries as long as the union existed. The exchange rate of the Swedish, Danish and Norwegian currency units remained one to one during the existence of the Scandinavian currency union. Voices of dissent have been noticed initially like that of an Italian Welfare Minister who called upon his country to quit the Euroland arrangement, but the Euro steadied on foreign exchanges in the very first week of its launch, after EU finance ministers rallied behind the single currency. Observer’s doubt about the health of Euro also takes shape from some of the dissolutions of monetary unions in the past. For example the outbreak of World War I signaled the end of the Latin and the Scandinavian monetary unions. But at the war time, anything can happen and the sharp increase in military expenditures forced the involved states to issue paper money. As paper money was not recognized as legal means of payment in any country other than the issuing one, the respective union was therefore terminated. Expressing apprehensions about the EMU, observers feel that a keeping dual currency helps each member nation when the co-ordination between member nations breaks up and a need is felt to rapidly re-establish the domestic currency. They also contend that the key economic cost from formation of a currency union by a group of countries is the loss of national autonomy in monetary policy. For the sake of argument the statement appears logical but it doesn’t make a sound economic sense, as it results in dual expenditure in maintaining two types of currencies. Also disproportionate volatility in exchange rates increases uncertainty, discourages trade, diminishes investment, and reduces overall economic growth Taking a cue from EU, in terms of factor mobility, ASEAN nations too are thinking towards more co-operations amongst the member countries. ASEAN has the advantage of greater labor mobility as well as capital mobility The saying goes ‘Unity is strength’. It helps in creating a bigger capital market and stronger Central Banking Institution. From a purely economic point of view, a set of countries should therefore opt for a common currency if the cost of losing national autonomy in monetary policy is mitigated by the benefits of a currency union. Common currency promotes greater trade among countries, openness and the volume of intra-union trade will be greater under a common currency than under a regime of floating exchange rates. It results in lower transaction costs in trade and less uncertainty about relative prices. As for the rigidities or flexibility part Neo-Liberal theorists indicate that societies face a forced choice between labor-market flexibility and job security. However, there is no inevitable trade-off between the two - both are desirable goals, and both can be achieved, through careful planning and an equitable distribution of the costs of achieving them. Resources: 1. Website of European Central Bank, “The Euro banknotes coins and more”,. http://www.euro.ecb.int/en.html (accessed on July 26, 2006) 2. the European Commission’s website on the euro, “The Euro, Our Currency,” http://europa.eu.int/euro/ (accessed on July 26,2006) 3. Gary Duncan, Economics Editor (2004) The hindu, “EU rejects threats to euro” http://www.blonnet.com/2004/12/04/stories/2004120400880700.htm (accessed on July 27, 2006) 4. OECD, “Economic Survey of the Euro Area 2004”, http://www.oecd.org/document/47/0,2340,en_2649_201185_33618087_1_1_1_1,00.html (accessed on July 27, 2006) 5. Michael D. Bordo, Lars Jonung (September 1999), “The Future Of EMU: What Does The History Of Monetary Unions Tell Us?” Read More