The Costs and Benefits of Joining the Economic and Monetary Union - Case Study Example

The Costs and Benefits of Joining the Economic and Monetary Union Introduction Economic and Monetary Union (EMU) came into force in 2002, where single currency began to circulate within the eurozone. Although the implementation of the EMU was successful, more challenges have arisen than it was expected. Cost of joining Economic and Monetary Union is greater than the benefits that a country may gain. Foundation of EMU was part of Rome treaty aimed at creation of a common market. Since the treaty had no explicit commitment in the achievement of integrating European countries to a common market, launch of EMU has played a key role towards this. Use of common currency has cleared the impediments in achieving free single market for European countries (Debra, & Colin, 2007, p. 162). The formation of Economic and Monetary Union was triggered by difficulties that impeded free trade within the European countries. Challenges in free movement of goods and services, and labour and capital have led to the formation of EMU. Also, the complexity of policies to ensure fair competition, and economic corporation and coordination among the EU member countries has been a driver towards establishment of EMU. Elimination of divergent monetary policies that undermine and distort interdependency benefits in any economic integration was also an objective towards the formation of EMU (Debra, & Colin, 2007, p. 162). Some countries have benefited from joining EMU, while others have incurred a lot of cost in trying to live within the stipulated union policies. The following are feature of EMU that help in achieving the objectives of the Economic and Monetary Union. Harmonization of policies to remove barriers that impede free movement of factors and products. As mentioned earlier, one objective of EMU is to have free movement of goods, services, labour, and capital. Availability of wide range of similar policies that ensure macro-economic stability within the region. Availability of common currency among the member countries which has irrevocable fixed rate of exchange. Common monetary policy. This has been through the provision of common exchange rate and rate of interest policy by the central bank. Economic and Monetary Union is aimed at reservation of foreign exchange. Lastly, Economic and Monetary Union is characterized by the inter-state transfers that are aimed at counteracting any distortion to the economies of member states of EMU (Debra, & Colin, 2007, p. 163) The Economic and Monetary Union has the powers in certain economic areas such as the: determining exchange rate policies, interest rates policy determination, and constraints acceptance in the process of macro-economic policy implementation. The politicians in member countries of EMU are obligated to bring in economic structural reforms that are required to ensure that the economies of their countries can survive within the Economic and Monetary Union (Debra, & Colin, 2007, p. 163). This also ensures smooth running of EMU. In addition, Economic and Monetary Union has brought in political debate on how EMU impact the need for broader political unity among the member states, and the nature and role of European Union for some years to come. This helps in determining if a political opinion should head the monetary union for Economic and Monetary Union to function (Debra, & Colin, 2007, p. 163). Benefits of Joining EMU The introduction of common currency under the establishment of EMU has had some benefits to the European countries. The common currency has made the economies of the EMU member states to be efficient. This has been through two ways: reduction of cost of transaction among the European countries, and elimination of risk arising from uncertain exchange rates fluctuations (Buti, 1998). The transaction cost in this case is incurred in different ways: one is the fixed commission, and two is cost incurred in the process of buying and selling currencies. Such costs are not incurred under the Economic and Monetary Union (Buti, 1998). This is of great benefit to companies or individuals dealing with foreign partners within the European Union region. Countries willing to join EMU will benefit from common currency in that; they will be able to make price comparison among the member states. This will further help to harmonize such prices if any differences exist (Buti, 1998). Price transparency and transaction costs disappearance make the European money market to be more integrated and deeper. The listing and issuing of financial instruments in euros has made prospective investors to have confidence as they invest on various financial markets of European Union members (Willem, 1996, p. 96). The integration of financial markets in European Union nations offers different channels for the members of Economic and Monetary Union to share risks. If we take the assumption that the equity and bond markets of German and French are completely integrated, it will be easy for the two countries to respond to asymmetric shocks (Willem, 1996, p. 99). The most argument for the establishment of EMU was to remove foreign exchange rate uncertainty which damaged the trade flows and investments (Willem, 1996, p. 101). This has the implication that, those investors facing trade or investment opportunities will not waste time trying to evaluate financial market as risk fluctuations in currency will not be included in their decision making (Willem, 1996, p. 101). If there are uncertainties in the financial market regarding the exchange rate, it will be risky for investors from foreign countries. This also has the implication that less companies will be willing to invest in foreign financial markets. For this matter, Economic and Monetary Union has eliminated the risk associated with fluctuations in foreign exchange rates (Willem, 1996, p. 106). Costs of Joining EMU Despite the fact that launch of EMU and use of common currency has been successful, there are many challenges which need to be addressed for EMU to move forward, and for the European Union country members to gain stability in their economic activities. There are costs which a country may incur when joining EMU. In the process of adjusting to a new currency, an individual or institution must suffer some costs (Crowley, 2002, p. 174). Also, the member states of EMU may lack the proper monetary tool necessary for readjustment to the equilibrium incase they face economic shock. New members of EMU must incur certain cost in the process of making adjustments in their: price lists, payrolls, invoices, office forms, databases, bank accounts, and postage meters among others (Weber, 2000, p. 3). The EMU macroeconomic environment has been experiencing unexpected economic shocks which have contributed to the instability in consumption, production, government spending, investment, and trade (Weber, 2000, p. 5). The worst effects of economic shocks are the one which do not affect the member states equally, that is, asymmetric shocks. The significant feature with these shocks is that, the economy of the affected country begins to decline, while the economies of unaffected countries continue to grow (Weber, 2000, p. 9). If the affected country had not changed its currency into euro, it could have had an opportunity to handle the economic shock by use of fiscal and monetary policy. However, since the country had joined Economic and Monetary Union, it has no right to carry out national monetary policy to correct the asymmetric economic shock. Instead, the country should look for other corrective measures to handle the situation (Crowley, 2002, p. 172). Given the several factors that have impeded the implementation of EMU objectives, the big question remains that, why the member states of European Union have went ahead and launched the EMU. Also it has been evidenced that there are many countries which are willing to join the Economic and Monetary Union (Feuerstein, & Grimm, 2004). These countries should first evaluate the costs and benefits associated with the Economic and Monetary Union. However, some of these benefits and costs are difficult to quantify but are significant to be considered before joining the Economic and Monetary Union (Feuerstein, & Grimm, 2004). Weighing Out Costs and Benefits of Joining EMU The assessment of the gains that a country may get after joining the EMU prove not to be great as it is expected. For example, it has been estimated that the EMU savings realized from the Gross Domestic Product of European Union is about 0.5 percent (Tavlas, 2004). Such benefits have also been found to be unevenly spread as the smaller member states which depend mostly on the trade within the European Union gain more from the Economic and Monetary Union. It has been argued that benefits from the EMU will be fully realized after a long duration of time (Tavlas, 2004). For example, such benefits will be felt after a period of ensuring price stability with the trade region. The impacts of Economic and Monetary Union are also not well distributed across the businesses. The most beneficiaries of this union are those business enterprises that carry out business activities in foreign market. Therefore, it is the larger business enterprises expected to gain more from the Economic and Monetary Union. The benefits which accrue to the larger enterprises also extend to other bigger non-European union business enterprises which have extensive investments in the European region (Debra, & Colin, 2007, p. 167). Despite the fact that the large business enterprises are prone to EMU benefits, it will not be the case to all of them. Those business enterprises with firm domestic market will not gain more from EMU until their markets grow and begin to show greater level of international-isation (Debra, & Colin, 2007, p. 167). In this case, it is hard to determine the benefits that small and micro enterprises may get from Economic and Monetary Union. Although several small and micro enterprises normally like to carry out their business in local markets, there some which are export oriented. These businesses may include information and technology businesses. Such SMEs may benefit from their member countries joining the Economic and Monetary Union (Debra, & Colin, 2007, p. 167). However, although one of the objectives of EMU is to harmonize macro-economic policies among the member states, there are still price differentials for products sold by the SMEs in European Union member states. For this matter, there is need for Economic and Monetary Union to hurry up in convergence of prices by helping the consumers to make price comparison among the member states without difficultness, because of the established price transparency (Feuerstein, & Grimm, 2004). Also, the transparency in this case will be experienced in labour market as there will be transparency in determining and setting wages. This will benefit the member states by allowing collective bargaining on labour costs among the European Union states (Feuerstein, & Grimm, 2004). Presence of price transparency as a result of joining EMU, can lead to a change in the patterns of supply as the exchange risk is eliminated. The high degree of transparency within the eurozone has helped business firms to optimize their sourcing processes. A country joining EMU should also expect to enjoy benefits such as price convergence in economic sectors such as: financial services, banking, cars, pharmaceuticals and chemicals. However, the price convergence within the European Union regions is faced with challenges due to existence of transportation costs, existence of cross-border shopping costs, differences in testes and preferences, differences in local costs, and different competitive situations (Debra, & Colin, 2007, p. 168). The benefits and costs of Economic and Monetary Union will be felt after a long duration of time. It has been argued that benefits arising from the EMU are directly related to the size of the union. The larger the size of the union, the more the benefits the member countries will enjoy. EMU opponents regard it as a political exercise that has no any positive economic impact to the member states. However, the big issue is when the European Union nations will have similarities that will enable them to co-exist with a similar currency. If there will be no stability within the European Union region, it will be very hard to sustain price convergence. The perception that the EMU countries are not at the same trade cycle stage, has been a major challenge for new entrants to join the union (Debra, & Colin, 2007, p. 169). For example, the delay by the United Kingdom to become EMU member was due to this perception. The same case applied to Ireland. In 1973, of all European community members, it was the poorest nation in terms of income per capita. However, in 1990s Ireland experienced dynamic expansion in its income per capita, where in 2000s it became the leading state in European community (De Grauwe, 2002). In connection to this, during the first years of common currency, higher rate of interests and restrictive monetary policy than those favored by Germany and Italy, which were struggling to end unemployment and unpleasing economic growth, would have been the right time for the Ireland to join Economic and Monetary Union (Debra, & Colin, 2007, p. 170). The big question here is that whether it is ideal for all countries to use one monetary policy. The implication from above is that for countries to apply one monetary policy, their economies should be aligned, otherwise one country will experience inappropriate rate of interest (Debra, & Colin, 2007, p. 170). Therefore, before a country makes decision to join EMU should make good evaluation on how different economies would enhance its factor mobility so as to ensure balance out of the differences that may exist, and to whether the Economic and Monetary Union will assist in aligning these cycles closely (Debra, & Colin, 2007, p. 170). One of the serious problem affecting states that are joining the Economic and Monetary Union is lack of real convergence (Debra, & Colin, 2007, p. 170). Lack of real convergence will expose EMU to asymmetric shocks. This will lead to different zone areas to be affected differently by the external shocks. For example, some states will experience high inflation rates while other experience increasing levels of unemployment (De Grauwe, 2002). This being the case, it will be very hard to practice the use of one monetary policy. The Economic and Monetary Union will only work if there is uniformity in shocks, or if the integrated economies have enough transfer mechanisms to make compensation for such impacts. The transfer mechanisms could include mobility and flexibility of resources, or fiscal transfers (De Grauwe, 2002). The fact that none of the above conditions is found in European Union, the Economic and Monetary Union will not be ideal for new entrants, and the EU should not be the starter of EMU for the member states (De Grauwe, 2002). The European states are subject to irregular shocks, and lack of enough resource flexibility or mobility to compensate the effects resulting from such shocks. For example, most European states have different levels of unemployment. This has the implication that there is need for the EMU to initiate labour market structural reforms if it has to run smoothly (De Grauwe, 2002). It has been very costly for policy makers in the process of complementing indigenous enterprises competitiveness (Debra, & Colin, 2007, p. 171). The competitive devaluation as an option to ensure competitiveness in international markets has not been rejected in terms of trade by the other European Union nations. This puts more emphasis on cost alteration by the firms and; that the firms should be flexible if they need to compete effectively in both global market and European market. Flexibility in this case requires the respective government to set the market forces to be free within the economies of European community members in both product markets and factor markets (Debra, & Colin, 2007, p. 172). Conclusion In conclusion, it is clear that although the establishment of Economic and Monetary Union was aimed for higher economic growth among the European countries, the costs incurred outweigh the benefits. There are factors which were not considered before the implementation of EMU economic policies. The case of existence of asymmetrical economic shocks distorts the economies of the affected countries, and also brings complexity in correcting the economics shocks. The fact that different economies are not at the same stage of economic growth and development is a clear prove that Economic and Monetary Union can not work smoothly. For a joining new member to EMU may see the theoretical benefits of Economic and Monetary Union, but practically suffer myriad costs. It is also clear, although the EMU is aimed at achieving convergence, there in no convergence due to existence price differentials, and asymmetry in economic shocks. As one country experience decline in economic growth due to economic shock, the other countries may be experiencing growth in their economies. Therefore, before a country has to join the Economic and Monetary Union should first evaluate its level of economic growth and see if it can absorb the economic shocks. References: Andy, B. & Hodson, D. 2005. Adjustment to EMU: One Europe or several? Basingstoke: Macmillan. Buti, M. 1998. Economic policy in EMU: A study by the European Commission Services. Oxford: Oxford University Press. Crowley, P. 2002. Before and beyond EMU: Historical lessons and future prospects. London: Routledge. p. 172-175 De Grauwe, P. 2002. Challenges for monetary policy in euroland. Journal of Common Market Studies, 40(4), 693-718 Debra, J. & Colin, T. 2007. European business. 2nd ed. London: Routledge, p. 162-172 Fair, R. 1998. Estimating stabilization costs of the EMU. National Economic Review 1(164) Feuerstein, S. & Grimm, O. 2004. The road to adopting the euro. Intereconomics, 39(2), 65-81 Tavlas, G. 2004. Benefits and costs of entering the Eurozone. The Cato Journal, 24, 18-26 Weber, A. 2000. The euro: A challenge and opportunity for financial markets: London: Routledge, p.3-10 Willem, V.V. 1996. European Union since 1848: A political and historical analysis. Oxford: Oxford University Press, p. 96-107 Read More