Economic Revolution Embodied in the European Union - Essay Example

Introduction The monetary and economic revolution embodied in the European Union (EU) entails far more than the elimination of 25 national currencies and the distribution of colourful new banknotes and coins across Europe. Chabot stated that this revolution involves the solidification of a European market of goods and services, major structural changes in countries plagued by fiscal negligence, and the reorganization of monetary policy in some of the world's most advanced industrialized economies (3). Chabot continues that though at a first glance it may seem that a new trans-European currency [and economic policies] would hold little significance outside of banking and tourist circles, the European Union [through its euro currency] has in fact invaded nearly every sector of the world economy, defining in terms of major elections and policy debates and rattling the international business environment (3). According to the European Commission, the "European Single Market" brought about by the fusion of the 25 EU member states is "the world's largest domestic market" (1). This single market involves over 370 million people in search of better employment opportunities, improved living and working conditions, and a varied choice of quality products and services - including access for everyone to services of general interest - at lower prices. This single market also allows individuals to enjoy the right move and work within the EU member states and also sets the basic standards of health and safety, equal opportunities and labor law (European Commission 1). The Birth of the Euro Project According to Temperton, the economic impetus behind the euro project can be traced from the relatively poor performance of the European economies over the past twenty years or more (8). Temperton states that Europe has, for a long time, suffered from relatively weak economic growth, persistently high unemployment and weak economic growth (8). In fact, a term, eurosclerosis, has been coined to describe the dismal performance of the European economy which became more pronounced in the 1980s. In order to correct these problems, European policy making in the last fifteen years emphasized in launching two significant projects: (1) the single European market, with the free movement of goods, labor, services and capital1, and (2) the euro project, the plan for European Economic and Monetary Union (EMU).2 Chabot pointed out that it is a common misconception that the euro, [or more generally, the European Union] is primarily an economic project (37). In fact, Chabot asserts that the project is intensely a political one that has been entangled in the history of Europe for many years. In short, the project has evolved as an essential step toward the ultimate goal of "ever closer" political integration first planned in the 1958 Treaty of Rome, and that the language of the subsequent treaties makes it clear that the euro's introduction is based far more than economic pros and cons (Chabot 37-38). Former Germany Chancellor Helmut Kohl viewed that euro's economic benefits are only secondary and emphasizing instead that "the unification project is the best insurance against a relapse of national egoism, chauvinism and violent conflict" (qtd. in Chabot 38). Chabot continues on that the legacy of two world wars plays a crucial role in the process of European integration (38). Benefits of a Monetary Union In his book, Economics of Monetary Union, Paul De Grauwe asserted that whereas the costs of a common currency have much to do with the macroeconomic management of a country, the benefits are mostly situated at the microeconomic level (60). Eliminating the costs of exchanging one currency into another is certainly the most visible and easily the most quantifiable) gain from a monetary union (De Grauwe 60). The European Commission estimates that the gains derived from the elimination of transaction costs fall between 13 and 20 billion euros per year, one-quarter to one-half of 1% of the Community GDP (qtd. in De Grauwe 60). De Grauwe argues that though this amount might seem very small, it must be noted that this gain has to be added to the other gains derived from having a single market (60). Quoting De Grauwe's words: It should be noted that these gains that accrue to the general public have a counterpart somewhere. They are mostly to be found in the banking sector. Surveys in different countries indicate that about 5% of bank revenues are the commissions paid to banks in exchanging national currencies. This source of revenue for banks disappears with a monetary union. (De Grauwe 60-61) Chabot cites the troubles and hassles tourists often experience when planning European excursions. Before the euro, tourists to Europe burden themselves with the inconvenience and cost of many currencies, each recognized by a small geographic segment of the European Union - and exchangeable only through banks, bureaux de change, traveller service offices and credit card companies for a fee in the form of fixed commissions as well as in the spread between the buying and selling prices of a given currency. One study estimates that the average tourist shells out $13 in such currency conversion costs with every European border crossing (qtd. in Chabot 42). Furthermore, tourism is only a fraction of the economic heartbeat of Euroland because tens of thousands of cross-currency transactions take place every day (e.g. Austrian manufacturing firms sell parts to clients in the Netherlands, France and Italy, which in turn sell their wares in Portugal and Spain). On the other hand, a single currency makes price differences between goods, services, and wages in different countries more evident, thus enhancing competition across markets (Chabot 43). A single currency provides a simple and consistent platform for comparison, spurring households and businesses across to compare prices abroad and easier for them to shop around (De Grauwe 61). In the absence of the euro, consumers find it difficult and cumbersome to compare the prices of computers, automobiles, etc. As a result, price discrimination can easily be implemented. In 1997, an Audi A4 costs about 38,000 marks in Germany compared to the 27,000 in Denmark; a Fiat Barchetta costs about 37,200 marks in Germany but 28,000 in Italy (qtd. in Chabot 43). Another benefit that members of the European Union enjoy is the reduction in the exchange rate risk brought about by the presence of a single currency in conducting trade among themselves. With the significant contribution of exports in the EU economies, uncertainty about future exchange rate changes introduces uncertainty about future revenues of firms. According to De Grauwe, it is generally accepted that this uncertainty leads to a loss of welfare in a world populated by risk-averse individuals. De Grauwe contends that eliminating the exchange risk reduces a source of uncertainty and should therefore increase welfare (De Grauwe 64).3 However, a lower risk due to less exchange rate variability has also a double effect. It reduces the real interest rate and also reduces the expected return of investment, or in other words, the expected value of future profits of firms. As a result, this reduction in risk has an ambiguous effect on investment activity, and thus, also on output growth (De Grauwe 74). In his study on the effect of the euro on the German economy, Nikolaus Keis (1995) assessed that the benefits to the German economy after the introduction of the euro, the real output gains from the euro are assumed to be five per cent over the time span of 10-15 years, or about 0.4% per annum based from the estimates produced by the European Commission in 1990. Keis states that these main gains stem from the disappearance of exchange rate-related transaction and information costs as well as the disappearance of exchange rate risks and the related reduction of investment risks. These changes in turn lead to a better allocation of resources and a more efficient market, likely to encourage stronger investment spending and give a further boost to growth (Keis 46). Using cross-section data and controlling for a multitude of other variables that affect trade flows (e.g. income, distance, trade restrictions, language, etc.), econometric studies pioneered by Andy Rose found that pairs of countries which are part of a monetary union have trade flows among themselves that, on average, are 100% higher than those among pair of countries that are not part of a monetary union (qtd. in De Grauwe 73). Also, using cross-section data, Frankel and Rose (2002) found that a 1% increase in trade between countries of a monetary union leads to an increase per capita income of 1/3 of a percentage point. To the extent that monetary union contributes to increasing trade the member countries of a monetary union could profit from a growth effect of belonging to a monetary union. In sum, these econometric evidences reveal a strong and positive empirical relationship between monetary unions and trade flows, and through this channel, a positive effect of monetary unions on the income levels of participating countries (De Grauwe 74).4 Entry to the EU: Short-Term Pains for Long-Term Gains Big gains entail big sacrifices. As not just any country can become a member of the European Union, the signing of the Maastricht Treaty has set the following "convergence criteria" that EU hopefuls must fulfil: (1) its inflation rate is not more than 1.5% higher than the average of the three lowest inflation rates in the group of candidate countries; (2) its long-term interest rate is not more than 2% higher than the average observed in the three low-inflation countries; (3) it has joined the exchange rate mechanism of the European Monetary System (EMS) and has not experienced a devaluation during the two years prior its application into the union; (4) its government budget deficit is not higher than 3% of its gross domestic product (GDP); and (5) its government debt should not exceed 60% of GDP (qtd. in De Grauwe 130). Fulfilling these criteria does not happen in a one-time event and would entail much of fiscal and monetary tightening for some countries to be accepted in. The European Union created these criteria so as to ensure its members that the joining country is fiscally responsible and that the participating countries are convergent to guarantee a single monetary policy. The inclusion of a country with high inflation, volatile exchange rates, skyrocketing interest rates, or a huge budget deficit would suggest to financial markets that the euro is a risky and unstable project (Chabot 21). As an illustration what EU aspirants have to give up in becoming part of the union, candidate member countries are asked to provide evidence that they cared about low inflation rate. In the case of Germany, it had to go for a disinflationary process that inevitably led to a temporary increase in the unemployment rate (a movement along the Phillips curve). Once the proof is given, these countries could be let in safely. EU aspirants with high existing debts also create a problem for the low-debt countries if high debt countries are to be admitted into the union. In the union, the low-debt country will be threatened with a partner who will have a tendency to push for more inflation. As long as one country has a higher debt-to-GDP ratio it will have an incentive to create surprise inflation. As a result, the low-debt country stands to lose and will be firm that the debt-to-GDP ratio of the highly indebted country be reduced prior to entry into the union. To achieve this, the high-debt country must reduce its government budget deficit. Once this is achieved, the incentives for that country to produce surprise inflation disappear and then it can be safely allowed into the union. In the case of Germany, with public sector deficit standing at 3.8 percent of GDP, it had to cut its government spending by DM40bn. The direct effect of the fiscal tightening was to cut GDP growth by 0.4 percent (Keis 41). This self-imposed suffering is added evidence for Germany that it is serious about fighting inflation. De Grauwe states that the motivation behind why candidate countries are required not to have devalued during the two years prior their entry into the union is that it prevents countries from manipulating their exchange rates so as to force entry at a more favourable exchange rate as a depreciated one would increase the candidate countries' competitive position (135). Finally, the requirement on interest rate convergence is aimed to prevent economic agents (mainly financial institutions) holding bonds denominated in the candidate country's currency from making capital gains in the expense of those economic agents holding euro bonds. This could create large disturbances in national capital markets and to limit them is to reduce interest rate differentials prior to entry to the Economic and Monetary Union (EMU) (De Grauwe 135).5 Apart from the measures that EU hopefuls have to implement in order to enter into the union, these countries have also to encounter a new array of sacrifices upon its membership. According to Chabot, these costs have served as ammunition for critics and have even resulted into a near collapse of the euro project prior to 1999 (Chabot 50). Some of these costs include6: (1) Transaction costs. Between 1999 and 2002, public and private institutions worldwide were estimated to have outlayed billions of dollars in adjusting invoices, price lists, price tags, databases, vending machines, ATMs and the like to new currency. Harder to measure, but equally important, are the countless training and disruption costs of making transactions using the new currency. Production of the euro notes and coins, for example, is costing billions of dollars themselves. (2) Job losses. Currency traders and analysts in Frankfurt and Paris wonder where their income will come from once the Economic and Monetary Union (EMU) is completed. Banks are seen to lose up to 50% of their foreign exchange business and 60% of their revenue from bond arbitrage trading. Simply put, the entry into a union with single-currency system will avert the need for many cross-currency transactions and hedging instruments. Chabot argues that though some of these losses might be offset by gains in industries associated with the introduction of the euro, it is clear that the sheer magnitude such as that of the EMU poses a painful threat to many professions. (3) Opportunity costs. Tremendous effort has been poured into developing the project by local, regional, national and international governments, including the countless hours of analysis and preparation done by the private sector. Critics point out that such resources (billions of dollars worth) would be better spent on reforming the candidate country's troubling structural problems, unsustainable public welfare programs or ineffective innovation. (Chabot 50-51) Other Issues on Membership to the European Union One of the issues raised on members' role in the EU is the question of sovereignty and the role of the state. Kelleher and Klein state that the European Union provides an example of a set of international institutions that, on occasion, actually cause states to do what they otherwise would not (161). Quoting Kelleher and Klein's argumentation: For example, the European Union sued in the European Court of Justice seeking to compel Greece to end its policy denying landlocked Macedonia use of a Greek port for exporting its products. This lawsuit was a significant factor in Greece's decision to drop its trade embargo of Macedonia. There are many examples of EU member states enforcing rules with which they disagree and rejecting policies inconsistent with agreed-upon rules. In other words, EU members accept constraints on their own behaviour imposed by international institutions. They [EU member states] have yielded sovereignty [emphasis mine] to the extent that individuals can sue them in the European Court of Human Rights. (161) The Treaty on European aroused a good deal of popular opposition among EU member states. The United Kingdom refused to endorse some aspects of the treaty and gained exemptions from them, called opt-outs. These included not joining EMU and not participating in the Social Chapter, a section of the Maastricht Treaty outlining goals in social and employment policy, including a common code of worker rights. Danish voters rejected the treaty in a referendum, while French voters favored the treaty by only a slim majority. In Germany, a challenge to the treaty lodged with the country's supreme court contended that membership in the EU violated the German constitution. In an emergency meeting of the European Council, Denmark gained substantial concessions and exemptions, including the right to opt out of EMU and any future common defense policy. Danish voters then approved the treaty in a subsequent referendum. Because of these difficulties, the EU was not formally inaugurated until November 1993 (Urwin, European Union). Beyond the "convergence criteria" that the union imposes on candidate states, many countries opt not to become part of the EU despite the fact that they sufficiently meet all the requirements prior to entry. The United Kingdom, Sweden, and Denmark met the Economic Monetary Union (EMU) criteria but decided not to participate. When Britain signed the Treaty on the European Union in 1992, it negotiated a specific "opt-out right' that allows it to forego the euro but still be a member of the EU. Switzerland and Norway are outside the EU as both countries have long traditions of nonalignment. Switzerland's tradition of independence and neutrality stretches as far as back as 1815. Swiss voters even turned down a parliamentary proposal to join the United Nations in 1986 (Chabot 24). According to Chabot, though many east European nations would like to join the EU, strict requirements concerning democratic institutions, economic stability, free trade, and human rights have precluded membership (24). Urwin (2005) stated that the introduction of EMU led to unprecedented integration and cooperation among EU members. He argued that the consequence was a growing concern among European citizens and some EU member governments that the major EU institutions were not sufficiently democratic or accountable, such as European Parliament having only little real power (Urwin, European Union). Today, the European Union is considering the application of three candidate states, namely, Bulgaria, Romania and Turkey. According to the AEGEE Europe7, analysts agree that "Turkey's membership bid confronts the EU with a challenge unparalleled in the Union's history." Imminent issues on Turkey's application for entry include Turkey would become the EU's most populated member state. Turkey's current population is 71 million, and demographers project it to increase to 80-85 million in the next 20 years. This compares with the largest current EU member state Germany, which has 83 million people today, but whose population is projected to decrease to around 80 million by 2020 (AEGEE, EU Enlargement). Another argument is whether it is possible to establish geographic borders for Europe, and whether Turkey 'fits' within these borders. This is seen by many as a dispute that rests on philosophical and intellectual prejudgements, especially since the Treaty of Rome is widely accepted to aim for the construction of a union of European states based on shared common values (AEGEE, EU Enlargement). Perhaps the most sensitive of all arguments centre on the cultural and religious differences. This is aligned with the fact that Turkey is predominantly as Muslim nation whereas most EU member states are Christian. Since the EU identifies itself as a cultural and religious mosaic that recognizes and respects diversity, the supporters of Turkey's EU bid believe that, as long as both Turkey and the EU member states maintain this common vision, cultural and religious differences should be irrelevant (AEGEE, EU Enlargement). Conclusion The European Union stands as integration of 25 European economies set to promote efficiency in its markets by reducing trade and export barriers. Candidates for membership have to comply with a set of "convergence requirements" that may be "self-suffering" for some especially for those high-debt countries. Issues that EU members and prospect candidates alike have to contend with range from political to geographic and extends to cultural and religious in nature. Works Cited "Action Plan for the Single Market: Communication of the Commission to the European Council." Luxembourg: The Commission, 1997. Chabot, Christian N. Understanding the Euro. United States of America: McGraw-Hill, 1999. De Grauwe, Paul. Economics of Monetary Union. Oxford: Oxford University Press, 2003. "EU Enlargement in 2007 and Turkey's Accession." Association des tats Gnraux des tudiants de l'Europe (AEGEE Europe). 2 Feb. 2006 < http://www.karl.aegee.org/aeg-web.nsf/Full/Events--Enlargementin2007Andturkey'saccession >. Keis, Nikolaus. "The costs and benefits of the euro: a case study for Germany." Temperton 39-50. Kelleher Ann, and Laura Klein. Global Perspectives A Handbook for Understanding Global Issues. United States of America: Prentice-Hall, Inc., 1999. Temperton, Paul. The Euro, 2nd ed. England: John Wiley & Sons Ltd., 1998. Urwin, Derek W. "European Union." Microsoft Encarta Online Encyclopedia 2005. 1 Feb. 2006 < http://encarta.msn.com/text_761579567___0/European_Union.html>. Read More