Why the UK joining the Euro Zone Could Be a Challenging Experience - Essay Example

Economically the case for the UK joining the Euro is problematic and fraught with uncertainty while the political case is much stronger. Background The European Monetary System (EMS) was created in 1979 as one of the attempts at integrating the European economies into one market that could compete with the economic might of the United States. Particularly, the EMS was introduced in order to minimize the risk of changes of exchange rates that hampered trade between European countries. Economists expect the Euro to raise the standard of living of the Euro Zone members over time. By ending the inconvenience and expense of exchanging currencies, the Euro will enhance the free flow of goods, services, and resources among the Euro Zone members It was the 1st of January 1999 when the Euro was officially adopted as the official currency in the participating countries of the European Union (EU), namely France, Germany, Spain, Portugal, the Netherlands, Belgium, Luxembourg, Austria, Italy, Ireland, Finland and Greece. Citing economic disadvantages, some EU countries refused to join the European Monetary Union (EMU) and have not introduced the euro in their domestic market. United Kingdom is one of these countries. Economic Arguments The United Kingdom’s economy is larger than any of the European Union members. Since 1992, the UK has enjoyed a growth of output and employment, combined with low inflation, superior to most European economies. (Dobson & Hook 2003: p. 113) Public opinion in Britain seems to equate economic disadvantage to the country once fully integrated with the weaker European economies by abolishing the pound in favor of the new currency. In fact, a big number of people do not want to give up the Pound for the Euro because the latter is thought to be inferior. (Wargitsch 2007: p. 1) Indeed, why change a successful system? The UK economy differs from the rest of the EU in three main ways, which may mean that it would be affected more significantly than other members by changes in policy, thus the hesitations. These differences are: 1. More UK borrowing is undertaken on variable interest rate terms than in most EU countries. So if the Euro area’s interest rate were to rise, this would affect UK home buyers and firms more than those in other EU countries. 2. The UK trades more with the US than other EU countries. 3. The UK is also still a major exporter of oil, so its economy is influenced more (and in a different way) by changes in the world price of oil than other EU countries that import oil. (Grant, Vidler, Ellams 2003: p. 202) Back in 1997, Tony Blair and Gordon Brown set five economic conditions for joining the Euro: 1) the UK economy needed to converge with the Euro Zone economy so that Britain could cope with Euro Zone interest rates; business and workforce had to demonstrate the ability to adjust to change; a decision needed to be made on whether joining the EMU would encourage investment in UK business; joining must not adversely affect the UK financial services industry; and the fundamental test, that would be promoted long-term., stability and employment would be promoted long-term. (Temple, p. 51) By 2003, these tests were deemed complete with the Treasury finally concluding that the five tests for joining the Euro had not been satisfied. And that the Euro Zone economies were not matching the UK’s growth. Economists predict the currency shift might prove costly for Britain, arguing that there would be transactional costs, which are costs of changing over from using the pound to using the euro; and that there would be a reduction in independence of macroeconomic policy and that in addition to no longer being able to operate its own interest rate, the UK government would lose the exchange rate as a policy tool and would have constraints imposed on its use of fiscal policy. (Grant, Vidler, Ellams 2003: p. 202) There are economists who argue that a serious economic problem could emerge if the UK were to abstain for a prolonged period of time from Euro membership. For instance, we have Welfens Paul (2001) , who stressed that: Since the UK business cycle is more dependent on the US cycle than Euroland, there could be cyclical reasons for pound-Euro exchange rates. If speculative attacks on the Euro should emerge a strong appreciation of the pound is likely. British industry and foreign investors in the UK will face disadvantages under such circumstances. (p. 109) Then, there is also the abolition of the overshooting and undershooting of sterling, which have led to swings of 30 percent or more in the exchange rate in recent years and destabilised British overseas trade. Brittan (1998), explained that merging the sterling with the euro is expected to leave only some 10 per cent of GPD affected by swings of the euro against other world currencies such as the dollar and the yen. (p. xi) Given all these facts, there is a general consensus gained much from experience that the advantages of keeping the pound far outweighs the disadvantages. This is one of the reasons why analysts believe that the economic rationale is a weak argument in adopting the Euro in Britain. However, there is a distinct possibility that the UK will adopt the Euro but this do not depend on the economic advantages but on the political merits. Public Opinion There are observers who points to the fact that the five-point test introduced by the Blair government has criteria that are peppered with ambiguities so that the decision not to adopt the Euro is largely politically inspired. Before his election in 1997, Blair told the Eurosceptic Spectator that he was determined to join single currency and end the ambiguous relationship Britain had with Europe. (Temple, p. 51) But he failed to deliver on this promise as poll after poll showed increasing public opposition to the Euro. In February 1999, the British government published its National Changeover Plan to the Euro but without setting any timetable for entry. The policy was labeled ‘prepare and decide’. If the government decided in favour of entry, the plan said, a referendum could take four months later. (Smith 1999: p. 116) This underscores our point that the five-point test towards Euro’s adoption rides much on the tide of public opinion. Recognizing that the political case would fare much better than the economic arguments, several interest groups have mushroomed over the past decade to encourage British euro membership. These issue groups have been created to shape public opinion and strengthen the political support for the euro. Politics At this point, it is now imperative to underscore why the British initiative about the euro could win through political means. According to Rosa and Secara (1999), political decision will eventually win out, “as with the Concorde, against all the economic considerations. The plan will be carried out to its terms against the opinion of the economists, just like the nationalization of 1982.” P. 203) This seems to follow the notion that everything starts as political with the expectation that the economy will follow. So, with the case at hand, what is at stake for Britain politically? The decision on the UK membership with the European Monetary Union and the adoption of the Euro will define the country’s economic relations with the European Union and the world economy, and will impact upon Britain’s national and regional economic and political performance. This is the strong political argument. Once Britain adopted the Euro, there would be increased influence within the European Union. Being part of the single currency would give the UK more say in the future direction of the regional bloc. Also, it would further establish the status of London as the financial capital of the European Union. Britain’s adoption of the Euro would also make the EU a stronger economic power. In the past 25 years, the D-mark and the Pound have admittedly made inroads into the dollar’s domain as a world currency, both as a key currency in the central banks’ reserve holdings, but these currencies never proved quite attractive as the dollar in many other respects, largely because the German or the British financial markets are dwarfed by the huge and dynamic US capital market. But the Euro immediately began life as an international currency and it claimed the new status as the world’s unrivalled number 2 currency. (Mundell & Clesse 2000: p. 89) Blair’s previous remark about mending Britain’s relationship with Europe highlighted the growing isolation of the country with the protracted entry into the single currency system. This could prove troublesome for Britain politically with the trend of coalition building in the region. In addition: A big percentage of the British public opposed to the Euro is concerned with the democratic deficit in the EU. Ton Notermans (2001) explored this by saying that economic and monetary union could not, and should not, be divorced from political union. The idea here is that Britain’s hesitation, apart from the economic disadvantages, is also attributed to the absence of political institutions which are capable of putting in place economic safety valves (such as real labour mobility and larger interregional fiscal transfers) will lead to destabilizing tensions between participating member states which may undermine the whole EMU project. (p. 61) References Brittan, Samuel, 1998, Essays, Moral, Political and Economics. Edinburgh University Press, Edinburgh. Dobson, Hugo and Hook, Glenn, 2003, Japan and Britain in the Contemporary World. Routledge, London. Grant, Susan, Vidler, Chris, Ellams, Andrew, 2003, Heinemann Economics for Edexcel. Heinemann, Oxford. Mundell, Robert and Clesse, Armand, 2000, The Euro as a Stabilizer in the International Economic System. Springer. Rosa, Jean-Jacques and Secara, Andrea Lyn, 1999, Euro Error. Algora Publishing, New York. Notermans, Ton, 2001, Social Democracy and Monetary Union. Berghahn Books, New York. Smith, David, 1999, UK Current Economic Policy. Heinemann, Oxford. Temple, M., 2006, Blair, Haus Publishing. Wargitsch, Rainer, 2007, Should the UK Become a Member of EMU? GRIN Verlag. Welfens, Paul, 2001, European Monetary Union and Exchange Rate Dynamics: New Approaches and Applications to the Euro. Springer. Read More