The UK, the Euro and EU Enlargement - Essay Example

The UK, The Euro and EU Enlargement Did the UK opt-out from the Euro and EU enlargement make Britain less attractive for foreign investors? Over the years, the European Union (EU) has evolved from a series of treaties and predecessor relationships between European continental states to a more perfect union between various states. The EU acts more or less as a federation (on monetary affairs, agricultural, trade, environmental, economic and social policy) or a confederation (on home affairs) and as an international organization (on foreign affairs). It has developed into a common single market of 25 member states which will expand to 27 members by 1 January, 2007. The primary bodies consist of a customs union, a common agricultural policy, a common trade policy and a common fisheries policy. Most importantly, the single currency i.e. the Euro is managed by the European Central Bank and is so far adopted by 12 of the 25 member states (Wikipedia, 2006). Initially, the primary purpose of liaison between the European countries was to avoid catastrophes such as the world wars which started in Europe and engulfed the world with time. However, the economic benefits also have to be considered because the European Economic Council and then the European Union have emerged as the world’s single largest developed market with a total population that is over 450 million. It also has the highest GDP i.e. more than six trillion British pounds (Wikipedia, 2006). The EU is certainly not resting on its laurels and is in the process of expanding its member base (27 countries by 2007). This expansion process makes the group more attractive to foreign investors since membership of the group signifies common laws, the advantages of uniform policies in a single market, the relatively free movement of goods and services, unhindered movement of skilled labour with similar employment and social policy between countries. For the financial and industrial sectors, the EU brings free movement of capital, uniform industrial and intellectual property rights, a liberalized energy market and uniform consumer protection policies. As a final step towards the union, European countries are adopting the single currency, Euro. There are numerous benefits of joining the Eurozone as discussed by Huhne (2004), adopting the single currency provides a better deal for consumers owing to competition and would also help in pension income, especially when the risk would be spread around the wider euro maket. UK will be able to focus on real monetary and economic environment instead of using interest rates to maintain over valuation of Pound Sterling. Alignment of interest rates will also lead to lower interest rates for borrowers – corporate or consumer. Since Britain will not be exposed to over valued currency, higher interest rates and competition, investment will increase resulting in increased jobs. Businesses will save on currency conversion costs. London is already a major financial centre of Europe and with joining the Euro has the potential of turning into “New York of Europe” considering the expertise already being provided to EU businesses. However, considering all of the advantages of Eurozone, UK has still not made a decision to either join or maintain pound. In case UK becomes a member of EMU, businesses will invest more because they will face fewer risks from volatile exchange rates. Currently companies are of the view point that Britain will join, which is maintaining the FDI. But criticisms have started to emerge and reactions are being noticed. If the take automobile industry as an example, Toyota and Nissan, major manufacturers with facilities in UK threatened to pull out of UK since the UK was not willing to join the Eurozone. What the big car companies are complaining about is the level of exchange rate since the pound has moved the wrong way for them against the euro. Toyota and Nissan both have plants on the continent so it would be easier for them to switch production especially due to the unfavourable exchange rate. Honda, even though has increased its production capacities, would prefer Britain to be in the single currency. Honda has elaborated that the decision was based on exchange rate between pound and yen moving in favour of British production just as pound to euro exchange rate has moved against British production. In case of further appreciation of pound, Honda might have to change their decision. Foreign currency exchange rate play a major part for Trans National Corporations’ (TNC) investment decisions. A study conducted by Barrell et. al. (2004) regarding relationship between foreign direct investment and exchange rate concluded that: “We find that exchange rate uncertainty in the Euro Area and in the UK has a strong negative effect on FDI. There is strong evidence that the correlation between the sterling dollar exchange rate and the euro dollar exchange rate influences location decisions of US firms in Europe. In particular, we found evidence that, as exchange rates become perfectly correlated, US firms tend to divert their investment from the Euro Area to the UK (Barrell et. al., 2004, pg.21).” Exposure to foreign currency fluctuations directly affects the profitability of TNCs. Stronger pound influences investment decisions. Large investment projects have long incubation periods and over valuation of pound has already effected the FDI in UK. In 1997-98 Britain attracted 52% of of FDI in EU which fell to 24% by 1999-2001 (Kenen, 2003). TNCs are positioning themselves to serve a large market of EU which brings the benefit of single currency, along with free movement of goods and services and human resources. The investment in shape of BMR and Greenfield projects is decreasing and TNCs are looking towards other EU member countries for their investment decisions. Peugeot plant and Ryton, UK closed because of this reason – even the British Government grant of fourteen million pounds for replacement was rejected by Peugeot. The reasons were simple as the plant was 40 years old and not flexibly constructed for balancing modernization and replacement. Even the grant couldn’t make the project competitive compared to new plant in Slovakia. The Japanese plants in UK have all been built using flexible techniques, which ensure longevity, and this has been confirmed by the introduction of new products lines in all of them. Even then the Japanese giants are evaluating moving their production facilities to other EU countries (Morely, 2006). The decision to not join the EMU will lead to decrease in Greenfield investment and may move toward merger and/or acquisitions considering that most of the payment is made in form of shares of the acquiring company and is comparatively easier to shift the focus. Honda is expanding the production facility in UK in comparison to pound/yen exchange rate parity makes it profitable. Toyota and Nissan’s vertical supply chain has already moved to other EU countries. As Mr Hiroshi Nemichi, chairman of Mitsubishi Corporation (UK) plc, as quoted by Huhne, says: ‘If Britain were to rule out membership of the single currency, as the anti-Europeans seem to want, Britain would be less attractive to inward investors.’ Regions like South Wales and the North West would be particularly badly hit if foreign investors went to the euro-zone rather than Britain, yet this is almost inevitable if we rule out euro entry. Given that up to 80 per cent of the output of many Japanese and US plants in Britain is aimed at the euro-zone market, why should they take the extra risk of the sterling exchange rate wiping out their profits? From a TNCs point of view, the EU provides low or no barrier’s to trade, easier access to factors of production, easier access to huge market. The single currency mitigates risks of foreign currency exchange rate fluctuations and also makes it easier to borrow funds and take investment decisions along with pricing of inputs and products. While Britain offers some of these advantages by being a member of the EU, not being a part of the Eurozone certainly causes some hesitancy for investors even if the pound is a relatively stable currency compared to many others in the world. It can be assumed with a high degree of certainty that if Britain is to have a future in the European Union, it will one day have to abandon the dear old pound for the shiny new Euro. However, this transition must be made carefully and the economic requirements for the transition must be there before any decision is made in this regard. At the same time, the political, social and technological implications of joining the EU must also be kept in mind since the pound itself is a very important international currency. The advantages of having more foreign direct investment coming to the UK can not be over stated since the Euro would certainly go a long way in helping that cause. However, Britain must also appreciate that there is a certain amount of risk in giving up control of the domestic currency and permanently linking the economy of the UK to those of the other members in the European Union which may not be as attractive to foreign investors. Works Cited Morley, K., 2006 , ‘Britain’s Car Industry Faces Uncertain Future’, British Broadcasting Company, [Online] Available at: http://news.bbc.co.uk/2/hi/business/4925436.stm Barrell, R. et. al., 2004, ‘Foreign Direct Investment and Exchange Rate Uncertainty in Imperfectly Competitve Industries’ Imperial College London [Online] Available at: http://www.niesr.ac.uk/pubs/dps/dp220.pdf Kenen, P. B. 2003, ‘Making the case for the euro: no economy is an island, entirely of itself or why Britain should join the EMU’. The international Economy [Online] Available at: http://www.findarticles.com/p/articles/mi_m2633/is_1_17/ai_97118169/pg_1 Huhne, C., 2004, ‘ 12 Reasons for joining the Euro’ Liberal Democrat European Group, [Online] Available at:: http://www.ldeg.org/articles/3.html?PHPSESSID=94196f22e8116b0b44eef91262fbd6c5 Thornton, P., 2005 ‘Foreign investment in Britain rises four-fold’. Independent, [Online] Available at: http://www.findarticles.com/p/articles/mi_qn4158/is_20050930/ai_n15650355 Wikipedia. 2006, ‘European Union’ [Online] Available at: http://en.wikipedia.org/wiki/EU Read More