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Economics in a European Context Coursework – Monetary Union Essay

The UK is one of three old member states in the European Union that have decided to opt out of the Euro. All new member states are required to adopt the Euro when they reach the right level of economic convergence which is set out by the ‘Maastricht’ convergence criteria. The Euro is the common currency of 12 of the member states, but the issue for Britain is whether the benefits will be sufficient enough to justify the costs of conversion. The implementation of the Euro by all member states would be the last stage of transformation for Europe to become a fully integrated single market. Joining the single currency would mean losing forms of independence but would the economic benefits lead to greater prosperity? My essay examines the effects of the EMU for British businesses and consumers.

Advantages

One of the greatest advantages to businesses would be the decrease in business costs by removing the need to convert the pound to the Euro when trading with the Eurozone. British produced goods may appear less price competitive than those that are produced within the Eurozone due to the additional costs of having to convert currencies for British firms. For example, Whiskey is exported from the UK to the EU, the Whiskey is sold to an Italian hotel, who in order to pay for it have to convert their Euros to Sterling.

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The cost of conversion will be passed onto the consumers in the hotel who may opt for a cheaper drink as a result of the increased cost. To combat this the Whiskey producer may artificially lower their prices so they are able to compete with Eurozone beverage producers, however this would reduce their export revenue. Eliminating the need to convert currencies would remove the extra cost and therefore the Whiskey producers in Scotland are likely to see a rise in demand for their product and an increase in income.

British firms who buy raw materials and other components from the Eurozone will have higher production costs so the UK’s exports are less attractive to foreign consumers and this will reduce exports from the UK. On the other hand, consumers in Britain are faced with more expensive imports from the Eurozone than their European counterparts who do not have to pay to exchange their currencies. Eliminating the costs of having to convert currencies would immediately solve these problems.

Another problem relating to the exchange rate costs is exchange rate uncertainty. When trading with different currencies firms never know which way the exchange rate will move. It could move in favour of the exporters or importers, if the exchange rate favours the importers then it will end up costing the exporters more and as a result less revenue per item exported. For British firms the problem occurs when trading with the Eurozone because their revenue is earned in euros but their costs are in sterling.

The problem with exchange rate uncertainty is that firms cannot be sure whether their revenue will exceed costs, if the exchange rate moves in favour of the importers. However, on the other hand the exchange rate could move in favour of the British exporters (sterling goes up, Euro goes down) and they may receive a larger than average increase in revenue. With a single currency this uncertainty will be eliminated and will benefit smaller businesses significantly as they are able to plan into the future and estimate the value of their goods and services.

A single currency, in theory, should create stronger competition between businesses as there will be greater transparency in prices and differences would not be masked by the exchange rate. The main beneficiary would be consumers as they would be able to compare prices across a greater range of firms across the Eurozone. For businesses there would be a huge increase in competition from firms in other EU countries, businesses would be able to compete with those from across the Eurozone. Price transparency will mean that consumers have a greater choice and firms with the higher prices will lose out on custom and this will force firms towards productive and allocative efficiency as the price war intensifies.

Productive efficiency will occur where firms have to become so efficient that wastage is minisimised and allocative efficiency is where firms sell their production near to the cost of is manufacture, these two situations are likely to be met with increased price transparency. Firms may go bankrupt while the more efficient ones survive. An example is in the computer market, where Eurozone countries are often paying slightly less for the latest technologies. If the UK were to join the Euro then consumers will choose the cheaper European suppliers and force the British firms to reduce their prices. However, some items such as tobacco which are a lot cheaper in the Eurozone may not be reduced in the UK due to differences in taxation, in this case VAT.

The single currency has shown the increased integration of Europe’s economies which has lead to economies of scale. Firms are able to become larger and their scale of operations increase to such an extent that they are able to experience reductions in their costs of production. For example, French supermarket giant Carrefour now has operations across France, Belgium, Italy, Holland, Spain and Germany and is now the 7th largest company within Europe heavily benefiting consumers with a wide choice and cheaper prices. Economies of scale would be advantageous towards Britain’s medium-sized companies allowing them to expand without restriction across the Eurozone. Secondly, firms, especially domestic monopolies will face more competition.

Finally, continuing enlargement of the monetary union with new European states means an ever increasing amount of consumers. Europe currently has in excess of over 200 million customers and the Euro is one of the most significant currencies in the whole world. If Britain were to join this would bring immense power and a greater customer base.

The importance of the Euro and the amount of consumers operating under it mean that inward investment from the rest of the world into Britain would appear more attractive and would be likely to increase. Foreign firms are a catalyst for better economic performance. They invest more, employ more skilled people and are more productive. In manufacturing, for example, foreign-owned firms produce about 40% more per worker than indigenous companies. Foreign-owned firms now account for almost a third of total R&D expenditure by businesses, double their share ten years ago – this could dramatically increase Britain’s real GDP.

The single currency has enhanced the European single market, removing the few barriers remaining. But does this mean that it is a requirement to realise the gains from trade?

Disadvantages

At present over 70% of Britons are against joining the Euro. Joining the Euro would be politically unpopular. One of the main reasons for this judgement is due to the lack of control the government would have over Britain’s economy if they were to enter the EMU. The UK would lose its monetary policy, which involves changing the interest rate to control inflation and influence exchange rates. Control over this policy is given to the European Central Bank, based in Germany. From here the ECB will set the interest rate for the whole of the Eurozone. The problem with this being that the interest rate cannot be suited to all Eurozone economies. There are several problems that could be identified with an externally set interest rate.

o Mortgages in the UK are different to those in the rest of Europe. In the UK, there is a high proportion of owner-occupiers with variable rate mortgages. In the rest of Europe, however, there is a higher tendency for long term renting, and those that do have mortgages are on long term fixed rates. Therefore, homeowners in the UK are more likely to be affected by interest rate changes than their counterparts in other EU states. For example, a low interest rate for Britain would thoroughly increase house prices whilst a high rate would mean less disposable income for British households.

o If Britain were to suffer a downturn in economic activity but other Eurozone countries were booming then the ECB might want to increase interest rates to slow their economic growth. This would only worsen the situation in Britain though. The same principle can also be applied to economic growth – if other Eurozone countries are experiencing recessions then the ECB may decrease interest rates to encourage investment this could result in an unsustainable rate of growth in Britain.

To counter-act these problems the government could use Fiscal policy to adjust tax and government expenditure but these policies once implemented take a long time to take effect.

The interest effect is also similar with the exchange rate. Britain would lose control to make appreciations and depreciations because it no longer has its own currency. If British exports became less price competitive then it could increase competitiveness by devaluing its currency. Britain could also make their imports cheaper by revaluation. This option would not be available with the Euro.

Regional differences are where resources can be shifted to counteract poor economic situations in one area. Using this method, although it is not ideal it is possible to alter unemployment and GDP levels in poor achieving regions. On a European scale this may be hard to achieve due to language difficulties and lifestyle differences. While one area may have a higher output and income, low productive regions may experience a fall.

Diseconomies of scale would be a major risk with converting to the Euro. It gives MNCs the opportunity to grow even further and may grow beyond the scale of production. If firms and industries grow to large then Eurozone consumers could be subject to higher price rises and limited choice. Markets could become more concentrated and firms could merge forming monopolies and oligopolies.

The changeover cost to the Euro would be huge. Both Firms and consumers would be affected. Shops would have to change their tills and billing systems to be compatible with the Euro and as would banks with their cash machines. Accounting software would have to be updated and bank notes and coins would have to be changed which is why it is essential that the exchange rate is right if Britain were to join the Euro. If it were wrong then consumers could see a decline in their savings and businesses a loss of revenue.

Conclusion

The British economy is still growing and is forecast for 2.9% growth this year, 0.3% more than expected. Many economists believe that this growth is more than anticipated and that it could grow faster next year. They call for increased interest rates, which have recently risen to 5% which is hoped to control the growth. I believe that while economic growth is still continuing and it is not essential for Britain to join the Euro just yet.

The exchange rate set before joining would be very important as it would determine relative prices. If the pound was too high against the Euro then firms who export would be left with products which have a too high price tag to other Eurozone countries and imports from other member states would be favourable. The disruption to our competitive position could have long-term effects as businesses would have to find ways of regaining the competitiveness that they had lost. If the rate were to low, imports would be too expensive but exporters may see increased revenues. The government would have to find a perfect balance against the Euro.

In my opinion the EMU seems to have many advantages over sterling and I believe that Britain should join when the time is right. I feel that when the British economy’s growth is declining the time would be right. Although there would be an economic price to pay it would be worth paying as the result would be a likely stimulation in growth. While growth is continued to forecast it would be important for Britain to keep control of its monetary policy so it can continue to implement measures to keep the growth sustainable. As Europe comes out of recession, people will see the advantage of the Euro, illustrated by the collapse of inward investment in the UK since we opted out.

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