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The New Europe: Understanding the European Union Essay

The debate over the United Kingdom’s involvement in the eurozone has been prominent ever since the British government decided to withhold UK entry until a later date. Although the euro only became a physical reality across Europe on 1 January 2002, it has been years in the making. The development of the euro dates back to the Treaty of Rome in 1957, when a common European market was declared as a European objective, aiming to increase European prosperity and develop an even closer relationship amongst the peoples of Europe.

Following agreements such as The Single European Act (1986) and the Treaty on European Union (1992), the European Monetary Union, EMU, has been introduced, laying the foundations of the single currency. The European Central Bank (ECB) was established on 1 June 1998. It is based in Frankfurt am Main, Germany, and aims to maintain price stability and to conduct a single monetary policy across the euro area. This is done through its own activities and through working with the national central banks. Together, the ECB and the euro area national central banks are known as the Eurosystem.

On January 1 2001, the exchange rates of the participating countries were irreversibly set. Member states implemented a common monetary policy and the euro was introduced as legal currency. Eligibility for participation in the single currency depended on satisfying a number of criteria set out in the Treaty of Maastricht. Along with Denmark and Sweden, both also members of the European Union, the UK has decided to withhold its involvement in the single currency. For a country to take part in the single currency, it had to satisfy a series of criteria laid out by the Treaty of Maastricht.

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The criteria required that: the national central bank of the country should be independent; the country’s currency should have participated in the Exchange Rate Mechanism (ERM) for at least two years, without stress; the country’s inflation rate should have performers; the ratio of the budget deficit to GDP should not exceed 3% and its debt-to-GDP ratio should not exceed 60%. It so happened that one of these criteria, the one relating to the ratio of government debt to GDP, was effectively ignored, whilst neither Finland nor Italy fulfilled the criteria relating to exchange rate performance.

Greece failed to meet criteria, whilst the UK and Denmark exercised the opt-outs negotiated in the Maastricht Treaty. Sweden, not yet a member of the EU at the time of the Maastricht negotiations, was also judged to have failed the criteria. Both Greece and Denmark were generally recognised as ‘pre-in’ countries, that is that they were simply waiting to join the EMU, which Greece actually did. Denmark is awaiting the results of a referendum to decide its fate. Sweden, as with the UK, seem less confident about making further progress towards joining.

Britain’s stance in particular seems to have caused much controversy and debate. Within the government itself there seems to be some debate as to whether UK entry will be a political or economic decision, with Foreign Secretary Jack Straw citing that it will be a political one, and Chancellor Gordon Brown saying it will be an economic one. Despite their differences of opinion, it looks definite that entry will be left down to public vote via a referendum sometime in 2003 and Gordon Brown’s ‘Five Economic Tests’ being satisfied. They aim to ensure that the UK economy is well prepared for entry into the final stages of the EMU.

In this sense the tests share a common objective with those laid out in the Maastricht Treaty, but in matters of form they are different. The five tests comprise the following: “whether there can be sustainable convergence between Britain and the countries of the single currency”; whether there is sufficient flexibility to cope with economic change; the effect on investment; the impact on our financial services industry; and whether that is good for employment. Those who are for the euro feel that time is running out for Britain to join the EMU.

The aim of the euro has always been to create an economy that will be of benefit to the whole of Europe. The large Eurozone will integrate the national financial markets, leading to higher efficiency in the allocation of capital in Europe. The UK will benefit from an increase in intra-European trade flows and higher capital investment resulting from the development of a single currency. Some commentators believe that the UK’s receipt of foreign direct investment will be threatened by non-participation in the currency union. As usually happens when trade increases, jobs will in turn be created.

The introduction of the euro will also benefit Europeans when buying goods, as a single currency promotes prices-transparency. This means that customers can readily assess the relative prices of similar products from anywhere within the union. One country can no longer devalue its currency against another member country in a bid to increase its competitiveness of its exporters. One of the changes that the public will become most aware of is that when travelling throughout Europe, they will not have to worry about the hassle of changing currency as they change countries.

The reduced exchange rate uncertainty for UK businesses and lower exchange rate transactions costs for both businesses and tourists will bring an increase in economic welfare. This, say some is enough reason to join the EMU. The euro will become a force for the Dollar and the Yen, something that the individual European currencies would have found almost impossible to do. The development of the European Central Bank means that there would be a less volatile interest rate policy than had the Bank of England, or other central banks fixed it.

Despite all these reasons of why joining the euro would be a good idea for the UK, it remains a public decision via referendum. However Britain stands to lose political as well as economic influence in shaping future European economic integration if it remains outside the new system. It seems clear that, at present EMU is not an overwhelmingly popular option. The survey of British Social Attitudes has consistently reported that less than a fifth of those polled since 1993 would ‘replace the pound by a single currency’.

It is clear that public opinion has some way to go before being convinced about participation in the EMU. But why exactly are the British public so against the introduction of the euro? Aside from the political and economical grievances over the euro, the main worry for Britons is the fear that they may lose their national identity. The relationship between British people and Europeans has always been somewhat frosty in the past and a number of Britons feel that the introduction of the euro could lead to increased integration in Europe, and eventually a kind of euro ‘super state’.

This loss of national identity is something that each country joining the euro has had to face, but for some reason opposition appears higher in Britain. Along with the loss of the pound, Britain would have to face a loss of control over a large number of its economic affairs with power being shifted to the European Central Bank. Entry would mean a permanent transfer of domestic monetary autonomy to the ECB implying giving up flexibility on exchange rates and short-term interest rates.

Domestic monetary policy would no longer be able to respond flexibility to external economic shocks such as a rise in commodity price inflation. The UK is thought to be more sensitive to interest rate changes than other EU countries, in part because of the high scale of owner-occupation on variable-rate mortgages in the UK housing market. The UK has developed with the Bank of England a very effective apparatus for managing interest rates. The EMU will remove this policy lever, along with removing the opportunity for exchange rate policy.

The euro will not be an optimal currency area. The European economies have not converged fully in a real structural sense and in some stage in the future, there is a fear that excessively high interest rates will be set because of an inflationary fear in one part of the zone which is unsuited to another area. There are economic costs and risks arising from losing the option to devalue the domestic currency in order to restore international competitiveness. This might lead to growing social dislocation and rising economic inequality within the EU.

There are fears about which countries might dominate the workings of the central bank and the effects on monetary policy within Europe if there are different inflation psychologies between member nations. Those against the euro state that holding back may not be such a bad thing. There is no reason why the UK should not continue to attract foreign capital inflows even if initially outside the new currency arrangement. Adjusting to a new European currency will invoke substantial costs for businesses and banks.

Adjustment to economic divergence by migration of labour or capital will be costly; there is no clear EC commitment to relieving these costs. Despite the government’s belief that the Five Economic Tests will prepare Britain for entry into the euro, critics believe that they are too vague to be meaningful. A big fear for British people is that currency unions have collapsed in the past. There is no guarantee that the EMU will be a success, so why risk losing the usually reliable pound? The euro may be a recipe for economic stagnation and higher structural unemployment.

The prospect of losing the power to manage our own interest and exchange rates when vitally needed proves too much a risk for some people. For others the prospect of withholding from such a momentous change in European policy could be devastating for Britain and eventually mark their separation from the EU. If Britain opts-out for the time being until the single currency has had a chance to both synchronise and improve the economies of the euro zone, then it might be in a better position to offer advantages that outweigh the risks.

On the other hand, if the euro fails miserably and its economies go into recession, then we will be suitably distant from it to avoid unnecessary damage to our own economy. Opinion is divided, as much in business as the unions, on the political left as well as the right. Polls suggest that the UK population is divided three-to-one against entering the European currency. Whatever its judgment of the five economic test might be, the government will have to make a sixth judgment over whether to risk a blistering public defeat on such an important and controversial issue.

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