The European Union - Assignment Example

At present the European Union is made up of 15 countries. This includes the UK, Rep. Pf Ireland, France, Germany, Denmark, Portugal, Spain, Sweden, Greece, Austria, Italy, Finland, Belgium, Luxembourg, and the Netherlands. All of these countries Except us, Sweden and Denmark belong to a single currency, the Euro. All these countries share the currency the euro, and it is thought to only be a matter of time until us, Britain, Sweden and Denmark join the Euro. The main debate in Britain at the moment is ‘Should Britain join the Euro?’

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I am going to discuss the arguments for and against Britain joining the single currency. Currently Tony Blair had stated that in order for Britain to join the Euro it must pass 5 economic tests that will say whether Britain’s economy is ready to be controlled by the European central bank. The 5 tests include:-

* Test 1- Convergence

* Test 2- Flexibility

* Test 3- Investment

* Test 4- Financial services

* Test 5- Growth, Stability and Jobs

At present Britain has not passed all of these tests but it is said to only be a matter of time until Britain does decide to join.

The 5 Economic Tests

1. Convergence

This test asks the question, “Are our business cycles and economic structures compatible so that we and others could live comfortable with the Euro interest rates on a sustainable basis?”

Joining the Euro will mean that Britain will loose its current independence of monetary policy and will not have the independence to set its own interest rates. Currently the Bank of England sets our interest rates and our sufficient to meet our economies needs. If we where to join the euro, the European Central Bank would decide on interest rates tom meet the whole European economy and would not be specific to us. This could be problem if one countries business cycle is significantly out of step with that of other member countries. For example if one countries in a point of recession at the time when the European Central Bank is raising interest rates then this would be disastrous for that country. Normally if a country were in a point of recession the country would normally lower interest rates to increase aggregate demand. This means that we need to judge whether our UK’s economy is similar to that of the rest of the EU.

2. Flexibility

This asks the question “If problems emerge, is there sufficient flexibility to deal with them?” This looks at how flexible the economy would be if Britain to get back to if it fell out of line. The test examines how changes in wages, prices and employment can help the UK and the Euro zone deal with the economic shocks. Flexibility is hard to measure and there is no simple indicator to say whether the UK’s economy is flexible enough to with situations if they were to occur. One problem here for the UK is that inflation rates would become variable if we were to join the Euro.

3. Investment

This asks ” Would joining the EU create better conditions for firms making ling term decisions to invest in Britain?” There are two aspects to this. One is, will UK firms find membership of the Euro conducive to investment and secondly, will foreign firms be prepared to still invest in the UK. If these firms will invest in the UK, it will depend on the ability of the UK to meet the convergence and flexibility tests. If expectations are high for the UK, then firms will be more likely to invest in the UK which will obviously be good for the UK.

4. Financial Services

This asks, “What impact would entry to the Euro have on the competitive position of the UK’s financial services industry, particularly the city’s wholesale markets?” This specifically looks at how London has been affected since the Euro’s launch and how its financial services sector is likely to change if the UK doesn’t join the Euro. The UK is seen to have a significant comparative advantage in wholesale financial services. It was a worry that being part of the single currency might damage the competitiveness of this sector. Evidence suggests the UK will benefit from the EU and we would benefit more if we were to join the Euro.

5. Growth, Stability and Employment

This asks, “In summary, will joining the Euro promote higher growth, stability and a lasting increase in jobs?” This compares the long term benefits with the costs of the UK joining the Euro. Euro membership could significantly raise UK output and lead to a lasting increase in jobs in the long term. Trade with in the Euro zone has increased from as much as 3% to 20% since the introduction of the single currency. This means that the UK could see a significant boost in trade, which is even thought to be as much as 50% over the next 30 years. This could also mean that the UK national income may rise between 5% and 9% over the next 30 years if we joined the Euro.

Advantages of Joining the Euro

Here I am going to look at the benefits for Britain if we decided to go ahead and become part of the single currency. I am going to look at how it would affect our economy, our interest rates, employment, businesses and our monetary policy.

* At the moment thousands of UK jobs depend on exporting. At the moment the British economy profits from increasing globalisation. If we were to join the euro then there would be a massive increase in trade between the European countries and would therefore boost our economy and create many jobs for people in Britain. The Department of Trade and Industry (DTI) found that 14% of our current GDP is created by the Euro zone exports. This shows that our economy relies greatly on trade within Europe and it would be a huge benefit to us if this trade could increase, ie by joining the Euro. In the long run this would mean that many more jobs would be created.

* Joining the Euro could mean lower costs for businesses. It would allow larger business to have access to over 360 million consumers. This allows the business to sell its goods or services to a larger market and therefore increase profits. Tariffs and taxes on exports and imports would be reduced. This would significantly cut costs to businesses who regularly buy or sell goods within Europe. As costs for businesses are being cut, then this would mean a decrease in the overall costs of products being sold to consumers. Products being cheaper will mean that more goods will be sold, allowing companies to expand in size. Because certain companies will be able to expand they will be able to take advantage of economies of scale. This is the idea that a bigger a company grows its costs per unit will decrease. This means a company can reduce cost even more, which benefits the business and will also benefit the consumer.

* Clear price transparency will be beneficial to businesses as they can compare prices of different suppliers around Europe. This will increase competitiveness and encourage suppliers to cut prices. This again is another point that will help businesses cut costs, meaning cheaper prices for consumers. Because of clear price transparency, British consumers will find that goods will be cheaper abroad because there is less VAT paid on goods abroad. This will encourage the government to reduce VAT which will benefit the consumer.

* Having a single currency will benefit the consumer, as there will be more comparison of prices. Consumers can compare prices of products in their country to what other countries are charging for the same product. This will mean businesses will be under pressure to reduce their costs as they will have to compete against prices in a wider market. Meaning buying will become cheaper for the consumer.

* The European Union reckons joining the Euro will save business �20 million, as they no longer have to pay for transaction costs. This is the cost of changing pound sterling into Euros every time they want to buy or sell and export or import with in the Euro zone.

* The risk of currency fluctuation is removed. (How much the pound is worth against the Euro.) Having to worry about currency risks makes trading outside the EU too risky for many small businesses so they are discouraged to access new customers and have the potential to grow. Removing currency fluctuation will benefit small businesses but that’s presuming that these small businesses will trade outside the UK as they may not need to, or the transportation costs will be too high for them to take advantage of this.

* The single currency will obviously increase trade. More companies will trade beyond their domestic market which will increase competition and lower prices. 40% of Euro zone companies have reduced their prices since joining the Euro.

*Joining the Euro is thought to lower interest rates and provide a stable environment for investment. Britain currently attracts 26% of investment in Europe, which is higher than any other Euro zone country. It is feared that if Britain doesn’t join the Euro, that other countries will exceed Britain’s investment. Interest rates would be lower as they are set at a fixed rate. This would encourage home ownership as mortgage rates would be lower. Britain’s interest rate is currently the lowest its ever been for over 40 years so why would we want someone else to control it.

* Membership of the Euro would mean that it is cheaper to travel around Europe and will boost tourism. Easy price comparison will mean that consumers can easily compare prices of holidays around Europe, encouraging tour operators to cut prices. This and no transaction costs of changing money up will boost the tourism industry and will particularly benefit industries who greatly rely on tourism. Also because of increased tourism it would encourage tour operators to expand giving the consumer more choice.

Disadvantages of Joining the Euro

* Once we join the Euro, The Bank of England will no longer be able to set our interest rates to suit our own economy. The consequences of this could be very damaging. The Oxford Economic Forecasting found that Britain is 4 times more sensitive to interest rate changes than any other member of the Euro zone. It could mean that we suffer from instability, lower growth, economic decline and higher unemployment. At present, Germanys economy is in recession whilst Britain’s economy is prospering, so the interest rate would be to low for the UK.

* Britain will loose its own independence and will have hardly any say in who runs our economy. Having one economic policy for all the different economies of the Euro zone may mean that it won’t suit many of the economies. This is thought to result in high unemployment and inflation, which is definitely not what we want to happen to the UK.

Not having the independence to set our own interest rates means we cannot respond effectively to our own countries economy.

* Having a single currency will mean fewer guidelines on public spending. They will be too inflexible compared with that of Britain. There is no distinction between current spending and long-term investment. Britain would have to cut spending on public services by �10million to comply with the spending rules of the Euro.

* Short-term interest rates, home ownership and mortgage lending are relatively more important in the UK than in Europe. Membership of the Euro would decrease consumer confidence in borrowing money, particularly affecting the housing market. If for example there was a fall of 20% in the demand for houses, the Bank of England would have to dramatically cut interest rates by more than 2% to stimulate demand. The Euro zone would only cut interest rates of between 0.3 and 0.9%. So if this situation occurred, having the wrong interest rate would see a dramatic fall in our GDP.

If we had joined in 1999 we would of experienced a boom and bust cycle. This meant property prices would have been pushed 30% higher than they are now. Leading to a bust part in our cycle and then by early 2002 we would of found ourselves in recession.

* Britain’s pension shemes will suffer if we join the Euro. Over the next 40 years, taxes or borrowing in the Eurozone will have to rise to finance their unfunded, pay-as-you-go pensions systems. If we give up the pound and control of our economy, their problems would become ours. Also the risk of higher interest rates may affect our pensions.

* The Bank of England’s monetary policy is better structured, more effective and more transparent than that of the European Central Bank. The record for the ECB has been poor since the introduction of the single currency, meaning the UK will have to accept an inferior monetary framework. Again loosing control of our own individual economy.

* A European currency needs a European tax to make it work. Overall the current European taxes are a 1/6 higher than that of the UK so taxes could become higher.

* The actual cost of joining the Euro will be costly for many businesses. The physical conversion of pound sterling to euro will mostly affect retailers and banks. In many cases it will be the smaller businesses that suffer. This is a short-term cost for all businesses and for larger businesses the long-term benefits will out weigh this short-term cost. The smaller businesses may find it harder to afford these conversion costs.

*We do more of our trade in dollars than euros. If we joined the euro, which has been highly volatile against the dollar, it would destabilise British trade. Since the introduction of the Euro, British trade has increased by 25% so we don’t need to be part of the single currency for our trade to increase.

Conclusions

There are many arguments for and against Britain joining the euro. That is why the debate to join or not to join the Euro has been going on for so long.

In 1997 Gordon Brown set aside 5 economic tests, which he said had to be passed in for Britain to join the Euro. You can see these tests in the appendix.

In June 2003 a referendum was made on whether the UK had met these tests. It was found that only 3 of the 5 tests had been met. This was investment, Financial services and growth, stability and jobs. Convergence and Flexibility did not pass the test.