UK Join the European Monetary

¶ … UK join the European Monetary Union?

The launch of the EMS or European Monetary System on December 5, 1978, was projected to accomplish monetary stability and foster convergence and cooperation of economic performance and policies between the member countries. The EMS became operational from March 13, 1979 and consisted of four areas, viz. ECU -- European Currency Unit, EMCF -- European Monetary Cooperation Fund, and VSTF -- Very Short-term Financing Facility and ERM -- Exchange Rate Mechanism. In 1992, the member countries approved the "Treaty on European Union" and adopted the EMU -- European Monetary Union and a single currency. However, the UK walked out of the ERM that very year due to currency problems despite remaining as a member of the European Union. The debate whether the UK should join the EMU has now become a hot topic of discussion within as well as outside the country. (Roney; Budd, 1998, p. 95)

Discussion

Arguments against joining the EMU

There are a number of factors which would go against the interests of UK if it joins the EMU. According to an IMF study brought out in 2000, the UK currency is overvalued as compared with the euro and therefore recommended that the UK should not join the EMU and implement a single European currency at least for now. (Harris, 2001, p. 362); (European Monetary Union: Should Britain join the single European currency?)

Some of the reasons cited by the IMF along with other factors that go against UK's joining the EMU are: (i) Political situation: The UK government feels that the country's economy is not prepared to accept the transition to a single currency. (Harris, 2001, p. 362); (European Monetary Union: Should Britain join the single European currency?) The UK government believes that the EMU would operate in an inflexible manner that would pose a risk to UK's economy which had a high tendency towards inflation. It would also result in a weakening of its competitiveness. The Conservative government led by Margaret Thatcher also opposed the joining of UK in the EMU because they wanted to introduce a monetary policy that would be effective in bringing down inflation. They reasoned that if the tools of monetary policy including interest rates were focused at lowering the growth rate of money supply, it would not be possible to simultaneously use it to direct towards the exchange rate. The present UK government is giving this issue a serious thought and had already considered it in 2003 but the tests against which this issue was considered -- Gordon Brown's five economic tests provided a result which was unfavorable to UK's entry in the EMU. However, the government has vowed to consider it once again. (El-Agraa, 2007, p. 223)

(ii) Lack of public support: A large section of the public is indifferent to the EU. This is despite the fact that around 46% of Britons feels that the European Parliament would turn out to be far more important to them than the British Parliament by the year 2020. Most of the public indifference stems from ignorance about the real benefits of joining the union. A very small fragment of the population has actually had any contact with EU activities and in fact, the fishing and agricultural community has actually been frustrated by EU actions. (Pilkington, 2001, p. 194)

(iii) Size of the European Union: Different countries have different types of economies which may not be consistent with the implementation of a single currency. For instance, the latest entries of the Eastern European countries may result in a problem since the difference in their economic system may make the Euro difficult to deal with. (Harris, 2001, p. 365); (European Monetary Union: Should Britain join the single European currency?)

(iv) Risk of losing the prerogative to take economic decisions independently: Monetary policy and interest rates would be set by an unelected body instead of by the UK government. Interest rates would be determined with the intention of achieving price stability as stipulated in the Maastricht Treaty. Moreover, the interest rates fixed at a "one size fits all" concept might not be appropriate for all nations. In case of an "asymmetric shock," an individual nation might not be able to implement a monetary policy suitable for that country alone. Therefore, UK might lose its monetary independence. The EMU would set inflation targets instead of the UK government. (Harris, 2001, p. 365); (European Monetary Union: Should Britain join the single European currency?)

The structural rigidities present in the labor markets of Europe may affect the UK as well. Britain would also lose its capability to devalue the sterling in order to ensure competitiveness of its products in the market during recession. The presence of a downward trade multiplier in the common currency area would still hamper efforts at competitive devaluation. (Harris, 2001, p. 366); (European Monetary Union: Should Britain join the single European currency?)As such a monetary union means that the authority to set rates of interests is assigned to a common central bank which has the capability to set only one interest rate. It is virtually impossible to fine-tune the interest rates to suit different economic requirements of individual countries. The only way out of this predicament is to ensure that member states possess the necessary instruments to tackle any asymmetric developments. Hence, labor market flexibility and reforms can provide member nations the required tools to help in adjusting to asymmetric shocks. (De Grauwe, 2007, p. 101)

(v) Following the American example: A common currency is followed in the various states of the U.S. with the unemployed people having the freedom to hunt for work in other states or ask for Federal benefits during periods of recession. However, this would be difficult for UK to adopt because of the vast diversity in language and cultures and absence of a central system that can provide benefits or support. Moreover, the present budget of the EU is small and any attempts to expand it would have an impact on fiscal autonomy. (Harris, 2001, p. 367); (European Monetary Union: Should Britain join the single European currency?)

(vi) Social, employment and agricultural policies: The Common Agricultural Policy of the EU has already resulted in an overwhelming damage to the British farming industry. The entry of peasant economies like Poland and other Eastern European countries have placed their own demands on the CAP which could further result in a deterioration of the situation in UK resulting in an irreparable damage. Common employment and social policies enforced by the EU has the potential to damage UK's market competitiveness and may stand in the way of its revival from recession. From the point-of-view of industry, joining the EMU can compromise UK's progress, development and efficiency. (Pilkington, 2001, p. 198)

(vii) Domination by some countries: There is a possibility that in situations of diverse inflation psychologies between member states, some countries may influence the operations of the Central Bank as well as influence its monetary policies. (What are the arguments for and against joining the Euro)

(viii) Sensitivity to changes in interest rates: The United Kingdom is believed to be susceptible to changes in interest rates compared to other nations of the EU. This may be partly due to high-level of "owner-occupation" with regard to "variable rate mortgages" in Britain's housing sector. Now the European Monetary Union does not have any monetary flexibility and joining such a union would necessitate UK to introduce more flexibility in the labor as well as the housing sectors. However, the rented market in UK is not large enough to function as a flexible alternative to owner-occupation. The UK has managed to effectively address this problem by establishing a very efficient mechanism for controlling the interest rates in the Bank of England. Joining the EMU will result in the elimination of this policy lever which will be accompanied by the removal of the prospect for exchange rate policy. (What are the arguments for and against joining the Euro)

(ix) Structural economic differences: The European Regional Policy's agenda for reducing the structural economic disparities between poorer countries of the Union might require significant fiscal transfers. This might be harmful for the UK since it would not be able to afford large amounts of fiscal transfers within Europe. (What are the arguments for and against joining the Euro)

(x) Foreign Direct Investment: The UK attracts a lot of FDI particularly from the U.S. FDI decisions usually serve strategic as well as microeconomic purposes. These may involve unimpeded access to a vast and lucrative market, labor productivity, labor quality, and transportation costs. AU.S. company would normally prefer to invest in a cheaper option available in the UK than negotiate with a "fortress EU." However, this is subject to the stability of the pound as compared to the euro. (Minford; Walters, 2004, p. 306)

(xi) Benefits of the pound: Using the sterling is a profitable means of diversifying portfolios. Portfolio managers as well as global investors would stand to lose if the pound becomes obsolete since chances for risk diversification would decrease significantly. (Minford; Walters, 2004, p. 306)

(xii) Competition to the U.S. dollar: In the likelihood of UK joining the EMU and adopting the single currency, the threat posed by the only international competitor to the U.S. dollar, the euro, would become real. Therefore, the U.S., at least would not encourage such a move and witness a downturn to its currency, the only true international currency. (Minford; Walters, 2004, p. 306) However, not all economic issues go against UK's joining the currency union. There are several factors which may benefit the UK if it joins the EMU.

Arguments in favor of joining the EMU

Some of the factors which support UK's joining the EMU are:

(i) A unified Europe where trade barriers are abolished and specialization and economic transactions occur as per the "Law of Comparative Advantage" will result in enhanced production and increase in the level of living standards. Increase in specialization will help in creating economies of scale along with decrease in production costs. (European Monetary Union: Should Britain join the single European currency?); (Should the U. K join the European Monetary Union?)

(ii) Lowered inflation and price transparency: Joining the EMU will provide the benefit of lowering inflation, a perpetual problem in UK, and expanding trade. It will also result in increased competition and higher price transparency. Consumers also stand to gain from this since they can now compare product prices and are less subjected to price discrimination. Business firms can also purchase and sell from a cheaper and larger choice of suppliers. Such benefits have the potential of enhancing integration and trade between member nations and offer lower inflation and better economies of scale. In addition, the traded goods market can get free access to markets that were previously protected by quotas and tariffs. This can lead to improved trade and more prosperity for the member nations. (European Monetary Union: Should Britain join the single European currency?); (Should the U. K join the European Monetary Union?)

(iii) Monetary Union helps in market integration: According to a study conducted by Andrew Rose of Berkeley, monetary union has a notable influence on trade. This may be because monetary unions eliminates the uncertainty associated with trading and makes trading and long-term decision making much easier. This also assists in enhancing economic performance. (Minford; Walters, 2004, p. 308)

(iv) Growth in inward investment: Having a stable currency as compared to UK's key business partners will enhance inward investment by foreign companies who want to set up base in the EU. A Euro land having exchange rate stability will encourage more investment which in turn can generate new jobs and increase physical capital. This will have the potential to act as a major catalyst to usher in change and foster economic growth. (European Monetary Union: Should Britain join the single European currency?); (Should the U. K join the European Monetary Union?)

(v) UK and the European market: In case UK joins the EMU, it will come closer to the European market which will help firms when they have to develop and market new and innovative products. Refusing to join the EMU can have an adverse impact on businesses since thousands of local jobs can be lost if foreign investors decide to set up their factories in Euro zone just like Toyota Motors which threatened to move out of UK. In such a situation British businesses may become somewhat uncompetitive as compared to their Euro land rivals. (European Monetary Union: Should Britain join the single European currency?); (Should the U. K join the European Monetary Union?)

(vi) Benefit for local firms: Local firms in UK will benefit tremendously if UK joins the EMU since they will have the opportunity to diversify across Europe which would be next to impossible if UK decides to remain isolated. (European Monetary Union: Should Britain join the single European currency?); (Should the U. K join the European Monetary Union?)

(vii) Status of London: One of the main concerns facing UK in joining the EMU is the loss of political sovereignty that may occur consequently. However, an equally disturbing probability exists in case UK does not join the EMU and that is the loss of London's status of being Europe's financial hub. This status might get transferred to Frankfurt since most of the financial transactions in Europe are likely to take place in Euro zone instead of in London. (European Monetary Union: Should Britain join the single European currency?); (Should the U. K join the European Monetary Union?) Joining the EMU can not only consolidate London's position as Europe's financial hub but even have the potential to enhance its status. (De Grauwe, 2007, p. 105)