Positive and Negative Effects of European Monetary Union - Essay Example

? What could be the expected positive and negative effects of European Monetary Union on a member country's economy? Explain the arguments for and against joining the EMU, for SPAIN and the UK. 1. Introduction The establishment of European Union in 1957 has been based on the willingness of the governors of European countries to promote communication and cooperation between the member states in regard to a series of critical political and economic decisions. The development of an economic framework that would be common for all member states has been included in the objectives of European Union founders. The European Monetary Union (EMU) has been such framework. However, the challenges related to the particular plan have been many. In practice, persuading the member states to align their fiscal and economic policies has been proved a challenging task. The gradual implementation of EMU across member states has been considered as a strategy for controlling risks related to this initiative (European Commission 2013). The incorporation of ‘the principle of freedom of capital movement in the Treaty for the European Union’ (European Commission 2013), in 1993, has been the starting point of EMU. At the next level, two important activities had to be performed for promoting EMU: ‘the introduction of the legislation related to EMU in all member states and the introduction of the common currency, the euro’ (European Commission 2013). These activities that lasted from 1994 to 1998 have been incorporated in the second phase of EMU’s implementation (European Commission 2013). From January 1999 the third phase of this plan has started; this phase involves in the replacement of national currencies of member states by euro (European Commission 2013). In practice, it has been proved that EMU can result to both positive and negative effects for member states. The particular issue is explored in this paper. Reference is made to UK and Spain, as examples, for showing the positive and negative effects of EMU both for countries within the euro zone and for those that are outside the euro zone. In this way also, the potential implications of the entry of a member state in Euro zone are made clear. 2. Which could be the expected positive and negative effects of European Monetary Union on a member country's economy? The participation of countries in a monetary union has been related to a series of benefits. For the member states that participate in EMU these benefits would be also available. According to Albertin (2008) one of the most important benefits of participating in a monetary union is ‘the significant increase of bilateral trade between the countries that have joined such union’ (Albertin 2008, p.3). It is not made clear though whether this benefit can continue in the long term or whether it is related only to the initial period of a country’s entrance in a monetary union. On the other hand, a monetary union can protect its members against strong market turbulences. Indeed, during strong financial crises the countries that are members of a monetary union can easier keep their economy stabilized at the level that their interest rates are not highly affected by the crisis, at least not so high as the rates of the countries that do not participate on monetary unions (Farina and Tamborini 2008, p.152). The recent financial crisis can be considered as an indicative example of the above case; the countries that are members of EMU have managed to protect their economy from extensive losses, mostly because they have been under the protection of EMU (Tausch and Heshmati 2012). The fact that not all members of EMU have managed to secure their economy against the global crisis is not related solely to their participation in EMU but it has been also related to their existing fiscal and social policies (Tausch and Heshmati 2012). In any case, the potentials of a monetary union ‘to protect its members against asymmetric shocks’ (De Grauwe 2012, p.27) seem to be high. Another important benefit of monetary unions is the following one: monetary unions tend to promote ‘the integration of banking and payment systems’ (De Grauwe 2012, p.27). Such practice can significantly decrease the cost of trade between the countries that participate in a monetary union (De Grauwe 2012, p.27). The negative effects of monetary unions for their members cannot be ignored. At a first level, emphasis should be given on the following fact: a monetary union cannot always protect its members from market pressures. More specifically, it has been proved that when a country ‘faces asymmetric pressures and its prices are not flexible’ (Katsioloudes and Hadjidakis 2007, p.162), then it would be preferable for this country to have its own currency and avoid participating in a monetary union. The case of Greece is an indicative example of the above phenomenon. Moreover, the participation of a country in a monetary union significantly reduces the country’s potentials to develop effective macro-economic policies at the level that two, key, instruments for facing market pressures, i.e. ‘monetary policy and exchange – rate policy have been taken over by the European Central Bank, ECB’ (Hemerijck, Knapen, and Doom 2009, p.231). In the context of EMU this means that the countries-members of EMU are not able to take critical measures for supporting their economy against market pressures, being depended on the economic policies set by the ECB. The latter may not be able to understand the actual needs and potentials of a member state, a fact that can severely harm the economy of the particular state, as in the cases of Spain, Portugal, Italy and Greece (Hemerijck, Knapen, and Doom 2009, p.231). 3. Which are the positive and negative effects of European Monetary Union on the economy of Spain and UK? - Arguments for and against joining the EMU. As a member of EMU, Spain can enjoy the benefits that the above union secures for its members. Reference can be made primarily to the benefits that are common for the members of any monetary union, such as the increased power to face external market pressures and the facilitation of trade, as analyzed above. According to Hall, Heilemann and Pauly (2004, p.150) by participating in EMU Spain has been able to keep its interest rates at low levels, a target that could not be achieved if Spain was not a member of EMU. Moreover, Staab (2011) notes that the participation of Spain in EMU has helped the country to improve its market position, meaning especially the increase of trade agreements between Spain and other countries, not necessarily members of EMU. However, different views in regard to the decision of Spain to join EMU have been also developed. For example, Farina and Tamborini (2008) refer to the increase of Spain’s exposure to market threats due to the following fact: Spain has been a country highly based on exports and tourism; by entering EMU the country’s ability to secure its competitiveness by lowering its prices, when necessary, has been eliminated (Farina and Tamborini 2008), since the monetary policy of the countries-members of EMU is decided by ECB, as explained earlier (Hemerijck, Knapen, and Doom 2009, p.231). Therefore, the actual benefits of Spain from joining EMU can be doubted. One of the most important concerns of Spain’s governors when had to decide the participation of the country in EMU has been the following one: the economic policies on which EMU is based ‘seemed to favour the more developed countries’ (Maes 2002, p.176). The crisis that EMU’s less developed countries face today proves that the above concern was fully justified. At the same time, Nagle (1999) has emphasized on the negative role of EMU in the development of Spain’s tourism industry. Indeed, as a member of EMU Spain has lost its right to change, with no control, its prices and exchange rates (Nagle 1999). In this way, the competitiveness of the country as a tourism destination has been significantly decreased a fact that severely harms the country’s economy which is highly depended on the tourism industry. At this point, the potential effects, both positive and negative, of EMU for UK would be explored. De Grauwe (2012) explains that monetary unions tend to favour countries that ‘are based on open economies’ (De Grauwe 2012, p.93). British economy can be characterized as such economy, a view that it is verified by ‘the role of City of London as a major financial centre’ (De Grauwe 2012, p.93). Therefore, the potential decision of Britain to join EMU would result to ‘the further enhancement of British economy in the global market’ (De Grauwe 2012, p.93). Faruqee (2004) explains that the expected trade benefits seem to be the key arguments of those who support the particular initiative, i.e. the country’s participation in EMU. The trade benefits, as achieved so far, of countries that are members of EMU, especially Germany, are used as examples for showing the need for Britain to join EMU (Faruqee 2004, p.3). At the same time, as a member of EMU Britain would secure a low level in regard to its ‘interest rates and inflation rates’ (Bamford and Grant 2000, p.74), an argument that it is used by the supporters of the country’s participation in EMU. From another point of view, Langhammer (2011) notes that after joining EMU Britain would acquire an important advantage: ‘its exports would become cheaper’ (Langhammer 2011, p.5), due to the lower value of euro compared to British pound. This fact would highly benefit the country’s economy. On the other hand, the expected negative effects of EMU for UK cannot be ignored. Reference should be made primarily to the structure of UK economy, which is highly differentiated from that of other countries which are members of EMU (Jones, Kavanagh and Moran 2007, p.58). For example, the country’s housing market has its own rules in regard to interest rates; in the context of these rules, flexibility in interest rates is not welcomed, a fact that comes to opposition with the rules of EMU (Jones, Kavanagh and Moran 2007, p.58). The potentials of British economy to align its structure and rules with those of EMU cannot be clearly identified in advance, especially under current market conditions. Mueller (2002) refers to another implication of Britain’s potential decision to join EMU. Britain has been considered, for many years, as ‘a gate to the European market’ (Mueller 2002, p.7). In this context, foreign direct investment in Britain has been kept at high levels due to the country’s independency from euro. If Britain decides to join EMU, the level of FDI would be significantly decreased, since the country would have no more the potential to offer a series of benefits to foreign investors but it would be aligned with the rules and the decisions of the European Central Bank (Mueller 2002, p.7). At the same time, the following fact should be taken into consideration: if Britain would decide to join EMU, this decision ‘would not be reversible’ (Bamford and Grant 2000, p.74); the exit from a monetary union can be a complicated and long-lasting process. It would be necessary for British governors to review the particular plan carefully before taking any decision. The fact that the cost of the relevant plan, i.e. the completion of the transmission from British Pound to Euro, could be as high as ?30 billion (Langhammer 2011, p.5), should be also taken into consideration by this plan’s initiators; it could be rather difficult to decide whether the investment made for joining EMU will be repaid for Britain and how much time such repayment would take to be achieved. 4. Conclusion The entrance of a member state in the European Monetary Union can have both positive and negative effects. The review of the literature published in this subject has proved that these effects are not standardized across member states but they can be differentiated according to the economic and social characteristics of each member state. For example, for Spain the entrance in the Euro zone has helped the country to get access to an increased market but it has resulted to the limitation of the country’s potentials to increase its competitiveness. Being obliged to keep prices at a particular level, the country has lost its competitive advantage as a major tourism destination, as analyzed above. For Britain also, contradictory assumptions can be made in regard to the potential country’s benefits in case that Britain would join EMU. Britain is already a strong economy but its power seems to be declined, mostly because of the strong financial turbulences in the international market. Under current market conditions, it would be probably preferable for Britain to join EMU based on the fact that being outside the EMU would threaten the stability of the country’s economy. As of the risks related to EMU, these seem to be controllable especially since appropriate strategic alliances, meaning the other member states, are available. References Albertin, G., 2008. Trade Effects of Currency Unions: Do Economic Dissimilarities Matter? Washington: International Monetary Fund. Bamford, C. and Grant, S., 2000. The UK Economy in a Global Context. Oxford: Heinemann. De Grauwe, P., 2012. Economics of Monetary Union. 9th ed. Oxford: Oxford University Press. European Commission, 2013. The Start of EMU and the Euro (1999). Available at http://ec.europa.eu/economy_finance/emu_history/history/part_a_2_d.htm Farina, F. and Tamborini, R., 2008. Macroeconomic Policy in the European Monetary Union: From the Old to the New Stability and Growth Pact. London: Routledge. Faruqee, H., 2004. Measuring the Trade Effects of EMU. Washington: International Monetary Fund. Hall, S., Heilemann, U. and Pauly, P., 2004. Macroeconometric Models and European Monetary Union. Berlin: Duncker & Humblot. Hemerijck, A., Knapen, B. and Doom, E., 2009. Aftershocks: Economic Crisis and Institutional Choice. Amsterdam: Amsterdam University Press. Jones, B., Kavanagh, D. and Moran, M., 2007. Politics UK. 6th ed. Essex: Pearson Education. Katsioloudes, M. and Hadjidakis, S., 2007. International Business. London: Routledge. Langhammer, F., 2011. The Euro - Should Britain Join the European Monetary Union? Norderstedt: GRIN Verlag. Maes, I., 2002. Economic Thought and the Making of European Monetary Union: Selected Essays of Ivo Maes. Cheltenham: Edward Elgar Publishing. Mueller, H., 2002. Should the UK become a member of the European Monetary Union? Norderstedt: GRIN Verlag. Nagle, G., 1999. Tourism, Leisure and Recreation. 2nd ed. Cheltenham: Nelson Thornes. Staab, A., 2011. The European Union Explained, Second Edition: Institutions, Actors, Global Impact. 2nd ed. Bloomington: Indiana University Press. Tausch, A. and Heshmati, A., 2012. Globalization, the Human Condition and Sustainable Development in the 21st Century: Cross-national Perspectives and European Implications. London: Anthem Press. Read More