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The Impact of The Euro on The World Economy

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Words: 3842 |

Pages: 8|

20 min read

Published: Apr 11, 2019

Words: 3842|Pages: 8|20 min read

Published: Apr 11, 2019

Table of contents

  1. Introduction
  2. History of the Eurozone
  3. Recent Developments
  4. Effects of the Eurozone
  5. Why Has the UK Not Joined the Eurozone?
  6. Reasons to Join the Eurozone
  7. Conclusion

Introduction

The Euro shines as a symbol of European integration after countless years of planning and strategy for unifying Europe. Largely successful, the Euro is an international competitor amongst the world monetary powers. However, not all member states have made the leap to joining the eurozone. One such example is the United Kingdom. Though still a massive decision maker of the European Union, Britain has continued to maintain its own currency despite having numerous deep trade and economic ties with the European Union.

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In order to understand why, one must analyze the history of the Euro, the eurozone, and the United Kingdom. Certain scholars such as Peter Howard and John Grahl argue that if Britain were to join the eurozone, both the EU and Britain would benefit from the furthered economic entanglement. However, other scholars such as Patrick Minford argue that Britain should retain its own independent currency. For the purpose of this paper, I will argue for the former; I believe that the United Kingdom should join the Euro, and in doing so, strengthen both the EU’s and the UK’s economies.

History of the Eurozone

To understand the eurozone, one must understand the history behind it. From the beginning foundations of the European Union, a common economy was the focus. The European Union was originally founded as a means of creating a single “common market”, or a central location where similar policies on trade and economic policy could flourish (Mamadouh & Van Der Wusten, 2011, p.111).

Creating a singular monetary policy was at the forefront of this goal. Having a single cohesive currency would allow more seamless trading, importation, and exportation of goods from European member states. (Mamadouh & Van Der Wusten, 2011, p.111). As well, a single currency would massively help bolster the monetary fluctuations that were ravaging Europe during the post war economy. Having a single currency would allow for a stabilization of the economic environment across Europe. (Mamadouh & Van Der Wusten, 2011, p.111).

The idea of an economic and monetary union across Europe preceded the creation of the European Communities. The first true attempt at creating such a union came from an initiative from the European Commission in 1969 (Bache, Bulmer, George, and Parker, 2015 p. 385). The idea of “greater co-ordination of economic policies and monetary cooperation” (Bache, Bulmer, George, and Parker, 2015 p. 385) officially put forward the concept of a unified Europe. During this time period, exchange rates between member states and other international players massively fluctuated due to a non-stable European currency (Bache, Bulmer, George, and Parker, 2015 p. 386).

In order to combat this, the European Council commissioned Pierre Werner, the Prime Minster of Luxembourg at the time, to come up with a plan to reduce or stop the massive fluctuations in currency that was currently plaguing Europe (Mamadouh & Van Der Wusten, 2011, p. 112). His 1970 report recommended “the development of a common concept of the state of economic and monetary union” (Werner, 1970, p. 116).

Although Werner did not actually argue for a singular currency, his ideas further led to consideration of monetary integration within Europe. The European Council in Hannover of 1988 began preparations for an all-encompassing monetary union in Europe (Mamadouh & Van Der Wusten, 2011, p.112). At this point in history, a majority of European states backed the idea of a European monetary union, with a single central bank (Mamadouh & Van Der Wusten, 2011, p.113). However, the British prime minister at the time, Margaret Thatcher, opposed such an idea. She argued that joining the Euro would drag the sterling down in value (Mamadouh & Van Der Wusten, 2011, p.115).

As a common European economic policy was moving forward with or without Britain’s approval, Commission President Jacques Delors was asked to form a committee to provide a detailed, outlined plan for creating a single European economic and monetary union. (Bache, Bulmer, George, and Parker, 2015 p.387) However, the issue of what to do with Germany continued to plague the planning process. France and Britain continued to be wary of the military powerhouse of Germany following World War II (Mamadouh & Van Der Wusten, 2011, p.115). As this economic policy would require German reunification, France and Britain vehemently argued against this plan (Bache, Bulmer, George, and Parker, 2015 p. 387).

However, Germany’s pledge to do away with the Mark and accept a European currency swayed France to support German reunification (Mamadouh & Van Der Wusten, 2011, p. 113). President Delors’ 1989 plan formalized the attempts to further economic integration across the budding Europe (Bache, Bulmer, George, and Parker, 2015 p. 387). The Delors report introduced the concept of an “Economic and Monetary Union”, or a single unified plan to merge all of the various economies of Europe into one single union (Bache, Bulmer, George, and Parker, 2015 p. 387-389). Under this plan, the Maastricht treaty was signed February 7th, 1992 which signaled the congruent agreement to form a single currency across Europe (Bache, Bulmer, George, and Parker, 2015 p. 387-389).

The next major step for the creation of the Euro was the creation of the European Monetary Institute (Mamadouh & Van Der Wusten, 2011, p. 112). Once agreements had been reached for the specifics of the currency, January 1st, 1999 was selected as the day to implement the new currency (Mamadouh & Van Der Wusten, 2011, p. 112). Prior to the launch, the European Commission adopted the Stability and Growth pact, a plan to ensure the stability of the future singular currency (Mamadouh & Van Der Wusten, 2011, p. 112). As well, this pact created the second exchange rate mechanism (ERM II) in order to help overall European currency stabilization (Bache, Bulmer, George, and Parker, 2015 p. 390).

On May 3rd, 1998, the European Council met in Brussels to decide which of the current European states would be selected as candidates for the new European currency (Mamadouh & Van Der Wusten, 2011, p. 113). Strict rules were required of the member states who wished to join the Euro. Specifically, “a maximum public debt of 60 per cent of the GDP and a maximum budget deficit of 3 per cent (the convergence criteria that regulated access to the euro contained the same thresholds)” (Mamadouh & Van Der Wusten, 2011, p. 114) were the requirements.

Of the original member states, Belgium, Denmark, France, Germany, Ireland, Luxembourg, and the Netherlands joined the Euro (Bache, Bulmer, George, and Parker, 2015 p. 390). Three member states met the requirements, but rejected joining for various reasons. Specifically, “Britain and Denmark were allowed to do this under the terms of their ‘opt outs’. Sweden was able to claim on a technicality that it had not fulfilled the conditions because it had not been a member of the ERM for two years prior to the launch of the Euro.” (Bache, Bulmer, George, and Parker, 2015 p. 390).

In order to facilitate a smooth transition between national currencies and the Euro, the European Central bank was created in order to take over the power from the European Monetary Institute (Mamadouh & Van Der Wusten, 2011, p. 111). The European Council established the currency exchange rate between the national currencies and the Euro from recommendations by the European Commission (Mamadouh & Van Der Wusten, 2011, p. 111).

The Euro originally took the form of an electronic only currency, as no physical means of producing the Euro existed at the time of creation (Mamadouh & Van Der Wusten, 2011, p. 111). On January 1st, 1999, the Euro was launched as the official currency of the European Union in France, Germany, Ireland, Italy, Luxembourg, and the Netherlands (Bache, Bulmer, George, and Parker, 2015 p. 390). Denmark and the United Kingdom held referendums and voted to not join the Euro (Bache, Bulmer, George, and Parker, 2015 p. 390). Following the creation of the Euro, the eventual number of member states grew to nineteen, the current number we know today (Bache, Bulmer, George, and Parker, 2015 p. 391).

Recent Developments

However, the creation of the Euro was not without its fair share of trials and errors. The eurozone crisis occurred when the sub-prime market in the United States crashed, causing a global market crash (Weber, 2015 p. 248). At one point or another, almost every European state failed to meet the Maastricht debt requirements of 3% (Weber, 2015 p. 252). As the “Debt-to GDP- ratios skyrocketed” across Europe, the financial crisis was triggered (Weber, 2015 p. 251). As unemployment rates spiked to nearly 27% in Greece and Spain, people began to question the validity of joining the eurozone at all. (Weber, 2015 p. 251) As an effect, the GDP of eurozone countries slowed to a grinding halt. At the third quarter of 2008, the eurozone was officially in a recession (Weber, 2015 p. 257).

In an attempt to combat the eurozone crisis, the Lisbon Treaty of 2009 officially created the Eurogroup (Mamadouh & Van Der Wusten, 2011, p. 116). The Eurogroup consisted of the finance ministers of the various members of the European Union and one elected president (Mamadouh & Van Der Wusten, 2011, p. 116). This group argued for stronger economic co-operation and economic entanglement in order to ensure the strength of the EU and the euro (Bache, Bulmer, George, and Parker, 2015 p. 390-391).

Eventually, a plan was formed to mitigate the financial crisis by pumping billions of euros into the European Union banking system (Bache, Bulmer, George, and Parker, 2015 p.387). In essence, the plan was to fund the European banks with enough money to encourage more lending. This plan was similar to the plan being used by the United States at this time. As time progressed, the plan worked and the Euro continued to be strengthened (Weber, 2015 p. 259). Ironically, the European Union did better during this crisis than the states that were criticizing the European Union during this time.

As fears of a weaker European state possibly collapsing continued to plague the European Union, eurozone leaders finally agreed to put a stipulation into the Euro agreement for bailouts. (Weber, 2015 p. 275). Known as the “European Financial Stability Fund”, This new program provided a temporary means of giving financial assistance to member states such as Ireland, Portugal, and Greece that were having trouble repaying Euro debts. However, in 2010, the European Financial Stability Fund was replaced with the European Stability Mechanism, a more permanent mechanism to provide assistance to failing member states. “The European Stability Mechanism is the permanent crisis resolution mechanism for the countries of the euro area.

The ESM issues debt instruments in order to finance loans and other forms of financial assistance to euro area Member States. The decision leading to the creation of the ESM was taken by the European Council in December 2010. The euro area Member States signed an intergovernmental treaty establishing the ESM on 2 February 2012. The ESM was inaugurated on 8 October 2012 (Why the Euro, 2015).

Effects of the Eurozone

In order to understand exactly how the eurozone effected the economies of the member states, a closer look into the economies of the eurozone states is required. A paper by Tal Sedah studied the effects of joining the Euro on economic trade both within and outside of Europe. The study found that the states within the eurozone overall did twice as much trade as similar states that were not within the eurozone (Sadeh, 2014 p. 214).

Specifically, he argues that from the beginning of the eurozone inception, trade was not altered much due to the lack of widespread circulation of Euro notes as the former currencies were still being collected (Sadeh, 2014 p. 227). Tal argues that the states within the eurozone did greater trade within other states in the eurozone as well as international states. He argues that “the euro mainly enhances variety-driven trade by lowering the fixed costs of cross-border trade, rather than lowering transaction costs. Since consumers and small businesses handle cash relatively more than large firms, for many of them, the euro was not a reality before they began preparing for the introduction of its notes and coins in 2002.” (Sadeh, 2014 p. 232-233).

As well, Tal found that even during the global 2008 financial crisis, states within the eurozone performed better than non-eurozone European states. He argues that the widespread use-age of the Euro helped to bolster the overall value of the currency, which allowed for greater buoyancy during the economic downturns (Sadeh, 2014 p. 232).

Another more specific study was conducted by Cavallo and others in order to investigate the specific benefits of joining a common currency union such as the Euro. The researchers used Latvia as a specific case study to examine how joining the Euro altered the price impacts across the international markets (Cavallo, Albernto, Neiman, and Rigobon, 2015 p. 282).

Essentially, the researchers studies the differences in sold goods in Latvia and other European states before and after Latvia joined the Euro. Specifically, the researchers used goods sold by Zara, a massive manufacturing company that sells goods internationally. The researchers found that “In the first week of 2014, when Latvia officially joined the euro zone, 90 percent of its prices (in levels of local currency) changed.” (Cavallo, Albernto, Neiman, and Rigobon, 2015 p. 289).

In essence, when Latvia based their prices on the Euro instead of the Lats, prices suddenly and massively changed further towards the median price of goods throughout Europe. This came as a massive surprise to the researchers, as the price differences between good prior to joining the eurozone were huge. The differences in price between one item in Latvia and one item in Germany could be as large as 100%. However, almost immediately after joining the Euro, price difference stabilized to zero (Cavallo, Albernto, Neiman, and Rigobon, 2015 p. 291).

For Latvia, this price stabilization meant that Zara could compete much more competitively in Latvia after the acceptance of the Euro. Instead of having massively price gouged products due to the currency exchange, Latvia could hold competitive prices in the goods they sold. However, this phenomenon extended beyond just Zara. A previous study by Cavallo, Neiman, and Rigobon (2014) found that prices almost immediately stabilized between eurozone states for good sold my H&M as well. (Cavallo, Neiman, and Rigobon, 2014, p. 529-530)

As well, the researchers “demonstrated lower price dispersion within the euro zone for more limited data on products sold by Adidas, Dell, Mango, and Nike” (Cavallo, Neiman, and Rigobon, 2014, p. 534-535) The authors concluded that Latvia joining the eurozone massively contributed to price stabilization of Zara good across the European business field. Specifically, “Whereas 6 percent of the goods sold in Latvia and Germany in November 2013 had the same price, about 85 percent did by the end of January 2014 and about 90 percent did by the end of February 2014” (Cavallo, Albernto, Neiman, and Rigobon, 2015 p. 293-294).

Why Has the UK Not Joined the Eurozone?

Given these economic benefits from joining the Euro, why does the United Kingdom continue to put off joining the eurozone? Patrick Minford, an economic analyst, argues that three specific economic concerns need to be analyzed to understand why Britain continues to refuse to join the European Economic and Monetary Union (Minford, 2004 p. 82-84).

Firstly, Minford argues that Britain joining the EMU would create massive variability within the United Kingdom’s economy when it comes to dealing with shocks such as the housing market collapse (Minford, 2004 p. 82). He argues that joining a single currency would retract from Britain’s ability to have a flexible exchange rate when trading with other countries (Minford, 2004 p. 82). As Britain trades more heavily with international partners than other European states, Minford argues that Britain’s economy more heavily relies on the flexible exchange rate to absorb shocks and fluctuations (Minford, 2004 p. 82).

The second main argument put forward by Minford is the idea of harmonization. Minford argues that as Britain remains independent of the eurozone, it maintains a larger capacity to remain flexible and independent in setting wages, maintaining taxes, and other economic institutions (Minford, 2004 p. 83).

Essentially, Minford argues that Britain maintains an advantage over the eurozone in its ability to independently set wages, taxes, and institute or retract various economic institutions. As the eurozone states have to act collectively, Minford argues that Britain maintains an advantage in being able to act alone (Minford, 2004 p. 83). Specifically, he cites his earlier 1998 study to illustrate the potential of large financial requirements to matching economic policies of other European states.

Lastly, Minford argues that the “Emerging State Pension Crisis” of Germany, France, and Italy threaten the stability of the eurozone, even before Britain joins (Minford, 2004 p. 82). Specifically, he cited the 1995 OECD paper by Leibfritz, Fore, Wurzel, and Roseveare that projects the various pension payouts to reach 10, 8, and 11 percent of the GDP of the states, respectively (Leibfritz, Fore, Wurzel, and Roseveare, 1995). Minford argues that as the pension payouts continue to swallow more and more of the GDP of the countries, the ability to rectify the situation will decrease. Specifically, he cites the increasing unemployment, and the slowing of growth plaguing Germany, France, and Italy (Minford, 2004 p. 84).

In essence, Minford argues that if Britain were to join the EMU, it would be held partially responsible, in a community sense, for helping to bail-out any of the member states that would end up unable to rectify these debts. As well, he argues that the debt of the other member states might create spillover effects on the economic prospects of the United Kingdom, should it join the EMU (Minford, 2004 p. 84).

Reasons to Join the Eurozone

While these three issues might seem like a deal breaker for Britain joining the EMU, I would argue that Britain joining the EMU could help rectify all three of the above issues. Specifically, I believe that Britain should bring forward a plan to the European Union to actively ratify past agreements for the formation of the EMU.

If the European Union and Britain were able to reach an agreement to actively bring Britain into the Euro, I believe that it would create a spillover effect into both Denmark and Sweden, the two out countries that have continually opted out of joining the Euro. If an agreement was reached between Britain and the European Union, specifically one that satisfied the British requirements for stability, Sweden and Denmark would have no reason to remain outside of the eurozone. Specifically, I believe that if Britain joined the eurozone, both Britain and the current member states of the European Union would benefit economically.

To understand why this would work, examine Britain’s current economic situation. First off, being one of the only major European states to not run off the Euro, Britain is losing out on massive amounts of trading possibilities with the rest of Europe due to transactional costs of the exchange rate (Simon, 2002 p. 315). As an example, look at German and French imports and exports to other member states. Specifically, in 1998, before joining the eurozone, German imports and exports to other member states constituted 27.2 percent of the German GDP (Simon, 2002 p. 315).

After joining the eurozone, that number has risen to 31.4 percent in 2001(Simon, 2002 p. 315). This same phenomenon is seen in France, as the same percentages rose from 28 to 32 percent. However, Britain, the main country to reject the eurozone saw the imports and exports fall from 23.4 percent to 23 percent of the GDP (Simon, 2002 p. 315). This is primarily due to the transactional costs of not accepting the Euro. These costs are only projected to continue to rise as Britain continues to remain in isolation monetarily from the rest of the EU (Simon, 2002 p. 316).

As for the fluctuating exchange rates, Simon argues that Britain could actually help curb these massive fluctuations by joining the Euro (Simon, 2002 p. 316-317). As Simon puts it, “This fluctuation is caused by the fact that manufacturing exports to countries with a different currency account for 37 percent of the UK’s manufacturing output, compared to 19 percent of the eurozone’s, and 15 percent of the United States’” (Simon, 2002 p. 318-319).

He argues that as Britain has such a massive amount of manufacturing exports to countries with different currencies, joining the Euro would actually help solidify Britain’s currency fluctuations by not requiring a currency change for manufacturing exports. Similarly, Peter Howard argues that by continuing to use the sterling, Britain will continue to have opportunities for greater manufacturing mobility stolen by member states that trade within the Euro (Simon, 2002 p. 319-320).

Lastly, in order to combat the “Emerging State Pension Crisis” (Minford, 2004 p. 82), I advocate for a ratification of the EMU to enforce more strict levels of debt to GDP ratios. The pension crisis continues to be an issue as the economic stagnation and the unemployment continues to fester in the eurozone states (Simon, 2002 p. 318).

I argue that bringing in Britain to the EMU would allow for a larger and stronger European Economic and Monetary union to be created. As Britain joining the EMU would massively bolster the Euro across the European Union, I argue that Britain should join in order to help bolster the various European states’ economies, as well as its own. As well, I believe that if conditions were met for Britain to join the EMU, Sweden and Demark would follow suit, joining the Euro in order to reduce the financial barriers that exist between Euro and non-Euro states.

Similarly, John Grahl argues that “The main lines of reform which are needed are: clear legal subordination of the European Central Bank to the Council of Ministers and the European Parliament; a broader mandate for the ECB; and moves towards a significantly larger central EU budget” (Grahl, 2009 p. 96 ). All three of these reforms would allow for a stronger and more unified EMU that would allow the eurozone and European Union to flourish.

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Conclusion

In conclusion, one can see from a historical context why the United Kingdom originally chose to not join the eurozone. As shown from the previous arguments, one can see why the United Kingdom would continue to be hesitant in attempt to join the European Economic and Monetary Union. However, the current economic trends and studies continue to point towards a mutually beneficial agreement from Britain partnering with the eurozone in order to form a larger and better funded EMU. As the partnership between Britain and the eurozone states could trigger a greater movement to join the eurozone, I argue that for the sake of European unity and economic success, Britain should make efforts to join the European Economic and Monetary Union.

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The Impact of the Euro on the World Economy. (2019, April 10). GradesFixer. Retrieved March 29, 2024, from https://gradesfixer.com/free-essay-examples/the-impact-of-the-euro-on-the-world-economy/
“The Impact of the Euro on the World Economy.” GradesFixer, 10 Apr. 2019, gradesfixer.com/free-essay-examples/the-impact-of-the-euro-on-the-world-economy/
The Impact of the Euro on the World Economy. [online]. Available at: <https://gradesfixer.com/free-essay-examples/the-impact-of-the-euro-on-the-world-economy/> [Accessed 29 Mar. 2024].
The Impact of the Euro on the World Economy [Internet]. GradesFixer. 2019 Apr 10 [cited 2024 Mar 29]. Available from: https://gradesfixer.com/free-essay-examples/the-impact-of-the-euro-on-the-world-economy/
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