Advantages and Disadvantages of Adopting a Single Currency: The Euro
Introduction The European Union is an economic and political grouping of 28 member-states in Europe. The market has a population of around 500 million people and accounts for 23% of global GDP. The union has its origins in 1958 through its predecessor European Economic Community which had six members. The current name was adopted in 1993 and ever since membership has increased to include countries that were previously viewed as non-European such as Turkey. In 1999, the union established the Eurozone as a monetary zone and was enacted in 2002 with the currency of choice named as the Euro. Of the 28 EU members, 18 members belong in Eurozone. The European Central Bank (ECB) was established to regulate its flow as a recognized legal tender in the market. This move for a single currency brought with it benefits and costs to individual countries with some losing and others gaining as identified relevant literature on the topic. Benefits The move to have a common currency in a common market eliminates the costs of currency conversion and fluctuation of prices owing to nominal exchange rate fluctuations. Differences in currencies have been noted as one of the most prominent hindrances to trade. Economist John Stuart Mill even once observed that So much of barbarism, however, still remains in the transactions of the most civilized nations, that almost all independent countries choose to assert their nationality by having, to their own inconvenience and that of their neighbors, a peculiar currency of their own Angyal 2009, p. 109). Xavier 2
The move to have the Euro was thus intended to address this barbarism noted by Mill and enhance trade among EU members. The removal of these foreign exchange challenges has increased foreign direct investment activity in Europe. According to the World Bank, FDI flow in and out of the Eurozone has increased impressively. In fact, the rate increased by 20% between 1998 and 2001 compared to the period between 1995 and 1998. A considerable amount of many is saved by adapting the euros in the Eurozone. It is roughly estimated that the common currency saves about 0.05% of total trade between a country and a non-Eurozone member. However, the cost of forex to international business ranges from 0.06% to 0.1% of the GDP. Majority of this growth is attributed to intra-EU investments, removal of pricing challenges using different currencies across international borders, ease in meeting in house cost calculations and financial reporting requirements, and exchange rate volatility (Sousa & Lochard, 2011). However, a model developed by Head and Ries (2008) shows that firms consider more about the possibilities of mergers and acquisitions in foreign countries as opposed to other factors such as currency. Data from the field also indicates that the Eurozone countries invest more in non- Eurozone countries than in Eurozone countries. The optimum currency area theory predicts that regional markets that adopt a common currency register increased economic activity. This theory predicts adaption of a common market, specifically in the Eurozone contributes to 0.08-0.012% growth in the GDP (Bancevicius, 2010). This theory is based on the assumption that the adoption of a common market allows easier flow of factors of production. However, in the case of the EU, Bancevicius reports that the flow of labor as a key factor in production has not achieved full mobility in the region as a Xavier 3
result of strict immigration laws. In most cases, the laws target the comparatively less developed Eurozone members such as Slovakia and Slovenia. These countries have been late entrants to the EU and Eurozone which technically means they should benefit most from the common currency according to the optimum currency area theory. The other benefit is to discipline economic policies to address inflation. This is based on the fact that the European Central Bank (ECB) has more responsibilities in keeping economic discipline in the sense that t has responsibility to a larger number than in the case of individual countries which seek to position their currencies in a position that benefits them but likely to hurt other members of the union or its trading partners. Costs The cost of Euro to member countries is of course loss of freedom in enacting key economic policies. With the Euro as the national current being shared by the rest of the Eurozone members, it means that the national monetary policies are infective in stabilizing any national economic shocks. This is a huge disadvantage in that it denies individual economies some degree of control in influencing the national economic climate. Some economists have pointed the adoption of the euro which resulted in giving up of monetary autonomy as being responsible for the predicament facing some countries in Eurozone such as Spain. To avoid such repercussions, Beetsma & Giulodori (2010) argue that the cost of giving up monetary autonomy should not supersede the trade, institutional and political benefits gained from it. The loss of a countrys ability to issue and regulate its foreign reserve means that the country loses a source of revenue. Member countries, through their central banks, still get some seigniorage which is most beneficial to the comparatively poorer economies. Nonetheless, the Xavier 4
fact that the members lose control of their seigniorage implies that they lose their seigniorage revenues. This issue has created sensitive debate among members with some members concerned about the loss of seigniorage revenue. For instance, Greece expressed serious concerns about this issue upon joining the Eurozone (Bancevicius, 2010). Intriguingly, a loss of the ability to inflate away the domestic-currency debt has been cited as one of the problems that has affected Greece in the recent past which is blamed the countrys membership to the Eurozone (Bulr & Hurnk, 2009). Loss of Seigniorage control implies loss in ability to control monetary policies as aforementioned. Therefore, member countries have to operate in a fixed exchange rate regime which can affect domestic and international business. Countries with such a forex policy have to keep stable monetary policies. However, The Czech Republic, Hungary, Poland and Romania have opted to set their own seigniorage level (Christiansen & Neuhold 2013). A look at the seigniorage levels of Poland and Czech Republic between 2004 and 2008 showed that these countries set their seigniorage levels at relatively low levels showing that they did not rely on the tool as a revenue source (Bancevicius, 2010). Conclusion From the above discussion, it is clear that every decision has two types of effects, positive and negative. In the case of membership to the EU common market, member countries have had to sacrifice a significant amount of their sovereignty especially regarding political and economic decisions. Membership also implies a significant loss of a source of revenue in form of foreign exchange and seigniorage. On the other hand, membership to the EU has its fair share of benefits. Most importantly is that there is reduced costs in doing business by eliminating the Xavier 5
costs and inconveniences of currency exchange. Others include increased FDI activity and more stabilized economies. The continued presence of the EU and retained membership in the union by individual members shows that clearly the benefits of the Eurozone outweighs its costs.
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References Angyal, Z. (2009). Monetary sovereignty and the European economic and monetary union. European Integration Studies, 7(1), 109-119. Bancevicius, R. (2010). New EU member states and the Euro: economic readiness, benefits and costs. Empirica. 38,461480. Beetsma, R. & Giulodori, M. (2010). The Macroeconomic Costs and Benefits of the EMU and Other Monetary Unions: An Overview of Recent Research. Journal of Economic Literature 48, 603641. Bulr, A. & Hurnk, J. (2009). Inflation convergence in the euro area: just another gimmick? Journal of Financial Economic Policy. 1(4), 355-369 Christiansen, T. & Neuhold, C. (2013). Informal Politics in the EU. Journal of common market studies. 51(6),11961206. Sousa, J. & Lochard, J. (2011). Does the Single Currency Affect Foreign Direct Investment? Scandinavian Journal of Economics 113(3), 553578.