European Union and United Kingdom

Economic advantages and disadvantages to the UK of participation in the European single currency, Euro. Will British businesses be better or worse off if the country decides to participate?

The Second World War which ended in1945 left a disastrous effect on Europe. Europe was greatly devastated politically and economically creating a divide among the people. The union grew out of the carnage and devastation of the war and has proved to be the world’s greatest peace process, uniting old enemies and friends alike in a common effort to ensure peace, freedom and prosperity for all of Europe.

The freedom and prosperity of the region were the core goals of the enabling treaty which has been successful. Today, the region has witnessed a lot of unprecedented growth in its economies.

In a bid to boost the economic well being of the region, it was envisaged that a single currency among other factors for the member states will enhance the progress of businesses in Europe. Whether the single currency will be of benefit to the UK has remained a debate over these years. Will it really work? Will UK be better or worse off?

Chapter 2: Origin of the European Union/ Objectives

The European Union came into being following the treaty of Rome which was signed by six member states namely; France, Netherlands, Belgian, Italy, West Germany and Luxembourg. They were commonly referred to as ‘The Six’. The union was basically formed to enhanced peace, political and economic growth among members who were greatly devastated by War.

The membership has risen to 25 following the joining of Poland, Romania, Bulgaria, etc. UK, Denmark and Ireland joined in January 1973, Greece in 1981, Spain and Portugal in 1986, Austria, Finland, Sweden, in 1995 while East Germany reunited with West Germany in 1990. The population of EU is in excess of 455 million people.

Common Market

Market can be defined as a setting where buyers and sellers meet to carry out transactions. In the context of our discussion, the common market is a physical geographical boundary within which goods and services can move freely. It is a market comprising of a group of countries which have no trade barrier between its members.

The Origin of the Euro

The treaty of Rome which was signed on March 25, 1957 resulted in the formation of the European Economic Community and later European Union formed the platform for a single market and obviously created the need for a monetary co operation between it then six member states. Events moved from EPU to EMA.

On January 1, 2002, the Euro became a legal tender. Some of the elements of the EMU include single currency, a European central bank, European economic policy and political control.

Chapter 3: Advantages and disadvantages of the Euro to the UK

1. External economic instability

The death of a sole trader might likely bring the business to a sudden end. Losses are bore by him alone. But in partnership, losses are shared by the partners. The effect is not actually felt as in sole trading.

Likewise, the EU member states are in partnership in the use of the Euro as a single currency. The Euro economy is of sizeable importance when compared with the US and Japan that have achieved enormous success as a result of overall regional integration. This will ensure that external shocks as a result of economic happenings outside of the zone will not have a much felt negative effect on member states.

Between 1974 and 1984, the UK economy witnessed a lower rate of economic growth than in the decade before accession. The plunge is not as a result of the membership of the EU rather to the rise in world oil prices by almost 400 per cent. What would have been the effect if the UK was not a member of EU? If such a shock happens again, the UK will be greatly affected because of its failure to adopt the single currency.

2. Competition/comparative advantage.

Joining the Euro will to a great extent ensure good competition which will lead to comparative advantage. It will bet easier for businesses to compare price. Every player in the economy will work towards lower prices and better quality of products to satisfy its customers, cutting costs and ensuring higher revenue due to the increase in demand. The above setting will ensure that comparative advantage as advocated by David Richardo is met. However, the above benefit will put UK businesses at a disadvantaged position if they continue to refrain from joining the Euro currency.

3. Exchange rate

The European single market is greatly enhanced by the use of the single currency. The Euro will reduce risks and uncertainties experienced by investors and exporters in their business transactions across the zone. The stability of the Euro will be a condition to be agreed upon before the eventual joining. Through it economic policies, the UK will ascertain whether to join. But, joining will be an advantage because of the reduction of risk and uncertainty.

However, the pound is very volatile. It was observed that the pound lost a 3rd of its value against the mark between 1989 and 2000, though it recovered. If the UK does not join in the single currency, an economic situation might occur where the pound will lose much value against the Euro and not recover. The conversion cost of the pound to the Euro and vice versa, and difficulties associated with it is a disincentive to business. It’s a disadvantage for the UK economy. But, if UK joins in the EMU, such problems will be eliminated and UK businesses will be better of.

4. Financial Services Industry

The UK economy has enormous earnings from the financial services industry. If the UK had joined the EMU, the European central bank, ECB, would possibly have been located in the city of London as against Frankfurt. This would have increased the level of activity in the city and subsequently increase income generated from that sector. This action could result in “banks relocating to the Euro zone, loss of jobs. In other words, it risks minimising our influence and maximising once again our chances of being once again shut out”

5. Trade

The Euro zone is the second largest market after the US. If the UK joins in the EMU, she will witness a higher market trade transaction because the separate currencies which act as a barrier to trade have been removed. These will translate to a higher confidence in the minds of investors because there will e no more fluctuations in currency. Studies have shown that Canadian provinces buy and sell more to each other rather than their immediate neighbour, the USA. This is as a result of the use of same currency among the provinces.

However, joining the Euro might likely have a negative impact on the UK economy. The Euro is quite unstable against the dollar and most of UK’s export is to the USA, being the reason why the pound is stable against the dollar. This is because UK has refused to join the Euro zone.

In other words, since the UK trades more with the USA, joining the EMU will have a negative effect on the UK since the Euro is unstable against the dollar.

6. Savers and Borrowers

The capital suppliers and capital users will benefit if the UK joins in the single monetary union. This is due to the opening up of huge opportunities within the currency zone. The Euro will help provide a single market for financial operators like banks, insurers, investment funds, pension funds etc because it will become easier to raise money from the combined capital market. With the sit and watch approach of the UK towards the Euro, the benefits as discussed above will continue to elude them. This is of course a disadvantage to the UK businesses

7. Mortgage issues/interest rates.

The UK economy is very sensitive to interest rate as when compared with the rest of Europe. This is because the UK has more floating mortgage rates. If the UK joins the EMU, any changes made by the ECB will hit her economy faster and harder than the rest of the continent where fixed rates dominate. This could be a disadvantage of joining the Euro.

8. Taxation

Taxation is a veritable tool to every government in piloting its economic issues. It is recognised as a defensive tactic during period of economic downturn and is too useful for any government to allow go down the drain.

If the UK joins the EMU, the union will gradually move from monetary union to economic. This is possible because the convection on the future of Europe has made reference to tax harmonisation across the region.

When UK joins, Euro land taxes level might damage her economy through decreasing her competitiveness. This is a disadvantage to UK economy and businesses.

9. Inward investment

In every economy, there is always foreign investment. Some major foreign investors have refrained from investing in the UK Since she has continued to stay out. The employees and steel users are of the same opinion too. In 1997, Ernst and Young indicated that UK’s share of direct foreign investment fell from 28% to 24%. In the same year, French economy grew from 12% to 18%. This has resulted in loss of investment and jobs. What a disadvantage!

But, it has been argued that UK’s continued stay out of the euro is not a disadvantage. That, most of its foreign investments come from the USA and are associated with high tech industries which are relatively insensitive to exchange rate fluctuations unlike with large scale production industries such as car manufacture with low profit margins.

10. Cost of conversion

It has been estimated that it will cost the UK about 10 – 30 million pounds for businesses and government departments to convert to the single currency. This will be a drain on the economy. The money could be used to further advance the course of economic prosperity. In essence, it’s a wastage and disadvantage.

Though it will be a burden on the UK economy, it could act as an injection by further bringing investment and up grading IT systems that will be beneficial to UK economy.

11. Influence

By joining the euro, the UK will have a voice in certain economic and financial committees that will affect her economy. They will be in position to oppose adverse policies and support those that will be of national benefit.

However, by staying out, UK will have more independence and will be able to follow a more national policy. In addition, she will be recognised as a major world player with more influence abroad.

Will UK be better or worse off by joining the Euro:

This debate is like the two sides of a coin. The head and the tail, which ever way the UK takes, will result to some benefits or negative consequences. To say the gains of joining will outweigh the losses of not joining is still debatable and vice versa.

It may not be impossible that the single currency may not be sustained in the present day modern and ever changing business environment. The Ireland withdrawal from the pound sterling goes to suggest that it could be beneficial to stay out of a common currency zone. So, if UK stay out it could be better of.

However, reduced exchange rate uncertainty for UK businesses and lower exchange rate transactions cost will boost economic growth of UK businesses.

The UK economy can easily react to interest rate changes more than its European neighbours and as such will her businesses affected by a change. Nevertheless, if the UK joins, the ECB will concentrate on economic and fiscal policies towards ensuring a less volatile interest rate.