Should UK Join European Union
A plethora of experts have presented different reasons on whether Euro should join Euro or not. The proponents hold that Euro is a strong economic plan, intended to reduce transaction costs and encourage convergence within the European Union. Other argued benefits include the stability of exchange rate, inward investment, and reduced/managed inflation. On the other hand, the disadvantages presented by the opponents includes loss of an independent monetary policy, complexity of getting out of recession, sensitivity to the interest rates and lastly, the loss of independence of the fiscal policy (Meenagh,and Minford, 2002). Gordon Brown formed out a technical committee in 1997 which adopted five key economic sets to measure the readiness of the United Kingdom to join the European Union (Krugman, 1991). The five elements include financial services, flexibility of the workforce and businesses, growth and employment, convergence, and investment. The entire tests failed. For instance, the test on convergence failed because, the treasury failed due to the interest rates and housing market in Britain. The interest rate set out by the Euro zone cannot meet the demands of the British market (House of Commons 2000). The discussion in the below sections will present economic arguments for and against the British joining the European Union based on the theory of the optimum currency area.
Firstly, the optimum currency area is delineated as an economic unit that includes different areas that are symmetrically affected by various disturbances between which specific factors of production and labour flows freely. An example is the collection of different countries using Euro with the intention of enhancing economic efficiency within its union b sharing a single currency. The optimum currency area theory is broken down to six main parts which are regarded as either political or economical. Three economic areas include labour mobility, diversification of product and openness. The political pillars on the other hand include Homogenous .homogenous preferences, fiscal transfers and conflict of solidarity and nationalism. (Mundell, 1961)
The Mundell Criterion of Labour mobility is anchored on the concept that labour and capital are completely mobile across borders; therefore the cost of currency sharing is removed. Therefore labour should move across borders to deal with the problem of excess demand. Mundell stated that the optimum currency areas are the ones within which people can afford to move easily. With regards to Euro, very small portion of the Euro can easily move. It is also clear that geographically, the labour force of Euro zone is immobile (Mundell and Swoboda,1969). People accept unemployment as opposed to migration. Britain is therefore better off handling the asymmetric shocks through exchange rate. The criterion shows that the union is not optimal and it is better for Euro to remain outside the union.
The production diversification developed by Kennen states how diversified partner countries are in a position to endure reduced costs from avoiding the nominal exchange rate changes and finds the benefit of single currency. The level of shocks will reduce when countries are diversified in terms of consumption and production (McKinnon, 1963). A portfolio that is diversified ensures that other sectors of economy can survive even if one is hit hard. Various economies in the European Union comprised of diversified industrial structure. This means that Britain will benefit when it enters the union through protection. Given that countries share similar industries, a shock in one industry will affect other regions. (Mongelli, 1976)
The McKinnon criterion on openness states that countries open to trade and trade with others form the optimum currency area; higher degree of openness means that the domestic price level will reflect changes in the international prices (Thom, and B. Walsh 2002). It will result to reduction of the exchange rate illusion. This criterion is met within the European Union. Prices are aligned across EU with high price liberalization. The openness currently stands at 40% of the GDP. On this basis, Britain should join European Union. (Quah, 2000)
Fiscal transfer is anchored on the criterion of risk sharing. The point is that there should be a system that facilitates the transfer of funds. It eliminates the need of the nominal exchange rate adjustment to compensate the shock. Such a system will require supranational body with view of coordinating their efforts and therefore requires high level of integration (Nickell, and Layard, 1998). Currently, Euro is working without any public risk sharing facility. If there is any asymmetric shock affecting Britain, it is not possible to compensate the mechanism of exchange rate. This criterion is not met and therefore Britain should not join. (Peersman, and Smets, 2001)
The view of homogenous preferences follows the point that there are different ways of solving a problem. Partners of OCA should agree on a single economic policy. This criterion is currently fulfilled in Euro though there have been reported frictions amongst the members. The issue will have minimal reason for Britain to either joining Euro or not. (Barrell, 2002)
The conflict of solidarity and nationalism is a political point when the monetary policy leans to a conflict of national interest. OCA should be able to survive on differences of opinion. Despite the differences members of the EU are always prepared to act for the good of the members. (Maes, 1992)
Based on the above discussion, the position of this paper with regards to the UK joining Euro is no, given that it fails to meet two key criteria, namely fiscal transfers and labour mobility. There is also no clarity with regards to homogenous preference and conflict of solidarity and nationalism. (Baldwin & Wyplosz, 2006)
At this point, the conditions do not favor British joining the union. The asymmetric shocks currently witnessed are unpredictable and any negative one might pose negative results to UK. Lack of federal style budget and inflexibility in labour market presents risks to economies economic health (Meenagh, and Minford, 2002). The productive specialization as result of trade integration is one problem that is likely to affect the union in future. Another main challenge is the language barrier is another reason for low movement, something that is unlikely to change in the near future (Eichengreen, 2001). The combination of above factors would make it impossible for Britain to join the union. The benefits as stated in the introduction section are totally outweighed by the costs from the asymmetric shock that Britain would have to deal with. (Tower, and Thomas 1996)
In a nutshell, Euro fails to meet the above criterion and therefore the conclusion is that Euro should not join the union. The method of fiscal transfers and the lack of flexible of labour market are the two main reasons behind this. Despite the fact that the former might change in the near future, the latter has no sign of making it less rigid. Therefore policies should be adopted to express the intention of reducing the protection of employment and encouraging mobility across borders. UK can then consider joining the European Union after enactment of those policies.
Baldwin & C Wyplosz, 2006; “The Economics of European Integration”; New York: McGrawHill.
Barrell, R. 2002, ‘The UK and EMU: choosing the regime’, National Institute Economic Review, April, 180: 54–71.
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Krugman, P. (1991), “Increasing Returns and Economic Geography.” Journal of Political Economy,Vol. 99, No. 3, pp. 483-499
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Nickell, S. and Layard, R. (1998), “Labour market institutions and economic performance”, CEPDiscussion Paper 407 (forthcoming, Handbook of Labor Economics)
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Quah D., (2000) “One Money, One Market: The Effect of Common Currencies,” Economic Policy, Vol.30, April, pp. 35-38
Thom, R., and B. Walsh (2002), ‘The effect of a currency union on trade: lessons from the Irish experience’, forthcoming European Economic Review, downloadable at
Tower, E., and Thomas Willet 1996, “The Theory of Optimum Currency Areas and Exchange Rate Flexibility,” International Finance Section, No. 11, Princeton University
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