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 The Single Market & the euro
Economic and Monetary Union (EMU)
This is the process, which enabled the introduction of the single currency, the euro. Economic and Monetary Union (EMU) has developed in 3 stages:
- Stage 1 was from July 1990 to December 1993. This removed internal barriers to the free movement of capital within the EU.
- Stage 2, beginning in January 1994 set up the European Central Bank (ECB) (or European Monetary Institute as it was then called). This strengthened monetary policy co-ordination and prepared for the establishment of the European System of Central Banks (ESCB).
- The final stage started in January 1999 with the irrevocable fixing of exchange rates of the old currencies to the euro, the transfer of monetary policy to the European Central Bank and the introduction of the euro. The use of euro notes and coins in the countries who had agreed to become full members of the euro (the eurozone) came into operation on January 1st 2002. The single monetary policy is now conducted by the Eurosystem (the European Central Bank plus the national central banks of the 12 participating countries).
Euro coins. Copyright: "European Commission Audiovisual Library".
The Single Market
The Single Market came into effect in January 1993 and works on the basis of four freedoms - the free movement of goods, labour, services and capital throughout the EU. This means, for example, that companies can buy and sell goods without them being subject to barriers to trade, that people can work in any member state with their qualifications recognised, that services such as banking may be used across member states, and that capital and currencies can move freely. All Member States of the EU are part of the Single Market, even if they have not joined the euro.
What are the opportunities of the Single Market?
- A wider market is accessible for both producers and consumers - there are over 500 million consumers in the EU following enlargement in May 2004.
- There is greater competition, which has led to lower prices on certain goods, for instance the liberalisation of air travel has contributed to the introduction of 'no frills' airlines.
- Consumer protection has increased as EU directives apply across the Single Market, for example the Fourth Motor Insurance Directive makes it easier to make a claim following an accident occurring in another EU country.
- Common standards on products means that they can be sold in other Member States without retesting. This improves consumer and producer knowledge and leads to greater competition which should, in turn, bring benefits to all.
- Workers are more mobile and can work with the same rights in other Member States. In theory, this should lead to less disparity in wages across member states and more opportunities for people within the EU to locate jobs.
What are the threats to the Single Market?
- Some countries are still protectionist and not implementing in full new single market rules. France and Italy are the worst offenders. For example, Italy has yet to abolish a set of technical rules, which restrict how trailers may be attached to tractors - this has blocked the opportunity for other European trailer manufacturers to enter the market.
- There are fears of possible cultural differences. For example, if Muslim states join would they be able to adjust their approach to women to meet the standards set by the EU? Should they have to?
- The opportunities that exist for criminal elements to exploit the single market could cause de-stabilising effects.
- The disparity between member states could lead to further social and economic problems, particularly in countries that used to be part of the former Soviet bloc where it is acknowledged that they are a long way behind the economic development of existing members. The experience faced by Germany when it united West Germany with the former 'communist' East Germany is a good example of the potential problems that could arise.
What is the euro?
The euro is the common currency used by 12 of the 25 EU member states. The 3 'old' member states not yet using the euro are Denmark, Sweden and the United Kingdom. The euro was introduced in the 12 participating states on 1 January 2002, replacing their old currencies such as the franc (France) and lira (Italy). This was the third stage of Economic and Monetary Union (EMU), which commenced in the early 1990's. Sweden (September 2003) and Denmark (September 2000) have both held public referenda on whether or not to join the euro, and both have rejected it in favour of keeping the krona and krone respectively.
The new member states which joined in May 2004 have not automatically joined the euro. They will only do so when they have reached the level of economic convergence required by the 'Maastricht' convergence criteria. This includes a high degree of price stability, sustainable government finances, a stable exchange rate, and convergence in long term interest rates. There is no timetable at present for the new member states to join the euro.
The eurozone. Copyright: "European Commission Audiovisual Library".
Will the UK join the euro?
The Treasury outlined five economic tests in 1997 that need to be met before the UK can adopt the euro. These tests are:
- Convergence. Are UK business cycles and economic structures compatible with euro interest rates on a permanent basis? This test looks at whether a single interest rate will be suitable for all Member States using the euro over a sustained period. It looks at what impact an economic disturbance or 'shock' would have on each of the Member States, i.e. whether each economy would react in the same way, and whether or not Members would be vulnerable to country specific shocks. If the latter applies, the government would not consider there to be sufficient convergence for the UK to join.
- Flexibility. Is there sufficient flexibility to deal with problems? This test looks at the ability to respond to economic change efficiently and quickly, and at ensuring that shocks do not have long-lasting effects.
- Investment. For firms wishing to invest long-term in the UK, would joining the euro create more favourable conditions?
- Financial Services. What effect would joining the euro have on the competitive position of the UK's financial services industry, particularly on the City of London's wholesale markets?
- Growth, Stability and Employment. Will joining the euro promote higher growth, stability and a long-term increase in jobs?
In June 2003, the government assessed whether the conditions of these tests had been met. They concluded that the first two tests of Convergence and Flexibility had not been met, but that the other three tests of Investment, Financial Services, and Growth, Stability and Employment had been met. Therefore, the government decided that it was not currently in the national interest to join the euro. They announced reforms including a new inflation target, reforms to housing, planning to promote flexibility in the economy, and consultation on a new fiscal regime in order to meet all five economic tests. The Government will report on progress on the economic tests in the Budget of 2004. If the 5 tests are met at that time, it is proposed that the issue would then be put before the British people in a referendum.
Should the UK join the euro?
Advantages:
- Reduction of opportunity cost, which may occur as a result of loss of investment and trade from eurozone countries. Small and medium sized businesses would be able to trade freely in the Single Market, perhaps for the first time.
- Stability would increase as vulnerability to short term shocks would be reduced, (such as house price and interest rate rises), as would changes in the exchange rate which affect the level of exports.
- The UK may find it is increasingly sidelined in terms of political decisions within the EU, particularly following enlargement, if it is not a full member in economic terms.
- It would cut business costs by removing the need to convert from the pound to the euro, and the associated changes in the exchange rate which may unexpectedly cut profits.
- Businesses will be able to make longer term decisions as unpredictable currency movements would be reduced.
- Competition would be stimulated, benefiting the consumer as prices throughout Europe would be more 'transparent' - differences could not be masked by changes in the exchange rate.
Disadvantages:
- In the present climate, it would be an unpopular decision, with the majority of Britons not being in favour of joining. This may lead to a lack of confidence in the economy. Many worry about the UK losing control over its own economy.
- The UK would not be able to set its own interest rate. Instead, it would be set by the Central Bank for all eurozone countries. This reduces the government's ability to react to shocks in the market. Any change in the interest rate will benefit the eurozone countries as a whole, which may mean it benefits some countries more than others.
- Mortgages in the UK are different to those in the rest of Europe. In the UK, there is a high proportion of owner-occupiers with variable rate mortgages. In the rest of Europe, however, there is a higher tendency for long term renting, and those that do have mortgages are on long term fixed rates. Therefore, homeowners in the UK are more likely to be affected by interest rate changes than their counterparts in other EU states.
- Joining the euro may restrict the amount of long-term borrowing the UK is able to carry out. Eurozone countries are subject to the Stability and Growth Pact, which means that countries must not spend beyond their means. If the UK wishes to borrow money for long-term investment, this would be against the guidelines.
- Some take the view that as the British economy is doing well at the moment, and outperforming the eurozone states, why move over to the euro?
Why is the exchange rate set between the euro and the pound before joining the euro so important?
The rate at which the UK might join the euro is important because this would determine relative prices. If the UK joined at too high a rate, it would mean that exporters would find that their prices had effectively risen making them less competitive whilst imports would appear cheaper. The disruption to our competitive position could have long-term effects as businesses would have to find ways of regaining the competitiveness that they had lost. This could be difficult - especially in the case of manufacturing industry - when margins might be already very tight and there is not much room for improving efficiency and productivity.
If we joined at too low a rate, the opposite position would arise - imports would become more expensive, thus increasing business costs but exporters would see some benefits in terms of improved prices. The effects in both cases is not 'real' in the sense that the prices received by both importers and exporters would not necessarily reflect the resources used in the production of the goods and services concerned.
In 1992, the UK joined the Exchange Rate Mechanism (ERM) at a rate of DM2.95 to the pound. This was seen as being too high and that the pound was effectively overvalued - not worth what you had to pay for it. The increased pressure on the pound to fall meant the government had to maintain interest rates at very high levels, which in turn exacerbated the downturn in the economy.
To further understand the problems, refer to the Purchasing Power Parity (PPP) theory. This states that relative exchange rates should reflect the cost of purchasing a similar basket of goods in different countries. If £100 would buy a specified basket of goods in the UK and an equivalent basket cost €200 in Europe, then the exchange rate should be £1 = €2.
Euro notes. Copyright: "European Commission Audiovisual Library".
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