European Economic And Monetary Union Essay Research

Paper

The Economic and Monetary Union (EMU) is a single currency area within the European Union in which people, goods, services and capital move without restriction (Europa Quest (1), 2001). Imperative to the success of the EMU is the implementation of a single European currency, the Euro, and the application of specific macro-economic policies by the EMU member states (Harris, 1999: 78). Moreover, it is the foreseeable intent of European governments to create a framework for stability, peace and prosperity through the promotion of structural change and regional development (JP Morgan, 2001). This essay will endeavor to highlight the fundamental gains likely to be accrued by the European business community as a result of EMU policy provisions. The developments and circumstances preceding the EMU formation will be examined to give insight into the functioning of a monetary union. Furthermore, it is essential to analyze the implications the EMU has for firms within both ‘Euroland’ and other European nations.

To establish a strong understanding of the intricacies of the EMU, it is essential to discuss both the antecedents and major developments in this monetary union. The origins of the EMU can be traced to the formation of the European Coal and Steel community (ECSC) in the early 1950s, which was the first attempt to harness European economic unity to achieve greater international competitiveness (Per Jacobson, 1999) (Duisenberg, 1998). The success of this venture prompted the foreign ministers of six ECSC nations to examine the possibility of further economic integration (Chulalongkorn University, 1999). Hence, in 1957 one the most significant agreements in European economics history, The Treaty of Rome, was signed. The Treaty of Rome’s fundamental goal was to provide for the creation of a common market (Kenwood & Lougheed, 1999:280). The most significant aspect of this treaty was the commitment made by such countries as Belgium, France, West Germany, the Netherlands, Italy and Luxembourg to facilitate the free movement of goods, services and factors of production. Essentially, these European governments sought to eliminate internal trade barriers, create common external tariffs and harmonies member states laws and regulations (Hill, 2001: 233). This movement towards a common European market continued with relative success until the late 1960s. During this period, the Bretton-Woods Exchange Rate Regime had begun to exhibit unmistakable flaws, whilst global inflation was alarming high. In addition, the revaluation of the German Deustchemark and the devaluation of the French Franc, created considerable exchange rate volatility within Europe (Barber, 1999). It was a common held belief amongst many member states, that Europe’s ability to compete within the global economy hinged on the introduction of a single currency (d’Estaing, 1997). Hence, in 1970 the Werner Committee was established to resolve the most efficient means to converge economic performance and currencies (Harris, 1999:76). The Werner Report proposed a three-stage process for achieving a complete monetary union within a decade. The final goal would be the free movement of capital, the permanent locking of exchange rates and the eventual replacement of the EC6 nations notes and coins with a single currency (Barber, 1999). The committee proposed a complete European Monetary Union by 1980, however the failure of the Smithsonian Agreement, the subsequent introduction of a floating exchange rate regime and the infamous Oil Price Shocks of the 70s, caused the plans outlined by the Werner Committee to be abandoned (Harris, 1999:79). In retrospect, the endeavors of the EMU were bold considering the erratic economic climate of the 1970s (Kenwood and Lougheed, 1999:310). Yet, even in this period of economic uncertainty, EC member’s still persued the concept of European Unity (Princeton Economics, 1998). In 1979, the European Monetary System (EMS) was established to foster a greater stability between member state’s currencies and stronger coordination and convergence of economic policies (Europa Quest (1), 2001). The EMS consisted of four main components, the European Currency Unit (ECU), The Exchange Rate Mechanism (ERM), The Financial Support Mechanism (FSM) and the European Monetary Cooperation Fund (EMCF) (Harris, 1999: 80). The ERM was at the ‘heart’ of the EMS and provided for “fixed but adjustable” exchange rates between countries, whereby currencies could move within certain margins or fluctuations. When limits were breached the responsible authorities were required to impose appropriate policy measures (Europa Quest (1), 2001). The EMS enjoyed considerable success during the 1980s, lowering inflation rates in the EC and easing the adverse financial effects of the global exchange rate fluctuations (Chulalongkorn University, 1999). The most problematic aspect of the EMS was that it held no true sovereignty over member states, rather these countries still maintained autonomy over currencies and macro-economic policies (Harris, 1999; 80). To rectify this systems inadequacy, Jacques Delors, the President of the European Commission, issued the Cockfield Report, which sought to define the current status of the European markets and establish the correct means for implementing a monetary union (Chulalongkorn University, 1999). Delors identified the greatest challenges facing the EC, which were;

1. The elimination of non-tariff barriers had not been achieved as specified under the Treaty of Rome. Instead, EC member states had begun to utilize such measures as Value Added Taxes (VAT), environmental laws, subsidies and difficult technical standards to circumvent established guidelines and protect domestic industry.

2. The growing dominance of the US and Japan, required Europe to economically and politically integrate in order to effectively compete.

3. Undertaking a concerted and structured attempt at implementing a single currency was imperative.

(Harris, 1999:70-71)

In 1987, the Single European Act was passed, based upon the recommendations outlined in the Cockfield Report (Chulalongkorn University, 1999). This paper outlined a comprehensive program of 282 measures to be implemented to achieve a single market and the timetable, which must be adhered to ensure the actions success (Harris, 1999:71). The Single European Act intended to have a single market in place by 1993. It proposed the removal of all frontier controls between EC countries, the application of the principle of mutual recognition to product standards and open public procurement to non-national suppliers. In addition, the Act purported the need to lift barriers in the EC’s retail banking and insurance industry, the elimination of restrictions on foreign exchange transactions and the abolition of the limitations on cabotage (Hill, 2001:235-236). Pivotal to the Single European Act’s implementation was the substantial surrender by member states of their economic autonomy to the European System of Central Banks (ESCB). The ESCB would assume responsibility for coordinating macro-economic policies (particularly monetary). Essentially, it was the primary role of the ESCB to fix internal exchange rates to the single currency (the Euro), control foreign reserves, interest and inflation rates (Harris, 1999:82). This actual movement of the EC towards a single currency, was hampered by the failure of the Delors Report to establish the economic standards which the EC member states must achieve in order to ensure convergence into one business cycle (Barber, 1999). In 1993, The Treaty of Maastricht expanded upon the Single European Act, primarily establishing a timetable for the implementation of the single currency and most significantly the convergence criteria to be reached by those nations ascending into the EMU (Princeton Economics, 1998). The Maastricht Convergence Criteria is an essential element of the EMU structure, as it sets five minimum economics requirements, which must be met in order to ensure membership (JP Morgan, 2001). An ascending country’s inflation must be no higher than 1.5% above the average for the three EU members with lowest rates during the previous year, indicating price stability must exists within an economy (Harris, 1999:85). A prospective EMU member state should also experience long run interest rates no higher than 2% above the three EU members with the lowest rates during the previous year (Heller, 1997). The exchange rates of each economy must have also been in the normal band (ie. + or – 2.25%) of the ERM for 2 years without devaluating (Antwelleer, 2001). Those considering imminent membership should also display fiscal prudence or rather the economy should not experience a budget deficit, which exceeds 3% of its GDP (Harris, 1999: 85). Finally, it is essential that national debt does not exceed 60% of GDP (JP Morgan, 2001). These strict economic standards ensure that all countries operating under the single currency could be brought to the same position of the business cycle. If all member nations are experiencing similar economic conditions, it is possible for the ESCB to prescribe uniform monetary and discretionary fiscal policy (Urken, 1997). The final agreement which of consequence to the development of the EMU, is the establishment of the Stability and Growth Pact (Harris, 1999:85). This arrangement was initiated in 1996 at the Dublin Summit of the European Council, establishing a set of rules relating to currency and budgetary disciplines for countries within ‘Euroland’. Essentially, this policy pact decrees that all EMU members must maintain the Maastricht Criteria and defines possible enforcement mechanisms (Salmon, 2000:23-26). Specifically, the Stability and Growth Pact states those conditions under which EMU members have the right to exceed the set public debt to GDP ratio. Should authorization not be granted, member states make a mandatory deposit, which shall be transformable into a fine 2 years later (Per Jacobson, 1999). The Treaty of Maastricht also outlined the timetable of events, which are scheduled to occur if the single currency will be fully operational by 2002. Stages One and Two, were completed between 1990 and 1999, providing the foundations for the imminent success of the Euro. During this period, the Single European Market was completed, all ERM members entered narrow exchange rate bands, member states initiated policies which conformed with Maastricht specifications and the ESCB was created to implement monetary policy for EMU (Harris, 1999:84). May 1998 marked the deadline for membership offers to those countries that had proven their compliance with the Maastricht Convergence Criteria. Belgium, Germany, France, Spain, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portgual and Finland all entered the EMU, with Greece being granted membership in January 2001 (Europa (4), 2001). From January 1999, the Euro became the official currency the EMU, which ensured from that point forward all foreign exchange operations and new public debt was issued in Euros. On January 1st 2002, Euro coins and banknotes will go into circulation and in March 2002 it is the intention of EMU authorities to cancel national currencies as a means of exchange(Antweller, 2001). The development of the EMU has indeed been a long and involved process spanning 50 years, yet it will undeniably yield benefits for business within ‘Euroland’ and have considerable implications for the business communities in other European nations.

The ‘Eurozone’ business community is likely to accumulate a number of benefits from the implementation of the EMU, making the lengthy nature of its development rather lucrative. The EMU facilitates the movement of goods, services, people and capital through the development of a single European currency and the removal of barriers to intra-community trade (Roubini, 1997). Essentially, European businesses are being given the opportunity to exploit the liberalization of cross-border controls, which had previously diminished their ability to trade within Europe (Harris, 1999:94). European firms will find it easier to access the 12 ‘Eurozone’ markets, creating an opportunity to introduce new or modified products for each member states, or alternatively to provide a standardized set of goods and services for ‘Euroland’ (Harris, 1999: 94). The EMU’s development also facilitates those companies who seek to derive the competitive advantage of factors of production inherent in some member states (Hill, 2001:133). The greater movement of capital and labour allows firms to establish different aspect of their business operations throughout the ‘Eurozone’ (e.g. Research and development in Germany and production in Spain) (Harris, 1999:94). The commitment of the EMU authorities to lowering transport cost specifically the abolition of restrictions on cabotage, allows ‘Euroland’ firms to develop more efficient channel to distribute goods and services throughout Europe (Duisenberg, 1998). Financial markets have also undergone considerable liberalization throughout the EMU evolution, resulting in the removal of barriers, which had limited cross-border borrowing. This commitment to reducing financial barriers, will ensure ‘Eurozone’ firms have inexpensive access to finance in all EMU member states (Duisenberg, 1998). The culmination of greater product choice, increased movements of factors of production, enhanced channels of distribution and a more liberalized financial market, guarantees ‘Eurozone’ firms will be operating in a highly dynamic, challenging and ever-expanding marketplace. Inevitably, this will stimulate the EMU to become a highly competitive economic community. Currently, intra-community trade accounts 60% of member states international exchanges, a figure which is likely to grow with the success of the EMU (de Silguy, 1997). It is foreseeable that initially ‘Euroland’ firms may suffer under the pressure of such intense competition, however long run efficiency gains are likely to develop amongst EMU firms ensuring their longevity (Salvatore, 1998:283). The development of the EMU and the subsequent removal of exchange rate, trade and administrative barriers, will enourage firms to seek strategic alliances and join ventures (Harris, 1999:84). Moreover, it is expected the union of firms could facilitate the sharing of intellectual property, research and development, capital and labour techniques, creating greater operational efficiency and improving both the firms competitiveness within the ‘Eurozone’ and international markets (Antweller, 2001). It was a common held opinion amongst European business leaders, that political and economic integration was necessary to ensure to ability of European firms to compete with multinational US and Japanese companies (Barber, 1999). It has been argued the key to challenging the economic strength of the Japan, and US is the realization of strong domestic competition (Salmon, 2000). The removal of barriers between ‘Euroland’ nations will allow domestic competition to intensify, which will cause the development of firms who possess the ability to compete successfully in international trade (Europa Quest (3), 2001). The full integration of the Euro into the EMU as a medium of exchange, will also eliminate foreign exchange risk firm engaged in international trade are exposed to. Firms trading within “Euroland’ will no longer have to factor foreign exchange fluctuations into their profit margins, providing even greater incentive for market entry of large firms and giving small to medium sized firms the confidence to initiate a more global strategy (Tett, 1996) (Europa Quest (3), 2001). The ESCB control of monetary policy forecasts interest rates within some EMU member states to fall to historically low levels. This creates an environment for growth and expansion within the economy, stimulated by high borrowing and positive business sentiments (Martin, 1997). It is without question, the development of the EMU will have some negative implication for ‘Euroland’ firms. Most significantly, European firm will have to bear the considerable financial cost involved in making their operations ‘euro- ready’. That is, equipment and software will need to be converted, labour will require training and new procedures for dealing with the Euro need to be implemented (Europa Quest (3), 2001). The financial industry will have to undertake the greatest burden as foreign exchange, bond, equities and managed fund transactions will now all be carried out in Euros (Solomon, 1999). There are also considerable implications for contract law, as a result of the development of the EMU. Whilst, the Principle of Continuity of Contracts prevents any unilateral attempts to use the introduction of the Euro as a premise for canceling or not fulfilling contract arrangements, it is inevitable that contract would become complex with the implementation of the new currency (Europa Quest (2), 2001). Arguably, the greatest drawback of the EMU for member states, is the loss of national autonomy or rather the ability to exercise choice of monetary and fiscal policy (Antweller, 2001). Of particular consequence, is the diminishing role of national governments, who can no longer rely on fiscal or monetary policy platforms as a means of election, because they are constrained by EMU economic guidelines (Heller, 1997). Countries such as Finland, Italy and Spain are historically prone to asymmetric labour market shocks, which induce high unemployment. Fiscal policy can no longer be utilized as a direct targeting instrument within ‘Euroland’, thus member states may begin to exhibit signs of political and economic disarray (Soltwedel, Dohse and Krieger-Boden, 2000). The ‘Eurozone’ business community may also be subject to excessive scrutiny of commercial practices, as a result of the EMU evolution. This increased surveillance stems from the EMU’s intent to protect consumers throughout this dynamic period within Europe, however this will inevitably raise the transaction costs faced by the business community (Europa Quest (2), 2001). The cost facing ‘Euroland’ firms are substantial, yet this new founded economic community will surely yield far greater benefits for its participants and ensure the EMU establishes a dominant presence in global markets.

The EMU will generate unparalleled benefits for ‘Euroland’ firms, however the implications for other business communities within Europe are complex. The effect of the EMU on the ‘non-Eurozone’ nations of Europe can be viewed from 2 perspectives; that of those countries who have chosen not to join the EMU and those who are seeking ascension into the EMU. The United Kingdom’s absence from the EMU has been a well-publicized and highly debated topic in Britain (BBC, 1998). The UK and Denmark exercised an ‘opt-out’ from the EMU, citing the need to make an independent decision on the ascension issue (Harris, 1999: 91). Each country possesses the economic stability and prosperity to meet the Maastricht Convergence Criteria, however at the deadline for membership in 1998, they felt their economies were not ready for the dynamic and challenging nature of the EMU (Europa Quest (2), 2001). Many feel that is imperative to the success of the organization that the UK join, as they will be required to counter-balance the inevitable attempts to dominate by France and Germany (Princeton Economics, 1998). The reluctance of the UK to adopt the Euro will undoubtedly have ramifications for the British economy, particularly manifesting itself in the form of intense currency pressure. To avoid exchange rate fluctuations, the UK’s central monetary authority will need to impose a very strong financial policy. These currency fluctuations and tight monetary policy are likely to expose UK firms to greater exchange rate risk and higher borrowing costs respectively (Europa Quest (2), 2001). The maintenance of the pound as a national currency will also limit UK firm’s ability to accrue the efficiency gains through intra-community competition, which their Euroland counterparts will experience, thus they will not be able to compete as successfully in international trade (Princeton economic, 1998). Alternatively, the reluctance of the UK to embrace full economic integration into Europe, may prove to be a highly successful protectionist measure of UK firms, should the Euro not produce the economic gains expected (BBC, 1998). Most other European nations seeking ascension into the EMU, are countries generally perceived to have less developed economies (Europa Quest (1), 2001). Detailed negotiations are currently taking place over the possible membership of Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic, Slovenia, Cyprus, Malta and Turkey (IMF, 2000). It is important to note, that prior to the development of the EMU many of these nations pegged their currencies to either the Deustchemark or the Franc, moreover they will now irrevocably fix their exchange rate to the Euro (Europa Quest (3), 2001). This infers any large fluctuations in the Euro, will have dire consequences for these developing economies (Per Jacobson, 1999). The goal of European Union ascension has become the key driving force behind the massive adjustment and reform efforts in these countries. Should these LDC’s be successful with their EU endeavors, the prospects of subsequent currency integration seems high, ensuring that such economies may well achieve future economic stability and prosperity (IMF, 2000). It is essential to remember that entry into the EMU is an awesome task for most of these countries. Moreover it is questionable whether firms will truly benefit from the net gains of ascension, whether the strict convergence criteria is to ambitious and whether adhering to the Maastricht timetable is too greater pressure for the business community to bear (IMF, 2000). EMU members will also need to provide a strong commitment to upholding the inherent values of the monetary union, when negotiating ascension. That is, countries seeking membership within the EMU should makes guarantees of democracy, the rule of law, human rights and protection of minorities as minimum requirements to entry, which would exclude many prospective countries from joining ‘Euroland’.

This essay has endeavored to demonstrate the fundamental economic gains likely to be experienced by the ‘Euroland’ business community with the development of the EMU. Improvements in domestic firm’s efficiency, increases international competitiveness, reduced foreign exchange risks, access to larger financial markets and the utilization of strategic alliances and joint ventures are likely to occur under the EMU framework and accrue considerable benefits to ‘Euroland’ firms. The cost of implementing the EMU to member states business communities are substantial, including the financial expenditures involved in making business communities ‘euro-ready’, contractual problems, loss of fiscal and monetary autonomy and excessive scrutiny of business practices. Whilst the implementation of the EMU will remain somewhat of a contentious issue, it is abundantly apparent that ‘Eurozone’ firms will derive a net benefits from the application of this monetary union. Moreover, the long and involved process of implementing the EMU policy framework has perhaps ensured a more efficient model of economic integration has finally been developed.

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