This paper discusses the impact and importance of the euro on the European economy. First, it looks at the European economy and then forces on the formation of the European Union as a common. The paper explains the circumstance leading to its formation and the road to its formation. The formation of the union took quite a long time before the realization of the single market in 1999 and a common currency in 2001.
The paper also looks at the introduction of the euro as a common currency to the union. It also discusses the process of its introduction, and the countries exempted from using the currency. Euro has helped the European Union towards the achievement of price stability, economic growth, and employment. The paper again focuses on the impact of the euro on international trade and how it has replaced the dollar as the international currency reserve. Finally, the paper looks at the shortcomings of the euro in the European economy.
Importance of euro in European Union economy
The European economy is made up of 718 million people in 48 countries. The European Union forms the backbone of the European economy. “The union made up of 27 economic and political countries who adopt one currency known as Euro” (Linter, 2001). Germany has the largest economy with the highest gross domestic product and is closely followed by the United Kingdom.
European Union is a form of economic union which is the final stage of the economic integration process. Economic integration is the process of harmonizing different economic aspects between economies into a common economy. Integration of economies is aimed at reducing trade restriction across the members’ economies and ensuring equal treatment of non-member states. Countries are free to negotiate on economic integration, and the result of negation primarily falls in either of the five stages of economic integration which include; preferential trade area, Free trade union, Customs union, common market, and economic union.
Of the five stages, the economic union is the last stage and it differs from other stages in that, countries under economic union adopt a common currency and a single market. A single market ensures that the movement of factors of production across member states is as free as within an individual country. Economic union requires coordination of monetary and fiscal policies with the harmonization of both transport and industrial policies for common goals. Since the countries in the union work in the same economic point, there is a need to have unifying and related policies for effective production in the area.
The use of common currency and similar monetary policies eliminate the idea of exchange rate volatility enhancing the functions of the union. The economic unions have institutions established to regulate the laws and ensure they are equally applied within the union. European Union was established in 1993 as the successor of the European Economic Community, after the signing of the Maastricht treaty and is said to be the most integrated union on the Earth. It was aimed at increasing member countries; economic, political, and security potential to effectively compete with the United States of America, Japan, and the emerging super economies of China, Brazil, and India. The European Community was established after the world second war as a base for restructuring the worst-affected countries.
The purpose of the Union was to create a common market among the member states hence opening the way for free movement of goods, people, services, and capital. The union is governed by standardized laws and adopts common trade policy which includes; common custom unions, common agriculture policy, single currency, same fisheries policy, and equal development policies. “Of the 27 members, only fifteen members have adopted the Euro as their currency by now” (European Commission, 2005).
The union plays a key role both with the member states and the rest of the world. In international matters, the union represents the member states in United Nations meetings, the G8 meetings and has played role in the implementation of common foreign policies within the member countries. Under common Commercial policy, “the union members negotiate as a bloc in international trade negotiations.” (The European Union, 2001). The union has helped in abolishing passport requirements between the member countries ensuring free movement of people with the union. The union operates through intergovernmental negotiation or established union institutions. At a certain time, the union operation is executed through negotiation and agreements among the governments of member states.
In addition, the union’s common institutions have the mandate to work beyond the agreements of national governments. Some institutions and bodies include the European Parliament, European Commission, European central bank, and European council. Its member countries are among them, France, Britain, Germany, and the Netherlands, Italy, Belgium, Austria, Poland, Malta, Greece, Romania, Slovenia, Spain, Sweden, and many more.
For any country in Europe to be considered to become a member, it must meet the criteria set in Copenhagen Denmark. A “country must have a political system that respects the rights, of people and the rule of law” (Barnard, 2007). The economy of that country must be functional and in a position to compete in the European Union market. The country must be ready to accept the role of the union including its rules and laws. The European Commission, headed by the president, is mandated to run the affairs of the union including executive duties, administration of legislation, and regulating everyday activities.
The president of the union is appointed by the members of the European council and has to receive support from the parliament. The judicial arm in the union is headed by the European court of justice which has power to interpret the treaties and administer the European Union law.
The union was established through a series of treaties with amendments of the preceding treaty to form another treaty. “The treaties set goals and enacted institutions with legal powers to see the implementation of the goals” (Nicholas, 2007). A number of treaties were signed before the establishment of what today is known as the European Union.
For the period since its establishment the union has formed a common economic market across its members. The union gross domestic product is said to account for 31 per cent of the world’s total output. This makes the union the “world’s number one largest economy in terms of nominal gross domestic product” (Desmond, 2004). The union is the largest exporter of goods, second largest importer in the world and much of its trade is done with India and china. The main objective of establishing the union was to have a common market and formation of customs union among the member states. The common customs union was made as base for adoption of similar external tariffs on all goods getting into the union market. With a single market movement of goods, services, people and factors of production across the states were made free. Goods from outside the union were not subjected to custom duties, import quotas or taxes upon entering the union market and in the process of circulation within the union market.
Free movement of factors of production in creased investment across the nation. Unrestricted movement of capital meant that people could invest in any member’s state capital market and purchase properties in these countries. Citizens of members’ states had the freedom to; work, study and live in any country of their choice since there is free movement of people. In order to ensure freedom of movement across the union, each member country is supposed to recognize academic qualification of the other countries, relaxing administrative procedures and lowering movement restrictions. Other than freedom of persons, the European citizens are granted specific social and political rights. Citizens of both nations have formed what is known as the Community citizens.
Free movement of services gave professionals the freedom to offer their services to any member countries. The European Union has a competition regulating commission aimed at ensuring health competition with the single market. The commission ensures that “competition with the market is fair and undistorted as well as regulating and approving cartels, mergers and championing for economic freedom/liberalization” (McCormick, 2005).
The desire to have a common currency in European Union dates back I n 1969. Its introduction did not happen until 1999 when Euro was adopted as common currency in eleven of the current 15 countries. Prior to 1999 adoption, the treaty of Maastricht of 1992 established the base for the introduction of the currency. The treaty defined on the requirements that any member country had to meet before adopting the use of the currency. It was officially launched in 1999 and become official currency for eleven countries. Euro replaced currencies such as Deutschmark and Franc of France. The introduction of euro took two stages; first the currency was only used for accounting purposes with the actual cash payment being done using currency of respective country. In January of 2002, the Euro note and coins were introduced in all member countries and replaced the domestic currency except the currencies of “United Kingdom and Denmark” (European Union).
The UK and Denmark were allowed by a clause in the treaty to maintain their old currencies but other countries which had not started using Euro had to wait until they met the required criteria. Then, once they met the criteria required they were administered into using Euro and did away with their domestic currencies. After introduction of “Euro, the European central bank was created to oversee the supply of unit currency and implementation of common monetary policies with the fiscal policies being implemented by individual government, though with adherence to agreed common rules on public spending” (European Union). Member countries are supposed to co-ordinate their fiscal policy to ensure economic growth, stability and employment.
Any currency play important role to the people and economy of a country. “The extent of a currency being used internationally depend s on extent on how citizens perceive it stable as a purchasing unit” (Richard, 2006). Currencies are used in both domestic and international trading, travel, payment of external loans and international donations and grants. Likewise Euro has played a crucial role in development of the European Union. First Euro has helped to eliminate transactional cost and exchange rate problems. Usually domestic currencies are traded against international currencies so that one can get the currency of the country he or she intends to go. The price of one currency against another is the exchange rate which varies depending on market forces of supply and demand of that currency in liberalized markets. The more currencies are the more the exchange rates; there are literally thousands of exchange rates, since each currency has a relative price in terms of every other currency. The cost of exchanging currency increases the cost of doing businesses. Introduction of euro eliminated these trade costs. This has allowed business people and individuals to increase their profits in international trade. Consumer also have benefited since the common use of Euro “require uniform charges on credit cards, debit cards and automated cash withdrawals”(Baldwin & Charles, 2004).
Euro has eliminated the risk restored to volatility in exchange rates. The unpredictable movement of exchange rates had increased risk and uncertainty to companies and individuals who wanted to invest internationally. Investors’ fear of loosing as result of changes in exchange rate is minimized by use euro. With common currency business people will save on hedging costs. Hedging is normally done by business people who want to protect themselves against the uncertainty of changes in exchange rate and foreseen fluctuations in prices of foreign goods. The risk to countries whose currency has been fluctuating much against strong currencies is reduced. Euro has maintained liquid and flexible financial markets across the member states that they were in the past. Euro has eased travel of citizen and movement of goods and services.
One aim of forming the union was to guarantee its union’s citizen freedom to crisscross its member states. In addition to this provision, introduction of Euro has made the movement much better and easier. When people are going abroad there is no need to consult bank or forex market to exchange currency or obtain foreign currency in advance, but one is position to travel using the common currency. No charges for currency change and transfer of large sums is made easier. It is evidenced the “exchange of currency costs people a lot of money and many looses a lot” (Alesina and Perotti, 2004 p, 29). This increases convenience and reduces cost of exchanging currency hence traveling to Italy from Spain will be just simple as traveling from Madrid to Barcelona.
Euro has increased tourist to countries within Euro zone because due to currency transaction, people find it easier to travel to countries within Euro zone. On the other hand movement of goods is cheaper and their prices are no longer affected by the exchange rates. Purchase of goods from Spain or Italy when one is in Britain is easier as buying them in the Britain. You don’t need time to exchange currency or prepare custom documents since there is harmonized custom union. Payment internationally for these goods is easier since one has to send cheques in Euro rather than currency of that country. There is no risk of currency devolution hence interest rates remain stable across the member states. Borrowing of money from banks across the union is all same no matter which country you are in. changes in value of currency of a country affects the interest rates in that country.
Euro has reduced the risky of currency devaluation hence increasing investor’s “confidence on mortgages and other interest bearing securities. Common currency ensures price transparency” (Richard, 2006). With goods quoted in same currency one will be in position to notice the cheap or expensive goods at glance helping the buyer to act wisely. There will be no need of currency conversion so as to establish in country exports are cheap. The extent of difference in prices of same goods in different countries is usually cancelled by the type of currency they are quoted. Such that a new refrigerator in EU member country is lower than that in non-member country. Goods in European Union are all quoted in euro hence somebody in Malta who wants to import something is in position to identify the country whose exports are cheap. Common price increases competition among industries of member countries. Increased competition has increased the quality of goods manufactured.
Adoption of common currency has facilitated international trade. Countries import raw material and spare parts from member countries and export some of finished goods to these countries. Difference in value of currency affects the prices of imports and export. For example if England was using her Sterling pounds and German her marks then, devaluation of Marks against Britain Pounds will increase the cost of importing from Britain, while on other side if Marks revaluate importers from Britain will have to pay more for same goods, reducing Germany’s exports. As result of difference in prices there will be a lot of speculation activities as speculators seek to maximize from the price difference. Common currency reduces such risk associated with speculation and hedging improving the international trade. Again use of Euro avoids conversion costs which are burden to business people who live outside the union. Currency difference affects the competitiveness of countries domestic industries. A value fluctuation of domestic currency affects the prices of export in international market. If country’s currency is strong internationally it increases prices of exports from that country, hence affecting the competitiveness of such goods in international trade. Common currency harmonizes prices between member countries for a healthy competition.
Euro has reduced overpricing of domestic currencies as it dominates trade within member states. “Continuous overvaluing of currency by non union member has adversely affected its domestic industry negatively” (Buti and Franco, 2003). Use of common currency and monetary policies restricts domestic authorities from revaluating or devaluating currencies as well as setting interest rates. Action of monetary authority of a country affects the economic conditions of that country. Common currency unifies monetary policies and hence a unified economic conditions across the union. Use of euro has reduced currency instability within its member countries. Its use in many countries has increased its credibility and reduced the speculative notion associated with major domestic currencies. Euro has reduced both internal and external currency fluctuations hence increasing importers and exporters certainty on markets.
This has created a potential environment for growth in trade. With absence of exchange controls, interest rates that prevails with a country are as result of international market force mechanism hence the degree of individual nation diverging from this condition is minimal. Countries doing business using euro enjoy lower interest rates since their domestic monetary authority has no control on the money supply. “Euro dominated bonds are said to have lower interest rates than the bonds dominated by domestic currencies” (European, 2005).
The European central bank issues the euro and manages the monetary policies. The bank has been trying to keep inflation rates and interest rates to increase business and commercial business across the union. The use of common currency has helped much in achieving this goal. Keeping the levels of inflation low has stimulated economic efficiency within the union. This has created single financial markets such that one can invest in capital markets of the other country. Use of euro has culminated European bond market into one market. This has added liquidity to the financial market since more players are participating in one market.
As result the euro denominated bonds have attracted many investors who can borrow at low interest rates and reduced financial risks. Borrowing in your own currency reduces risks of exchange rate; hence borrowing using euro has been important to the European Union. The common bond market has encouraged non-union member countries to borrow in euros. Euro has ensured the rule of law of one price’ in Europe hence maintaining price stability caused by currency fluctuations. Prices of mostly traded goods have been harmonized to certain level although the harmonization process has caused inflation on one side and deflation on the other. Low prices encouraged by dominance of euro have checked the rate of inflation across the Union.
Other than the role of euro in European Union it has played major role internationally. Initially the world market was dominated by dollar but as at now euro has replaced dollar in major transaction worldwide. A particular study is in Asian case. For long time, the Asian states have been using dollar in their transaction. “Since introduction of euro, the Europe has gained as many Asian goods end in Europe while the US market shrunk” (Haruhiko, 2007) Use of euro has strengthened European Union in international role, in International Monetary fund, the World Bank and other economic organizations. Euro has been recognized as international currency and has been used as reserve currency and in investments outside European Union.
The euro has created rival with dollar since now some international securities which were dollar denominated are now euro dominated and is being used to borrow money internationally. It use internationally is expanding significantly hence increasing and strengthening European Union position in international trade than before. Now if the European Union was counted as a country, then it would be the world biggest economy. The increasing use of euro is creating threat to the big economies of the world especially the US. The use of euro in EU has increased European power in trading with it and has helped international companies to get a single investment market in Europe. Apart from economic importance of the currency on the union, the currency gives political symbol and identity to the union. Citizens of the union holding the currency are proud to be associated with union.
Cleary the culmination of the European countries into one common economic unit and use of euro has helped much in developing the European economy. Use of euro has helped in harmonizing resources of different countries into one economic unit. As result European economy has grown immensely as result of the cooperation. The currency has eased trade between the block members and has formed the largest economic block in the world today. “Since the launch of the euro in January 1999, the average annual rate of inflation in the euro area has been just a bit above the 2 percent limit—2.1 percent, to be precise” (Richard, 2006).
The use of euro has never been to great success as it was intended since integrating fifteen nations with different economic strength and performance and differing languages has not been easy task. The language difference has hindered labor movement. Even though the currency has united the European Union there still difference exist in economic performance of members’ countries. The common use of euro has lost individual sovereignty of member countries.
The transfer of monetary policy powers to the European central bank would mean that strong and stable countries would have to cooperate with weaker economies, prone to inflation in the field of economic policy. The cost of introducing the euro was quite expensive to many participating countries because they had to spend a lot of money to make the necessary changes. Although countries like United Kingdom and Denmark are members of the union, they have not adopted the use of euro but still use their domestic currency. Due to this the issue of exchange rate difference still affects the economies of the European Union members who trade with Britain. The changes include educating customers and training personnel.
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