Economic and Political reasons for not joining the Euro

It is more for political reasons rather than economic ones that the UK and Denmark have not yet introduced the euro. The governments are in favour of EMU membership in principle, but they cannot be assured of public support in a referendum. The respective populations are concerned about the loss of national identity and monetary decision-making.

Denmark fulfils all the Maastricht criteria as things stand today. The problem for the UK is the exchange rate criterion, which requires smooth participation in the Exchange Rate Mechanism II (ERM II) for at least two years before the convergence test.

UK and Denmark negotiated an “opt-in” clause in the EC Treaty. They have managed to stay outside EMU without experiencing large disadvantages. However, they do not enjoy the specific benefits of EMU such as the fostering of trade and investment brought about by the elimination of exchange-rate risks with EMU partner countries, the reduction of transaction costs and participation in a large und liquid financial market.

The decision whether to join the euro is one of the most important economic and political issues likely to confront the UK over the next few years.

Economic Reasons against adopting the euro

The erosion of national economic sovereignty is the overriding argument against the euro.

Once UK join, it cannot set its interest rates, in line with the needs of the national economy, and sterling will no longer be a key adjustment mechanism. The consequences could be very damaging: instability, lower growth, higher unemployment and economic decline. Some believe that removing the United Kingdom’s ability to set its own interest rates would have detrimental effects on its economy. One argument is that currency flexibility is a vital tool and that the sharp devaluation of Sterling in 2008 was just what Britain needed to rebalance its economy.

Euro land is not an ‘optimal currency area’.

For a monetary union to be successful, the following key conditions must be satisfied: wage flexibility, labour mobility, and a sufficiently large central budget to compensate countries and regions that are disadvantaged. Unless these conditions are broadly met, the costs and drawbacks of a single currency could greatly exceed the benefits. When one examine these conditions, it is clear that Euro land is not an ‘optimal currency area’. The labour markets are fairly rigid, labour mobility is limited, and the central EU budget is less than 1.3% of GDP.

If the UK joins the euro, failure to adjust may have adverse consequences.

If, once inside the euro, the UK experiences a shock, or underperforms the others in term of productivity or unit labour costs, the economy may suffer reduced growth and higher unemployment.

Joining the euro will be costly for many businesses.

If UK joins, the physical conversion from sterling to euros will involve sizable costs, particularly for banks and retailers. The Government is unlikely to cover most of these costs. In many cases the businesses affected will be SMEs, which will not derive direct benefits from the adoption of the euro.

A one-size-fits-all monetary policy is harmful.

Given the lack of real convergence in Euro land, it is highly likely that cyclical trends and pressures will often vary considerably as between different members. Therefore, a common interest rate that may be appropriate for Euro land as a whole will be the wrong rate for some individual members. This fact partly accounts for Euro land’s poor growth performance since 1999, particularly that of Germany.

Short-term interest rates, home ownership, and mortgage lending are relatively more important in the UK than in Euro land.

Although more UK lending is now longer term and at fixed rates, a large proportion of lending (both to individuals and businesses) is still based on short-term, floating, interest rates. Consequently, changes in monetary policy could have a more unsettling and destabilising effect on the UK; and, because UK home ownership is relatively large, interest rate rises could generate adverse political reactions.

Inside the euro, structural rigidities are more likely to spread to the UK.

The euro will undoubtedly encourage greater tax coordination and more centralisation in various policy areas. However, the main reason why the UK has accepted measures such as the social chapter or the working time directive has been the membership of the EU, rather than of the euro. If UK remains more flexible and competitive than its trading partners, the euro may benefit it and the UK could be a successful member.

If UK joins, it may be affected by Euro land’s huge pension liabilities.

Though UK pension liabilities are fairly modest, Euro land’s huge liabilities may have adverse long-term effects on the UK. While the UK cannot be forced to finance German or Italian pensions, it may suffer through higher interest rates.

Inside the euro, the ‘growth and stability pact’ will hamper the UK.

This pact, which constrains the euro’s members’ fiscal freedom, will be particularly harmful for the UK. The Government’s fiscal plans, to finance much of its ambitious increases in public investment through borrowing, will conflict with the pact; but these plans are justified, given the UK’s low public debt.

Joining will create serious risks for sterling.

One major risk is that Britons may lock themselves into the euro with a grossly over-valued exchange rate, thus exposing the British economy to a competitive disadvantage. Alternatively, in order to avoid this risk, the authorities may try to weaken sterling deliberately and, in doing so, cause inflation and economic instability.

The Bank of England’s MPC is better structured, more effective and more transparent than Euroland’s ECB.

The record of the ECB has been poor. It has shown a deflationary bias and, in the face of a major global downturn, it has eased policy too little and too late. If UK join the euro, the latter will have to accept an inferior monetary framework.

Political Reasons

The government of former Prime Minister Tony Blair declared that “five economic tests” must be passed before the government could recommend the UK joining the euro and promised to hold a referendum on membership if those five economic tests were met.

THE FIVE ECONOMIC TESTS

The UK Government has announced that any move to the third stage of EMU will depend on five economic tests being met:

Convergence of business cycles: Business cycles in the euro zone and the United Kingdom must be compatible. The assessment will focus on economic indicators such as inflation, interest rates, the output gap and the real effective exchange rate with a view to long-term convergence.

Flexibility: The UK economy must be flexible enough to ensure that any asymmetrical shocks can be absorbed by, for example, labour-market flexibility and mobility and by fiscal policy.

Investment: UK participation in the single currency must promote investment (foreign or domestic) in the long term.

Financial services: EMU must improve the competitive position of the UK’s financial services industry, particularly in London.

Growth, stability and jobs: EMU must have positive effects on employment and growth, measured by the impact on UK foreign trade, price differentials and macroeconomic stability.

They are in addition to the formal criteria laid down in the Treaty. An assessment of British membership based on five economic tests was published on 9 June 2003 by Gordon Brown, when he was Chancellor of the Exchequer. Though maintaining the government’s positive view on the euro, the report opposed membership because four out of the five tests were not passed. However, the 2003 document also noted the considerable progress of the UK towards satisfying the five tests since 1997, and the desirability of making policy decisions to adapt the UK economy to better satisfy the tests in future. It cited considerable long-term benefits to be gained from eventual, prudently conducted EMU membership. A decision to adopt the single currency is therefore not currently in the UK national interest, according to reports from the Treasury.

The UK would also have to meet the EU’s economic convergence criteria (Maastricht criteria), before being allowed to adopt the euro. Currently, the UK’s annual government deficit to the GDP is above the defined threshold. The government committed itself to a triple-approval procedure before joining the Eurozone, involving approval by the Cabinet, Parliament, and the electorate in a referendum.

Gordon Brown, Blair’s successor, ruled out membership in 2007, saying that the decision not to join had been right for Britain and for Europe.

In the UK General Election 2010, the Liberal Democrats increased their share of the vote, but lost seats. One of their aims was to see the UK rejoining ERM II and eventually joining the Euro, but when a Coalition was formed between the Liberal Democrats and the Conservatives, the Liberal Democrats agreed that the UK would not join the Euro during this term of government.

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 the 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 UK 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 June 2003, Gordon Brown stated that the best exchange rate for the UK to join the euro would be around 73 pence per euro (On 26 May 2003 the Euro had reached 72.100, a value not exceeded until 21 December 2007). In April 2008, the euro rose to 80.610. It was 80.650 on 5 Nov 2008 and peaked at 97.855 on 29 December 2008. With the impact of the Global financial crisis of 2008 on the British economy: failing banks, plunging UK property values and the pound sterling at £0.8598 (€1.1631/£) against the euro on 19 November 2008, some British analysts stated that adopting the euro was far preferable to any other possible solutions for Britain’s economic problems. On 29 December 2008, the BBC reported that sterling had reached roughly €1.023/£, due to more poor economic forecasts. This report stated that many analysts believed that parity with the euro was only a matter of time.

During 2009, the value of the euro against the pound fluctuated between 0.96100 on 2 January and 0.84255 on 22 June. On 28 September 2010 the euro closed at £0.84985 (€1.1767/£) against the euro. The weakness and the volatility of the pound have raised concerns for the costs it entails for British consumers at home, and Britons living or travelling abroad. On the other hand, a report in Britain’s Daily Telegraph has argued that the high euro has caused problems in the euro zone outside Germany. The liberal democrats have expressed interest in seeing Britain join the euro in the long term.

Conclusions:

The issues involved are clearly very complex. Joining the euro for the UK entails massive risks. Equally, staying outside the euro permanently also involves serious dangers. The immediate risks for the UK, resulting from losing the ability to set its interest rates in line with its own needs and locking sterling permanently, must be weighed against the more long-term benefits produced by greater exchange rate stability and increased competition and dynamism unleashed by the euro.

Jobs: 3.5m UK jobs depend on trade with EU countries – and 60% of exports. UK export more to Belgium than Japan and only 16% of goods go to the USA. Fluctuating exchange rates mean risk for businesses which export their goods. The Euro takes away that risk – and the cost of insuring against it. When people talk about saving the pound, they should make sure it’s not at the expense of their job!

Prices: Many people fear that prices will rise if UK switches to the Euro. Evidence from the Euro zone, shows that though some prices were rounded up, others were rounded down, the overall effect on inflation being minimal. In the long term, the Euro will create competitive pressure, as it will be easier to compare prices across borders and shop around for cheaper suppliers. Prices should fall as a result.

Investment in the UK: Many foreign companies invested in the UK to have access to the EU’s common market. But research shows that some foreign manufacturers, hardest hit by the strength of the pound, are switching new investments to other countries. Investment in the UK fell by 15% in 2000, while it increased by 38% in the Euro zone, France being the most popular destination.

Academic research on the effect of an entry on the UK economy has generally found that it would have a positive effect on the British economy. The most evident impact would likely be a positive effect on trade with the other members of the Euro zone. It could also have a stabilizing effect on the stock market prices in the UK. A simulation of the entry in 1999 found that it would have had an overall positive, though small, effect in the long term on the UK GDP if the entry had been made with the rate of exchange of the pound to the euro at that time. With a lower rate of exchange, the entry would have had more clearly a positive effect on the UK GDP. A 2009 study about the effect of an entry in the coming years finds that the effect would be likely to be positive, improving the stability for the U.K. economy.

However, the Government’s insistence that the decision will be determined only by economic considerations lacks credibility. For some people, the most powerful argument against joining is the fear that it may lead to political union. For those supporting entry, many of the economic risks of staying out (e.g. discriminatory rules and adverse effects on foreign investment) are equally driven by politics. Ultimately, only wider political considerations, including a ‘vision’ of UK long-term role in Europe and an assessment of the implications of staying outside permanently, may eventually persuade the British people to join.

Some commentators argue that the five tests are now adequately met and that a stable exchange rate would be beneficial in dealing with the shocks to the system following the financial crisis. [1] Others argue that Britain is still better off with a flexible exchange rate and eurozone interest rates would not necessarily be appropriate for the UK economy – the UK now has lower interest rates than the eurozone. [2] Would the UK be able to fulfil the conditions of the SGP at least as well as the existing members? Given that the Commission forecasts that the UK’s deficit will be 8.8 per cent this year and 9.6 per cent in 2010, Britain is a long way from meeting the SGP criteria on budget deficits (although its overall debt/GDP ratio remains a long way below other eurozone members such as Belgium and Italy). Nonetheless, these are all questions which merit calm and rational debate. Although euro membership is clearly not on the political agenda of either of the main parties (and indeed is vigorously opposed by the Conservative Party), their reluctance to engage with the issue now need not, indeed should not, preclude a proper assessment of what is in the UK’s interest over the longer term given the current economic situation and the prospects for the future European and global economy.

March 2009

Note : the italic part I is not include. Dunt no wher and how to put it..take a look if it is important..some points hv already been included..

Denmark

Denmark uses the krone as its currency and does not currently use the euro, having negotiated an opt-out from participation under the Edinburgh Agreement in 1992. However, a referendum on the introduction of the euro is planned before the next national election, due in 2011.

The Maastricht Treaty originally required that all EU member states except the UK join the euro. However, following a referendum on 2 June 1992 in which Danes rejected this treaty, Denmark negotiated the Edinburgh Agreement, under which Denmark was also allowed to opt-out from euro zone membership, which was accepted in a referendum on 18 May 1993. As the result Denmark is not required to join the euro zone.

The preconditions for Denmark to gain accession to EMU are to meet the convergence criteria and witness a positive referendum.

In contrast to Sweden and the UK, Denmark has participated in the ERM II since the start of EMU in 1999.

There has been a narrow fluctuation band of +/- 2.25% for the exchange rate of the Danish krona (DKK), which has kept close to the central rate (DKK 7.46/EUR). Given the stable development of the DKK to the euro,

Denmark easily meets the exchange rate criterion. Regarding monetary policy, Denmark behaves de facto as if it were already a part of EMU, however with none of the advantages of the euro. The Danish central bank has more or less to follow the monetary policy of the ECB. The remaining small exchange rate risk is associated with somewhat higher interest rates than in the euro zone along the whole range of the yield curve.

However, Denmark meets all five criteria.

Convergence criteria

Inflation rate 1

Government finances

ERM II membership

Long-term interest rate 2

annual government deficit to GDP

gross government debt to GDP

Reference value 3

max 3.2%

max 3%

max 60%

min 2 years

max 6.5%

 Denmark (July 2009)

0.7%[2]

-3.6% 4[3]

30.0%

joined ERM II on 1 January 1999

4.42%[4]

     criteria fulfilled

     criteria not fulfilled 1 No more than 1.5% higher than the 3 best-performing EU member states. HICP rate as published by the ECB.

2 No more than 2% higher than the 3 best-performing EU member states.

3 Values from May 2008 report [2]. To be updated each year.

4 Negative value is a surplus.

A referendum held on 28 September 2000 to decide whether or not Denmark would join the single currency and replace the krone with the euro. The result was 53.1% to 46.9% against adopting the euro with 87.6% of eligible voters.

The reasons were entirely political, originating from the Danes’ deep fears about the EU. The two most popular reasons for voting “no” in the referendum were the fear of “more integration in Europe” and the wish to “preserve the Danish identity”.

Those in favour of adoption of euro

The “Yes” camp, led by the governing Social Democratic Party, tried to convince voters to support the euro by warning that remaining outside Euroland threatened a financial crisis and would represent a far greater danger to social spending. PM Rasmussen told a special conference in May, “The greatest threat against our welfare system is the speculators on the world’s money markets who will throw themselves at us if we reject the euro. Our best insurance against this is adopting the common currency.”

The main arguments found in the Yes-campaign were:

– A stronger economy

– Prevention flight of money from the country

– Protection of the economy

– Removing currency swings

– Boost of Denmark’s influence in EU

Those against of adoption of euro

The No vote represents a sharp refusal to the Danish government and the entire EU political establishment. The widespread identification of the social gains of the working class with a defence of the Danish state and its currency is the political responsibility of groups such as the former Stalinists of the Socialist People’s Party (SPP) and was successfully exploited by the extreme right wing and racist Danish People’s Party (DPP). It enabled the DPP to proclaim the result as a victory for nationalism and, “a very good signal to the political correctness [lobby] in Denmark to slow down the political integration in Europe, and say that we still want the individual states.”

The “No” campaign presented the euro as a threat to social services and living standards, which could only be alleviated by maintaining Danish independence to decide its own tax and welfare levels. This set the agenda for the entire referendum, coming as it did following the fuel tax protests throughout Europe that attracted popular support due to widespread discontent with the rising indirect taxation of working people.

The main arguments found in the No-campaign were:

– The erosion of Danish sovereignty

– Increasing European bureaucracy

– Welfare cutbacks

– Increased immigration from less prosperous EU Member States

Conclusion of referendum 2000

Due to the G7 intervention prior to the Danish referendum, Bloombergs, the financial agency, noted, “the week before the vote has seen a coordinated and so far successful intervention to bolster the euro has been a plus for the Yes campaign. But the weeks before that the currency was sinking to new lows against both the dollar and yen. That made it seem a currency in permanent crisis. It was no coincidence that as the euro sank in value, so did Danish support for the euro.” But the threat of G7 intervention seems to have scared off speculators for the time being.

The speculators’ most obvious next target would be the Danish krone, which had been fixed against the German mark and then the euro after it was born in 1999. As a precautionary move, Denmark’s central bank nudged up interest rates by a half-point to 5.6%. Central bank governor Bodil Nyboe Andersen pledged to maintain the Danish currency’s value. “The fixed exchange rate policy has served Denmark well for the last two decades, and it is extremely important that this policy be maintained unchanged,” Andersen said.

Ironically, Denmark’s exchange rate policy may have played a small but crucial role in influencing voters to reject the euro. Because the exchange rate is fixed, politicians like Prime Minister Rasmussen who supported the euro had a hard time articulating the economic case for joining, especially after a committee of economists known as the Wise Men said in a report that there would be no significant economic changes under the euro.

Obviously, the timing of the referendum was wrong and premature. The vote should have taken place after the introduction of the euro as a “real” currency. In fact, the smooth adoption of euro cash in early 2002 has substantially changed public opinion in Denmark. In June 2002, a majority of nearly 59% was in favour of adopting the euro, and only34% against, giving fresh support for debate on EMU entry (see Chart1).

On 22 November 2007, the newly re-elected Danish government declared its intention to hold a new referendum on the abolition of the four exemptions, including exemption from the euro, by 2011. Rasmussen also said he would seek a “noticeable reduction of income taxes” and improved conditions for asylum-seekers in Denmark as he presented the government’s platform for the next four years.

Denmark was expected to vote on whether to join the euro in 2008 according to Rasmussen’s statement, but due to the result of the Irish Lisbon referendum, the debate was postponed.

Due to the economic crisis of 2008, Rasmussen expressed that Denmark is at a disadvantage being outside the eurozone. His idea of Denmark joining the eurozone was supported by Peter Straarup, general manager of Denmark’s biggest commercial bank, Danske Bank.

On May 13, 2009, Danish PM Rasmussen confirmed a referendum on the euro will be held before the next general elections (due in 2011). At the same point, he said that Denmark was already using the euro (because of the currency peg); only they have decided to call it “danske kroner”. On October 30, 2009, he repeated this pledge, saying “The euro ensures political and economical stability in Europe and the current financial turmoil makes it evident that Denmark has to join the euro.” A referendum before the next elections seemed however less likely due to a high level in budget deficit.

Conclusion

If Denmark were to adopt the euro, the monetary policy would be transferred from the Danmarks Nationalbank to the ESCB. In theory this would limit the ability of Denmark to conduct an independent monetary policy, however a study of the history of the Danish monetary policy shows that, “while Denmark does not share a single currency, its central bank has always tracked changes made by the ECB”. As a consequence the Danish monetary policy is in practice already set by the decisions of the ECB. However, Denmark does not have any representation in the ECB direction. This motivated the support for an adoption of the euro by former Prime Minister Rasmussen: “De facto, Denmark participates in the euro zone but without having a seat at the table where decisions are made, and that’s a political problem”. Furthermore the ECB does not defend the Danish krone exchange rate. This is done by Danmarks Nationalbank, and the Danish government. In a crisis it can be tough for a small country to defend its exchange rate.

The expected practical advantages of a euro adoption are a decrease of transaction costs with the eurozone, a better transparency of foreign markets for Danish consumers, and more importantly a decrease of the interest rates which has a positive effect on growth. However, when joining the euro, Denmark would abandon the possibility to adopt a different monetary policy from the ECB. If ever an economic crisis were to strike specifically the country it would have to rely only on fiscal policy and labour market reforms.

The euro is highly important for the Danish economy since 43% of its exports are to and 50% of its imports are from the euro area. If Denmark joins EMU, trade and foreign direct investment will benefit from the elimination of the exchange rate risk vis-à-vis the euro. The business cycle in Denmark is closely in line with those of the rest of the EU.