The Single Market is widely viewed as a significant achievement of the EU - expanding its economies and income by stopping national rules and borders being barriers to trade. Many who want a vote to Leave the EU still want the UK to keep its access to the single market, as non-members like Norway have done. But a market isn’t completely unified while people in different parts of it are using different currencies, with varying exchange rates. So the EU has attempted to follow ‘One Market’ with ‘One Money’. It started to fix the exchange rates among members’ national currencies under the European Monetary System from 1979. Then in 1999 eleven EU countries formed an Economic and Monetary Union (EMU), adopting a common currency, and forming a Euro Area (Eurozone) that has since expanded to 17 of the 28 member states.
Why they did it
The main advantages of a single currency were believed to be:
- Promoting cross-border trade and investment by shielding consumers and businesses from sudden changes in another country’s costs and prices, caused by exchange-rate movements (‘currency risk’).
- Keeping inflation rates low, by ending the tendency of some EU countries to allow higher inflation offset by periodic weakening (devaluation or depreciation) of their exchange rates
- Ending a previous pattern of ‘competitive devaluation’, in which several EU members tried to promote their exports by devaluing their currencies against one another, resulting in all suffering higher inflation and none achieving ‘export-led growth’.
- Making the Euro a rival to the US dollar as a global currency, so countries that use it gain various benefits - extra buying power, printing the world’s currency, borrowing abroad in their own currency – that currently only the US enjoys.
What went wrong
But there were several drawbacks which the Eurozone’s designers knew about, and some that have come to light since:
- Member states whose costs and prices rise faster than others can no longer offset this (and avoid an ever-worsening excess of imports over exports) by weakening their exchange rates. They must instead arrest and reverse their loss of competitiveness by forcing wages and prices down. Several countries, including Ireland and Latvia (successfully) and Greece and Italy (unsuccessfully) were forced into such ‘internal devaluations’ after the financial crisis and recession of 2008-9. Eurozone architects believed this wouldn’t arise, because of ‘convergence’ between member states’ inflation rates and productivity growth rates.
- Other large single currency zones, such as the US and China, enjoy high internal labour mobility, so less well-off households can go wherever jobs are more plentiful and better paid. Labour mobility in the Eurozone is much more restricted (by differences in language, culture and tolerance towards migrants). In economic terms the Eurozone (even with just the original eleven members) is not an Optimum Currency Area. Exchange-rate adjustment allowed EU countries to generate new jobs, and eventual wage growth, for workforces that weren’t able or willing to go abroad. So Eurozone members, no longer having currencies to devalue, have suffered significantly higher unemployment and lower wage growth than comparable industrial countries.
- Other single currency zones also have a large central government, which redistributes income (vial taxes and welfare) from well-off to worse-off regions. This keeps up the living standards of people who can’t move to find better jobs, and prevents regions getting steadily poorer if they buy more from other regions than they can sell to them. The Eurozone lacks and cannot create this central redistributive mechanism (sometimes called ‘fiscal federalism’), because – as recently demonstrated – prosperous regions like Germany will not accept ongoing transfers to deprived regions like Greece.
- The Euro is not a sovereign currency. No sovereign country controls it, so it is effectively a foreign currency to all the states that adopt it (including Germany). Its issuer, the European Central Bank (ECB), lacks some of the basic powers enjoyed by other central banks (like those of the US and China) which do issue a sovereign currency. In particular, the ECB cannot issue Eurobond debt that is backed by the whole Eurozone, or provide collective backing to Eurobonds issued by one member country. So when Greece cannot repay all the debt it has issued, this becomes a Greek problem and not a Eurozone problem.
Why a ‘Euro crisis?’
When the Global Financial Crisis (GFC) struck in 2008, the Eurozone initially seemed to suffer no worse than the UK or US. This was partly because the ECB appeared able to respond to the crisis with the same emergency measures as other central banks: pushing interest rates down towards zero, and engaging in ‘quantitative easing’ by buying up public debt, enabling governments to borrow cheaply. In principle, this action by the ECB should have encouraged firms start investing again (after the interruption when private-sector banks stopped lending), and enabled Eurozone governments to inject more demand into their recession-hit economies by borrowing cheaply and spending more than they raised in tax.
However, the Eurozone economy has remained near-stagnant, with some members in outright recession, while the UK and US return to growth even though their financial sectors were harder-hit by the GFC. This has been traced to a number of structural features of the Eurozone which now appear problematic:
- Its governments can’t apply the sort of fiscal stimulus that lifted the US quickly out of recession, since Eurozone rules require members to keep their fiscal deficits below 3% of GDP.
- It can’t make the fiscal transfers that would offset a polarising imbalance in national income flows: Germany, producing much more than it consumes, gets richer, while competing with Germany’s surplus production leaves other member countries worse-off.
- It doesn’t collectively back the Euro-denominated debt that member states run up.
- Its endemically slow growth has caused member states to run up public debt to levels that are substantially above that of comparable countries, and above the limit (60% of GDP) set for members before they joined.
Implications for the UK
The UK secured an opt-out from adopting the Euro in 1992. Unlike other EU members, it will never have to adopt the single currency unless it wants to, even if it meets the ‘convergence conditions’ that qualify it for Eurozone membership. The terms of the opt-out are strengthened by the special-status deal secured by David Cameron in February 2016. The UK will not have to adopt any of the new financial sector regulations introduced by the Banking Union now being developed by Eurozone members, who are also obliged not to do anything which damages the financial interests of EU countries outside the zone. The UK does not have to work towards the Euro convergence conditions (on inflation, interest rates, government deficits and debt), although it also undertakes not to adopt any policies that would “jeopardise the attainment of the objectives of the EMU.”
Supporters of continued EU membership say this gives the UK the best of both worlds. It can enjoy the economic boost from the EU single market without having to put on the leaden boots that the Eurozone imposes. Supporters of an exit from the EU say this is the only way to avoid being ensnared in the protracted economic downturn that might accompany a downsizing or dismantling of the Eurozone, and the erosion of control over financial and economic policy required by the ‘deepening’ of EMU now needed to keep the Eurozone alive.
This article is part of an EU Referendum Hub. To find out more from the official 'leave' campaign visit 'Vote Leave' and to find out more from the official 'stay' campaign visit 'Britain Stronger In Europe'.
Please note: The opinions expressed in this hub are those of the individual authors, and do not represent the views of The Open University.