Why Does UK Stay Out of the Euro-Zone

8/13/2019 Why Does UK Stay Out of the Euro-Zone

1/29

Why does the UK stay out of the Euro-zone?Benefits vs. costs of adopting the Euro for the UK

Blagovesta ChonkovaRuslan ShopovYana Naneva


2/29

HM Treasury TestsAre business cycles and economic structurescompatible with Eurozone interest rates on apermanent basis?If problems emerge, is there sufficient flexibilityto deal with them?Would joining the euro create better conditionsfor firms making long-term decisions to investin Britain?

What impact would entry into the euro have onthe UKs financial services industry?Would joining the euro promote higher growth,stability and a lasting increase in jobs?


3/29

Common Currency Benefits

Elimination of transaction costs

Elimination of exchange ratevolatilityPrice transparency

Capital market integration


4/29

Since the Euro adoption, trade among the Euro-zonemember has increased by 20% without being at the

expense of trade with the rest of the world. In contrast, theUKs trade with the EU has diminished relative to its GDP. As we all know, greater trade leads to higher productivity.

The evidence shows that the UK misses a huge opportunity.


5/29

Optimal Currency Area

The importance of asymmetricshocksThe three economic criteria: Factor mobility Product differentiation and similar

economic structures Openness to trade


6/29

The Evidence

Britain is no more different in economicstructure from the rest of Europe than thetypical US region is different from the whole ofthe US

The UK is very unlikely to experiencesignificant asymmetric shocks

People not only do not move across bordersdue to cultural factors but they also do notmove within their own countries either Labor mobility is limited anyway


7/29

50% of the UKs trade is with the EUThe independent exchange rate will not help

Britain to adjust real prices


8/29


9/29

The Myths

The UK is Europes only oil economy

The UK should not join the Europesfailing economyContinental Europes social model

will be exported to the UK


10/29

Conclusion for the convergenceand flexibility test

To sum up, the convergence test set by the HMTreasury measures the likelihood and size ofasymmetric shocks. The flexibility test measuresthe ability of the UK to cope with asymmetricshocks. The limitation of these tests is that theymeasure the current state of the UK economy andignore the future accelerated convergence afteraccession in the EMU. They asses, for instance,how the British economy will react to a single

currency given the present level of convergence.But the history of the European Union suggests thatafter joining EMU the present level will quickly bealtered, thus becoming an irrelevant benchmark forassessment.


11/29

Impact of EMU Membership

on the investment level in UK


12/29

Two channels of impact

1) Macroeconomic: Keeping low andstable the inflation rate macroeconomic stability and secure

environment for long-terminvestments2) Microeconomic: Removing exchange

rate volatility vs. the rest of theEuro-zone incentives for investorswilling to export in the Euro-zone


13/29

1) Macroeconomic channel

Overall decrease in the volatility ofthe European economy brought byreduced exchange rate, inflation,

interest rates, and personalconsumption and GDP volatilityIncreased confidence of the investorsin the future prospects of theeconomy and, therefore, in theinflow of long-term investments.


14/29

2) Microeconomic channelRemoving the exchange rate volatilityToyota exampleHedging with forward markets? Drawbacks, related to manufacturing production

difficult to predict correctly the revenues and the costsof production

Small-scale producers - not accustomed to use thisoption or cannot bear the costs of financing it

Multinational corporation also avoid relying on forward

market options because of the high costs associatedwith exchange rate volatility - uncertainty of the profitsand increased risk - premium, generating highernominal interest rates


15/29

The Statistics

1990-1998: UK: 20% of the total FDI inflows to the

EU

Euro-zone: 60-75% of the total FDIinflows to the EU2001: UK: 16% of the total FDI inflows to the

EU Euro-zone: 78% of the total FDI inflows

to the EU


16/29

Impact of EMU Membershipon the financial servicesindustry in UK


17/29

Advantages for the functioning of thefinancial services in EU, brought by EMU:

Relieved comparison of the costs and quality offinancial services across national borders;

Increased cross-border competition in

wholesale banking, retail banking, securitymarkets and financial centers; Promotion of greater securitization of

borrowing.

Easier functioning of the non-EU investorsthrough introduction of one currency balancesheet to support operation across manycountries


18/29

Taking into account the comparativeadvantage of the City of Londonamong the other European financialcenters, the British entry into theEMU would further consolidate theleading position of the City


19/29

The CityComparative advantage of the City of London pool offinancial expertise in the region, limited regulation ofsecurity trading, relatively benign tax system, accumulationof financial market activity and support services, andaccess to a large English-speaking workforce with relativelyflexible labor market regulation

self - reinforcing cycle of success, which ensures Citysleading position among the European and worldwidefinancial centers. It is generally agreed among the scholarsthat in the short run the dominant position of the Citywould not be threatened by the decision of British authorityto stay out of the Euro-zone

In the short run the dominant position of the City would notbe threatened by the decision of British authority to stayout of the Euro-zone


20/29

Long Run Implications for the City

The financial centers in Frankfurt andParis increasing shares of financialoperations performed worldwideWarnings for shifting the balance ofcompetitive advantage in financialservices from London to Frankfurt


21/29

Political Criteria

Fiscal transfers

Homogeneous preferences

Commonality of destiny


22/29

Fiscal transfersRationale risk sharingPossibility of becoming a contributor orbeneficiary depending on the currenteconomic statusFiscal transfers directed to reducestructural inequalitiesUK is concerned that it could not be ableto afford this in a large scale

The need to create a system to increasethe EU budget and distribute the fiscaltransfers automatically


23/29

Homogeneous Preferences

Supposes that in case of shocks thecountries will react in the same wayHard to achieve due to thefundamental differences in economicphilosophy between the UK andContinental Europe


24/29

Commonality of Destinyvs. Nationalism

In case of a conflict of nationalinterest a country should accept thecosts in the name of the common

destinyThe UK is very reluctant to sacrificeits national interest

Strong emotional attachment to thenational currency with a symbolicmeaning


25/29

Public Opinion


26/29


27/29

Politicians love making speeches about how

we can't be "half-in, half-out". Yet that issomething like what we, the British, noware, and we seem to prefer it. Since wefell out of the ERM and later declined to

join the single currency, we have provedfor the first time that it is positivelyadvantageous to us not to do whatBrussels wants, and yet we do not have todestroy "Europe" in the process. It is aprecedent of huge importance.


28/29

Conclusion:

Although the UK will benefit from joining the Euro-zone, the Britishpublic opinion is strongly against it,which makes it politically impossiblein the foreseeable future.


29/29

Thank youfor your

attention!

Documents

Why Does UK Stay Out of the Euro-Zone