Brentwood School

1. Brentwood School 20th January 2009.

2. Thank you • For inviting me and I hope we can work together to improve your knowledge of the EU • I have given Mr Rees a number of presentations which you might find both interesting and useful to look through • Today I am going to examine (a) the effects of an appreciating Euro and the pros and cons of the Euro and (b) the potential for this currency to sustain its development – it was introduced 10 years ago this month.

3. Evolution • 25 March, 1957 • His Majesty The King of the Belgians, the President of the Federal Republic of Germany, the President of the French Republic, the President of the Italian Republic, Her Royal Highness The GrandDuchess of Luxembourg, Her Majesty The Queen of the Netherlands, • resolved by pooling their resources to preserve and strengthen peace and liberty and calling upon the other peoples of Europe who share their ideal to join in their efforts,

4. The EU - 2007

5. Being inside the Single Market Free movement of product, people and capital (soon services) with no artificial barriers to trade BUT protected where necessary from outside competition by Common External tariff Benefits arising from free trade within the Single Market- • Opportunity to exploit their various comparative advantages in many industries as possible and increase exports to “richer nations” as a source of further economic development • - Enlargement will eventually create a Single Market of over 500 million consumers, with relatively similar tastes in consumer durables • The need to be efficient in terms of BOTH price and non-price factors, so as the business and the wider economy are competitive BOTH within the EU and in the wider global economy

6. Joining the Euro • What you must show before entering the Euro Zone • Price stability, measured according to the rate of inflation in the three best performing Member States; • Long-term interest rates close to the rates in the countries with the best inflation results; • An annual budget deficit which does not exceed 3% of gross domestic product (GDP) and total government debt which does not exceed 60% of GDP or which is falling steadily towards that figure; • Stability in the exchange rate of the national currency on exchange markets The exchange-rate mechanism of the European Monetary System requires this stability to be demonstrated and sustained for two years. • Independence of Central Bank 

7. Why did the Euro appear? • Needed to reduce uncertainty and volatility of currencies • needed to bring national monetary and fiscal policies more together • needed to reduce use of exchange rate as macro tool • Needed to control money expansion within member states • needed to control expansion on money stock v competitive de-valuations • Started with ERM • Modelled on the D Mark and German monetary policy

8. Convergence Criteria • amount of money owed by a government - known as the budget deficit, has to be below 3% of Gross Domestic Product (GDP) - the total output of the economy. • The total amount of money owed by a government, known as the public debt, has to be less than 60% of GDP. The public debt is the cumulative total of each year's budget deficit. • Countries should have an inflation rate within 1.5% of the three EU countries with the lowest rate. This was supposed to push down inflation rates and lead to more stable prices. • Long-term interest rates must be within 2% of the three lowest interest rates in EU.  • Exchange rates must be kept within "normal" fluctuation margins of Europe's exchange-rate mechanism.

9. The Euro – an overview • Fixed exchange rates from 1999 • Started 2002 • Transaction costs • reduce uncertainty • transparency of prices • encourage mergers • BUT what of initial costs? • Role of ECB • loss of control of economic/political decisions • problems with expansion

10. Gains and Losses • Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as prices remain stable, integrated bond markets, stricter discipline in tax issues • BUT Loss of economic sovereignty • Asymmetric shocks • Lack of convergence – two speed Union? Different labour market regulations • Different growth rates • What if one country gets out of synch? • What if monetary flexibility required? • What if the global economy hits problems

11. Gains and Losses • Structural differences between countries – we export 52% to EU, Germany 56%, France 63% • Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU • More vulnerability to oil price and other commodity price hikes? • Can it be sustained as enlargement continues? • Can Regional Policy cope? • Can the poorer nations be accommodated? • Will it cause a drift of production and employment to new, mainly poorer members? • Is their the political will, or in times of economic distress will ‘nationalism’ re-appear?

12. Will it survive? • Will probably depend on? Competitiveness on economy (price/non-price), spare capacity, financial resources- more later Knowledge of market, distribution systems, strength/stability of Euro, affect of joining Euro on macroeconomic management, loss of sovereignty, implications for UK business, price at which we join (ERM memories).

13. Competitiveness

14. The EU in the world • Market of 490 million • World’s biggest trader (20% of global imports and exports; Transatlantic economy = 50% of world GDP and 40% of world trade) • EU (inc. Member States) provides nearly ½ the world’s aid • € is the 2nd currency in international financial markets • US bankers asked China not to sell US $ and buy Euros

15. So, what are consequences of the Euro’s appreciation against other major currencies • It is now the SECOND most used currency in world, so hitting it with speculative motives is difficult • Can it survive this appreciation? • Will exports struggle and imports gain – well, CET reduces potential impact of import penetration • But will different economies move at different speeds, structures and efficiencies?

16. Consequences of Euro advance • Good – stability, interest rates lower, stimulates growth, co-ordinated strategies to deal with economic crisis, fairer distribution of wealth via regional policy, so less tension between nations • Bad – will jobs drift to lower cost economies, how will less competitive economies react, will politicians allow differences to emerge.

17. Is it an ‘experiment’ that might fail? • Harmonisation – taxes, legislation, rules • Political will – what happens when things go wrong • Power of single market and Euro – could member states allow it to fail? • Would international financial system allow it to fail? • Let’s stop and discuss this

18. Sustainability • Well, once 16 countries have changed currency and 27 have altered laws to meet the 100,000 pages of ‘Acqui’ it’s not easy to escape. • We need to think (a) what will be needed to keep this ‘experiment’ alive and (b) what would replace it if it died • Let’s start to look at the EU in a little more detail

19. The ‘ideal’ model? Single Market and Currency (EMU) A virtuous circle of investment?1. Higher output, productivity and employment2. Increases incomes, spending and saving3. Raises profits and spurs further investment If this is the case then the older members will have export potential increased

20. But are there potential disadvantages? • Adverse political and economic cycle in the EU • Fear of "overstretching" the Union • Uneven public support in the current EU members • Insufficient communication • The Turkish question – though quietly Turkey has now become a principal negotiator in The Middle East • Migration – brain and skills drain? • The Legacy of the Soviet Economy

21. Can the older members gain? • Export Potential – commercial opportunities from enlarging the Internal Market • a) Classic trade creation effects of increasing the size of a customs unionb) Accession countries are small – but have grown more quickly than the old EU(15) in recent years and have much faster growth potential (higher trend growth rates) • The long run economic potential of the accession counties is much greater than their current size!c) If living standards increase – export potential for consumer goods industries is huged) Much recent FDI into accession countries has concentrated on retailing, banks and hotels! These are our strong areas.

22. The older members - 2 • Exploitation of economies of scale from supplying to a larger market • a) Gains in productive efficiency / increasing returns to scaleb) Exploitation of principle of large minimum efficient scale in many industries • Foreign Investment and Incomes and Profits • a) FDI into accession countries will provide a net flow of interest profits and dividends - boosting a country’s GNP and supporting the balance of paymentsb) FDI flows likely to supplement rather than reduce domestic capital spendingc) FDI will speed up the transformation of accession countries   

23. What will determine competiveness and sustainability of Euro • Montesquieu observed that “two nations who traffic with each other become reciprocally dependent; for if one has an interest in buying, the other has an interest in selling; and thus their union is founded on mutual necessities”. • So, will deeper involvement in inter-trade between members mean that the currency will become an integral part of EU trade? • Who will not be using it 2020?

24. Greater competiveness etc. • Technological advancement within EU will force member states to become more competitive as prices cannot be disguised by exchange rates • But will demographic trends allow this – the older economies are seeing an increase in their elderly population. EU populations are growing at an average 0.3 per annum, whilst US is growing at 1.3% - immigration within EU will have to encouraged but it is politically sensitive

25. Competitiveness • Productivity rates remain low – 0.5 in EU 1.5%+ in US • Labour utilisation remains low in some countries – 70% of available workforce work in EU whilst 80%+ do so in US. Are our welfare systems too generous? • EU workers work on average 300 hours less then their US counterpart.

26. Competiveness • Work ethic (Puritan Gift) –EU population tends to enjoy leisure, whilst US work extra hours • institutions, regulations, traditions, preferences – these too influence labour markets. What of influence of Trade Unions, will wage bargaining be VERY localised?

27. Competitiveness • Structural Changes - Structural reforms are crucial in labour markets so as to make them more flexible and adaptable, to support the creation of new jobs and to increase labour utilisation. • Will we continue with this drive towards more going to HE? • How will future generations learn?

28. Competitiveness • Employment protection legislation and wage-setting mechanisms, including wage indexation, also need to be reviewed. • A sufficient degree of wage differentiation is important to ensure that wage adjustments closely reflect differences in regional and sectoral productivity. • We trade together BUT we are also in competition with one another

29. Competitive etc • With a single currency, cost developments in individual countries, as captured by unit labour costs, play a key role in determining changes in competitiveness across the euro area countries. • If a country’s unit labour costs persistently rise by more than the euro area average, this will obviously have a negative impact on its competitiveness vis-à-vis the other euro area countries as well as vis-à-vis other (non-euro area) countries that are competitors in world markets. • Remaining competitive by favourably influencing domestic cost developments is, therefore, crucially important for economic activity and employment

30. Competiveness • Further efforts should therefore be made to reduce firms’ entry costs, such as the administrative burden on start-ups, and – more generally – to reduce red tape. In this context, specific emphasis should be placed on enhancing competition within and across our economies by liberalising trade in services – which account for almost seven out of ten jobs in the EU. • Ensuring an institutional environment that encourages business creation and expansion should therefore be among the priorities, together with supporting innovation and the diffusion of technological progress.

31. Competitiveness • In order to successfully harness technological advancements – and thus to compete in world markets on the basis of superior quality and scientific and technological edge – a continuous improvement in human capital is crucial. • As economic activity becomes increasingly knowledge-based and jobs shift from low to high-skilled workers through the process of Schumpeterian “creative destruction”, sustained investment in education and in research and development becomes indispensable.

32. Is the euro challenging the dollar's role as a global currency? • Competitiveness of Euro Zone – though some evidence of divergence is becoming visible e.g. Germany v Italy and Spain • The member states will have to cut costs and co-ordinate more on fiscal policy • Will this promote capacity shift to the ‘east’? • Turbulence in US$/Euro rates – 4.1% in just TWO days in early January 2009.