Transcript Why does UK stay out of the Euro

Why does the UK stay out of the Euro-zone?
Benefits vs. costs of adopting the Euro for the UK
Blagovesta Chonkova
Ruslan Shopov
Yana Naneva
HM Treasury Tests
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Are business cycles and economic structures
compatible with Eurozone interest rates on a
permanent basis?
If problems emerge, is there sufficient flexibility
to deal with them?
Would joining the euro create better conditions
for firms making long-term decisions to invest
in Britain?
What impact would entry into the euro have on
the UK’s financial services industry?
Would joining the euro promote higher growth,
stability and a lasting increase in jobs?
Common Currency Benefits
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Elimination of transaction costs
Elimination of exchange rate
volatility
Price transparency
Capital market integration
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Since the Euro adoption, trade among the Euro-zone
member has increased by 20% without being at the
expense of trade with the rest of the world. In contrast, the
UK’s 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.
Optimal Currency Area
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The importance of asymmetric
shocks
The three economic criteria:
• Factor mobility
• Product differentiation and similar
economic structures
• Openness to trade
The Evidence
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“Britain is no more different in economic
structure from the rest of Europe than the
typical US region is different from the whole of
the US”
The UK is very unlikely to experience
significant asymmetric shocks
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“People not only do not move across borders
due to cultural factors but they also do not
move within their own countries either”
Labor mobility is limited anyway
50% of the UK’s trade is with the EU
The independent exchange rate will not help
Britain to adjust real prices
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The Myths
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The UK is Europe’s only oil economy
The UK should not join the Europe’s
failing economy
Continental Europe’s social model will
be exported to the UK
Conclusion for the convergence
and flexibility test
To sum up, the convergence test set by the HM
Treasury measures the likelihood and size of
asymmetric shocks. The flexibility test measures
the ability of the UK to cope with asymmetric
shocks. The limitation of these tests is that they
measure the current state of the UK economy and
ignore the future accelerated convergence after
accession 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 that
after joining EMU the present level will quickly be
altered, thus becoming an irrelevant benchmark for
assessment.”
Impact of EMU Membership
on the investment level in UK
Two channels of impact
1) Macroeconomic: Keeping low and
stable the inflation rate 
macroeconomic stability and secure
environment for long-term
investments
2) Microeconomic: Removing exchange
rate volatility vs. the rest of the
Euro-zone  incentives for investors
willing to export in the Euro-zone
1) Macroeconomic channel
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Overall decrease in the volatility of
the European economy brought by
reduced exchange rate, inflation,
interest rates, and personal
consumption and GDP volatility
Increased confidence of the investors
in the future prospects of the
economy and, therefore, in the
inflow of long-term investments.
2) Microeconomic channel
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Removing the exchange rate volatility
Toyota example
Hedging with forward markets?
• Drawbacks, related to manufacturing production 
difficult to predict correctly the revenues and the costs
of production
• Small-scale producers - not accustomed to use this
option or cannot bear the costs of financing it
• Multinational corporation also avoid relying on forward
market options because of the high costs associated
with exchange rate volatility - uncertainty of the profits
and increased “risk-premium”, generating higher
nominal interest rates
The Statistics
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1990-1998:
• UK: 20% of the total FDI inflows to the
EU
• Euro-zone: 60-75% of the total FDI
inflows to the EU
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2001:
• UK: 16% of the total FDI inflows to the
EU
• Euro-zone: 78% of the total FDI inflows
to the EU
Impact of EMU Membership
on the financial services
industry in UK
Advantages for the functioning of the
financial services in EU, brought by EMU:
• Relieved comparison of the costs and quality of
financial services across national borders;
• Increased cross-border competition in
wholesale banking, retail banking, security
markets and financial centers;
• Promotion of greater securitization of
borrowing.
• Easier functioning of the non-EU investors
through introduction of one currency balance
sheet to support operation across many
countries
Taking into account the comparative
advantage of the City of London
among the other European financial
centers, the British entry into the
EMU would further consolidate the
leading position of the City
The City
Comparative advantage of the City of London  pool of
financial expertise in the region, limited regulation of
security trading, relatively benign tax system, accumulation
of financial market activity and support services, and
access to a large English-speaking workforce with relatively
flexible labor market regulation
“self-reinforcing cycle of success”, which ensures City’s
leading position among the European and worldwide
financial centers. It is generally agreed among the scholars
that in the short run the dominant position of the City
would not be threatened by the decision of British authority
to stay out of the Euro-zone
In the short run the dominant position of the City would not
be threatened by the decision of British authority to stay
out of the Euro-zone
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Long Run Implications for the City
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The financial centers in Frankfurt and
Paris – increasing shares of financial
operations performed worldwide
Warnings for “shifting the balance of
competitive advantage in financial
services from London to Frankfurt”
Political Criteria
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Fiscal transfers
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Homogeneous preferences
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Commonality of destiny
Fiscal transfers
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Rationale  risk sharing
Possibility of becoming a contributor or
beneficiary depending on the current
economic status
Fiscal transfers directed to reduce
structural inequalities
UK is concerned that it could not be able
to afford this in a large scale
The need to create a system to increase
the EU budget and distribute the fiscal
transfers automatically
Homogeneous Preferences
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Supposes that in case of shocks the
countries will react in the same way
Hard to achieve due to the
fundamental differences in economic
philosophy between the UK and
Continental Europe
Commonality of Destiny
vs. Nationalism
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In case of a conflict of national
interest a country should accept the
costs in the name of the common
destiny
The UK is very reluctant to sacrifice
its national interest
Strong emotional attachment to the
national currency with a symbolic
meaning
Public Opinion
“Politicians love making speeches about how
we can't be "half-in, half-out". Yet that is
something like what we, the British, now
are, and we seem to prefer it. Since we
fell out of the ERM and later declined to
join the single currency, we have proved
for the first time that it is positively
advantageous to us not to do what
Brussels wants, and yet we do not have to
destroy "Europe" in the process. It is a
precedent of huge importance.”
Conclusion:
Although the UK will benefit from
joining the Euro-zone, the British
public opinion is strongly against it,
which makes it politically impossible
in the foreseeable future.
Thank you
for your
attention!