The belief in monetary unions appears to have survived the recent struggles of the Eurozone, and several new unions are currently being planned around the world. What is the appeal of monetary unions and, more importantly, can other nations succeed where Europe could not?
In the late 90s, many economists viewed monetary unions as the best way of ensuring a strong political and economic future. The launch of the European Monetary Union (EMU) was the first to test this concept in practice on a big scale. However, the economic mechanisms behind the project quickly proved challenging for politicians to handle. Instead of becoming the world’s leading trade bloc, Europe entered a prolonged struggle to keep the union together while several countries battled crippling debt levels.
One might think that the appeal of monetary unions died down with the troubles that haunted the EMU project. However, this has not necessarily been the case. Despite the unsatisfactory performance of this concept when put to its largest test ever, new monetary unions are currently being planned around the world. These include the Gulf Cooperation Council in the Middle East, UEMOA in West Africa and the East African Community. What do these regions believe they can do better where Europe went wrong?
The appeal of Monetary Unions
A Monetary Union (MU) generally combines a common market and customs union with a common currency. For this reason it is a far-reaching step towards integration between countries. It requires harmonization of monetary, fiscal and to some extent even non-economic policies. Governments wanting to reap the benefit of a monetary union typically have to surrender power to a common institution, such as a central bank.
So what is the appeal that, despite the difficulties experienced by the Euro-project, drives countries to seek a common currency? One important aspect seems to be the political power associated with a unified region. As part of a big trade bloc, countries may have more power over trade and world affairs than they would on their own.
Another benefit of a common currency is that trade requires fewer currency exchanges than before. This means lower prices and effort for trade within the union. For this reason monetary unions can boost trade (and thereby economic growth) as well as lead toward further integration between the participating countries.
Another commonly mentioned benefit is greater economic stability. Bigger currencies are generally more stable than smaller ones, and a stable currency makes returns from investments more predictable – something that is attractive to foreign investors. For within-bloc trade, the benefit of a common currency is even larger as all exchange rate-related price volatility is eliminated.
Against these benefits stands the downside that monetary policies have to be surrendered from the own government to a joint institution. Furthermore, any financial policies undertaken by individual countries would affect the value of the currency for them all. Because of this, monetary unions require a strict fiscal discipline. A government wanting to quickly boost domestic production by rapid spending would be unable to do so (or at least ought to be). On top of this, with a common currency economic tools may be too blunt to appropriately address problems for individual member nations. The medicine needs to be the same for all, even when the individual economies suffer from different diseases.
Fiscal discipline and differing economic needs among the participating countries have proved a tough challenge for the Eurozone. Is there any reason to suspect that others might handle these problems better?
For the African unions, fiscal discipline might look hard to achieve since several governments independently have struggled with this. However, both the UEMOA and the East African Community have so far seen more willingness to surrender power to common institutions, such as central banks, than has been the case in Europe. In the case of UEMOA, the West African countries have already had their currencies tied to the Franc – and subsequently the Euro – which means that existing economic policies are already targeting a set exchange rate. This backing has helped to keep the local currencies stable; ironically through the stability of the EMU. However, concerned voices have pointed out that France would be unlikely to guarantee the value of the new currency – the Eco – in a similar way. Another potential threat to the UEMOA is that the economic needs of its member countries may differ substantially, especially if the highly populated Nigeria joined the union.
Where the UEMOA and EAC countries are too diverse to form an ideal monetary union, the Gulf countries have an advantage. Given that all economies in the bloc are heavily dependent on oil exports, macroeconomic shocks might hit them more equally. This may also be the reason that the last years have seen strong actions to back the idea of a monetary union, such as agreeing upon the location of the future central bank.
Will these planned monetary unions ever see the light of day? Certainly many fundamental issues still need to be overcome, but credible commitments have been made. Perhaps the recent Eurozone struggle has just highlighted the policy areas most in need of attention rather than discouraged the will for future integration. In the end, monetary unions might be more about political will than economics. Because of this, the belief in a common destiny may very well lead countries into one.