Essay: Britain outside the Euro - good for the… | tutor2u Economics
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Essay: Britain outside the Euro - good for the economy?

Here is an example of a student essay on this question: Evaluate the argument that the UK's relative economic performance has benefitted from remaining outside of the Euro since it was launched in 1999.

One significant benefit of remaining outside the Euro is that the UK has been able to maintain an independent monetary policy (defined by the government and the Bank of England as opposed to the ECB). This includes the drop in base rate to 0.5% in 2008 and the large-scale QE (worth £375 billion), both of which were executed far sooner than the ECB following the financial crisis. It could be argued that this allowed the UK to get a head-start on recovery by dampening the drop in AD through both a reduction in borrowing costs and a general increase of the money supply in circulation. Indeed, examining performance following the crisis, the UK has come out of recession both faster and in a healthier state than the Eurozone, which was severely affected by deep and persistent recessions in Ireland, Greece, Spain and Portugal.

However, one could argue that the effectiveness of monetary policy in the perspective of global market forces is limited at best. Recent events have shown that factors such as economic performance (or lack thereof) in China have greater effect on the UK economy than the Bank of England can hope to have. Falling commodity prices arising from a slowdown in China has dragged inflation down further than the Bank of England can hope to manage. The theory of ‘liquidity trap’ comes into play here: the Bank of England is unable to drop interest rates any lower as they already are basically at 0%, thus any scope for traditional monetary policy has become limited. Low rates have also helped create the problem of ‘zombie companies’: firms that are not efficient or effective enough to continue to survive in “normal” economic circumstances, but have been able to make use of very cheap borrowing costs to perpetuate their existence. Clearly, this is an inefficient allocation of resources, thus the ability for the UK to control its own monetary policy may not be as important as on first thought.

Isolation from the Eurozone also reduces the UK’s responsibility and liability to contributing to Euro bail-outs – especially those of Greece and Ireland. Although it is true the UK must still contribute some as part of the EU, the amount is significantly less than if it were part of the Euro. Greece has now undergone three major stimulus packages delivered by the Troika (ECB, IMF and European Commission), and the UK’s absence from the Euro has helped limit the contributions it has had to make, reducing the fiscal deficit and meaning that its current policy of fiscal austerity is not as severe as it could have been. The net result is that more of the tax revenue the UK government earns has been able to be allocated into addressing problems within the UK rather that in Europe.

However, it should be noted that simply because the UK has reduced its liability to supporting Eurozone bailouts, this doesn’t mean that it has avoided its liability to problems in Europe. Given our proximity to the Eurozone – geographically, politically, demographically (migrant workers in both directions) and trade-wise (especially Germany, which is our second biggest trading partner) – if the Eurozone struggles, the UK is also dragged down with it. Thus if the lack of UK contributions to Eurozone post-crisis leads to its recovery being significantly slowed, then this also has negative effects of UK growth through a worsening of the current account deficit reducing aggregate demand.

By remaining outside the Euro, the UK has also been able to retain a floating exchange rate. This has obvious effects such the ability for the UK to depreciate the pound by 25% during the 2008 crisis. This provides a boost to aggregate demand by making exports relatively cheaper and imports relatively more expensive, hopefully with the effect of increasing demand for domestic goods and services. This extra stimulus was thus able to be used as a tool to counter the depressionary and deflationary effects of the financial crisis. Another factors is that an independent exchange rate meant that the UK avoided the need for internal devaluation, which can often be a painful and controversial process. Internal devaluation involves slashing unit labour costs and other strategies to increase competitiveness of the economy – often including slashing the minimum wage, reducing subsidies and privatising state assets. Nations such as Estonia and Greece (forced by the Troika in the latter case) undertook internal devaluation since, being part of the Euro, currency devaluation was not an option. However, reducing labour costs has obvious downsides for workers, who are often laid off or see their wages slashed. The UK’s retention of a floating independent exchange rate avoided the need for such policies.

But it should be noted that relative competitiveness is determined by factors other than exchange rate. Although the UK was able to depreciate its currency following the 2008 crisis, this has been undermined by its relatively poor performance in non-price factors and, more noticeable, productivity. UK productivity (output per worker) is still struggling 8 years on from the crisis, and the consequence of this is the UK unit labour costs are relatively high compared to what they could be, reducing the relative competitiveness of UK goods and services on the international market. The clear evidence for Britain’s continued poor competitiveness is the large current account deficit which, despite government promises to reduce it, has consistently remained high as a ratio to GDP, suggesting British goods and services are uncompetitive on the global market.

Finally, Britain has arguably benefited from remaining outside the Euro in that it has avoided the Euro member requirement of 3% fiscal deficit to GDP ratio. Indeed, the British fiscal balance has exceeded this proportion significantly and numerously following the 2008 crisis. It could be argued this has allowed Chancellor George Osbourne to spread out and dampen the effects of the crisis by ‘smoothing over’ the business cycle, and delay fiscal austerity to a time where the economy was in a better position to handle such a change.

Ultimately, the decision for the UK to remain outside the Euro must be judged in terms of its relative economic performance the in the period following 1999. Certainly, Britain’s real GDP growth has significantly outstripped the Eurozone’s, particularly following the 2008 crash (beforehand, Eurozone growth was impressive, although in hindsight it can been seen that this was unsustainable and supported only by plummeting yields driven by the (falsely) assumed low-risk nature of the Euro). Unemployment is also much lower in the UK: 5% versus 10% in the Eurozone as a whole, much higher in some parts. There are now 7 Eurozone countries with deflation, the UK is slowly edging its way up to its target of 2%. Thus by the books, the UK has certainly not run into difficulty by choosing to remain outside the Eurozone. Although Britain cannot say it is completely detached from the Eurozone – it is still a huge trading partner – ultimately it appears that the fears that Britain had ‘missed the bus’ with the Eurozone (rather like we had when the UK refused to join the EEC in 1960) are unfounded.

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