European Economic and Monetary Union aims to build an integrated EU economy by coordinated economic and fiscal policies, a common monetary policy and a common currency, the Euro. The 1992 Maastricht Treaty obliges most European Union (EU) members to adopt the euro. While all 27 EU Member States are taking part in the economic union, some countries have yet to adopt the euro. UK was granted an exemption when it joined EU, but 20 years have passed and it still has not replaced GBP with the Euro currency. It has long been debated whether UK should join the European Monetary Union (EMU) and adopt the Euro.
Since 1992, UK had experienced steady economic growth. After the 2008 financial crisis, most EU countries started to show declines in GDP and signs of recession.. With the help of its on monetary policy, the UK in on the road to recovery, in comparison to many of its European neighbors. However, facing difficult economic times, talks over whether the UK should join EMU to benefit from easier trading transactions and combined economies of scale have resurfaced again. Although majority of EMU Member States are still going through a recession, Germany has shown GDP growth and a strong recovery; this supports the argument that UK should join EMU in order to benefit like Germany. Our argument is that the UK may potentially not benefit in a similar manner as Germany, it could face serious challenges with lack of monetary flexibility, converging to the Euro and therefore, it potentially could become another PIIGS country.
This paper will examine UK’s economic fundamentals from 1992 to 2008, its monetary policy and economic recovery post 2008 financial crisis, and the benefits and the costs of becoming an EMU member. Based on the analysis, we conclude that UK should not join EMU, as the benefits do not outweigh the gamble of losing flexibility with its own monetary policy.
United Kingdom Economy Overview 1992 - 2008
Steady GDP Growth
The United Kingdom had been experiencing consistent growth prior to the 2008 financial crisis. The compounded annual growth rate of GDP from 1992 to 2008 is 2.9% and the GDP per capita had grown from 14,600 to around 217,00 GBP during the same period (See Figure 1). Compared with other strong European economies, UK outperformed in terms of both average GDP annual growth and GDP per capita measures (See Figure 2 & 3). The following sessions will look at the GDP components in more details. On average, UK economy is mainly driven by consumption (on average 63% of GDP), followed by government spending (21%), investments (18%), and net export (-2%).
Government Spending to Improve Productivity
UK government spending has been growing steadily at a compounded annual rate of 5.7% with increasing investment in education, welfare and defense (See Figure 4). Continuous investment in education contributes to accumulating capital stock, which improves labor productivity and reducing unit labor cost over the years.
Higher Than Savings Investments Financed by Capital Inflow
The savings and investment data shows that there is a divergence in investments and savings starting from 1999, as UK experienced much higher investments compared to savings (see Figure 5). Domestic savings are not sufficient to meet the demand of increasing investments; the additional investments were financed by capital inflow from overseas (see Figure 6). One of the sources providing capital inflow to UK is China. Traditionally, large economies have had gross savings to GDP ratios of between 15 and 20 per cent. However, China’s is 50 per cent. Household’s account for half, while firms and government hold the rest. Savings are now on such a scale that it badly distorts Western economies. Due to this savings glut, China is investing into the UK via UK government bonds and helping finance its increase in investments causing an increase in capital account surplus....