The Euro's Effects on Trade within the Eurozone

By Job, Ann | Indian Journal of Economics and Business, March 2012 | Go to article overview

The Euro's Effects on Trade within the Eurozone


Job, Ann, Indian Journal of Economics and Business


Abstract

Panel data analysis, OLS and time series regressions were conducted to determine the euro's effect on trade in eurozone countries. Included cases were: Finland, France, Germany, Greece, Norway, Spain, Sweden, and the United Kingdom. Explanatory variables were real GDP, euro membership, exchange rate, and direct investment. The dependent variable, trade, was measured as the net current account. Direct investment was the variable of interest in explaining variation in the current account. Direct investment was significant in the panel data analysis o fall countries. Individual country OLS and time series regressions revealed that direct investment was significant for Greece, Spain and the United Kingdom.

I. INTRODUCTION

The creation of the euro is the grandest international economic experiment since Bretton Woods. It is also proving to be considerably more risky and less beneficial than anticipated. The Mundell-Fleming model dictates that countries can have two of three choices: monetary policy autonomy, fixed exchange rates, or capital mobility, but not all three (Frieden, 1991, p. 431). By adopting the euro, countries are choosing to sacrifice a powerful economic tool of adjustment--monetary policy. As Mundell (1961, p. 659) explained "in a currency area comprising many regions and a single currency, the pace of inflation is set by the willingness of central authorities to allow unemployment in deficit regions." Conversely, the potential advantages of joining the eurozone and adopting the single currency depend on the size of the country (population), size of the economy (GDP), and other less obvious variables such as the nation's level of autarky, and the strength and stability of its independent currency. This study looks at how adopting the euro has affected trade in several eurozone countries.

The eurozone never met Mundell's (1961, p. 661) definition of an optimum currency area (OCA), which is based on an economic region, "defined in terms of internal factor mobility and external factor immobility." In fact, there was debate even at that time of the strengths and weaknesses of forming a Western European common currency. Mundell (p. 661) summarized the arguments of Meade and Scitovsky: "In both cases it is implied that an essential ingredient Of a common currency, or a single currency area, is a high degree of factor mobility; but Meade believes that the necessary factor mobility does not exist, while Scitovsky argues that labor mobility must be improved and that the creation of a common currency would itself stimulate capital mobility." Their disagreement was about the degree of the region's present or potential factor mobility and presaged the subsequent arguments about the creation of the euro. Theoretically and from the perspective of stabilization policy, an OCA would be small; however, this assessment ignores transaction costs and political motivations (Mundell, p. 662).

Economics was only one consideration in the decision to create the common currency, and many political economists have argued that the motivation behind the euro was more political than economic. Its realization marked a significant milestone in what began as the European Coal and Steel Community as outlined in the Schuman plan in 1950 (Fontaine 2000). Unfavorable OCA assessments for the eurozone seemed to have been disregarded or trumped by a grander political vision for the region. Zysman (1996, p. 5) argued that "in Europe, an economic community was created as much to accomplish a political purpose as to generate economic development." However, several others have argued that this is not the case.

Frankel and Rose (1997, p. 3) summarized the criteria for an OCA as "1) the extent of trade; 2) the similarity of the shocks and cycles; 3) the degree of labour mobility; and 4) the system of risk-sharing, usually through fiscal transfers," with higher linkages equating with a better OCA. …

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