For Ireland, the decision to join the European Monetary Union (EMU) was believed to be the most important and controversial economic and political challenge since independence. Despite the economists' worries about the future effects of the Euro on the Irish economy and the consequence of the new monetary regime, Ireland decided to break the sterling link and joined the monetary union in 1978.
This paper discusses the advantages and disadvantages of Ireland's participation in the single currency area. It also examines the impact of the EMU regime on Ireland as well as its links to the current financial crisis.
In general, Ireland's experience with the single currency can be examined in two parts. The first period between 1979 and 1986 was quite disappointing for Ireland. Despite the efforts made by the Irish government to lower the interest rates, the inflation remained high. Moreover, the trade ratio with other EMU members did not increase as much as hoped. As a result, the PPP theory did not have the sufficient impact on Ireland as the level of trade between Ireland and other EMU member states was not adequate.
Additionally, the sterling's absence from the exchange rate mechanism of the EMS caused policy issues for the Irish authorities as well as trading problems for Irish businesses (so called ‘sterling problems' where sterling and the mark often moved in opposite directions).
However, despite the initial struggle, the performance improved between 1987 and 1992. The introduction of the Single European Act (SEA) in 1987 gave a major boost to the Irish economy. The EU efforts to create a feasible single market by eliminating tariffs and providing financial assistance to its member states proved to be a major factor in enhancing Ireland's international attraction as a low cost manufacturing base for exporters, thereby inviting foreign investment and boosting local employment.
Since the level of trade with other EU countries has also improved, the other main advantages of the single currency such as lower transaction costs and lack of exchange rate risks, contributed to significant savings for Irish businesses. It is estimated that the eradication of the transaction costs alone increased Ireland's GDP by an additional 1%.
Additionally, Ireland, with public expenditure largely out of control at that time, benefited from the restrictions forced on its public finances in the attempt undertaken the EU to enhance the credibility of the new monetary systems and maintain a price stability within the whole Eurozone.
The SEA also forced some positive changes in Irish business strategy. New technological standards and the guarantee of protection by EU legislation quickly contributed to the expansion of Irish exporters. The forced increase in productivity and efficiency of domestic Irish companies soon led to lower prices for consumers and prepared Irish firms to compete in other markets more effectively.
From 1993, state aids were outlawed which added the incentive for greater private sector investment, hence creating more jobs. This form of deregulation, initially so politically criticised, proved to be incredibility beneficial for the Irish consumers (new competitors on the markets resulted in lowering the prices). It is believed that Irish companies such as Ryanair and Estat Telecom could have not been as successful without the creation of more integrated single market.
The introduction of free movement of capital has proved a major boost for the Irish financial services market - international financial institutions have established themselves in Ireland (the IFSC), creating thousands of jobs in the process. Irish citizens could also invest in a broader range of equities, bonds and differing investment funds both inside and outside Europe. This greater choice has forced companies to deliver greater returns to their shareholders thereby ensuring a very coimpact of euro on Ireland.
And a result of the new regime, Ireland's financial position within the EU improved significantly. From 1988 to 2007 real GDP expanded by 6 per cent per annum on average (reaching double digits on average during 1995-2000). Even more astonishing, the unemployment rate shrank from 16 per cent (on the ILO basis) in 1994 to 4 per cent in 2000 - essentially full employment for the first time in modern history. Non-agricultural employment jumped from 33 per cent of the population in 1993 to 41 per cent in 2000 and 46 per cent by 2007.
But is the Euro all so positive? …
Although the Eurozone has offered exchange rate stability and strength to the Irish economy, the membership has also some significant downsides in terms of the loss of authority and particular control with regards to monetary and exchange rate policies. In reality, however, some economists argue that prior to the EMU, Ireland had limited independence in these policy areas anyway (strong links with sterling).
Additionally, Britain's refusal to participate in the monetary union makes the EMU less attractive for Ireland. Despite the fact the level of trade between Ireland and the UK has fallen - 55% in 1973, compared to 20% today - the UK is still Ireland's main and most important trading partner. Therefore, the Britain's decision to ‘opt out' from the Euro brings further concerns in terms of the future exchange rates links between the EU countries inside and outside the single currency area (a weak sterling affects Irish exporters, while a strong sterling causes inflationary worries in the country).
Some economists are also concerned about the possible danger of the ECB not being able to make decisions to reflect the economic situation in each individual country. Ireland has already experienced the consequences of the new regime where currency devaluation is no longer an option. In the past, Irish public authorities have tackled unemployment and improved competitiveness of exports by devaluating the domestic currency, in order to boost foreign demand for Irish products (In 1998 the government decided to revaluate the Irish pound and reduce interest rates by total of 3%.). Lack of that option seems to be a huge disadvantage for Ireland, especially in the current recessionary times.
Another downside of the participation in the EMU is the problem of peripherality and the question whether the EMU can lead to economic convergence. As the history shows, economic activity tends towards the centre, where the benefits of scale are most evident. Therefore, further economic integration may result in widening the wealth gap between Ireland and the core nations.
Therefore the question of whether EMU is a suitable regime for Ireland has still remained unanswered.
Some experts also claim that an export boom in Ireland was a result of a 10% devaluation of the Irish punt in January 1993 and was not directly related to the participation in the EMU .
Some economists argue that the Euro is flawed because it subjects countries like Ireland to inappropriate monetary regimes that cause their economy to overheat and bust. Honohan, for instance, believes that EMU membership contributed to the Irish property boom and to the drop in wage competitiveness as the EMU gave Ireland artificially low interest rates more appropriate to the German economy which ECB was trying to awaken. Low interest rates and the removal of exchange rate risk facilitated the boom but also eroded a traditional external control or at least warning sign. Additionally, the increase in wage cost (33% compared to Euro average of 14%) and the fact that Ireland can longer recover competitiveness through lower exchange rates became a major issue for the country in the recent years.
On the other hand, the advantages of euro membership have become more visible when the current economic downturn increased in intensity. While Iceland and some other Easter European countries experienced capital drained from currencies that investors saw as risky, the Euro area has been spared the currency crisis. Some experts believe that it was the euro saved Ireland from Iceland fate. Ireland's Eurozone membership means the country's financial problems also became the problems of the ECB. The EU has much more at stake in Ireland in terms of the stability of the euro currency on the world market.
As Joe Gill, Director of Research at Bloxham Stockbrokers claims:
“If Ireland was not part of the euro when the recent financial crisis erupted in Dublin, its stock market would fall a further 50% while interest rates would climb above 10% and inflation would be in double digits. The security provided by the euro gives Ireland an opportunity to navigate the toughest economic conditions in the history of the State. It does not obviate the need for radical decision making by Government but it provides valuable foreign exchange and interest rate buffers for our economy. In that context, it is crucial that Ireland's relationship with the Eurozone is strengthened during this crisis.”
Taking into account the downsides of the EMU for a fringe country like Ireland, it is highly understandable that the future participation in the single currency areas has been questioned so many times. However, one cannot say that Irish economy would have reached the same economic growth and financial position had they not given up the punt. At the same time, interest rate policy could adjust more closely to the needs of the Irish economy with their own currency. But this is the price paid in order to be part of the Euro. Some economists believe that a recession may well be what the Irish economy needs right now - as the country needs to balance before moving forward again. Let's just hope that it proves to be another economic theory of economic success.
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