EMU, Investment and Growth: Some Unresolved Issues

Abstract

At the heart of the evaluation of the economic costs and benefits of adopting the euro lies the question of whether living standards would be higher outside or inside the Euro Area. It is well established that there is a strong positive relationship between openness to international trade and investment and the performance of the UK economy. European integration is continuing to help raise the openness of the UK economy, as well as stimulating product market competition and making the UK a more attractive location for mobile investments. This provides an additional channel through which potential output in the UK is linked to the degree of integration with the rest of Europe. Adopting a common currency may bring modest further gains to productivity and living standards by stimulating trade as well as competition. Reducing exchange rate volatility may also raise the level of fixed capital investment in the UK, although the direct evidence for this is limited, and stimulate inward investment from outside Europe, but could reduce the level of foreign direct investment between the UK and the Euro Area. However it is far from clear how big the net benefits might be or how soon they might start to appear. If the UK were to enter monetary union at a significantly overvalued real exchange rate the gains might never materialise at all and there could easily be significant net losses.