G:/WORK/Blackwell Journals/PolQ/PolQ83-1/10_POQU_2264.3d ^ 7/2/12 ^ 17:44 ^ bp/amj The Eurozone as a Flawed Currency Area MARK BAIMBRIDGE, BRIAN BURKITT AND PHILIP B. WHYMAN Introduction Historically, European Union (EU) membership has imposed significant net costs upon the United Kingdom economy, which we have previously discussed in this journal. 1 However, these pale into relative insignificance compared to those associated with the creation of the Euro- pean single currency. The system has come under unprecedented strain since 2008 and there is little reason to assume that this will diminish, in any significant way, in the near future. Indeed, there is sufficient evidence to suggest that the combination of tight fiscal policy, man- dated by the Stability and Growth Pact (SGP), and the conservatism of the Euro- pean Central Bank (ECB) has already resulted in the eurozone economy suffer- ing a decade or more of slow growth. Since the inception of the euro, many commentators have argued that despite its resilience to immediate collapse due to the volume of political—and from 2010, financial—capital invested in it by the EU establishment, it remains a fundamentally flawed creation. 2 Therefore, Economic and Monetary Union (EMU) constitutes a ‘leap in the dark’ with potentially destructive implications if its participants are insufficiently cyclically and structu- rally convergent. 3 The reasons are varied: the eurozone fails to fulfil, or even approach, the Opti- mum Currency Area (OCA) criteria agreed by economists to be the minimum requirement for the efficient operation of a monetary union; crucially it lacks an adjustment mechanism to meet inevitably changing economic circumstances, both internal and external, other than price and income deflation; its governing insti- tutions, the ECB and the European Com- mission, are not subject to democratic accountability, let alone control; it was adopted for essentially non-economic motives as the next stage of an integra- tionist European project, but without the necessary political coordination to under- pin it. In addition to these longstanding potential problems inherent with the cre- ation of the eurozone, its design in terms of risks emanating from spill-over and free-rider effects resulting from a lack of fiscal discipline has been relentlessly exposed following the 2008 credit crunch induced recession. Whilst theoretically fiscal policy should be used as a counter- cyclical tool, governments may also use the policy for purely political reasons; however, if this is the case, fiscal policy may become challenging within a mone- tary union such as EMU through the occurrence of spill-over or free-rider effects. 4 The former may occur if EMU members run large budget deficits over a prolonged period of time leading to their fiscal stance being on an unsustainable path, which given its financing through the financial markets, results in ever high interest rates on sovereign debt. Addi- tionally, with such growing recourse to the financial market, the availability of finance may decrease and therefore further drive up interest rates. Thus, one member’s debt issue spills over to others as financing sovereign debt becomes more expensive for all countries. 5 The potential hazard of free-rider effects materialises when a country can- # The Authors 2012. The Political Quarterly # The Political Quarterly Publishing Co. Ltd. 2012 Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA 96 The Political Quarterly, Vol. 83, No. 1, January–March 2012 DOI: 10.1111/j.1467-923X.2012.00000.x