Currency Unions-Fro And

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Currency Unions-Fro and Con While the countries of Western Europe and Central America ponder on whether their currencies should be united, countries in Africa can offer some practical lessons based on experience with currency unions. J. V. Mlddek

HE ISSUE of a common currency—or a currency union whose members have not at T currency union—appears on the agenda the same time observed the rules of a com- in three continents: Europe, America, and mon market. This is true of both the West Africa. It figures in the program of the Euro- African and the Equatorial African currency pean Economic Community, although there are union, and it is still largely true of the East few signs that it is considered urgent. In Cen- African currency union. Nor is there any plan tral America, it is being discussed within the for a future currency union which would not framework of proposed economic integration, be accompanied by a common market, thus toward which some steps have already been forming an economic union. taken. Plans for economic integration in Europe Africa is the only continent which can boast and in Central America recognize that a cur- real live currency unions: the West African rency union cannot be envisaged until inte- (CFA franc), the Equatorial African (CFA gration is well advanced, although a unified franc), and the East African (shilling) cur- currency may be expected to stimulate inte- rency unions. Of these, the last is preparing gration. The degree of economic cooperation for liquidation, following the example of three required in order to achieve a currency union other unions which expired at about the time makes it a waste of time to discuss plans for of their members' accession to independence. common currencies in vast areas where in- Africa can therefore offer some lessons based dividual countries have not taken the first on practical experience with currency unions, steps toward bringing their economies any which may be of interest to developing areas. closer together—and perhaps could not do so if they tried. Currency Union and Economic Integration What advantages does a currency union A currency union in practice is either an in- offer to its members? Its main merit can be strument of economic integration or a feature appreciated only on the basis that amalgama- of an already existing economic union; in re- tion of small economic units into large ones cent history there has been no instance of a is desirable.

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Economic Integration: Advantages and Drawbacks If the desirability of such amalgamation is TERMINOLOGY used by different authors in this field accepted, two further questions may be asked: varies; the present author offers his own definitions First, what are the benefits of having an eco- without claiming universal validity for them. All the nomic union? Second, what are the advantages definitions are of ideal concepts; in existing arrangements of a full economic union—including a common there are many exceptions to rules. currency—over a less complete form of union, such as a common market? A currency union is an arrangement between two or more sovereign states to share the same currency and The basic claim of the partisans of economic responsibility for its management. (A country may use integration is easy to understand. The stepped- another country's currency without participating in its up competition resulting from the abolition of management, but that is not a currency union.) protective restrictions leads to increased spe- A further distinction should be made between currency cialization, efficiency, and productivity. The unions and what used to be termed monetary unions in factors of production—labor and, particularly, the nineteenth century. All member countries in a cur- capital—are used more efficiently, and the rency union use one single currency. Countries in a enlarged markets make possible the applica- monetary union—such as the short-lived Latin Monetary tion of modern technology, which often de- Union and the Scandinavian Monetary Union of the nine- pends on the so-called economy of scale, that teenth century—use separate currencies that are freely is, on plants whose optimum size is relatively interchangeable at fixed rates. As long as the rules of large. When these claims are made good, a a monetary union are observed, the difference between common market has already achieved consid- the currency union and the monetary union appears, at erable success. least in theory, to be slight. In practice, however, there is a difference. What does a common currency add to such A customs union is an agreement between countries to an achievement? In theory, a common market remove customs tariffs on trade between members and to establishes freedom of movement for products create a common customs barrier vis-a-vis the rest of the and factors of production across member world. countries' borders, thus unleashing the forces A common market means a free market for the goods of competition. In practice, however, it is pos- and services produced by its members and also for the sible for any common market to have many factors of production, that is, capital and labor. There imperfections, so that it stops short of com- are no quantitative restrictions or multiple rates of ex- plete freedom for products and factors, as illus- change and no customs barriers, the rules of a customs trated by the European Economic Community. union being part of the whole structure. Under one currency, some of these imperfec- An economic union is a combination of a common market tions could not survive, and others would be and a currency union. There are no restrictions on the subject to new pressures. The very first con- movement of products or factors and there is one currency. sequence of having a single currency is, of course, that it allows complete freedom of pay- ment by any one place to any other place in

©International Monetary Fund. Not for Redistribution Finance and Development the union; thus a currency union gives com- will not act as an equilibrating factor in pay- plete liberty to capital movements, which under ments between member countries because tra- a common market may still be restricted. To dition, language, and religion will discourage an investor, besides providing him with free- it. Other critics, while not doubting that the dom to move his money as he thinks best, the integrating process will work, are disturbed by currency union brings another gift: guarantee some of the results that they expect from it. against a devaluation loss. Even under full Thus, mobility of capital may be harmful if it interconvertibility of currencies of countries in results in capital being attracted to more de- the common market, a change in par values veloped areas rather than to the neglected ones remains a real possibility, a threat which is which need it most. So integration may actu- finally removed only by the unification of the ally increase the uneven geographic distribu- currencies. This is indeed the great advantage tion of incomes and wealth. of a currency union over a monetary union. Yet often, opponents of integration—espe- What applies to capital is equally true of the cially if their opposition is political—take their earnings and savings of labor and should en- stand on other grounds and stress the loss of courage migration across national borders. freedom of action which integration would en- Payments within a union would become swifter tail for national governments. This argument, as exchange controls were shed. politically sensitive and therefore of con- The happy expectations of benefits which sequence, deserves analysis. economic integration may bring are not, however, equally shared in all quarters. There has Integration and Sovereignty been considerable controversy about the extent The simplest way of describing what hap- to which the benefits are offset by switching pens to governmental prerogatives in the proc- from less expensive foreign markets to the ess of economic integration is to list the more expensive (because less efficient) sup- weapons that a sovereign government possesses pliers within a union. Furthermore, an eco- for the defense of its balance of payments and nomic union, or a common market, may over- to show which of these weapons the country protect its area and thereby tend to create has to give up when it enters an economic unsound industries. Essentially, these are union. arguments against excessive protectiveness, but The government of a fully independent it is true that the very process of integration, country that experiences an upset in its bal- through the elimination of internal barriers and ance of payments can take any number of the maintenance of external ones, involves measures to set it right. It can cut down out- some losses which have to be subtracted from lays on imports by applying import restrictions, the benefits. imposing import taxes, or raising tariffs. On Some critics of integration plans, while not the receipt side of the balance of payments, it attacking the theory, argue that local circum- may attempt to boost exports by providing stances often prevent the plans from working. subsidies or by introducing a specially favor- They say, for instance, that migration of labor able exchange rate for exports. Finally, if the

©International Monetary Fund. Not for Redistribution Currency Unions trouble is persistent, it may devalue its cur- that its development policy, and for that matter rency. With the exception of devaluation, ex- its employment policy, must be coordinated ternal measures usually appear easier than at- with the policies of other member countries. tacking the root of the problem through Should the common market graduate to a internal action, which is directly felt and re- full economic union because its members have sented by the population, or at any rate by signed a treaty establishing a common cur- the business community. If it is assumed, for rency, the country in question would have to instance, that the cause of the balance of give up its last external instruments of defense. payments disequilibrium is a too ambitious It would be unable to devalue, and it could not development program, the correct remedial ac- impose any restrictions on capital movements. tion would be to slow down the pace of in- vestment or possibly to review the program What freedom of economic policy is left to and supervise spending more closely. More member countries on the internal front? If likely than not, the lowering of aims will be they have free banking and free mobility of unpopular; a decline in the volume of public funds, only limited differences in credit policy works may easily affect working opportunities are conceivable. Differences in taxation are for labor, and the resulting reduction in con- possible, provided, however, that they are not sumption may be resented in business circles. so big as to drive labor or capital to the areas Faced with the possibility of political trouble, of lighter taxation. Even a country's budgetary authorities often tend to delay the unpleasant policies become a legitimate interest to its fel- moment and to rely for the time being on low members in the union. As a matter of external expedients. course, deficit financing in one country, All such external measures are barred to a whether by the banking system or the central country in an economic union. Even a com- bank, would be watched with attention by all mon market considerably reduces a member other members of the union. Monetary ex- country's arsenal of defenses. While the gov- pansion in one country alone would increase ernment would maintain the right to devalue that country's share in the union's products its currency and might retain some freedom and resources. It would be tolerated only up to regulate capital outflow, it would be unable to a point, beyond which it would be chal- to impose any form of restriction on its im- lenged by the other members. In practice, pre- ports and current payments without explicit cautions would almost certainly have been authority from its fellow members of the com- taken at the outset to prevent such a contin- mon market. The country in our example gency by centralizing credit policies in a cen- could not raise its external tariffs above the tral monetary authority and possibly by setting common tariff level, and it might find that re- a fairly strict limit on the credits which the strictions on imports from third countries common central bank could grant each mem- were ineffective unless internal controls were ber government. reimposed on the movement of goods within A country's inability to escape from eco- the market. Short of going from one devalua- nomic difficulties by settling its own policies tion to another, our country would discover may sometimes be a real privation. A mone-

©International Monetary Fund. Not for Redistribution Finance and Development tary policy which is right for most of the quently been misused and have tended not to union may be wrong for one particular country counteract, but to accentuate, the bad effects or area. Such a situation can arise even within of government policies. The existence of a a country, where the interests of one region central bank, with its limitless power of creat- may clash with those of others. But it is far ing money, often seems to encourage govern- more dramatic in a union of sovereign states ment laxity about deficits, and this arouses where the remedies, such as migration, are doubts whether national central banks in the less easy to put into motion. In sovereign hands of inexperienced, irresponsible, or weak states, too, social discontent can easily take on governments are much of a blessing. nationalistic overtones. The answer to this Experience shows that governments seldom problem seems to lie mainly in intermember resort deliberately to inflation, but that, al- arrangements for relief action, which in de- though aware of the perils involved, they are veloping countries would usually be connected unable to resist political pressures and that with machinery for stabilizing incomes. they would actually be helped by a constitu- tional stop sign. Some countries have such a Requirement of Discipline stop sign in the form of central bank laws The requirement of a thorough coordination banning certain policies or limiting the govern- of policies, the transfer of so many preroga- ment's borrowing powers. In other countries, tives of sovereignty from member governments however, where inflationary deficits have be- to central organs, is a price that some con- come something of a habit, the national mone- sider forbidding. Yet it may be asked whether tary authorities no longer have such signs. It the discipline and restraint which an economic is clear that, as a restraining influence, a multi- union imposes on its members is really an en- national central bank is in a considerably tirely negative aspect of integration, especially stronger position to take an anti-inflationary for the new countries. In "Why a Central stand against one or several governments than Bank?" (Finance and Development, Vol. II, is a national institution that has to face its one No. 3), J. Keith Horsefield called attention to and only government. It is not easy for an countries' experiences with central banks over individual country to disregard a warning from the last 40 years. In 1920, the international a multinational bank that it must not damage financial conference at Brussels recommended the common currency by allowing excessive ex- that every country should set up its own central pansion in a part of the territory. A govern- bank. The recommendation was made on the ment that is eager to avoid inflation, but fear- assumption that national central banks would ful of taking alone the full responsibility for be able to restrain their governments from un- refusing excessive demands, may actually find wise policies. relief in the firm policy of a multinational central bank and possibly in the statutory limits But this hope has not been entirely fulfilled on the central bank's credit to the government. since then. While the restraining influence of Furthermore, in such situations a government, central banks has often been exercised, the in answering its critics, would also be able to banks' powerful credit instruments have fre- use to some advantage the weight of public

©International Monetary Fund. Not for Redistribution Currency Unions opinion in other countries. Undoubtedly, a mitted, bring their production under the purify- violent disagreement between governments on ing flame of competition with industries in de- budgetary and monetary policies might bring veloped countries. The most obvious favorable about a breakup of, or secession from, the consequence of integration would be the crea- union at any time. On the other hand, if the tion of markets large enough for modern in- members of the union manage to avoid harsh dustrial enterprises and of the modern in- actions over the years, a tradition of reason- frastructure needed for economic growth. Yet ableness may grow up and tend to eliminate an economic union, while creating more favor- crises. able conditions for new industries, does not in itself make redundant the efforts of govern- Institutional Cost ments to carry out purposeful development policies. Even in an economic union it is pos- Partisans of economic integration often sible to live insouciantly, especially under the mention among its favorable consequences the umbrella of foreign aid, or jealously and waste- reduced duplication, and hence the reduced fully to duplicate a neighbor's projects. cost, of centralized agencies. While the saving on the cost of public administration is a minor The problem of capital movements may be consideration in the developed countries, it is a serious one for developers in an integrated of considerable consequence in the developing economy. If directed exclusively by investors' countries, most of which lack skilled personnel choice, such movements may result in the as well as funds. The Common Services Or- further accumulation of the means of produc- ganization in East Africa is an example of tion in more developed regions and perhaps efficient and inexpensive administration in in stagnation or even backsliding in less several countries of tax and customs collection, favored areas. This anxiety was in fact one transport and mail, and some other services. of the main causes underlying the dismantling The central banks in West and Equatorial of one important economic union in Africa. Africa are other examples of efficient, very in- It appears unlikely that the process of indus- expensive organizations, which, far from being trialization could be left entirely to investors' reduced to the basic essentials of central bank- decisions. It may be hoped that an acceptable ing, provide for their member countries valu- distribution of resources can be achieved able statistical and research services. through agreements between member governments on such means of channeling invest- Development ments as are not likely to discourage capital. Does economic integration help economic Thus, in the last analysis, promise of full development? It has been pointed out by many and balanced growth is to be weighed against that, unlike the countries of Western Europe, the hardships of economic discipline and the most developing countries pondering the pos- need for uniformity in policies. Economic sibilities of economic integration have little union is possible only for countries that think mutual trade and little industry. Free trade alike on political and economic questions. within these areas would not, it must be ad- Discipline, while strong, must also be flexible,

©International Monetary Fund. Not for Redistribution Finance and Development which seems to be possible only in an atmos- a memory of a common past, political kinship, phere of mutual sympathy. and a community of language and culture be- Although the form of the future political tween the countries. In Africa, where the organization of Europe is now, more than ever, unions have come into life not through a long clouded by conflicting views, there is little effort of integration but by accepting and doubt that the founders of the movement for modifying a heritage from preindependence European unity were moved not only by eco- times, the success and survival of the remain- nomic considerations but also by the desire to ing economic unions will be determined in the cement inter-European relations and to re- first place by their ability to develop among store Europe to its position of influence among their members a strong feeling of common the world powers. In Central America, there is loyalty.

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