Economics 101: Cultural bonds make strong case for single GCC currency
What are the advantages and disadvantages of a single currency?
In 1999, the year in which the European single currency was launched, the Nobel Prize in Economics was awarded to Robert Mundell for his theory of the conditions under which it is desirable for multiple countries to use a unified currency rather than each having their own one. Today, due in part to the euro’s challenges, the GCC countries have decided to further review the best way to implement their own single currency.
The pros and cons of single currencies revolve around the fact that prices do not instantly adjust in a manner that balances supply and demand in markets. Changing a price can be physically costly (as in the case of the price on a restaurant menu), and those setting them may suffer from information deficiencies that stifle optimal price readjustment. Moreover, humans are psychologically sensitive to price changes, especially wage cuts.
Slower price adjustment means lengthier mismatches of demand and supply, and this is undesirable in the context of a persistent excess of supply over demand in labour markets, commonly known as unemployment.
Qatar exports natural gas to the UAE, while the UAE exports diamonds to Qatar. Each has its own currency. If natural gas prices suddenly drop, then one of two things has to happen: either Qatari gas workers have to earn less or some of them have to be laid off. Neither is politically desirable. However, the pressure on Qatari gas wages and employment to change is diminished if the Qatari riyal decreases in value, as it constitutes a back-door way of decreasing Qatari gas workers’ wages: the price of international goods rises, including UAE diamonds, meaning that Qatari gas workers’ wages purchase less than before.
Changes in the value of a currency are politically far more palatable than disrupting labour markets directly; this constitutes the biggest advantage of currency autonomy.
In contrast, Greece’s adoption of the euro has meant that it has had to suffer cripplingly high unemployment.
So why would any country surrender its currency? The first reason is facilitating trade with currency partners: there are no transaction costs, and price comparisons become easier. Some types of market speculation can lead to volatility in exchange rates, which makes long-term investment riskier; currency unions eliminate that problem by eliminating exchange rates.
Second, the inflexibility of prices creates a dangerous temptation for the government: if it can surreptitiously print money faster than prices adjust, it can redistribute wealth in its favour in the short run, which it can use to pay off debt and fund programmes. Ultimately, prices do catch up, and this creates cycles of high inflation and high interest rates. Some governments are forward-thinking enough to avoid the temptation to abuse the money supply, but for those that are not, joining the currency of a “credible” country is a quick way to impose restraint (like Odysseus tying himself to the mast).
Thus, countries which cannot resist the temptation to print money face a quandary: high inflation and interest rates outside the currency union or bouts of high unemployment inside it. Mr Mundell outlined an escape route: if workers can relocate across the political boundaries of single currency countries, then when unemployment rises the excess workers can simply move to the country with more jobs. That is why the EU implemented free labour mobility as a precursor to the euro’s launch.
The problem for the EU, however, is that there exist many non-legal impediments to labour mobility, such as language and cultural differences (imagine a Finn moving to Portugal). While GCC citizens tend to prefer living in their home country, potential mobility is much higher than in the euro zone, so the foundations of a single currency are arguably preferable.
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Updated: October 29, 2016 04:00 AM