When looking at who benefits the most from the Single European Market it is important to look at varying comparative advantages within the EU. Most EU countries have labour which is expensive compared to capital, and these countries tend to have similar balances between industries. Therefore EU countries where labour is cheaper, for example Eastern and Southern European countries may benefit from increased demand due to lower costs. Countries which have a different comparative advantage within the EU are likely to benefit the most.

Also countries which have the largest barriers to trade are likely to gain most from the abolition of tariffs and non-tariff barriers.

 

The idea of the monetary union came about in 1979 with the launch of the EMS (European Monetary System). An aspect of this system was the ERM (Exchange Rate Mechanism), countries which choose to adopt the ERM agreed to maintain their exchange rates within a range of plus or minus 2.25% against the European Currency Unit (ECU - the average of ERM member countries). When the UK operated within the ERM it was permitted a larger fluctuation range of 6%. During EMS, 11 realignments of currencies occurred between 1979 and 1987, but the conditions under which they could occur became more strict to reduce the number of times they occurred. 

Capital controls were also removed under EMS but most countries limited the movement of financial capital across borders during the initial period, hence allowing them to use monetary policy independently of other EMS countries. Eventually these capital controls were phased out over the lifetime of EMS.

 

In 1989 the Delors Plan was released which proposed EMU (European Economic and Monetary Union) along with the single currency (euro) and the ECB (European Central Bank) to administer monetary policy within the EMU (the group of countries which adopted the euro as their domestic currency, and hence forfeited the ability to control monetary policy independently). 

 

The Maastricht Treaty brought about the European Union and introduced the single currency along with a common foreign, defence and security policy to integrate European countries further. To have a single currency it was believed that EMU countries would need to have similar economic characteristics to make any monetary policy relevant and sufficient for all member countries. A convergence criteria was established and (in theory) to adopt the euro a country had to meet these criteria.

 

The EMU was a separate proposal to the formation of the Eurozone, but paved the way for it. The EMU locked in exchange rates between countries, but each member country initially held on to their individual national currency until the Eurozone was formed later.

Inflation - the first criteria was to have an inflation rate that was no more than 1.5% higher than the average of the 3 countries in the EMS with the lowest inflation rate. This is because countries with high inflation rates may argue for high interest rates to reduce inflation, whereas countries with lower inflation would argue for lower interest rates. However it was also debated whether there ought to have been an inflation target, as a benefit of joining the EMU was that it would cure inflation by removing the ability to administer fiscal policy nationally.

Interest and Exchange Rates - interest rates were to be no more than 2% higher than the average of the 3 EMS members with the lowest interest rate and that each country wishing to join the EMU had to be within the permitted band of the ERM for at least 2 years without realignment. 

 

Fiscal Policy - it was argued that if members of the EMU had large variations in unemployment rates there would be a need for fiscal transfer between member states which may be opposed politically. However there was no official target for unemployment as a convergent requirement. The target was instead set that the budget deficit had to be smaller than 3% of GDP and that national debt couldn't be greater than 60% of GDP(economists consider a level above this as unsustainable, however during the current Debt Crisis over the last few years (2010-2013), national debt has been much higher than this in many countries including EMS members).

 

In 1999 exchange rates between countries were locked and no further realignments were permitted. The ECB was also established and set a common interest rate throughout the union.

The euro came into effect as the national currency of Belgium, Spain, Germany, France, Ireland, Italy, Greece, Luxembourg, the Netherlands, Austria, Portugal and Finland on 1st January 2002, as these countries were deemed to have met the Maastricht criteria (including the convergence criteria). When evaluating the costs and benefits of the eurozone the arguments proposed for a fixed exchange rate against a floating regime are often heard, this is because the euro area was effectively a fixed exchange rate regime. An optimal currency area occurs when a group of countries are better off with a single currency.

Monetary efficiency gain - this has the effect of increasing trade between member countries. It is also believed that there will be increases in economies of scale and greater comparative advantages. Transaction costs are reduced as a result of a single currency; firms no longer have to buy a foreign currency if they want to export or import goods/services to a country within the single currency bloc. For example a French firm wishing to export wine to Germany, no longer has to spend money purchasing Deutschemarks with Francs, because both countries use euro’s. This saves money as there is no longer the fee of converting, as well as the varying exchange rates which may not have the same purchasing power. There is also a reduction in uncertainty because a firm no longer has to estimate how the exchange rate will fluctuate in order to evaluate when it’s best to transfer money. Therefore there may be increased trade as firms are less hesitant to spend and invest because the currency won’t float.

 

The benefits will be exacerbated if the single currency bloc contains countries which trade heavily with each other. For example 50% of the UK's exports go to the eurozone, therefore there may be large benefits in terms of monetary efficiency gains if the UK joined the euro (however there also many costs, as well as political considerations to take into account).

Within a single currency, each sovereign government no longer has the ability to administer unique and tailored monetary policy to benefit its country. Therefore each country has to be able to deal with external shocks in a similar way otherwise the medicine administered by the Central Bank may only help some countries whilst damaging others. This is why it is important that the business cycles of economies that are part of the single currency are well attuned. 

Nobel Prize winner Paul Krugman has suggested that the higher the degree of integration, the lower the costs and the higher the benefits of a single currency. This can be seen in the cost/benefit diagram below. If integration is less that t* the costs from joining the single currency are greater than the benefits. If this analysis was done prior to joining the union it could be concluded that it would be beneficial for an economy not to join the union under this situation. Conversely if the degree of integration is larger than t* then benefits exceed costs and hence it would be beneficial for an economy to adopt the single currency.

 

However it is difficult to evaluate the costs and benefits and put a definitive number on it. It is also difficult to judge to what degree of integration has occurred. The procedure can be further complicated as the costs are mainly macro (the devolution of monetary powers) but the benefits are mainly micro (seen in individual markets). 

 

Some argued that the benefits of the single currency were only experienced during the initial phase of the introduction of the euro, and that there were very little future gains to be had. It was also argued that countries which didn't adopt the euro, still benefited (almost as substantially) as much as Eurozone members.