In concluding that Europe or, more precisely, the European Union, is not an Optimal Currency Area (OCA) one needs to first go back to the origins of the concept of an OCA and compare it with the lessons learned following the turbulent period of the past decade. The phrase "Optimal Currency Area" is attributed to a Canadian economist named Robert Mundell. Mundell studied, and wrote unbelievably dully about regional economic integration and the role of unitary currencies such as the Euro, the common currency of members of most members of the European Union. In his 1961 A Theory of Optimum Currency Areas, Mundell considered at length the feasibility of single currency unions such as the emerging European Common Market, also known as the European Economic Community. In his essay, he postulated certain criteria for the establishment of an OCA, including the ability of labor and capital to move freely throughout the defined boundaries of the region in question; a system by which member nations or regions shared the risks associated with a common currency, and sufficient similarity among local economies to ensure that each disparate region with the OCA functions at the same pace as the others, experiencing shocks and sustained growth at or near-simultaneously. In one of the -- to this educator, anyway -- more muddled of this Nobel Prize-winning economist's assertions regarding the feasibility of an OCA, Mundell wrote the following:
"In the real world, of course, currencies are mainly an expression of national sovereignity, so that actual currency reorganization would be feasible only if it were accompanied by profound political changes. The concept of an optimum currency area therefore has direct practical applicability only in areas where political organization is in a state of flux, such as in ex-colonial areas and in Western Europe."
Further along in his seminal study, Mundell includes a section titled "Upper Limits on the Number of Currencies and Currency Areas," the crux of which is difficult to decipher, but which comes down to this: grow too large, and you fail to sustain an OCA. As he wrote in this section of his paper, "we have, thus far, considered the reasons for keeping currency areas small, not the reasons for maintaining or increasing their size."
So, what does all of this mean for the European Union? Plenty, as it turns out. The European Union, as originally conceptualized, would have been a reasonable, but uncertain, zone in which to establish an OCA. There are two main sets of criteria for membership in the European Union, the "Copenhagen criteria" and the "convergence criteria," the former focused on larger questions of economic and political development, and the latter focused more specifically on economic and financial conditions. Each is summarized by the European Union as follows:
Copenhagen criteria:
"Any country that satisfies the conditions for membership can apply. These conditions are known as the ‘Copenhagen criteria’ and include a free-market economy, a stable democracy and the rule of law, and the acceptance of all EU legislation, including of the euro. [http://europa.eu/about-eu/countries/joining-eu/index_en.htm]
Convergence criteria:
"The convergence criteria are formally defined as a set of macroeconomic indicators which measure:
- Price stability, to show inflation is controlled;
- Soundness and sustainability of public finances, through limits on government borrowing and national debt to avoid excessive deficit;
- Exchange-rate stability, through participation in the Exchange Rate Mechanism (ERM II) for at least two years without strong deviations from the ERM II central rate;
- Long-term interest rates, to assess the durability of the convergence achieved by fulfilling the other criteria.
"The exchange-rate stability criterion is chosen to demonstrate that a Member State can manage its economy without recourse to excessive currency fluctuations, which mimics the conditions when the Member State joins the euro area and its control of monetary policy passes to the European Central Bank (ECB). It also provides an indication of the appropriate conversion rate that should be applied when the Member State qualifies and its currency is irrevocably fixed." [http://ec.europa.eu/economy_finance/euro/adoption/who_can_join/index_en.htm]
Now, we come to the reasons the European Union has failed to quality as an OCA as sketchily-defined by the concept's founder, Robert Mundell. The concept of economic integration was a bedrock of post-World War II diplomatic efforts among the countries of Western Europe -- in effect, those not occupied by the Soviet Army. Following not one but two catastrophic world wars, the hope was that economic integration would lead to political integration and, consequently, the elimination of the national differences that led to the two wars. For better or worse, however, early post-war concepts like the European Coal and Steel Community and the Common Market were relatively small, confined to the Western European democracies that were most helped and influenced by the U.S.-sponsored Marshall Plan. The European Coal and Steel Community was originally founded by six countries, France, West Germany, Italy, Belgium, Luxembourg, and the Netherlands. Today's European Union, the modern-era culmination of a 60-year evolutionary process, has 28 members, 19 of which belong to the "Euro zone," meaning they discarded the old national currencies and share the common currency of the European Union, the Euro.
What this means is that the European Union grew too large and unwieldy to continue to function effectively as an OCA. This, then, is the first reason Europe is not an OCA. it is one thing to forge unity among a handful of countries sharing identical political orientations (i.e., democracy) and, within reason, similar levels of economic development. The current European Union, however, is comprised of dozens of countries of vastly different levels of economic and political development, as is evident in the ongoing debt crisis pitting Greece and other smaller EU economies against Germany, the union's largest single economy and the one most susceptible to being tagged with responsibility for bailing out the smaller economies when problems hit. And, this leads to the second reason that Europe is not an OCA: its member states are too economically dissimilar and experience economic perturbations at very different rates. Germany has emerged as one of the most economically powerful nations in the world, while Cyprus, Greece, Portugal and other smaller, weaker economies continue to drag-down the Union's aggregate level of development. The huge disparities in levels of economic development fundamentally conflict with Mundell's notion of an OCA.
There is a reason Mundell, in his 1961 paper, targeted his native country, Canada, as a viable candidate as an OCA. Canada is geographically very large, but its population is small, but industrious. While it consists of two ethnically-distinct halves, each a remnant of Canada's origins as a colonial possession of Britain and France, it meets Mundell's criteria for an OCA, being restricted in size with only two languages and a common currency.
