Implications of the Introduction of
the Euro for the Mediterranean
Countries
Nora Colton
Simon Neaime
Executive Summary
The Mediterranean peripheral countries cannot afford to be passive viewers of the fundamental changes that are taking place in Europe after the introduction of the Euro.
The new developments pose formidable challenges and opportunities. It will be argued
that no single group of developing countries will be more affected by these changes than
the Mediterranean countries given their geographical proximity to the region and their
long historical record of extensive and large economic interactions (trade, finance, and
migration). This article examines the implications of the introduction of the single currency in Europe on Mediterranean central bank reserves and foreign external liabilities, trade and capital flow, and exchange rate policies. It is shown that since most
Mediterranean trade is with the EU, Mediterranean central banks will be necessitated
to hold major portions of their foreign exchange reserves in Euros. Also, a Mediterranean
currency peg to the Euro, or to a basket of currencies where the Euro is allocated, will be
important in reducing financial and trade transaction costs. It will also be hypothesized
that Mediterranean foreign debts will eventually have to be converted to Euros. Finally,
parallels between this region and the U.S–Caribbean region will be drawn to reinforce
the argument that trade and capital dependence will eventually lead to a pegging of the
Mediterranean currencies to the Euro. © 2003 Wiley Periodicals, Inc.
1. THE EURO-MEDITERRANEAN REGION
F
or the past three decades, the European Union (EU) has been engaged in financial and trade co-operation agreements with the Mediterranean countries.1 This
is not only justified by geographical proximity, but also by their long and extensive trade and cultural ties. These agreements lasted 5 years and consisted of uni-
1
Algeria, Cyprus, Egypt, Israel, Jordan, Lebanon, Malta, Morocco, Syria, Tunisia, and Turkey.
We wish to thank two anonymous referees for very helpful comments on an earlier draft.
Nora Colton is an associate professor of economics at Drew University, New York. Simon Neaime
is a professor of economics at the American University of Beirut, Lebanon.
Thunderbird International Business Review, Vol. 45(1) 31–49 • January–February 2003
© 2003 Wiley Periodicals, Inc. • Published online in Wiley InterScience (www.interscience.wiley.com).
DOI: 10.1002/tie.10054
31
Nora Colton
Simon Neaime
lateral trade concessions by the EU to the Mediterranean countries
(duty-free access for industrial goods and trade preferences for agricultural products, and the maintenance of varying degrees of tariff
protection against EU imports). This framework of cooperation (last
reviewed in 1990) was substantially altered at the Barcelona
Conference in 1995. One of the prominent features of Barcelona is
to create a Euro-Mediterranean Free Trade Area (FTA) by the year
2010 that will promote trade flow in the region, as countries will lift
obstacles to trade and perceive trade as a source of growth, rather
than an intrusion into their domestic economies.2 Another feature of
the agreement is to establish an integrated Euro-Mediterranean
region of mutual economic cooperation.
The
Mediterranean
accord is strictly
a free trade
agreement aimed
at allowing the
EU to continue to
have some type
of preferential
trade with the
region, but without violating
international and
European policies
that forbid such
arrangements.
Although the Barcelona accord enhances trade relations with the
Mediterranean region, it should not be confused with the enlargement process. Enlargement is one of the most important and yet divisive aspects of the EU. Most of the discussion about enlargement
centers on 13 countries: Bulgaria, Cyprus, Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Malta, Poland, Romania, the Slovak
Republic, Slovenia, and Turkey. As can be witnessed from this list of
countries, the process appears to involve a number of diverse countries. These countries have signed agreements with the EU that cover
trade-related issues, political dialogue, legal approximation, and other
areas of cooperation, including industry, environment, transport, and
customs. These accords recognize that these countries intend to
become members of the EU. These countries are mainly central
European and have their right to membership guaranteed by the
Treaty of Rome Article O, and now Article 49 of the Amsterdam
Treaty. It is important to differentiate these countries and the accords
they have signed from the Barcelona agreement with the
Mediterranean countries. The Mediterranean accord is strictly a free
trade agreement aimed at allowing the EU to continue to have some
type of preferential trade with the region, but without violating international and European policies that forbid such arrangements.
It is interesting also to note that in spite of the fact that the EU agreements with Central and Eastern European countries have been asymmetrical, lifting restrictions on exports from the countries of Central
Europe more quickly than those on EU exports, the overall trade balance of the EU with these countries remains positive. Indeed, the trade
2
The Barcelona Declaration signed in 1995 by the EU and the eligible Non-EU Mediterranean partner
countries (Algeria, Morocco, Tunisia, Turkey, Egypt, Lebanon, Syria, Jordan, Israel, the Palestinian
Authority, Cyprus, and Malta) provided for the creation of the “Euro-Mediterranean Partnership” consisting of mainly economic and financial partnership, to promote regional integration.
32
Thunderbird International Business Review • January–February 2003
Implications of the Introduction of the Euro for the Mediterranean Countries
surplus in favor of the EU has grown, reaching a total of around Euro
22.2 million in 1998 vis-à-vis all 10 candidate countries of central
Europe. In spite of the general agreement on enlargement, there
remain a number of concerns, particularly for countries such as Britain.
Britain, Denmark, and Sweden have continued to be defiant not only
on issues surrounding monetary union—insisting on the right to opt
In spite of the
out of the European Monetary Union (EMU)—but also on the level general agreement
of integration that should take place.3 The British have historically on enlargement,
wanted the EU to be nothing more than a free-trade zone. There is
there remain a
the presumption that the agreement could be the beginning of somenumber of conthing larger and more integrated with the EU. Presently, this is not
cerns, particularly
the case in the Mediterranean (MED) accord, and there is nothing in
for countries such
the EU Treaties that would imply such a right to these countries.
as Britain.
Agreements have already been concluded with Tunisia (1995), Israel
(1995), Morocco (1996), Jordan (1997), and the Palestinian
Authority (an interim agreement was signed in 1997). Negotiations
are still taking place with Lebanon, Egypt, and Algeria, while preparatory talks have begun with Syria. These agreements are intended to
reinforce the importance of Europe to the Mediterranean region,
especially in terms of trade and capital flow.
The article is divided into eight sections. Section 2 discusses the
Barcelona Declaration and its political implications. Section 3 sheds
light on the existing trade patterns between the Eurozone and the
Mediterranean region. The Euro-Mediterranean capital flow is studied in Section 4. Section 5 discusses the prospects of the use of the
Euro as an anchor currency as opposed to the U.S. dollar in the
Mediterranean region. Section 6 outlines the main factors that might
induce Mediterranean central banks to shift significant portions of
their foreign exchange reserves and foreign liabilities into Euros.
Section 7 highlights the main similarities between the
3
With membership of 11 countries, the Eurozone creates a market of about 290 million consumers shared
by a common currency about 10% more populous than the United States. Eventually, the market will comprise 15 countries or more. Among the remaining four EU members, Demark, Sweden, and the United
Kingdom have been reluctant to join the Euro since its inception, but they have not ruled out membership in
the future. By May 1998, when the selection of initial EMU entrants was made, Greece, the fourth country,
did not satisfy the economic and fiscal criteria of the Maastricht Treaty, and its membership into the single currency has been postponed to the year 2001. After the adoption of the Euro by the four deviant states, the
Eurozone will have a population of 373 million and a Gross Domestic Product (GDP) of $7.743 trillion (at
1990 prices and 1990 exchange rates). In contrast, the United States represents a market with a population of
268 million consumers and a GDP of $6.862 trillion. The respective figures for Japan are 127 million consumers and a GDP of $3.256 trillion (OECD, 1999, p. 215). The Euro, representing a much larger unified
economy than that of any one of the members individually, could encourage further trade and foreign investment between the EU 15 member countries and the rest of the world. Also, a Euro that represents a larger
economic bloc could become more attractive as a reserve currency, affording the EU the benefits of international seigniorage. Furthermore, the free flow of capital in the unified market will increase by the elimination
of currency risk and currency transaction costs. All these will improve resource allocation within the EU.
Thunderbird International Business Review • January–February 2003
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Nora Colton
Simon Neaime
U.S.–Caribbean and EU-MED economic and financial relationships.
Section 8 concludes the paper and presents policy implications.
2. THE BARCELONA ACCORD
It is believed that the framework of the Barcelona Accord favors the
EU more than partner countries. This belief rests on several facts.
First, the accord is almost identical to the Commission’s draft proposal, which was adopted without any major change. In fact, the dec. . . the accord is laration establishes partnership between one set of somehow
keener about
homogeneous economies and another set of completely heterogeremoving tariffs neous economies. The EU member countries have all met the conand trade-related vergence criteria set by the Maastricht Treaty in terms of low inflation
rates, and appropriate fiscal and debt policies. In the Mediterranean
barriers on
region, the economic fundamentals are not quite the same, and in
industrial prodfact, many Mediterranean countries have accumulated a high level of
ucts, while it is
adopting a more external debt and deficits and are still trying to contain inflation.
Thus, the new Trade Agreements did not take into account the subconservative
stantial economic differences that exist between the Mediterranean
stance when it
economies and their EU trading partners. While, the EU acknowlcomes to the
edges that the Mediterranean counties are in deep need of structural
liberalization
aids to help them adjust smoothly with the heavy costs of liberalizapolicies on
tion, it prohibits EU governments from channeling the urgently
agricultureneeded subsidies.
related products.
Second, the accord is keener about removing tariffs and trade-related
barriers on industrial products, while it is adopting a more conservative stance when it comes to the liberalization policies on agriculturerelated products. Specifically, the same stance toward agricultural
products continues to be adopted, although in the past analysts raised
considerable doubts about it. Since the early 1970s, the EU has granted partner Mediterranean countries full free entrance for their industrial products, an area where they have a comparative disadvantage.
But it has maintained some protection in trade in agricultural products, an area where the EU might be at a comparative disadvantage.
Third, although the Barcelona Accord is setting up a Free Trade Area
by 2010, many doubts have been raised about partner countries’
means to fully integrate without substantial aid channeled from their
EU partners. These aids will be prohibited whenever they endanger
EU firms. For instance, one clause in these agreements provides the
EU with the means of blocking subsidies to the Mediterranean
region whenever they favor firms operating in that region.
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Thunderbird International Business Review • January–February 2003
Implications of the Introduction of the Euro for the Mediterranean Countries
Finally, there are also some concerns that the Barcelona Accord is a
bilateral framework rather than being a multilateral one when it
comes to EU state aid to their Mediterranean partners. While state
aid is prohibited on a multilateral level, it would become available,
and sometimes abundantly, on a bilateral level. One problem under
this framework is the political pressure, which will be the driving
force behind any channeled type of aid, not real economic factors. . . . many partner
Not to mention that this will distort and alter the cooperation envicountries have
ronment with one of competition to obtain and have more access to
been forced to
these aids. Another area where bilateralism has been favored and pro- directly renegotimoted under the Barcelona Accord is the issue of North-South debt.
ate their debt
The accord has set no specific policy with regard to its outstanding
structures with
debt with partner countries in the South. This has paved the way for
their respective
partner countries to unilaterally act on this issue. Consequently, many
creditors compartner countries have been forced to directly renegotiate their debt
pletely ignoring
structures with their respective creditors completely ignoring the EU.
the EU.
And EU countries have full bargaining power in sometimes writing
off some important portions of their debts, whenever this serves their
political interests and in no way the economical aspirations of the
Union and its partner countries.
3. TRADE AND THE EURO-MEDITERRANEAN REGION
Many analysts have put forth the argument that once the EMU is
fully established with the Euro as its only currency, the growth rate
of the EU will improve considerably (see IMF, 1997). It is also
assumed that the macroeconomic stabilization programs introduced
by the Growth and Stability Pact, along with the reduction in government debt and deficits, will also contribute to higher growth
rates. Although, the convergence criteria have presumably attempted to create economies that would act and react to economic shocks
in a similar manner, the reality is that such integration will eventually give way to regional specialization. Paul Krugman puts forth this
idea in his work on trade and geography (Krugman, 1991). In fact,
it can be anticipated that as the EU begins to act as one market,
rather than a number of linked economies, it will begin to experience increased returns to scale as various industries begin to experience external economies of scale (economies of scale that occur
when the cost per unit depends on the size of the industry but not
necessarily on the size of any one firm). This scenario leads itself to
the idea that there will not emerge in Europe a number of homogeneous economies, rather one economy with various regional centers
of specialization.
Thunderbird International Business Review • January–February 2003
35
Nora Colton
Needless to say,
this increased
growth and
prosperity in the
EU will be
expected to spill
over to the
Mediterranean
peripheral
countries as
Europeans begin
to consume
more imports as
well as domestic
goods.
36
Simon Neaime
The United States has seen the regionalization of a number of industries as they have reaped the benefits of such economies. Most recently, we can think of the computer industry, which located much of its
research and development activity in Silicon Valley, California. The
benefits of such regionalization for certain industries will definitely
increase their efficiency and profitability. The gains from locating firms
in the same industry together take the form of specialized suppliers,
labor market pooling, and technological spillovers. In the EU, the specialization will also mean greater growth and increased GDP. In fact,
simulation models presented by the IMF (1997) have indicated that
by 2010 the economic growth rate in the Eurozone will reach 3% at a
time when it is expected to be 0.2% in other industrial countries and
0.3% in some developing countries.
Needless to say, this increased growth and prosperity in the EU will
be expected to spill over to the Mediterranean peripheral countries as
Europeans begin to consume more imports as well as domestic
goods. The Southern Mediterranean region is particularly poised to
benefit from this geographic proximity for a number of reasons.
Historically, the Mediterranean region has had strong trade and cultural ties with Europe. Existing trade patterns point significantly in
this direction since on average more than 55% of Mediterranean trade
is with Europe (see Table 1).
Most countries in the region are former colonies that have maintained close trade links with Europe, even in the post-colonial period. The Mediterranean region has usually offered unskilled labor
and land-intensive goods, while the EU has provided the
Mediterranean region with human and physical capital-intensive
goods. As is apparent, this trade relationship has rested on the principle of comparative advantage. Often this has translated into the
Mediterranean providing raw materials and semi-finished goods to
Europe in exchange for finished goods from Europe. This exchange
has been based on a number of asymmetries; consequently, the
Mediterranean has remained less developed and dependent on the
EU. Although the Barcelona Declaration sets in place a free-trade
area, the two regions have always had preferential trade agreements
and, in fact, the eventual free trade area is no more than a reassertion of these previous ties. A case in point is Morocco. The EU and
Morocco have had longstanding trade agreements that have
allowed Morocco to channel some agriculture products into the
EU’s market. They have also had agreements that have allowed
industrial exports easy access to the EU. Thus, the Free Trade Zone
will not change present trade relations between the EU and
Thunderbird International Business Review • January–February 2003
Implications of the Introduction of the Euro for the Mediterranean Countries
Table 1. Euro-Mediterranean Trade Flows
Countries
Imports from EU
(Millions of US$)
1995 1996 1997
Algeria
Cyprus
Egypt
Israel
Jordan
Lebanon
Malta
Morocco
Syria
Tunisia
Turkey
6699
1910
4563
14717
1227
3167
2139
4321
1620
5643
16862
Countries
Imports from EU
(% of total)
1995
1996
1997
Exports to EU
(% of total)
1995
1996
1997
Algeria
Cyprus
Egypt
Israel
Jordan
Lebanon
Malta
Morocco
Syria
Tunisia
Turkey
66.20
51.70
38.90
52.20
33.50
48.20
72.70
50.50
34.40
70.30
47.20
67.50
34.80
45.80
31.30
6.20
23.40
71.50
55.30
57.00
78.50
51.2
5589
1935
4711
15488
1359
3293
1927
4469
1924
5560
22336
67.10
48.60
36.20
51.70
31.50
43.60
68.70
46.10
30.20
72.30
52.60
5401
1757
5031
14806
1463
539
1822
6420
1667
5732
24835
60.80
47.50
38.20
51.00
37.80
47.50
71.40
67.40
27.60
72.40
51.00
Exports to EU
(Millions of US$)
1995
1996 1997
7039
428
1577
5957
90
161
1367
2565
2262
4539
11084
7841
417
1613
6571
122
205
991
2915
2312
4418
11501
62.20
29.20
45.60
32.30
8.30
17.80
57.00
42.40
58.70
80.10
49.7
8616
337
1621
6781
179
163
886
4894
2244
4203
12248
61.90
27.10
41.50
30.20
12.10
22.90
54.00
69.60
55.40
78.40
46.7
Source: Direction of Trade Statistics, Yearbook 1998, International Monetary Fund.
Morocco significantly, except in the area of agriculture, where some
tariff and non-tariff barriers have limited their produce.
Consequently, we can anticipate an intensification of previous trade
patterns in light of increased trade flow. In fact, it can be assumed
that the sectors in which the EU emerges as having external
economies of scale (low production costs via a large industry with
many firms), will continue to be the sectors that will dominate EU
trade. Moreover, the learning curve argument implies that even if
one of the EU’s trading partners could produce a good cheaply, it
could not replace Europe as the producer of this good due to the
fact that it would initially incur higher short-run costs. Since the EU
already provides the good at a lower price, the short-run cost considerations would deter its production in the partner country unless
there was some type of short-run subsidization of production for
Thunderbird International Business Review • January–February 2003
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Nora Colton
Simon Neaime
this industry. This obstacle could prove particularly difficult for
Mediterranean partner countries because the Euro-Mediterranean
Free Trade Area agreement, which has already been signed by Israel,
Jordan, Morocco, the Palestinian Authority, and Tunisia, stipulates
that state aid in partner countries will be prohibited whenever it
endangers competition in Euro-Mediterranean trade.
Krugman (1980) has asserted that external economies potentially
give a strong role to historical accident in determining who produces what, and may allow established patterns of specialization to
. . . the EU will
persist even when they run counter to comparative advantage.
Consequently, the EU will have to consciously pursue a strategy of
have to consciously pursue deeper integration with its partners in the Mediterranean if trade
patterns other than those founded on low wages and natural
a strategy of
deeper integra- resource extraction are to develop. Yet, despite these current trade
patterns, we can anticipate an increase in trade between the two
tion with its
regions. This increase in trade flow will be a result of increased
partners
growth and prosperity in the EU, which will lead to an increased
in the
demand for goods from the Mediterranean countries. This increase
Mediterranean
if trade patterns in trade, which will be based on the classic model of comparative
other than those advantage, will also lend itself to a much higher percent of the
partner countries as opposed to the European countries GDP
founded on low
being in international trade.5
wages and natural resource
This situation will arise from the fact that Mediterranean countries
extraction are to
will have to rely on the EU for most of their finished goods (goods
develop.
that have much more value added). Consequently, the partner
countries will have to export most of what they produce to Europe
in order to pay for what they consume. This scenario will inevitably
force many of the partner countries to run a trade deficit with the
EU. Tunisia, which has had preferential trade agreements with
Europe dating back to the years immediately following independence, is a case in point. Tunisia has continued to run a trade
deficit with the EU before and since reaching accord with the EU
in 1995.
These trade agreements, along with present and future trade patterns
and trends, will be at the foreground in terms of determining the
implications for the Mediterranean countries of the full adoption of
the Euro in 2002. In fact, these patterns and flow reveal much about
5
Hakim and Kandil (1999) have argued that the Mediterranean region depends heavily on trade with the
EU and that its economies are extremely sensitive to the economic performance of their trading partners in
the North.
38
Thunderbird International Business Review • January–February 2003
Implications of the Introduction of the Euro for the Mediterranean Countries
the potential impact of the Euro and possible reactions by the
Mediterranean countries.
On the other hand, Krugman (1980) has argued that transaction
costs are the main determinant of the use of a currency. Needless to
say, transaction costs increase as the facilitation of trade transactions
increases in any given currency. These transaction costs can be the
result of a number of factors. The most important factors for the
Mediterranean countries will be the traditional functions of money
as a store of value, a unit of account, and a medium of exchange.
These functions and the transaction costs that they could levy on the
Mediterranean countries will all be important incentives not only to
conduct transactions in the Euro, but also to eventually peg their
currencies or substitute their currencies for Euros. In any trade
transaction the role of money becomes paramount. First, it is imperative to have goods priced in a currency that is a stable, reliable vehicle currency. Thakur (1994) points out that an international
currency that maintains a constant purchasing power can be used in
international trade and commercial contracts. The ECB’s mandate
to promote price stability within the Euro zone should render the
Euro the preferred currency choice for the Mediterranean region.
These functions
and the transaction costs that
they could levy
on the
Mediterranean
countries will all
be important
incentives not
only to conduct
transactions in
the Euro, but
also to eventually
peg their currencies or substitute
Historically, the dollar has played this role for most Mediterranean their currencies
countries. In fact, the dollar is often used in lieu of direct exchanges
for Euros.
between two currencies, since the use of the dollar as the third party
currency involves lower transaction costs. This has meant that most
Mediterranean countries exchange their own currency for dollars,
even when making payments to EU countries. Lebanon, for example, began to use the dollar as a substitute currency for the Lebanese
Lira during its protracted civil war, but even continued using it in
the post-war period. The Lebanese civil war has been officially over
for more than a decade now; nevertheless, the dollar remains a perfect substitute for the Lira on the streets of Beirut. In fact, one of
the arguments as to why the dollar is still tolerated as a medium of
exchange within Lebanon is that traders have found it much more
efficient and profitable to buy and trade only in dollars in spite of the
fact that 45% of Lebanese trade is with Europe.
This extensive use of the dollar has also been reinforced by the fact
that much of the exports from this region are in primary products–
potash, oil, and gas. All of these products or resources are priced on
the international market in dollars. Yet, stronger agreements and
trade relations with the EU may challenge the wisdom of only using
the dollar for international quotes and trade invoicing.
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Simon Neaime
4. EURO-MEDITERRANEAN CAPITAL FLOWS
. . . during the
last two
decades, controls on capital
flow between
countries have
been reduced,
resulting in
increased
international
financial
integration.
40
Trade flow between the EU and the Mediterranean region are not
the only balance of payment component that will increase with
greater internal efficiencies. Capital flow is more likely to move to the
EU from the Mediterranean region. There are two reasons for the
emergence of this pattern of capital flow. First, a higher level of
investment than in the past will be needed to sustain the rapid growth
of the Eurozone economies. Second, the formation of the single
European market introduces market security for its members.
Monetary integration further reduces the exchange-rate risk within
the EU. As the domestic market within the EU stabilizes in comparison with its trading partners, investments will move toward the more
secure EU market. Industries with high mobility costs, such as those
that are capital and technology intensive, are usually more sensitive to
the security of their markets than others. All this could create an
interest-rate differential between the EU and the Mediterranean
region in the short run right after the introduction of the Euro.
Interest rates in the Mediterranean region will have to rise (a risk premium) to compensate for the relative insecurity brought about by the
improved market security in the EU. Foreign investors will demand
this risk premium before they choose the Mediterranean region over
the EU. These higher interest rates, which are expected to prevail in
the short run after the introduction of the Euro, might negatively
impact growth rates in Mediterranean countries. This effect will be
short lived as greater interest-rate convergence is expected in the long
run with greater financial integration.
On the other hand, during the last two decades, controls on capital flow between countries have been reduced, resulting in
increased international financial integration. Technological
advances such as cross listing of stocks and the gradual elimination
of barriers to the flow of capital have spurred a substantial increase
in cross-border financial activity between Mediterranean countries.
This trend is expected to strengthen and spill over into significant
financial flow between the EU and the Middle East. Mediterranean
countries have started to implement the adjustment measures to
benefit from the competitive environment imposed by the globalization of the EU’s financial markets. This increased financial integration is expected to lead to more convergence in interest rates
between the two areas in the long run, or at least to greater convergence in interest rate fluctuations. However, in the medium and
short run, the EU’s rates are expected to be much lower than their
Mediterranean counter parts.
Thunderbird International Business Review • January–February 2003
Implications of the Introduction of the Euro for the Mediterranean Countries
Alessandrini and Resmini (1999) have argued that the adjustment
process might take some time. However, countries like Morocco and
Turkey have already begun to implement the structural adjustment
programs necessary to reduce domestic and external imbalances.
While Syria and Turkey still have various types of restrictions on capital flow, Egypt, Jordan, and Lebanon have virtually no restrictions.
Israel and Morocco have liberalized their policies with regard to capital inflow but still maintain some restrictions on capital flowing out
of their respective economies. In terms of money-market transactions, Lebanon, Israel, and Jordan have fully removed all restrictions.
Tunisia has minor regulations on foreign lending, while Lebanon,
Syria, Algeria, and Tunisia have still restrictions on borrowing from
Some analysts
abroad. Full free foreign exchange convertibility is allowed in Egypt,
believe
that joinIsrael, Jordan, and Lebanon (see Nsouli & Rached, 1998).
Some analysts believe that joining the EU block will give
Mediterranean countries considerable advantages relative to Asia.
Also, deeper links with the EU will probably generate greater credibility of policy commitments and the potential to attract greater
investment as part of a large market. Wages in most Mediterranean
countries are a fraction of those in most EU countries, implying a
substantial potential for competitiveness. Thus, as a result of greater
integration with the EU, European Direct Investment flow to the
Mediterranean Region is expected to increase. However, El Hedi
(1999) has raised some doubts about FDI inflow to the region.
Contrary to expectations and despite the worldwide expansion of
FDI (and hopes associated with the FTAs with the EU), the region
has lagged well behind other developing regions of the world. This is
attributable to the fact that the infrastructure is still inadequate, and
high tariffs are still in place. Both constitute major obstacles to the
development of intra-regional trade. The key to promoting FDI in
the region is the removal of regional and intra-regional trade barriers.
The larger integrated market will thus promote the attractiveness of
the region as a target for FDI.
ing the EU block
will give
Mediterranean
countries
considerable
advantages
relative to Asia.
5. THE EURO: AN ALTERNATIVE TO THE DOLLAR AS AN
EXCHANGE RATE ANCHOR
In 1975, nearly 65 countries had a dollar peg. However, as of 1997,
only about 15 countries have maintained this peg. This declining trend
is expected to continue for two main reasons. The first is the tendency
to move toward more flexible exchange regimes in general, and the second is the emergence of the Euro as an alternative anchor currency to
Thunderbird International Business Review • January–February 2003
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Nora Colton
Simon Neaime
the dollar.6 Interestingly, many countries with announced flexible
exchange-rate systems are in fact pegging their currencies to either one
currency or to a basket of currencies. Table 2 indicates that most
Mediterranean countries are still either under a dollar peg, with narrow
or wide exchange-rate bands, or under a currency basket peg weighted
heavily toward the U.S. dollar, at a time when all these countries are
moving toward more economic, trade, and financial integration with
the EU. To reap the expected benefits of low inflation and high EU
GDP growth rates, Mediterranean countries will have to lower restrictions on financial transactions and open up their goods and capital markets. The best choice would then be the Euro as an anchor for their
It is expected
respective currencies; the second-best choice would be to peg to a basthat a high
ket of currencies where the Euro (as opposed to the dollar) enjoys the
degree of ecohighest weight. The dollar anchor, therefore, will cease to constitute a
nomic integration
rational exchange rate peg for the Mediterranean countries.
between
Mediterranean
countries and the
Eurozone will
magnify the
monetary efficiency gain these
countries reap
when they peg
their currencies
to the Euro.
The Mediterranean countries’ costs and benefits from a Euro anchor
(as an alternative to the dollar anchor) will depend on how well integrated their economies are with those of their potential EU partners.
Membership in an exchange rate area may involve costs, as well as
benefits even when the area has low inflation.7 The costs arise because
a country or group of countries joining an exchange rate area give up
their ability to use exchange rate and monetary policy for the purpose
of stabilizing output and employment. Most Mediterranean countries
have pegged their currencies to the dollar or to a basket of currencies
and are still operating under fixed exchange-rate regimes. These
countries have never used exchange-rate policies to stimulate their
exports and the growth in their GDP.
These fixed exchange rate arrangements are expected to prevail in the
Mediterranean region. This is because all the economies of the region
are relatively small with low degrees of financial sophistication and
diversification in production, and have a high degree of trade integration with the EU. Once the Euro becomes a stable and strong
currency, there will not be any real costs associated with a Euro peg,
only benefits to reap. It is expected that a high degree of economic
integration between Mediterranean countries and the Eurozone will
magnify the monetary efficiency gain these countries reap when they
peg their currencies to the Euro.
Some Mediterranean countries, like Cyprus, have recently pledged to peg their currencies to the Euro.
A country may wish to peg its exchange rate to an area (or another country) of price stability to import
the anti-inflationary resolve of the area’s monetary authorities. When the economy of the pegging country
is well integrated with that of the low-inflation area, low domestic inflation is easier to achieve. The reason
is that close economic integration leads to international price convergence and therefore lessens the scope for
independent variations in the pegging country’s price level.
6
7
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Implications of the Introduction of the Euro for the Mediterranean Countries
If one looks at justifications for a dollar peg for the Mediterranean
countries, the economic arguments are rooted in history. The fact that
the dollar has been the only anchor after the breakdown of the Bretton
Woods system has justified an on going dollar Mediterranean anchor.
Additionally, this has led to international pricing of primary products in
dollars, as well as the development of a number of hedge facilities that
center on the dollar. Moreover, the Mediterranean countries, like many
developing countries, benefited from U.S. aid (in the form of dollars)
during the Cold War. This situation accounted during the 1970s and
early 1980s for the focus on the dollar in these economies. However,
with the introduction of the Euro, any rationale for a dollar peg can no
longer be sustained based on efficiency and monetary considerations.
All the recent developments point toward more trade and financial integration between the Euro zone and the Mediterranean countries. It is,
therefore, foreseeable that Mediterranean countries will shift toward a
Euro peg to reap all the benefits of integration with an area of low inflation and significant growth potential. Moreover, a Euro peg should
prove superior to the dollar peg in the future. This is not only embedded in the geographical proximity and existing trade patterns of both
Europe and the Middle East, but also due to the Euro’s expected rise to
world currency status. Quere and Revil (1999) used a sample of 49
countries, including Algeria, Morocco, Tunisia, and Turkey, to determine the preferred anchor currency for each one of these countries.
Their empirical results showed that for the four Mediterranean countries
the preferred nominal peg is the Euro and not the U.S. dollar.
6. MEDITERRANEAN DEBT AND CENTRAL BANK RESERVES
Krugman (1980) emphasizes the role of transaction costs in international financial markets and central bank reserve holdings. Only a
Table 2. Exchange Rate Arrangements of Mediterranean Countries (September 1997)
Currency Pegged to
More Flexible Regime
U.S. Dollar
Weighted Toward
the U.S. Dollar
Basket of Currencies
Geared to the
U.S. Dollar
Managed Float
Independent Float
Syria
Jordan
Cyprus
Malta
Morocco
Israel
Turkey
Tunisia
Algeria
Egypt
Lebanon
--
Source: World Economic Outlook, IMF (1998), and Joint Arab Economic Report, September 1998.
Thunderbird International Business Review • January–February 2003
43
Nora Colton
Simon Neaime
currency that minimizes transaction costs will become a vehicle currency. If the Euro is the optimum currency choice for Mediterranean
countries, the lower transaction costs it offers will make it attractive
in their financial markets (portfolio diversification and central bank
reserve diversification). Dooley, Lizondo, and Mathieson (1989)
argue that only currencies with low transaction costs will be part of a
central bank’s foreign reserves. If that is the case, then other countries will use this money to intervene in the foreign exchange markets
to defend their respective exchange rates. Since most Mediterranean
trade is with the EU, the adoption of the Euro as an anchor currency and as an official currency for price quotations is expected to
reduce Mediterranean transaction costs associated with trade in
goods, services, and assets.
. . . ECB’s strong
focus on price
stability should
render the Euro a
valid alternative
store of value
and encourage
its adoption as a
reserve currency
in the
Mediterranean
region.
Central banks hold foreign reserves to conduct transactions. It was
argued that Mediterranean trade flow is expected to increase following the implementation of the FTA with the Eurozone, and the Euro
is the logical unit of account for this trade flow. This situation will
prompt Mediterranean central banks to hold their reserves in Euros
to either pay for their EU imports or to save the proceeds of their
exports to the EU denominated in Euros. The central bank of a
small, open economy also holds reserves to meet liquidity needs arising from unexpected capital outflow. A Euro peg, for example,
requires it to hold reserves in Euros. This enables the central bank to
intervene on the foreign exchange market by buying or selling the
domestic currency in exchange for Euros to protect its peg. Since a
Euro peg is the likely alternative to the dollar peg, we expect most
Mediterranean central banks to eventually start shifting the denomination of their foreign exchange reserves into the Euro. The ECB,
currently the world’s most independent central bank, has successfully kept inflation and interest rates at relatively low levels.8 Thus, the
ECB’s strong focus on price stability should render the Euro a valid
alternative store of value and encourage its adoption as a reserve currency in the Mediterranean region.
The currency denomination of foreign debt typically dictates the
denomination of a substantial portion of foreign reserves, as the debt
servicing is usually denominated in the same currency. Most
Mediterranean debt is still denominated in dollars; however, lower
interest rates in the EU are expected to prevail during the next few
years. This will make borrowings in Euros much more attractive. It is,
8
In contrast, the Federal Reserve System in the United States is concerned with inflation but sets no
numerical target for it. Along side with inflation, it is required by law to take into consideration output and
employment. Moreover, the Federal Reserve is accountable to Congress, which questions its top officials and
tries to influence their views.
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Implications of the Introduction of the Euro for the Mediterranean Countries
Table 3. Currency Composition of Mediterranean Long-Term Debt (%)
Country
1995
Euro1 USD
Algeria
Egypt
Syria
Jordan
Lebanon
Malta
Morocco
Tunisia
Turkey
25
35.7
3.9
24.7
9.4
9
29.3
20.8
22.1
38.30
34.1
82.4
28.8
28.8
29.4
28.2
17.2
38.3
1996
Euro USD
25.3
34.8
3.6
24
9
8.5
28.7
17.6
21.4
39
35.7
82.7
29.4
29.4
30.1
28.8
24.1
41.4
1997
Euro USD
24
32.5
3.4
22.3
13
7.8
26.8
16
25.1
41.7
38.8
84.8
30.3
30.3
31.9
30.9
28.2
49.2
Source: The World Bank, Global Development Finance, 2000.
1
Euro currencies are composed of the French franc and the German mark.
therefore, expected that Mediterranean countries will soon start borrowing from the EU bond market, thereby converting significant portions of their foreign debt into Euros.9 In most developed economies,
the currency denomination of trade flow is the same as that of foreign
debt. In the Mediterranean countries, however, this is surprisingly not
the case. While most trade is with the EU, the dollar, followed by the
Japanese Yen, still constitutes the main denomination of most
Mediterranean external liabilities (see Table 3). One explanation for
this is the fact that the EU’s debt markets have, until the introduction
of the Euro, been segmented, illiquid, and more expensive. Unlike
corrections in the denomination of Mediterranean trade flow, which
could occur instantaneously, the correction in foreign debt will probably be gradual, taking place over an extended period of time.
7. THE CARIBBEAN AND U.S. RELATIONSHIP: LESSONS
TO BE LEARNED
If one wants to truly appreciate the type of relationship that can be
seen evolving between Europe and the Mediterranean region, the
best parallel for prophecy is probably the U.S.–Caribbean region.
The Caribbean region lies on the southern flank of the United States.
and has come to rely heavily on the United States for trade, as well as
currency stability. Many of the countries of this region have been able
to keep their inflation rates under control by pegging their currencies
to the U.S. dollar. They also benefited before 1984 as points of offshore banking centers for many U.S. institutions (offshore banking
9
Lebanon has been actively taping the Eurobond market. By the end of 1998, the total borrowings by its commercial banks amounted to $1297 million. These borrowings are in the form of Eurobonds, certificates of deposits,
global depository receipts, and subordinated loans (see Central Bank of Lebanon, Annual Report, 1998).
Thunderbird International Business Review • January–February 2003
45
Nora Colton
Simon Neaime
was not permitted in the United States before 1984). As small states
that are considered a part of the developing world, these countries
have provided the United States with primary products and laborintensive goods in exchange for finished goods and capital-intensive
goods. The area has also been a popular vacation destination for
Americans who want to go abroad without traveling far from home.
It is not surprising, given their geographic proximity coupled with intensive trade and capital flow, that most of these countries have decided to
peg their currencies to the U.S. dollar. This has proven to be an effective policy for controlling inflation. Most of these countries have lower
inflation rates than their Central American neighbors who do not peg
their currencies to the dollar (IMF, 2000). They also have minimized
the transaction costs of doing business with the United States, and the
stability that this has created has helped attract many banks and other
U.S. financial institutions to have branch offices in this region. It is also
worth noting that in spite of the unique relationship these countries
have had with the U.S., it has not been a catalyst for change in terms of
trade patterns (IMF, 1997). As was argued earlier in this article, established trade patterns are not easily broken without a conscious and vigorous effort on the part of both parties. Thus far, the U.S. has not been
willing to make the kinds of investments necessary in the Caribbean
region to really bring about such change. Moreover, given the differences in size and resource endowments, it could be argued that any
attempt on the part of these countries to create any additional competitive advantage in the United States would not be effective. However, it
does appear that they have appropriately pegged their currencies to the
dollar in an attempt to optimize the present relationship (see Table 4).
8. CONCLUDING REMARKS AND POLICY IMPLICATIONS
This article has studied the implications of the introduction of the Euro
for Mediterranean countries. Some analysts had predicted that after its
introduction the Euro would appreciate against the U.S. dollar.
However, since its introduction, the Euro has been volatile and has in
general been depreciating against the U.S. dollar. The impact of the
introduction of the single currency in Europe has only manifested itself
since July 1, 2002, while its impact in the Middle East is yet to occur.
Ultimately, it is in the Middle Eastern countries’ best interest to shift
their currency anchor, foreign exchange reserves, and foreign external
obligations to the Euro. Geographical proximity is not the only reason
for this shift. Trade, cultural, and historical considerations are also
important factors justifying the transition to the Euro.
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Implications of the Introduction of the Euro for the Mediterranean Countries
Table 4. Exchange Rate Arrangements in Caribbean Countries
Country
Currency
Exchange Rate
Arrangements
Percentage
of
Industrial
Countries
Imports
With U.S.
Antigua
& Barbuda
Aruba
Eastern Caribbean
Dollar
Florin
N/A
N/A
N/A
N/A
Bahamas
Bahamian Dollar
46%
29%
Barbados
Barbados Dollar
42%
32%
Belize
Belize Dollar
N/A
N/A
Dominica
Eastern Caribbean
Dollar
Eastern Caribbean
Dollar
Gourde
Jamaican Dollar
Eastern Caribbean
Dollar
Eastern Caribbean
Dollar
Trinidad
& Tobago Dollar
Pegged to U.S.
Dollar
Pegged to U.S.
Dollar
Pegged to U.S.
Dollar
Pegged to U.S.
Dollar
Pegged to U.S.
Dollar
Pegged to U.S.
Dollar
Pegged to U.S.
Dollar
Independent Float
Independent Float
Pegged to U.S.
Dollar
Pegged to U.S.
Dollar
Independent Float
83%
70%
N/A
N/A
75%
70%
N/A
83%
46 %
N/A
N/A
N/A
62%
70%
Grenada
Haiti
Jamaica
St. Lucia
St. Vincent
Grenadines
Trinidad
& Tobago
Percentage
of
Industrial
Countries
Exports
With U.S.
Source: IMF (1997): Exchange rate arrangements and exchange restrictions, IMF: IFS-tape, August 1998,
and IMF (1998): Direction of Trade Statistics, Quarterly.
With the full adoption of the Euro in 2002, it is anticipated that trade
flow will strengthen between the Mediterranean countries and the
Euro zone. This increase in trade flow will be the result of increased
growth and prosperity in the EU, which will lead to an increased
demand for goods from the Mediterranean countries. Although there
will be short-run costs associated with increased integration with the
EU, it is anticipated that the long-term benefits accruing to the
Mediterranean countries as a result of trade and financial integration
with the EU will be much more significant.
Most Mediterranean countries still peg to the dollar or a basket of
currencies where the dollar is dominant, at a time when all these
countries are moving toward more economic, trade, and financial
integration with the EU. The dollar is thus expected to cease to
constitute a rational exchange rate peg for Mediterranean countries. If one looks at justifications for a dollar peg for the
Thunderbird International Business Review • January–February 2003
47
Nora Colton
Simon Neaime
Mediterranean countries, there are no real economic arguments.
Only the dollar’s status as the only anchor after the breakdown of
the Bretton Woods system justifies an ongoing Mediterranean dollar anchor. This could have been a logical choice during the late
1970s and early 1980s; however, with the introduction of the
Euro, any rationale for a dollar peg can no longer be supported
based on efficiency and monetary considerations.
All the recent developments point toward more trade and financial
integration between the Eurozone and the Mediterranean countries.
It is, therefore, imperative for Mediterranean countries to shift
toward a Euro peg to reap all the benefits of integration with a zone
of low inflation and significant growth potentials. Moreover, the
adoption of the Euro as an anchor currency, as a denomination of foreign external liabilities and reserves and as an official currency for
trade transactions and quotations, is therefore expected to reduce
Mediterranean trade and exchange rate transaction costs and the cost
of foreign borrowings.
From the EU’s perspective, the Barcelona Agreements are a new
effort to deepen relations with Southern Mediterranean countries
with the ultimate objective enhanced economic prosperity on both
sides of the Mediterranean. We believe that the benefits of these
agreements could be substantial. However, they might materialize
relatively slowly unless major reforms are implemented consistently
and early on. Having signed on, the Mediterranean countries now
really have no choice but to integrate the EU agreements in a comprehensive development strategy. They should act quickly and make
full use of the 10-year transition period provided. The current
framework of the Barcelona Accord favors the EU more than partner countries. However, by shifting to the Euro, Mediterranean
countries would have much better chances to alter the existing onesided trade agreements into a genuine multilateral framework of full
trade, economic, and financial integration. The adoption of the
Euro by this region will leave the EU with little room to maneuver,
forcing it to pursue a strategy of deeper integration with partner
countries. The EU will be obliged to offer partner countries the
trade and financial concessions that up until now have been ignored.
The Euro is, therefore, offering the Mediterranean region a unique
opportunity to fully integrate and benefit from closer trade and
financial ties with the EU.
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