Common currencies and trade

January 9, 2001

Free Market Foundation

The value of the euro is highly suspect. Recently Denmark rejected the euro as its currency. However, a recent study lends credence to the euro and the idea of its acceptance. This study argues that a single currency does indeed boost trade, which in turn boosts living standards.

A primary argument is found in Canada. Canadian provinces trade among themselves 12 to 20 times more than with the United States, after adjusting for distance and size. This occurs despite:

The industrial advantages of the United States and lack of trade barriers.

A common language, similar culture and norms.

Similar legal institutions.

Using data from 200 different countries, researchers find those countries with the same currency trade over three times as much with each other as countries with different currencies. A currency’s geography and regional trading partners are additional considerations for developing a single currency. For example, Albania,

Would boost its per capita income by an estimated 23 percent if it adopted the euro as it currency; by contrast, it would gain only 1 percent if it adopted the U.S. dollar.

On the other hand, El Salvador or Ecuador could increase their incomes by as much as 19 percent by using the dollar as opposed to 5 to 6 percent by instituting the euro.

This is due to their geographic proximity to trade partners using the euro and dollar, such as Europe and the United States.

According to the authors, currency unions could boost per capita income significantly by tripling trade within the currency area.

Source: Gravity, Trade, and Currency Unions, Economic Intuition, Fall 2000; based on Jeffrey A. Frankel and Andrew K. Rose, Estimating the Effect of Currency Unions on Trade and Output, National Bureau of Economic Research, Working Paper No. w7857, August 2000, and Andrew K. Rose, One Money, One Market: Estimating the Effect of Common Currencies on Trade, Economic Policy, April 2000.

For more on Economic Intuition research summaries http://www.economicintuition.com

For more on Currency Issues http://www.ncpa.org/pi/internat/intdex2.html

RSA Note:
The research findings contained in this article suggest that South Africa could boost its foreign trade and per capita incomes significantly by adopting the euro or dollar as its domestic currency instead of the rand. Based on volume of trade the euro would probably be the better option for South Africa despite its current relative weakness. Adopting one of the major currencies would have other substantial benefits for South Africa. Inflation would decline to the same level as is experienced in the host currency area. Currency depreciation would be reduced. Exchange controls could be abandoned. Most importantly, entrepreneurs would be able to do long-term forward planning with a much greater degree of certainty than at present a factor that would greatly increase the countrys rate of economic growth.

Eustace Davie, Director, FMF.