T C A Srinivasa-Raghavan: Currency unions - Birds of a feather needed

OKONOMOS

To work, politicians have to give up their acquired right to push economies back.

Given the benefits it brings, especially to trading, the entire region to the east of Turkey should probably have the same currency. But that is not about to happen.

The next best alternative is to think of a currency union for the region to the east of Pakistan. This, too, is not about to happen, but could. This paper* by R Kannan and Atri Mukherjee tells us why. It also contains an excellent discussion of what has happened to attempts to unite currencies in other places, such as Europe, West Asia, Africa and the Caribbean Islands.

The only one to have succeeded is in Europe. The rest went belly-up even though there is the pretence of one still going on in Africa. What they have is a currency union (of sorts) but practically no financial integration.

The Arabs haven't done much better, either, for pretty much the same reasons. But the experiment in Eastern Caribbean seems to have worked better where a Caribbean Currency Board was established in 1950. But some of the islands have gone out of it.

The idea of an optimal currency area is not a new one. Robert Mundell (and others) started talking about it back in the early 1960s. They concluded that economies with huge divergences would not be able to come together in a currency union.

But being economists, they didn't go to the next level of analysis, namely, that economic divergences are caused as much by political factors as by economic ones. In some cases "" for example, India "" political factors are far more important than the economic ones.

Kannan and Mukherjee also skip this aspect. But they do say that "the region displays significant cross-country variation in the size of the economy, stages of development, growth performance, inflation control, degree of openness and other important external sector indicators. There are also substantial differences in some key qualitative aspects such as the quality of the institutions and preparedness for technological advance."

Ergo, in spite of other similarities, such as economic openness, trade integration and synchronisation of output growth, a currency union remains a pie in the sky.

That said, they point out that India has a lot to gain from joining such a union. But in order to reap those benefits, its politicians would have to give up their acquired right to screw up.

Or, more gently, "...given its large size, joining a currency union would result in a loss of macroeconomic policy independence for India." No more attempts to win elections at the taxpayers' expense, that is.

From this follows the rest, namely, "India is a large economy with substantial differences in macroeconomic indicators compared to the other countries, which constitutes another disadvantage.... there is absolutely no synchronisation of economic growth and the underlying output disturbances of India with the other members."

How about some movement towards a common currency within SAARC? The authors say these countries " may consider aligning their domestic currency with a strong optimal one in the region and move towards adopting a single currency within the region at a later date." Yes, and I did hear that pigs have wings.

There is one gap in the study which, considering Kannan's background "" he was heading economics research at the RBI until three months ago "" is strange. This is India's own experience with currency union after 1947 when the princely states were forced to integrate with what was British India. A few paragraphs on that would have made the rich discussion even richer.

*Is East and Southeast Asia including India an Optimum Currency Area: An Exploratory Analysis, available from the authors at ramalingakannan@hotmail.com; atri_b@hotmail.com