1  Introduction

The Maastricht Treaty and the subsequent European Monetary Union are highly visible manifestations of the European drive to intensify economic and social ties across the continent. While these measures have struck many observers as excessive, they have come at a time when academic research is showing that economic activity within countries is considerably more integrated than economic activity between countries. Borders still matter, relentless globalisation notwithstanding; or as, Helliwell (1998; p118) elegantly writes,

“…the global economy of the 1990s is really a patchwork of national economies stitched together by threads of trade and investment that are much weaker than the economic fabric of nations.”

The evidence that external economic links are imperfect substitutes for internal economic links raises uncomfortable questions for small economies, for the scope for internal specialisation is relatively small. Even though most small countries have greater international trade than large countries, a bias towards domestic trade means that people living in small countries trade less overall than people living in small regions within large countries. This difference has spurred most small countries to adopt policies explicitly aimed at enhancing international linkages. Many small countries have joined customs unions with other countries, for instance, and have taken steps to harmonise business law. Others have pegged the value of their currency to that of a larger country, deciding that the benefits of enhanced economic integration are sufficient to offset the loss of monetary independence.

The adoption of a single currency by eleven European nations has re-ignited interest in the economics of monetary unions, and it is natural to ask whether there is a case for New Zealand forming a currency union with another country, possibly Australia. In drawing this parallel, however, it is wrong to exclusively focus on the monetary aspects of the European single currency, for monetary union is seen not as an end in itself but as part of the process of forming a Europe-wide economic union - the European Community - predicated on the promotion of “economic and social cohesion and solidarity among Member States”[1]. For this reason, section 2 of this paper begins by comparing the intensity of international economic links to the intensity of internal economic links, with a particular emphasis on the extent to which currency factors explain the difference. Given the evidence on this issue, the paper proceeds to ask how much a monetary union is likely to enhance economic integration, and what the costs of such a policy are likely to be. Section 3 discusses the traditional literature on the topic, including a brief analysis of the factors considered most important by the European Commission, while section 4 discusses two recent influential ideas. The final section summarises the paper, and discusses the relevance of the literature to New Zealand. It concludes that the arguments and evidence in favour of New Zealand forming a monetary union are stronger than they have previously been.

It must be stressed that the paper is a review of the modern international literature examining economic integration and monetary union rather than an assessment of the costs and benefits of New Zealand forming a monetary union with another country. Nonetheless, the paper argues that a new assessment is in order, for the benefits of a monetary union seem greater than previously considered, and the costs much less. This conclusion is not an endorsement of a monetary union. It is not even clear whose currency should be preferred, although Australia and the United States are the most obvious choices. Nor is it clear that the formation of a monetary union is the most important policy option for a government wishing to enhance economic integration with the rest of the world. That said, the intellectual arguments favouring New Zealand forming a monetary union are stronger than before, and any new debate should be conducted cognizant of them.