Updated: Aug 21
On January 1, 2002, eleven member states of the European Union jointly committed to abandon their monetary sovereignty, instead adopting the “euro” as a multinational currency to be used in the eurozone currency region.
The advantages of a currency region (otherwise known as a monetary union) where multiple countries adopt the same medium of exchange, unit of account, and store of value appears manifold in economic theory: as transaction costs go down between member states, foreign trade and multinational competition increases, boosting economic growth across the monetary union while stabilizing inflation due to a diversification of economic activity.
This is, of course, what a quick glance at economic theory would suggest for a monetary union, yet a little over twenty years in and the eurozone has expanded to 20 members, and is used to back currencies in 60 countries outside of the European Union altogether. The Western European countries comprising the majority of the eurozone’s members remain among the wealthiest nations in the world, begging the question: if a monetary union can prove to be successful in aiding economic growth for the world’s wealthiest countries, can it also be helpful in promoting the growth and converge of developing economies as well?
Within the literature on monetary unions, sub-Saharan Africa is a developing region that has served as a case study in testing this experimental question, mainly because the sub-continent already boasts its own currency union, the Franc Zone. The Franc Zone, comprising 14 countries in Western and Central Africa, is unique in that it’s the outgrowth of the countries’ pasts as former colonies of France. The union was originally created to spare French colonies a drastic devaluation in their currencies following France’s ratification of the Bretton Woods Agreement after World War II, and while such colonies would go on to find their independence, the CFA franc (the common currency of the Franc Zone) still persists as a common currency tied in value to the modern-day euro, and requiring at least 50% of all CFA franc reserves to be parked at the French Treasury.
While the CFA franc has ushered in lower, more stable inflation for members of the African franc zone, it has come at the cost of both short and long-term economic growth in the region. In the short-run, tying the common currency to the euro, managed by the notoriously hawkish European Central Bank, comes with an opportunity cost as tighter monetary policy sacrifices potential economic growth for lower inflation. West African members of the Franc Zone, for example, show lower growth rates in GDP per capita than the sub-Saharan African average and run a greater risk of deflation, which I note in a previous Lake Street Review article, particularly damages developing economies “where debt is often issued to finance larger portions of public and private spending.”
In the long-run too, however, the CFA franc’s fixed exchange rate with the euro has been found to overvalue the currency by up to 30%, leaving the franc zone on a shaky foundation. An overvalued currency brings in artificially greater amounts of foreign investment, as evidenced by the franc zone’s greater GDP share of Foreign Direct Investment (FDI) than the rest of sub-Saharan Africa. Given that Franc Zone members’ economic growth tends to be volatile as they rely on the export of commodities such as oil, gold, and diamonds, a greater share of foreign investment incurs a greater risk of default for developing African economies. On the flip side, a net capital inflow brings with it a trade deficit, discouraging exports from Franc Zone economies and encouraging imports.
While balance of trade often serves to be an irrelevant issue, because African members of the Franc Zone, as aforementioned, are heavily reliant on the export of one or a few key commodities, a trade deficit discourages export diversification and instead incentivizes these developing economies to continue to allow the export sector they rely upon to be monopolized by the incredibly volatile swings in value of commodities. Perhaps most importantly, even if sub-Saharan Africa were to adopt a new currency union that was not tied in value to any other currency, the volatile economic growth of a multitude of the region’s countries as a result of their reliance on commodity exports would quickly serve to jeopardize this venture. Shocks in supply and demand to resources such as gold, diamonds, and oil serve to greatly fluctuate each country’s economic growth and inflation rates on a yearly basis. Compounding this across an entire currency union, one would find a common currency in disarray that’s simultaneously overvalued in some countries and undervalued in others.
Nonetheless, economic theory’s suggestions on the outcome of a currency union have seemingly been proven by the success story of the eurozone. Thus, the idea of a monetary union encompassing sub-Saharan Africa may indeed prove possible for the developing region down the road. In the meantime, however, countries in the region must go to great lengths in diversifying their exports and ensuring that their economic growth is not tied to the volatile fluctuations in commodity exports. A key measure in this process may consist of severing ties with the Franc Zone altogether.