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ECON216_Spring2011_Tutorials_Optimum_Currency_Area_Article_2_pages_5_to_14

ECON216_Spring2011_Tutorials_Optimum_Currency_Area_Article_2_pages_5_to_14

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Are GCC Countries Ready for Currency Union? By Belkacem Laabas and Imed Limam * April 2002 * Economists at the Arab Planning Institute, Kuwait.
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1 Are GCC Countries Ready for Currency Union? ABSTRACT Using formal and informal criteria, we test whether GCC is an optimum currency area (OCA). Based on the traditional OCA criteria, we find that GCC countries are yet to fulfill the necessary pre-conditions for the establishment of Currency Union (CU). The structure of their economies remains dominated by the oil sector, intra- regional trade is very limited and, unlike what many believe, there does not seem to be evidence of convergence in their main macroeconomic fundamentals nor synchronization of their business cycles. The more formal test based on the Generalized Purchasing Power Parity Theory (G-PPP), shows that real exchange rates in GCC are closely related and share the same stochastic trend and hence points to the readiness, although to different degrees, of the countries of the region for CU. We argue that the main factors that are favorable for the establishment of CU are the commitment by all GCC countries to fixed exchange rate arrangements and a strong political resolve to achieve economic integration. Despite the lack of diversification and actual weakness of intra-GCC inter-industry trade, CU, once established, can expand intra-industry trade among GCC if the proper steps are taken toward more specialization and sophistication of their respective industries. On the other hand, CU may result in more synchronized business cycles provided that GCC countries achieve convergence in their economic structure, policies and regulations. In order to achieve these potential benefits of CU, GCC countries need to accelerate economic integration and fulfill the requirements of the GCC common market through the lifting of all restrictions on the free movement of goods and factors, and the creation of supranational institutions that would subordinate national interest for the regional one. This would be possible only if individual countries are willing to surrender some of their national prerogatives in favor of the interest of the region as a whole.
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2 1. Introduction In May 25, 1981, the countries of the Arab Gulf region, Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, have ratified the charter establishing the Cooperation Council for the Arab States of the Gulf (GCC countries hereafter). In their second Supreme Council meeting held in November 1981, the GCC leaders have adopted an Economic Agreement (EA) setting the stage for a full economic integration. The agreement had set out broad lines for the realization of coordination, integration and cooperation in various aspects of economic affairs. The Council has taken the necessary steps toward realizing the different stages of a full economic integration namely, a free trade area, a customs union, a common market and economic union. The intensification of cooperation in the relevant areas has been
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