LABOUR EURO-SAFEGUARDS CAMPAIGN

BULLETIN JANUARY 1998

 

QUESTIONS AND ANSWERS ON THE ECONOMIC RISKS TO THE EUROPEAN UNION FROM GOING AHEAD WITH THE SINGLE CURRENCY

 

 

  1.  
  2. Has a thorough assessment ever been carried out of the benefits to the European Union as a whole of having a Single Currency?
  3. Certainly not by the European Union authorities, although many other people have made serious attempts to weigh up the advantages and disadvantages of Economic and Monetary Union. The political élite in the EU have simply assumed a Single Currency must be beneficial. They have never therefore felt it necessary to analyse the pros and cons in any objective and systematic way. Nor, in consequence, have they felt it necessary to expose its political and constitutional implications.
  4. What should such an assessment cover, if it is to be done thoroughly? What questions need to be answered to reach an informed judgement?
  • We would need to know whether the European Union met the requirements widely recognised by economists as being essential for a Single Currency area to be successful. We should have to assess the history of previous attempts to create Single Currency areas among nation states. We would need to compare the costs of changing to a Single Currency with the benefits to be secured, such as reduced transaction costs. We would need to establish whether an EU Single Currency area would be more or less likely to produce improved economic growth and better job prospects than a flexible exchange rate régime. Would there be political gains which might offset economic costs? Above all, we would need to assess whether the clear and bankable benefits from the Single Currency were large enough to offset the project’s downside risks.
  • 3. What are the requirements for a successful Single Currency area?

  • Successful and long lasting Single Currency areas, which history shows are almost invariably nation states, have three key characteristics. First, the differences in competitiveness and living standards between different regions of the Single Currency area need to be reasonably small. Secondly, because some regions will inevitably do better than others, there needs to be sufficient taxation and spending power in the hands of the government of the Single Currency area to even out the disparities to an acceptable extent. Thirdly, for the same reason, it has to be reasonably easy for those without jobs in depressed areas to move to more prosperous regions to find work. Unfortunately, the EU fulfils none of these requirements. The differences in living standards and competitiveness between the countries in the EU are much wider than between the regions in nation states. The proportion of the national income of the EU Member States which currently goes through the EU budget is tiny – only just over 1.25%. By contrast, about 20% of the USA’s national income goes through the Federal taxation and spending system, and more than 40% for the typical West European country. For obvious cultural, linguistic and legal reasons, labour mobility between Member States in the EU, is much lower than between the regions of the average country. Many EU countries also have relatively inflexible internal labour markets.
  • 4. What benefits are there for business and the public from having one currency throughout all parts of the European Union?

  • There are obvious advantages in not having to change money from one currency to another, both for businesses and private individuals. These benefits are not, however, large when compared to the costs of converting millions of accounting and computing systems, cash registers and coin operated machines to the euro. The savings have been calculated to be about 0.5% per annum of EU aggregate income, assuming that every country joins the Single Currency, but considerably less if only some do. On the other hand, the costs of the changes have been estimated at about 3% of EU aggregate income. Thus the change over has, at best, about a six year pay back period, and much longer if not all EU countries participate. In addition, it is argued that having a Single Currency will make pricing across the EU more transparent, will lower prices as a result of greater competition, and will encourage increased investment. Firm evidence that these favourable developments are likely actually to materialise is hard to find, however, particularly on investment. The same arguments were used for the ERM, but the deflation produced by locking currencies together caused investment to fall, not to rise.
  • 5. What can we learn from past experience of Single Currency areas?

  • There is plenty of historical experience of Single Currency areas made up of nation states. The late nineteenth century saw the Latin Union, a Single Currency area comprising France, Belgium, Switzerland and Italy. In the twentieth century examples have been the Central, East African and Caribbean Federations, Maphilendo, comprising Malaya, the Philippines and Indonesia, and, in different circumstances, the constituent parts of erstwhile Soviet Russia. Without exception, all have broken up. Within the EU itself, there have been two distinct periods when the currencies of Member States were locked together – in the Currency Snake between 1970 and 1975, and in the Exchange Rate Mechanism between 1979 and 1993. Both succumbed to economic failure, triggering a combination of political and speculative pressures which led to their collapse. In all cases, the arguments for currency stability were very similar to those heard today for the Single Currency. History, therefore, is full of ominous warning signals about the current drive to establish European Monetary Union.
    1.  
    2. Is the Single Currency likely to produce higher growth and more jobs within the European Union than a more flexible exchange rate régime?
    3. During the period of the Snake and the ERM – a total of 19 years - there is no doubt that lack of exchange rate flexibility led to deflation and slow growth. This happened because most Member States had problems competing with Germany’s industrial power and low inflation rate. As a result they had to deflate their economies to protect their exchange rates, which led in turn to slower growth in Germany, as two thirds of German exports went to other EU Member States. There are grave risks that similar problems will recur with the Single Currency, exacerbated by the terms of the Maastricht convergence criteria, the independence, power and terms of reference accorded to the European Central Bank, and the terms of the Stability Pact, which controls government borrowing. With taxation and spending powers left with the Member States, and subject to political pressures, but monetary policy controlled by the independent European Central Bank, the prospects for the worst possible combination of economic policies looks all too likely to materialise. This is a lax fiscal regime combined with tight money, high interest rates and an overvalued and uncompetitive currency – the high road to stagflation, as the experience of the last 25 years has so clearly shown.
    4. Are there political benefits to offset the economic risks associated with the Single Currency project?
    5. The answer to this question depends on your point of view. If you believe that the creation of a United States of Europe is a goal of such supreme importance that all other considerations should be subordinated to attaining it, and that the Single Currency is a major stepping stone to this end, you may believe that the political gain from European Monetary Union justifies the economic risks. This is not a view, however, which is shared across the whole of the EU. There are majorities in favour of the Single Currency in countries which gain heavily from the EU budget, such as Ireland, Greece, Spain and Portugal, and in the Benelux EU heartland. Among the larger Members, however, while Italy and France have majorities in favour, Germany and Britain have significant majorities against, as do Sweden, Austria, Finland and Denmark. The strong opposition in Germany to the submergence of the Deutsche Mark in the euro is particularly significant.
    6. Why, then, are the political élites across the European Union intent on pursuing the Single Currency despite all the risks attached to it, and the lack of popular support for it?
    7. The answer, in part, is that most of the current generation of leaders in the EU believe in the political concept of a United States of Europe almost as a matter of faith, however reluctant their electorates may be to follow them. When faith takes the place of reason, economic considerations are of secondary importance. To challenge the concept of the Single Currency in these circles, especially with economic arguments, is not politically correct and is rarely done. In part, too, the answer lies with the advantages the leaders of various Member States see in the project for their own countries. The Germans want a federal European state in which they can feel secure. The French believe that they could run a United Europe. The Italians believe that rule from Brussels is better than rule from Rome. Spain, Portugal and Greece, all with relatively recent undemocratic pasts, want to anchor themselves more tightly to relatively prosperous and democratic northern Europe. These countries also want to protect their EU subsidies, as does Ireland. Austria and the Benelux countries have for a long time been in what is effectively a DM zone. Significantly, it is the more independent Nordic countries, Denmark and Sweden, together with Britain, which are unlikely to be in the first Single Currency wave, although Finland probably will be.
    8. What judgements can be made about the Single Currency in the light of all these considerations?
    9. Surely the major one is that the Single Currency is a hugely risky enterprise, not least for the enthusiasts for greater European unity. Even if there is a honeymoon period as the Monetary Union comes into being, which may well occur, it is hard to believe that at some time over the next decade the Single Currency will not come under severe strain. If it does, one of two outcomes seems inevitable. The first is that it may break up, which in the light of all the evidence is far from inconceivable. If it does, this will be a huge set back for those promoting European unity. The resulting uncertainty and cost will also be a disaster for everyone else. The other possible outcome is a further large transfer of powers from Member States to the EU, to hold the Single Currency in place against the odds, triggered by the need to respond to rising unemployment and social unrest as the EU economies falter. This is likely to entail much larger taxation and spending authority for the EU, with a corresponding further diminution in the roles of the Member States. Is either outcome one which the majority of people in Europe would like to see? It is hard to believe that they would.
    10. What should Britain do in these circumstances?

     

  • The British economy is out of phase with the rest of the EU, and for this if no other reason, waiting for a period to see how events develop must be the best policy. We need, however, to do more than this. Even if the prospects for the Single Currency look more favourable in 2001 or 2002 than they do now, as may well happen, and especially if we are then subjected to a huge Euro-propaganda campaign to join, we need to make sure that we do not lose sight of the long term dangers. The Single currency project is driven by politics. It is not, and never has been, based on rational economic analysis. There is no substantial economic case for it. The risks are much too high that it will eventually either come to grief, or that it will suck Britain much more deeply into an increasingly centralist and undemocratic EU. We will need long lasting vigilance to ensure that we do not squander our future for short term, illusory gains.
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