The EU's Single Currency project has never been primarily concerned with economics. It has always been seen by its architects as a major building block in the creation of a United States of Europe, with its impact on the economy being of secondary importance. All politicians on the continent recognise this, and are openly explicit about it. Only in Britain do our political leaders try to mislead us into believing that joining the euro would be of no great constitutional significance, and that the tests to be applied as to whether or not it is to our advantage to adopt the Single Currency are purely economic. Nevertheless, whether or not joining would be to our economic benefit is highly significant, not least because bad economics is almost invariably bad politics. How, then, should we judge the economic pros and cons?
The starting point has to be the performance of the euro over the period since its inception. Its sagging value - currently down some 25% since its launch in January 1999, and now falling back again after a brief rally - says much about the international view of the Single Currency. The major reason for its fall has been a flight of capital from the EU, which is widely regarded as having poor investment prospects. The resulting sluggish performance is in turn reflected in persistently high levels of unemployment in almost all Single Currency countries, which are now on the rise again. Germany now has 4.3m registered unemployed and an estimated 1.7m who would like to work, but who are no longer seeking employment. France has 9% of its labour force out of work, and Spain 13%. Of greater long term significance, however, are the strains already showing from having a "one size fits all" interest and monetary policy. The German economy desperately needs a stimulus, whereas Portugal and Ireland are over-heating and riding for boom and bust. Germany, in particular, is in a double bind. Because of the Growth and Stability Pact, the authorities there are not allowed to use a fiscal deficit of more than 3% of GDP, to which Germany is already very close, to boost the economy. The Commission's displeasure at this prospect is mirrored in the warnings already given to our own Chancellor against increasing public spending, despite the strength of the British economy's finances. At the same time, the unelected European Central Bank will not lower interest rates or loosen monetary policy, despite threatening world economic conditions.
It is against this background that the Treasury is showing so little enthusiasm for giving a favourable report on the Chancellor's five tests. The requirement is that they should be able to pronounce there to be "clear and unambiguous" economic advantages to Britain joining the euro. Even senior Treasury officials, however, are on record as saying that the case for Britain becoming a member of the Single Currency will never be this clear cut, and that the decision on whether to apply to join will be based on political not economic considerations. This is hardly surprising, because there is now a wide and growing consensus not only within the Treasury but also in the Bank of England and among most professional economists that the EU is far from being an "optimal currency area". This means that the advantages of price transparency and avoiding exchange costs are heavily outweighed by the tendencies to instability caused by the patent lack of cohesion, uniformity of living standards, mobility of labour, and ability to transfer funds from advantaged to disadvantaged areas within the EU. It is against this background that the Chancellors five tests need to be judged. What are the questions to which answers have to be given?
The first of the Chancellor's five tests is whether the business cycles in Britain and the rest of the EU are converging. There is little evidence that they are. The gap between long term interest rates has closed, but inflation, growth and unemployment remain far apart. The reality is that the British economy has done much better in recent years than those in the Single Currency, very largely because we have not had to sustain the deflationary policies necessary to bring the euro into being. Furthermore, the British pattern of trade and the structure of our economy make it unlikely that convergence will occur in future. We have a much higher proportion of our trade with countries outside the EU than other Member States. In addition, there are big differences in our housing market, our energy resources (particularly oil), the way our commercial sector is financed, and our pension system, all of which tend to make the British economy react to changing circumstances in different ways from those on the continent.
The issues which this test throws up are not so much those associated with the resilience and adaptability of the British economy, but the inflexibility of those already in the Single Currency area, aggravated by institutions for running the euro currency as a whole. The single biggest problem, buttressed by the Growth and Stability Pact with all its baleful consequences, is the power of the European Central Bank. This institution, modelled on the former Bundesbank, is secretive, virtually immune to democratic pressure, and obsessed - in line with its remit under the Maastricht Treaty - with keeping inflation down to between 0% and 2%, if necessarily at the expense of all other economic objectives. The deflationary conditions thus generated, with low investment and high levels of both unemployment and taxation, much of which is used to finance the cost of having so many people out of work, are just the opposite to those conducive to the restructuring which most of the EU economies badly need.
One of the scares put about by those who said that we ought to have joined the euro when it was established at the beginning of 1999 was that outside the Single Currency inward investment in Britain would languish. Nothing of the kind has occurred. Latest figures show that it rose by no less than 36% in 2000 to œ341bn, creating 71,000 new jobs. It remains far higher both in total and as a percentage of GDP than in major EU economies such as Germany and France. In 2000, outside investment in the UK represented 26% of the EU total, compared to 24% in 1999. Meanwhile the French share fell 3% to 15%, and the German share went down 2% to only 7%. The reasons for the strong British performance - the English language, flexible labour markets, relatively low taxation, and confidence in our institutions especially in the USA - are unlikely to change for the better if we join the Single Currency. If proposals for more regulations and tax harmonisation are implemented across all euro-zone economies, as they may well be, the prospects for UK inward investment may well worsen rather than improve.
We were also told that being outside the euro would damage the City's position, leaving growth in financial services migrating to Frankfurt and Paris. Again, such fears have proved groundless. On the contrary, the City has thrived outside the Single Currency, partly because it has a degree of independence and global outlook, as well as talent, experience and sophistication, which the more inward looking financial centres in the EU have found impossible to emulate. The City is a magnet for the business and financial community, and it is still strongly drawing in new participants who cannot afford not to have a presence in the world's international financial capital. Hardly surprisingly, therefore, despite Britain not being a member of the Single Currency, London has become far the largest centre for foreign exchange trading in euros. The real risk to the City comes not from Britain being outside the Single Currency but from excessive and misplaced regulation, which is much more likely to occur if Britain is in the euro than if we are outside it.
Surely the most relevant test is to compare what has actually happened to the euro-zone economies with the British experience since preparations for the euro began. The outcome is unequivocal. On every count - growth, unemployment, investment trends and inflation - Britain has done much better than the EU average. Is this likely to change in future? The biggest danger is that misplaced enthusiasm for the euro, driven by short term political considerations, may leads to us joining at much too high an exchange rate. This would undercut the competitiveness of British industry, leaving us sooner or later with just the sort of unbalanced economy which cannot prosper in the long term. Regrettably, if we ever do join the Single Currency, this is all too likely to happen.
For all these reasons, the economic risks to Britain from joining the Single Currency look far too high to be worth the candle. Never forget, however, that the issue involved is fundamentally political rather than economic. If policies go wrong, and we are still in control of our destiny through the ballot box and our own parliament, we can always make the changes we need. If we were ever to join the euro, on the contrary, our ability to run our own affairs would be dramatically diminished. Our influence on the way the whole euro-economy is run would be reflected in only a small share of the votes, diminishing as the EU expands to up to 27 members, where we would be all too likely to find ourselves in a permanent minority on vital issues, simply because our economy is so different from those comprising the rest of the EU. In these circumstances, bad economics would be piled on top of bad politics. This is why Britain needs to summon the courage and fortitude required to buck the euro trend, and to maintain our ability to run our own affairs and whatever economic policy suits us and the rest of the world best.
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