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The Economics of the Euro


Tuesday, 18 December, 2001, 12:04 GMT

The (UK) economics of the euro

Euro montage

On our next few trips to the continent, we Brits are poised to discover one effect of euro notes and coins: it will get harder for us to change money than in the past.

With so many currencies disappearing, there won't be a need for as many bureaux de change kiosks at every location as there has been - which won't matter to card carrying members of the euro-club, but which will not be helpful to people still holding pounds and pence.

But aside from the practical implications, will the elevation of the euro from a virtual currency to a real one make much difference to the debate in Britain and prospects for UK membership?

Referendum push?

Ask the political correspondents, who tend to get much of their information from Number 10, and you will be told that Britain is definitely going to have a referendum on its membership of the single currency.

Certainly, we are being warmed up for that with a series of speeches from the PM himself, and from his lieutenants Charles Clarke and Peter Hain, and with some apparent remarks of Downing Street adviser Roger Liddle that a referendum has been pencilled into the diary for spring 2003.

But ask the economics reporters, and you get a decidedly more reserved response. Perhaps that's because we are more influenced by the Chancellor at Number 11, who has stuck firmly to the spirit of the line that the economic tests really do matter, and that we will only have a referendum if the conditions are right.

And perhaps the economics brigade has been more imbued with those crucial words in the official line, that the tests have to be met in a "clear and unambiguous" way. Few things in economics are clear and unambiguous!

Of course, if the political will is there, a referendum can be held - the five tests for entry can easily be fudged to give an unambiguous answer.

But a referendum will move the euro argument on from the five tests, to the real economic issues. So what are those, and what's the evidence on them?

Real issues

First and foremost is the issue of whether Britain will get a better economic policy in a "one size fits all" eurozone.

Membership comes with a pan-European interest rate and with limits on the government's right to borrow money.

Is that better than an independent Bank of England Monetary Policy Committee, and Gordon Brown's fiscal rules?

The current situation in Germany is hardly an advertisement for euro-membership, as it is facing recession and unable to do anything about it. And Germany has an economy that is closer in tempo to the euro-beat than ours.

You might be optimistic that at the moment, with a synchronised global slowdown, we Brits are close enough to the European economy for their economic policy and ours to match.

That might suggest we would not suffer much at the hands of the European Central Bank.

But the challenge of membership is in believing not that we are synchronised right now, but that we will stay synchronised for the rest of time.

We might - but being a more oil-based, American leaning and service producing economy, we may not.

Two-speed economy

In defence of the euro, though, it is worth saying that the one-size-fits-all policy of the UK sterling zone represents something of an awkward compromise between the needs of different industries and different regions.

The manufacturing heartlands might well have done better in the eurozone than in the pound zone over the past few years. They have suffered badly against euro-linked competitors and customers, while UK interest rates stayed high to tame the southern England boom.

So perhaps, economic policy would not be better in the eurozone, but it may not be much worse either, taken across the economy as a whole.

And even if economic policy is a little less suitable for Britain in the eurozone, there may be an offsetting factor: a more stable effective exchange rate.

Exchange rate

That represents the second big issue for UK membership: the value of the pound.

It's wrong right now - would it be right if we went in? Or, to put it more clearly, can the UK go in at a pound-euro conversion rate that reflects a competitive UK?

And will the jealous French allow us in at such a rate, given that they will then face a more competitive UK?

It is clear that entering at the wrong rate would unleash damage on our economy, and unlike membership of the Exchange Rate Mechanism, it would be for life.

Single market

Perhaps the third big issue is whether Britain can really be a part of the European market, while outside the currency zone.

Will European firms do business with each other as though the eurozone is one market, but thinking of the UK as another market?

Will our firms be able to consolidate and merge with eurozone counterparts as easily as their competitors? Will we be isolated?

Will inward investment dry up as US and Japanese firms stop viewing the UK as a European base?

Well, they may, although it has to be said that so far, evidence for that is lacking. Inward investment has been satisfactory. British companies like Vodafone have been in the centre of Europeanisation, not on the edge of it.

It's unfortunate that no-one can give conclusive answers on any of these issues. It is a matter of judgement and of choosing which risks you prefer to take.

It is, in the end, a matter of instinct, and gut prejudice. Or, dare one say it, a matter of politics.

Adapted from the bbc.co.uk: 18.12.01



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