Why Britain should join the single currency now

Euro membership will create wealth to pay for the better hospitals and schools we want
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The Independent Online

In recent weeks, anti-Europeans have put a new argument at the centre of their case against the euro. They claim that Europe is an economic failure, that Germany's economic problems are a consequence of the euro and in particular the Growth and Stability Pact. So what is the economic case in favour of British entry into the single currency?

In recent weeks, anti-Europeans have put a new argument at the centre of their case against the euro. They claim that Europe is an economic failure, that Germany's economic problems are a consequence of the euro and in particular the Growth and Stability Pact. So what is the economic case in favour of British entry into the single currency?

If we join the euro, we shall over time achieve higher living standards. This is because we shall be full members of a huge single market, which can achieve the economies of scale and competitive excellence that a single currency has made possible in the US. From our greater wealth we shall be able to pay for the better hospitals, schools and railways that we all aspire to.

The mechanism is quite straightforward. Separate currencies, fluctuating against each other, are a real barrier to trade and thus to efficient levels of production. On past experience the pound can easily and quickly rise or fall by 20 per cent against the euro, with a huge impact on profitability. This exchange-rate risk discourages trade, and thus reduces productivity and living standards.

This same exchange-rate risk used to exist between countries on the Continent, discouraging trade between them as well. But, since January 1999 when the euro was established, this risk has been eliminated. The result has been a remarkable 20 per cent increase in trade between eurozone countries, relative to gross domestic product. By contrast trade between Britain and the Continent has fallen relative to GDP. In just three years since the euro was launched the average euro-country expanded its involvement in European trade by one-fifth, while we reduced ours.

As trade patterns change, so do investment patterns. Any business that wants to serve the large eurozone market will now naturally move its production inside that area, in order to avoid exchange-rate risk. Since the euro began, Britain's share of the foreign direct investment coming into Europe has fallen from one-half to one-quarter – an astonishing collapse. The amount of direct investment flowing between the 12 euro-countries is up by a factor of four.

In this great process of restructuring, we shall be increasingly on the sidelines. For we are now in a new, more exposed position than before the euro was launched, since we are now the only large country in Europe where businesses face exchange-rate risk when selling on the Continent.

Our productivity per hour worked is currently 20 per cent below the level in France, Germany, the Benelux countries and Northern Italy. And investment in our economy is also lower relative to GDP. If we want the standard of hospitals, schools and railways that exists on the Continent, we have to join the euro. Otherwise we risk growing more slowly than the rest of Europe, which is what happened when we refused to join the Common Market after the Second World War.

At present the Bank of England tries to cushion shocks to the British economy by raising or lowering interest rates. If we joined the euro that would not be possible, since there would be one interest rate for the whole of Europe. It would be set by the European Central Bank, on which all countries including ourselves would be represented.

Our view would be one among many. While the ECB should protect us against shocks affecting Europe, it would not protect us against shocks that were particular to Britain. Since we would have lost our own monetary policy to combat those shocks, it would be more difficult to offset them in the traditional manner.

Yet it would not be impossible, since we would still be able to use the Budget to offset shocks to our economy. In this respect Britain would be better off than a US state when it is hit by a shock that does not affect the whole of America. For the typical US state is obliged to balance its budget year on year, including during a recession. This means that during a recession it has to raise taxes or cut spending, both of which are positively harmful. By contrast the US state undoubtedly benefits from greater labour mobility than that between Britain and the Continent. But, all things considered, there is no reason why a single currency should not work at least as well for Britain as it does for any US state.

A single currency removes one major source of shocks – the floating exchange rate. A floating exchange rate is not a smooth mechanism of adjustment; it is more like an unguided missile. As capital becomes more mobile, it is likely that exchange rates will become even more unstable. Good monetary policy can partially offset the effects of an errant exchange rate, as it has recently. But we cannot fully rely on it.

Now is as good a time to join as any other that is likely to arise. The cyclical patterns in Britain and the eurozone are extremely similar – neither of them are far from their sustainable levels of output (relative to trend). Both have identical long-term interest rates. And short-term interest rates and inflation rates are not far apart.

There is no case in favour of "wait and see". For even if we waited a long time before joining, the next shock might not arise until after we had joined. Meantime, by waiting we should have missed out on the great restructuring of the European economy and its trading patterns that is already under way.

More than half our trade is with Europe and only 16 per cent with the US. The rest is spread around the globe. This pattern reflects the realities of geography. If we want to integrate into a large market, the only one available is in Europe. Joining the North American Free Trade Agreement would make no sense and would require us to leave the European Union, at massive cost.

Critics argue that Europe is a failing economy. This is simply false. Productivity per hour of work is 20 per cent higher in France, Germany and the Benelux countries than it is in Britain. Over the past 20 years it has grown faster there than in the US, and those Continental countries are now as productive as the US.

France, Germany, Italy and Spain have higher unemployment than Britain. Germany, of course, is a special case because of the problems of absorbing the former communist East Germany. But six other European countries have lower unemployment rates than Britain or the US. So there is no single European problem with unemployment. The differences between countries are caused by different national labour market policies. If we join the euro, this would have no effect on the labour market policies we can choose in Britain.

Nor does linking our currency to that of a high unemployment country such as France mean that we ourselves would risk higher unemployment here. The Netherlands has only one-third the unemployment of Belgium. And within the single currency area of Britain, the South-east has one-half the unemployment of the North-east. The link to the North has not increased unemployment in the South.

High unemployment in some European countries is therefore no argument against joining the euro. And the argument that we should wait for the unemployment rates to converge is like saying the South-east of England should have its own currency.

In 1957 we were the richest major country in Europe. But we decided to go it alone. In the years that followed, France, Germany and the Benelux overtook us. We are still trying to close the productivity gap that emerged then. If once again we fail to join the European leaders, we risk falling further behind them.

The above article is based on a pamphlet published today by Britain in Europe. The co-authors are Richard Layard, Willem Buiter, Peter Kenen, Adair Turner and Will Hutton. www.Britainineurope.org.uk

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