False trails on road to single currency: Economic View
Thursday 09 February 1995
It is unfortunate therefore that almost all this talk is based on the wrong conditions. Whether one sticks to them rigidly, as the Bundesbank wants; or flexibly, as the European Commission wants; whether one adds to them, as John Major wants; or amends them, as the Labour Party wants - the conditions laid out in the Maastricht Treaty for eligibility to join a European currency club are not the conditions we should be most worried about.
What the Maastricht conditions do is set out various national policy goals. Only countries attaining those goals will be allowed into the so-called "single currency". The aim is to ensure that members will be in fit shape, both fiscally and monetarily. Specifically, there are rules for national debt, the government fiscal deficit, relative inflation performance and relative interest rates. These conditions have one very direct purpose. They are not there for aesthetic reasons, or as an incentive to goodbehaviour. They were designed only to exclude from the club those members who would potentially disrupt its activities.
You don't want, say, Italy in if she is always going to be wasting time at meetings arguing for more inflation to devalue her debt. So nations without the common purpose of keeping inflation down must be kept out.
In that sense, the Maastricht conditions are like the entry conditions for joining a graduate course at Manchester University: you need, say, an A and two Bs to get in. This is to ensure that you will keep up and not slow the class down. But just becauseyou qualify to get into Manchester University doesn't mean that it is right for you to go there.
The same is true of a shared currency: just because a country could meet the minimum eligibility requirements doesn't mean it should join. And that is where extra conditions come in. What is needed is a set of criteria to help a country to make up its mind whether it is appropriate for it to join stage three of monetary union.
It is here that discussion has focused on the wrong kind of things. The British Government, as John Major reiterated last week, has chosen labour market flexibility as its central extra concern. But this is largely a red herring. It is true, in theory, that the labour market is a relevant factor. A lack of competitiveness can always be solved by a cut in wages, rather than by devaluation.
However, there is no country - least of all Britain - whose wages are so flexible that they can be adjusted as easily as the exchange rate. It is unlikely we ever will be in that state. But you don't need to rely on labour flexibility to justify retaining a single currency. Plenty of inflexible labour markets already operate a single currency. The United Kingdom is one.
A stronger - and more popular - argument about conditions is that what is needed is so-called "real economic convergence", rather than the financial convergence envisaged in the Maastricht Treaty.
On this view, targets for unemployment or GDP growth rates should be given greater weight than those for interest rates or currency stability. This appeared to be the view of Eddie George last week. It also underlies the thinking of economists sympathetic to the Labour Party.
The idea behind the notion of "real convergence" is that monetary union requires all its member countries to pursue the same kind of monetary policy at the same time. If Greece and Germany always enjoy monetary expansions at the same time, they can dispense with drachmas and marks. One currency will suffice. But if Greece likes monetary expansion (to reduce unemployment, for example) just as Germany wants monetary contraction, then you have a problem if you only have one currency to expand or contract.
The wrong-headedness in the "real convergence" argument lies in the idea that meeting a number of conditions for a short period of time in itself amounts to economic convergence. Economic convergence requires not that countries happen to look similar fora year or two: it requires that they respond in a similar way to events as they arise for ever more; events like oil price shocks, financial liberalisation, German unification.
These are the kind of things that have led countries along economic ups and downs in recent decades; and it is those ups and downs that determine whether or not you need a change in monetary policy. Indeed, it matters little whether countries look similar at all. It doesn't matter for monetary union that France has higher unemployment than Germany. All that matters is that French unemployment should rise and fall at the same time as German unemployment.
So does there appear to be enough real "real convergence" to merit monetary union? For the rest of Europe - by which one really means Germany and France - it is possible to answer yes. The economic cycle of Germany and France does appear to have synchronised. The countries co-ordinate their policies to a substantial degree. And in natural resources, the countries are in the same boat. Germany depends more on manufacturing than France; but France is a heavy trading nation none the less.
For Britain, it is harder to answer that question. Our resource base, our policy cycle and our economy seems to beat to a more Anglo-Saxon drum than the others in Europe. As the table indicates, Britain lies somewhere between the Continent and the dollarzone. We could as easily apply to the Federal Reserve for membership as to the European central bank. Given our schizophrenic economy, schizophrenic political attitudes to the conditions for membership of a European single currency are inevitable.
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