It won't work unless politicians show some guts
Focus on the euro: one view of the new currency's chances of success; scepticism on Wall Street; and British banks prepare for change; Painful reforms will be necessary for the single currency to deliver lasting benefits, writes George Magnus
Sunday 03 May 1998
The euro will continue its life as a radical force, shaping European financial services and altering the pricing, invoicing and payments mechanisms for companies. It will contribute to the development of more sophisticated capital markets and will stimulate investor interest in continental European equity markets and in the region's emerging markets.
But if you think the euro is going to change the economic outlook for Europe and guarantee economic success for this continent of 220 million people and nearly 20 per cent of world GDP (excluding the UK), think again. The euro, itself, is unlikely to do anything of the sort.
If you want a glimpse of how Europe will develop over the next few years, keep a hawkish eye on the German election campaign this summer and its outcome in September. This is far more important to Europe's future than the introduction of the single currency.
This begs an explanation. Euro cheerleaders argue that the single currency will administer market-oriented shock treatment. Trade and competition within Europe will increase; merger and restructuring activity will receive a boost, paving the way for faster productivity growth and higher living standards; and barriers to labour market rigidity and high taxation will tumble. Put simply, the euro will allow Europe to pick up America's new paradigm baton and the world had better watch out.
Unfortunately, this is a total fantasy - and one which more reasoned euro-protagonists are quite happy to concede. It is not without foundation, but to make it accord to some future reality there is one vital missing link: the political will and mandate to change and embark on broad-based structural reforms and deregulation.
If you recognise a UK link here, you've broken the code. Many of the factors listed in the preceding paragraph describe, to a large extent, the UK economy today, but this could not have occurred - and New Labour could not have inherited it - without many of the politically painful measures implemented over the past 20 years.
This is not to make a political point other than to note the cliche that if you are going to make an omelette, you have to break eggs first. Europe doesn't have to become Anglo-Saxon in the pejorative sense often heard on the Continent, but it is unlikely to achieve its own new economic paradigm without decisive political leadership, focused on structural change.
The real test for the euro will not be its creation, difficult though that has been at times over the last few years. Rather, it is going to be the political will and cohesion to implement change in the face of vested interests and occasional economic storms, including the first post- EMU recession, whenever that happens - which could be around 2000 or 2001.
To secure EMU's success over the medium term, European governments are going to have to deal with a plethora of so-called "supply-side" issues, the most important being to dismantle labour market rigidities, lower the burden of taxation while broadening the tax base, and creating a more conducive environment for an accelerated pace of development and the incorporation of new technologies. It is politics rather than the euro that will achieve these objectives.
The political acid test for the success of EMU in the first instance will be Europe's ability to deliver sustainable employment growth, higher labour force participation and, of course, a significant decline in unemployment. Just consider the US comparison: unemployment there is below 5 per cent, less than half of Europe's rate; US employment has been growing by over 2 per cent a year over the past few years, while it has been stagnant or falling in Europe until very recently; and over half of America's per capita GDP growth since 1994 has come from higher labour force participation - again stagnant and much lower in Europe.
That is why I think the German elections are more important than the introduction of the single currency per se. It seems most likely that Germany's Social Democratic Party will oust Chancellor Kohl and the CDU/CSU later this year. The key point, though, is the platform on which it may be elected. If the campaign is dominated by a debate about restructuring, reform and modernisation rather than employ-ment and social security protection, subsidies and income dis- tribution, then the door will be open not just for Europe's most important economy to fast-forward into the 21st century but also to carry the rest of Europe with it - yes, even the more dirigiste French establishment.
Then, perhaps, Europe can really build successfully on a euro platform - and beckon a still dubious UK. But if this does not happen, then Europe's economic prospects do not look very encouraging and the euro's birth and early years could become increasingly fractious amid sharp regional and country growth discrepancies and mounting pressure for a system of fiscal transfers, such as are specifically excluded from the Maastricht Treaty.
There is too much about EMU that none of us can know with any certainty yet. But as you see European politicians championing their achievements this weekend on the evening news, read their statements in the media over the next few days and wonder what the euro is really going to mean, bear in mind that this is just the beginning. Without meaningful political change, you'll get only a bit of loose change out the euro.
q George Magnus is chief economist at UBS and chief economist designate of Warburg Dillon Read on completion of the merger between UBS and SBC Warburg Dillon Read.
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