The costs of staying semi-detatched in Europe

The problem of the "ins" and the"outs" may sound like something which only oarsmen need worry about, but the rest of us may hear rather a lot about it in the next couple of years. It is Euro-speak for the issue of how the EU should structure relationships between those countries that enter the single currency, and those that remain outside, after the launch date.

John Major is absolutely right to argue that this is a huge issue which has so far been virtually undiscussed in the EU. It is already clear that the birth of the Euro will create a schism in the EU of unprecedented proportions. Whether the EU can survive in anything like its present form remains an open issue.

Furthermore, whether the British political system will accept the possibility of the UK becoming a semi-detached member of the EU, with virtually no say in many of the key economic decisions being taken by the Union, is far from determined. At present, much of the political running is made by the Euro-sceptics, who permanently need placating. But imagine a situation in which the UK had opted out of a single currency, perhaps by referendum, while the rest of the EU makes a success of the venture. The boot would then be on the other foot - at every turn, the Europhiles, who remain in the majority in our political elite, would be agitating for delayed UK entry.

These questions will not lie down and slumber in the election run-up, not least because they will need to be settled immediately after polling day. According to the Maastricht treaty, the UK needs to inform the EU whether it will exercise its opt-out rights by early 1998, possibly only eight months after the election. So it is vital we start addressing these questions now.

In some respects, the Maastricht treaty foresaw the prospect of a two- tiered Union. For example, after the single currency is launched, the European Central Bank will operate in a schizophrenic manner. Although all the national central bank governors will sit on the general council, only those inside the single currency itself will sit on the governing council with voting rights. This means that Eddie George will be excluded from most important matters.

Similarly, when monetary policy inside the single currency area crops up at the Council of Ministers, non-members will be excluded from voting. Many of the questions relating to the co-ordination of fiscal policy will be treated in the same way. So there will immediately be a core club that will be involved in the determination of interest rate, exchange rate and budgetary policy for the monetary union, with the rest being instantly disenfranchised on these issues.

Many may say that the UK is scarcely enfranchised now when it comes to the monetary decisions taken by the Bundesbank. If we continue to pursue an independent monetary strategy, why should anything change? Why not just lie back and think of the Bank of England, much as before?

This option might be economically feasible, but it will not be easy for the British political system to swallow. Whereas it might be acceptable for the UK to be just another medium-sized European country that cannot influence the Bundesbank - after all, misery loves company - the position will look radically different after monetary union. At that point, countries such as France and Holland will be enfranchised in ways that the UK is not, and the decisions taken by the inner club will undoubtedly exert great influence over our lives.

Initially, as in the 1950s, some in Britain might delude themselves that we can set ourselves up as the king-pin of the Euro-also-rans, the equivalent of Derby County in the Endsleigh League. But as in the Endsleigh League, where the sole objective of the top clubs is to gain promotion to the Premiership, so in the EU the sole objective of countries such as Italy and Spain will be to gain admission to the single currency. Quite soon, the UK could find itself as the king-pin of the Latvias and Portugals, surely an unbecoming fate.

And even if Westminster could reconcile itself to such a reduced status, there are other awkward questions. As the "ins" go about their business after monetary union, they will undoubtedly deepen their economic ties in ways that are not currently foreseen, and this will slowly colour their attitude to the "outs".

Take fiscal policy, for example. It is almost certainly another British delusion to believe that a monetary union can operate for very long without extending its tentacles into budgetary policy. The first change that Britain will notice is that our contributions to the EU budget will be denominated in Euros instead of ecu. Not only will this be someone else's currency, but it will be a harder currency than the ecu, thereby increasing the sterling cost of our budget contributions.

In addition, strict new rules relating to national budget deficits, with a stringent system of fines, have already been proposed by Germany, and are being studied by other countries.

After monetary union, such rules are likely to be developed and policed by the "ins", with scant regard for the opinions of the "outs". Yet the financial markets may in effect force the "outs" to follow the same rules, anyway. Or, if the "outs" decide to run higher budget deficits in a recession, the "ins" might say that they should no longer be able to finance these deficits by unbridled access to the common pool of European savings. So there could be pressure for capital controls to be erected around the single currency area.

Obviously, none of this is foreseeable in any precise way. But the point is that there will be powerful new forces unleashed which will deepen the economic ties between the "ins", and tend to throw up new barriers between the "ins" and "outs". As the single market inside EMU becomes more integrated, there will inevitably be a need for closer co-ordination on matters such as market regulation, social security and tax policy. This will not apply to the "outs", so invisible barriers will begin to emerge between the two classes of members.

More dangerous still, new barriers to free trade could be erected between the "ins" and "outs", particularly if the UK tries to follow the route favoured by many Tories - in effect establishing itself as a low-cost offshore Trojan horse, with low wage costs, a competitive currency, and the right to trade freely with the rest of the EU. How long would it take before the rest of the Union became impatient with this situation?

So we face a stark choice. Taking sterling into a single currency in 1999 may well be economically premature, given the large differences that still exist between the structure of our economy and the rest of the Union. Ideally, these differences should be eradicated first. But staying outside would probably carry large political costs, and may not in the end be viable. Quite a decision for the next Prime Minister to take within a month or two of the election.