Singled Out?

It's the year 1999. Several European states led by Germany and France are about to go ahead with a single European currency. The British referendum on the issue is nigh. How would you vote? Yvette Cooper and Diane Coyle weigh the arguments
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The Independent Online

So that's it, they've gone and done it. The mark and the franc are to be no more, and British exporters are having to grapple with calculating in the euro instead.

Those in the "Join Up" camp are having a hard time persuading voters in Britain's forthcoming referendum to listen to the rather dull economic arguments for joining the single currency. They want to convince us that the benefits - in terms of lower inflation and higher productivity - will be significant. But that is not their main argument. More important, they believe the costs of staying outside a new "Euro-block", even for a short period, will be immense.

Signing up to submerge sterling within the euro, they maintain, will be good for Britain's macro-economic stability. By that they mean German fiscal and monetary discipline will be good medicine for British inflation. Historically, Britain has a bad record for controlling inflation compared with our European counterparts, and Germany in particular. Inadequate levels of investment and training, and a tendency towards wage inflation, have remained persistent economic problems for decades. Many economists believe that Britain will never make the difficult decisions to tackle those underlying problems with its economic performance while it can still devalue its currency as a way to make its exports competitive.

When British goods become too expensive to compete abroad, the easiest thing to do is let the pound fall in value, so goods become cheaper on foreign shelves. The trouble with that is that it starts the inflationary cycle all over again. If we cannot devalue - because we are locked into the euro - we will have to sort out our inflationary problems once and for all. Tough medicine - but worth it in the long run.

Even those who don't have such a grim view of the British economy accept that joining the euro will make it easier to convince the financial markets that we are serious about keeping inflation low. The financial markets will view sterling as a weaker currency and a greater inflationary risk outside the euro. As a result, British interest rates would need to be higher. (The technical explanation is that higher interest rates will be needed to offset the risk for investors that inflation would eat into the value of assets valued in sterling.)

Christopher Taylor, of the National Institute for Economic and Social Research, has suggested that interest rates could be 0.75 to 1 per cent lower inside the single currency, with huge long-term benefits for investment levels in Britain.

The impact of a single currency will not be limited to interest rates and inflation. Businesses will feel the benefits directly. Most tangible of all will be the savings to frequent travellers and traders who no longer have to pay middle men every time they change currency. But as much of Britain's trade is still with countries outside the euro region, the benefits to the country as a whole will not be huge.

David Miles, the senior UK economist at Merrill Lynch, the US finance house, suggests we will save only 0.2 per cent of GDP from the benefits of not having to change currencies when trading in Europe - hardly so overwhelming a benefit that we must to join up.

There may be less predictable benefits to businesses, however. The fiercest enthusiasts for a single currency argue that a truly single European market is impossible without it. If firms operate without any regard for national borders, there could be significant productivity gains as they take advantage of huge markets to specialise and make economies of scales. Wider competition should drive down prices for consumers.

The larger risk is that France and Germany will be so annoyed at Britain's failure to join the single currency that they will renege on their commitment to allow us the privileges of the single market. They will form an inner European core from which we will be excluded. Legally, they can't discriminate against British companies, or erect trade barriers against countries outside the single currency. But covert barriers could be considerable. Britain could be at a disadvantage in any industry where personal contacts make a difference, or where government is involved in procuring contracts.

If trade barriers - no matter how discreet - started to emerge, we could say bye-bye to Far Eastern investment in the UK. The car plants and the electronics factories built in Britain by inward investment from the Far East are aimed at European markets. Future inward investors might switch to the euro countries if they felt Britain was out on a limb.

For the "Join Up" campaign, even dithering and delaying a single currency until a later date is too costly. Britain will be excluded from discussions about the European Central Bank, left out of critical European economic policy meetings and generally left unloved by our European partners. That price might not be paid for a long time but it could be high indeed.


The "stay-out" campaign is adamant about the economic case for resisting French and German encouragement and staying out of a new single currency - at least for the time being. They argue that the competitive gains from European integration will all be achieved in the single market anyway without the extra burden of a single currency. At the same time, handing over control of monetary and fiscal policy to Europe could be extremely costly.

Relaxed about the risks of provoking French and German protectionism, they maintain that the existence of different currencies is not a big obstacle to a single market. So long as firms are spared variations in technical specification, customs and excise restrictions, and direct barriers to trade, there should be little to prevent them producing and selling without regard to national borders. The competitive gains from a single currency are therefore - they maintain - insignificant.

The risks, on the other hand, to the overall functioning of the British economy could be considerable. For those in favour of Britain joining a single currency, a single Euro-wide interest-rate policy is a good thing because it prevents Britain indulging in inflation. For the "stay-outs" however, a single Euro-wide interest rate is a clumsy economic tool which prevents different countries reacting to the particular economic problems that beset them.

They have a very good point. Interest rates and exchange rates are useful tools for helping economies adjust to shocks. If countries are affected in different ways by economic changes, they can need very different responses to help them cope. For example, if America goes into recession, demand for British goods is affected far more strongly than demand for other European goods. A cut in British interest rates could ease the pressure on British firms and prevent a recession. But in the new world of the euro, that kind of adjustment won't be possible.

The stay-outs argue that this kind of thing will happen all the time: the British and German economies are so different that they are inevitably beset by different kinds of problems. The right interest rate reaction in one country could mean recession and unemployment in the other.

There is a further reason why Britain and the core euro countries should not be subject to the same monetary policy: they respond in different ways to changes in interest rates. In Britain we are heavily dependent on mortgages. If interest rates go up, mortgage repayments rise, and consumers scream. In 1990 around 10 per cent of household income in Britain was taken up with debt repayments, compared to 3.2 per cent in Germany and 3.7 per cent in France. Businesses have lower debts in Britain than in the euro core countries, but we are more dependent on variable interest rates. The result is that a 1 per cent rise in interest rates to choke off inflationary pressures in France and Germany could be far more damaging in Britain.

Joining the euro also means losing control over fiscal policy. Under the Maastricht criteria, and under the proposed "stability pact" rules for countries inside the single currency, national governments must not borrow more than a specified amount each year. This gives countries even less freedom to manoeuvre when coping with their distinctive economic problems. The single currency fans have a retort here, however. To make a single currency work, all the euro countries would need to share the burdens of unexpected economic shocks, transferring cash to the country that most needed it. True, there is not yet much political support for taxing the French to give to the Brits, but it is not entirely unworkable. Even without a single currency, Europe is preparing to bear much of the cost for compensating British farmers for the damage done by BSE.

The stay-out campaign has one further advantage on its side. It will be joined by many people who accept the arguments for the euro in principle, but want to dither a little longer before committing Britain to a great and possibly very expensive experiment.

Initial teething troubles could be costly for everyone involved, and economic tensions between member countries could yet pull the whole thing apart. Of course there are costs to waiting and joining later on. But there are even bigger costs to joining now and pulling out again. Meanwhile a few more years of integration in the single market could lead to greater convergence in the way countries respond to different economic changes, so all the problems generated by a single European interest rate might be reduced. All things considered, they might prefer to wait and see.