1) What kind of choice is it?
¥ The question is irrevocably a pragmatic political decision - the choice is between different practical alternatives. For this reason it is futile to make arguments about the merits or demerits of joining on principle.
¥ The basic reality is that monetary union is likely to begin from 1999 on terms essentially negotiated betw een Germany and France. The British choice will be whether it wants to be inside that specific project. If the British government wants to seriously influence the terms of monetary union it will have to make a very quick decision to join. By the time a La bour government arrives in office it may be too late.
¥ The British choice may well be constrained by the convergence criteria. Even if Britain improves its budget deficit performance, there is still the vexed question of ERM membership. Although Kenn eth Clarke secured an agreement at the Madrid summit in December 1995 to postpone the decision about whether the ERM Maastricht criterion still held, statements from German ministers that all the criteria are equally important do not bode well. This would mean that a Labour government would need to be thinking about a return to the ERM as soon as taking office if it wanted to preserve the opt-in, as well as taking legislative steps to make the Bank of England independent.
2) The problems of going in
¥ The danger that it might not work - a large monetary union, which included the Mediterranean states and Britain, would be far from an optimum currency area.
¥ Lack of political consensus in Britain about either Europe or the virtues of price sta bility, or the problems of international interdependence. The quality of the British debate in the political arena about the single currency has been poor. It takes a supreme act of faith to believe that British membership of a single currency would not b ecome a scapegoat at the first sign of economic trouble. This problem is particularly exacerbated by the unfortunate experience of ERM membership when Europe, rather than the governmentÕs policy mistakes, was blamed for the economic problems of 1991-1992. A Labour government which goes into a single currency will be faced by a Conservative opposition sure to see the issue as the route back to power. For this reason, above all else, a referendum will probably be necessary is a Labour government did want to go in.
¥ Could the British economy stand the pace?
- could a Labour government be confident that Britain over the medium to long term could match the inflation performance of Germany and the other hard currency states? Britain has done quite well on inflation since 1991 but did very badly in comparison to other big EU states in the second half of the 1980s. Although British wages increases have not accelerated during this recovery as previously at this stage of the economic cycle, at the end of the Lawson boom British percentage annual increase in wages was running at nearly nine per cent ahead of the best performing EU states. Certainly the particular nature of the last recession made an impact on wages, but the skills shortage in the British w orkforce, which in the past has created inflationary pressure from this source, persists. It is no good thing going in and thinking that the single currency and the commitment of a European central bank to price stability will in themselves sort these thi ngs out. Devaluation may more often than not now be counterproductive but when economies do not perform well it provides a less painful and more politically viable means of short-term adjustment than will be possible inside a single currency. This again r elates to the problem outlined above.
- would the proposed Waigel Stability Pact, and the terms for budget deficits which Germany will continue, probably successfully, to push for, be too great a constraint on fiscal flexibility? Not only are there go od reasons, contrary to Waigel, to believe that automatic fiscal stabilisers are an important economic policy tool, subject to the avoidance of excessive deficits, but BritainÕs recent fiscal performance gives cause for concern. The government is now borr owing more than it planned for because it is failing to collect projected revenue, the fall in VAT receipts being particularly worrying.
¥ Problems of accountability
Whilst some of the talks in terms of sovereignty on this subject can be criticise
d as naive, the particular statutes concerning the European Central Bank (ECB) raise some problems. In line with the Bundesbank model the ECB will be a fairly unaccountable central bank. The Treaty of European Union simply requires the ECB to address an a
nnual report on the activities of the European System of Central Banks and on the monetary policy of both the previous and current year to the Council of Ministers, the European Council, the Commission and the European Parliament, which may hold a general
debate on that basis. Even those in Britain who have made the case for giving the Bank of England greater autonomy have, with a few exceptions, preferred the New Zealand model in which the central bank is given a specific mandate by Parliament to achieve
an inflation target and is then held to account by Parliament in pursuing that task. It would be foolish to assume that British opinion will take on trust, the way that Germans have in relation to the Bundesbank, the legitimacy of the ECB to act as it ch
ooses in pursuing its statutory responsibility.
3) The problems of staying out
¥ Interest rate premium and sterling weakness
Although the Conservative government has pursued relatively successfully an independent monetary policy over the last
few years, a large part of this must be put down to luck and the particular vagaries of the dollar. After its departure from the ERM the Italian government has been a lot less fortunate. At the same time over the last few years the relative cyclical posi
tion of the British economy in relation to Germany and France means that British short-term interest rates have anyway for domestic reasons been higher than those in these two states. Salutarily, British long-term government bonds have not performed well
over the last few years. At one point this month the British market stood as the second highest yielding in the EU after Greece. In the medium to long-term an independence monetary policy is a bad bet. Given the British experience outside the ERM during t
he 1980s, it would seem reasonable to presume that outside a single currency Britain would most likely face interest rate premiums over the Ôin statesÕ and the perpetual risk of sterling depreciation.
The dash of the southern European states to join t he single currency also raises the question of how far fiscal consolidation (excessive borrowing will still be penalised outside monetary union, just in terms of the exchange rate) could effectively be pursued as an ÔoutÕ EU state? Italy, Spain and Portug al have certainly agreed that participation in a single currency, lower nominal interest rates and deficit reduction become a virtuous circle with success rewarding success.
¥ Second-Tier status within the EU
By staying out of monetary union from
1999 a Labour government would probably relegate Britain to a second tier status within the EU. As the furore over Target has shown an inner core can set the rules over matters which the ÔoutsÕ do not, reasonably or unreasonably, believe to be solely abou
t monetary union. The recent Franco-German joint paper to the IGC arguing that no member state should be able to veto closer cooperation between groups of EU states leaves open a future in which states that do not participate in the single currency, as th
e most salient new integration project, will be cut out of the core affairs of the Union. Integration could then be used by the Franco-German bloc to exercise power over economically and diplomatically weaker states. It is probably within this context tha
t the concerns expressed by some about the cost to the City and internal investment of staying out are most valid. In short-term economic terms the City will still be able to defend its position as the leading European financial centre and Britain will re
main an attractive site for international investment, but if Britain lost even the structural capacity to exercise influence within the EU then these circumstances might change. Any effort of the ÔinsÕ to tie the Single Market more closely to the single c
urrency would certainly cause problems.
4) Conclusions
In straight-forward macro-economic terms wait and see might well be the best approach. Whether Britain would pay a significant macro-economic price for staying out in 1999 and deciding again in 2001 or so would depend on both particular economic circumstances nearer the time and a large element of fortune. By that time, with some effort, a Labour government might have shifted some of the prevailing attitudes towards Europe and the economy wh ich would make membership a politically difficult task. The most pressing problem with staying out would seem to be in terms of BritainÕs overall position within the EU - can Britain afford relegation to a second tier, especially if some of the southern E uropean states make it into the 1999 club?
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Helen Thompson
November 1996