Britain and the Euro Oct02

Should the UK, with the world’s fourth largest economy based on global trade and investments, join a eurozone that has so far failed to respect the rules of economic management? Ongoing difficulties amongst Europe's Member States with growing budget deficits and public debt, continued aid for state-owned enterprises, labour inflexibility and corrupt governance are hardly signs of encouragement.

The Euro continues to fluctuate against the US$ and Sterling and it's value remains well below the $1.16 at which it was first launched in 1999. The European single currency is managed by the European Central Bank (ECB), and functions much like the German Bundesbank. The ECB’s brief is to maintain an inflation rate of 2.5% maximum throughout the eurozone and it has an interest rate policy which is less reactive to the Euro’s exchange rate against the US$.

The EU, unlike the USA, has no single federal tax structure that can offer appropriate help to weaker states. Labour is highly mobile in the USA as there is a common language and ‘culture’. There is flexibility of wages, terms of employment and easy access to housing in the USA that encourages people to simply pack their bags and move from state to state for work. The EU has 15 Member States with significant differences in financial architecture e.g. unemployment levels are different in each Member State; many German Länder (local authorities) own their own utility companies and own their own banks whilst all these are privatised in the UK; Italy and Spain continue to subsidise their airlines whilst the UK does not; the Swedish government owns all alcohol and pharmacy outlets whilst most other states do not, most people in the UK own their own homes whilst there is a higher trend for rented and social housing in other states.

Therefore, the economic situation in the 15 Member States cannot be easily managed with a single currency and a common fixed interest rate, as such a situation will not allow individual governments to manage employment and inflation to suit local conditions. This is why Germany, with a £23bn deficit and high unemployment, is struggling to kick-start its economy because it cannot lower the interest rate. Before joining the Euro, Ireland had a growing economy without inflation. On joining, its interest rate dropped from 6% to 3%, property prices shot up and so did domestic demand. Ireland, like Spain, now suffers from high inflation and needs higher interest rates to reduce domestic demand and inflation. Public debt as a percentage of GDP is too high in Italy, France and Belgium and such poor economic management of national economies breaches the rules of the stability pact and weakens the Euro exchange rate. This immediately impacts on inward investment and economic growth for other Member States.

The UK experienced great difficulties, including loss of reserves and high unemployment, when it was locked in the Exchange Rate Mechanism (ERM). Clearly, there is to date no significant convergence between the major economies in the EU to justify the UK joining the Euro at present.

It is true that 60% of UK exports are to the EU but the UK has a trade deficit with the EU. Trade does not necessarily increase with a single currency. For example, German trade with France has increased less than its trade with other countries outside the eurozone since the introduction of the Euro. The members of NAFTA have their own national currencies but have still  managed to increase their mutual trade substantially by reducing customs duty and trade barriers.

The decision to join will be one for the British people. Economic convergence, labour mobility, wage flexibility and national government adherence to financial discipline will determine the success of the eurozone. Ultimately a tax raising central government of the EU may well be the outcome – is the UK ready for this? I am not so sure!