CHANGING PUBLIC OPINION
Four years ago I delivered a speech on the implications of economic and monetary union (EMU) for British business, to the inaugural meeting of the German British Chamber of Commerce south west branch in the Guildhall at Exeter. You might say that a lot of currency has flowed under the bridge since then so I thought it would be worthwhile reviewing the text to see what has changed and what has not. Particularly as the euro and the UK relationship with it has been pushed up the political agenda by Peter Hain MP, the Minister for Europe, talking up prospects of a referendum being held in 2003. His master, and I don't mean poor old "Man of Straw" the Foreign Secretary, hopes that the introduction of euro note and coin throughout Eurozone combined with a long summer of Britons taking holidays and using the single currency in Euroland will change public opinion at home enough for him to win a vote to give up the pound and join the euro.
THOUGHTS FROM THE PAST
I attach the original text altered in only two respects. First I have inserted dates in italics to show the context of certain remarks, and second, my sub-editor has used her skills to introduce some headings to break up the text a bit. The content remains the same to show where I got it wrong and how much of it remains valid.
I mentioned the hope for a transparent single market. Well, I now know that my copy of the Daily Telegraph costs €2.90 in Brussels, €2.60 in Strasbourg and €2.50 in Madrid but that is an almost exact conversion from the price in Belgian Francs, French Francs and pesetas, so comparison is easier, but no change in price yet. I also know that my hotel in Brussels used the opportunity of the changeover to whack up my room rate by 10%, admittedly after a long period of
virtual price stability. So it seems too soon to tell.
Another argument raised in favour of the
euro was that it would create a single
capital market in debt and corporate equity. Well, three years after the introduction of the euro there is no sign of one, beyond a policy statement to have one by 2005. I said I expected the City to consolidate its position regardless and I think I got that one right so far. The challenge from Frankfurt seems to have fizzled out.
Another argument was that the euro will consolidate a low inflation economy through a single interest rate and monetary regime. This goes to the heart of the matter as to whether a 'one size fits all' interest rate can work and be to our economic benefit. Well, we have seen an upturn in Euroland inflation at the beginning of 2002 and, although this may well be a blip that will not last, if put in the context of rising unemployment in Germany, rising public sector deficits in a number of countries as well as general signs of stress for the stability pact from some member states growing a bit too fast, such as Ireland, then it does not seem very encouraging to me.
COMPETING WITH THE DOLLAR
The most enthusiastic supporters of the euro see it as the way to make a currency large enough and strong enough to both defy the currency speculators and match if not surpass the mighty dollar. Well, at present the euro is worth 86.5 US cents or thereabouts having started three years ago at $1.17 and there is precious little sign of it taking over from the dollar as the main international trading currency. So, I make that currency speculators and the dollar two, euro nil.
The final argument in favour of the euro which I could identify was that it would stimulate growth and employment. This is also one of the Labour Government's five tests for entry. I suggested that if the European Central Bank (ECB) did its stuff properly and displayed true independence, then interest rates would tend to be higher and more deflationary than would be the case under politicians' control. This is a difficult one to prove, but it is evident that growth has been lower and unemployment higher within the eurozone than in the U.K. which is outside.
I also referred to the requirement for labour market flexibility comparable to that which we have enjoyed in the UK since the Thatcher Government structural reforms of the 1980s, to enable the eurozone to deliver growth and higher employment. And I suggested we would cease to enjoy so much flexibility as various New Labour taxation and administrative burdens on business began to bite. I expected the minimum wage proposal to have a more pronounced effect than it has, so I got that wrong, but on the other hand I stick to my basic argument that all the cumulative measures, not least those driven by European social legislation, adopted by this government are progressively undermining our competitiveness. Perhaps I should say regressively to emphasise the point. Furthermore there are many more measures than I thought of four years ago because New Labour is so adept at talking about supporting business while actually taxing and burdening it at the same time.
I suggested that the cost of changeover would be huge and was being glossed over by the proponents. Well, it may have been huge and glossed over, but it does not appear to have been a problem thus far. I also pointed to the risks of a big bang approach to the changeover and suggested there might be turmoil in the currency markets as well as problems with the millennium bug. So its hands up to getting these points wrong.
SOUND AND STABLE POUND
I pointed to the more fundamental reasons against giving up the pound,namely loss of control over interest rates and the ability to allow the exchange rate to adjust to changed economic circumstances. I referred to the challenges to the UK in adapting to a hard currency regime such as the euro. Well, I think I got that wrong as well. We have managed to adapt to the pound being a sound and stable currency against both a strong dollar and a weakened euro.
However the fact that our exchange rate was able to change against both the dollar and the euro underlines the continued need to retain control and flexibility as well as making the point that we have not converged our economy with euroland. Furthermore the way the Monetary Policy Committee (MPC) of the Bank of England cut interest rates in response to changed market condition, while the ECB made token cuts and mainly sat on its hands, emphasises the importance of retaining national control over interest rates and the hazards of joining a one size fits all monetary system.
Another issue I raised was the pensions funding question. Namely whether the huge costs of paying for future pension promises in those countries where pensions are wholly or largely paid out of current taxation revenue will force them to borrow more money and have to pay higher interest rates as a consequence. I now think this is more of a worry than it was, because there is not much sign of the countries concerned recognising the problem let alone taking steps to address it.
At the end of the speech my final thought was amazement that the Labour Government had been able to get away with not addressing the exchange rate issue. If they want to take the UK into
the euro at what exchange rate would they suggest? Many observers say the present rate would permanently disadvantage our export and international trade sectors. As sterling is a floating currency we may presume it is at open market levels, so how would Labour engineer a reduction in value and to what level? How long would it have to stay at the chosen rate to meet EMU stability criteria (two years according to the Treaty)? Would the existing members of euroland agree to a significant depreciation, say 10% for the sake of argument, in the terms of trade? Some would say sterling is stronger because it remains outside the eurozone and that the moment a decision was announced to take the U.K. in, a sharp fall in value would take place. Would that be good news or bad (bad I reckon)?
AT WHAT PRICE
However these are technical arguments rather than fundamental points of principle. Rather like the story of George Bernard Shaw who asked a pretty young woman seated next to him at dinner whether she would sleep with him for £500 (serious money a hundred years ago). She replied coquettishly "Well that depends" so he then asked would she sleep with him for ten bob (do I need to explain that ten bob was 50p). "Certainly not", she says, "what do you take me for?" "Well I rather thought we had established that and were merely negotiating the price", said GBS. In other words it doesn't matter what the exchange rate may be if you have already decided on the principle of the matter to go in. Nevertheless, in order to make a recommendation to the nation, I think Blair should be obliged to state in advance at what exchange rate he thinks the U.K. should enter the euro.
NEW EUROPE TRUST
Late last year the New Europe Trust published a pamphlet entitled "The economic case against the euro". I recommend it to anyone who wants to read about the issue in detail. It is priced at £10 and you can contact them at 56 Ayres Street, London SE1 1EU tel:- 020 7378 0436 fax:- 020 7089 3827 or email:- email@example.com. In the pamphlet five new tests are suggested in addition to the existing ones set by the Government in 1997.
First is labour market and other reform. Has the Eurozone taken steps to make its markets more flexible to enable different regions and countries to cope with the one size fits all interest rate regime? At present the signs are in the opposite direction with a long list of social measures making employment more difficult, rejection of measures like the takeover directive and delays on opening up the markets in electricity and gas to full liberalisation.
REFORMING FISCAL POLICY
Second is reform of the fiscal policy framework. Can the eurozone countries come up with mechanisms for fiscal transfers from prosperous regions and countries to those in need of economic regeneration (of sufficient sums to make a difference) which do not harmonise taxes
at the highest level? Can they change the growth and stability pact to allow Member States some more room to cope with downturns and shocks? Judging by the reluctance to find any extra funds for the candidate countries for enlargement and the stresses visible already within the stability pact, the signs are not encouraging.
BECOMING MORE ACCOUNTABLE
Third is reform of the ECB. Is the monetary policy pursued by the ECB better than that of the MPC at the Bank of England? How can the ECB become more transparent and accountable e.g. by publishing minutes and voting records? Will it adopt a symetrical inflation target like the UK model? Over how long a period does it need to operate to establish a track record of success? At present the answers would seem to be a)no; b)with great difficulty; c)probably not; and
d) who can say, but two or three business cycles would seem to be the minimum period of time.
EXCHANGE RATE MECHANISM
Fourth is the exchange rate. This is a crucial aspect of the Treasury first test on convergence yet the Labour Government has both sidestepped and ducked the issue. The pamphlet says a judgement must be made about the level at which British business feels competitive against the Eurozone but omits to suggest whom should make the judgement. It says the level would have to be negotiated with the Member States inside the Eurozone and the agreed value made public prior to any referendum. Furthermore the issue of whether a two year period of fixed exchange rates should be observed would have to be clarified. I note that those sections of the business community who favour entry, namely exporters and multinationals, are conspicuously silent on what the rate should be while agreeing that the present
rate is wrong.
REFERENDUM AFTER 2004
Fifth extra test is described as a constitutional settlement for the E.U. It is widely believed that the euro can only work if there is far greater co-ordination of national economic policies and a more centralised direction of the eurozone economy. The test is - can a constitutional settlement make that work while safeguarding against a single European state being established, and against our wishes at that? The pamphlet suggests that there should only be a referendum after these issues are addressed at the Constitutional Convention which is due to report by 2004.
CONVERGENCE OF ECONOMIES?
All this adds up to a lot of points that need careful consideration before a question can be put to the people in a referendum.
Personally I do not find the arguments in favour of entry persuasive while the economic case against is convincing. To say that we should suffer if we are left out when we are the fourth or fifth largest economy in the world seems rather an illogical and unprovable argument. By that line of reasoning we should be queuing up to join the dollar where we would have about the same amount of influence, i.e. not a lot, but in the main trading currency of the world. I would be more impressed by a long period of exchange rate stability against the euro as evidence of the convergence of our economies.
NATIONAL IDENTITY AT RISK
In the meantime the issue remains fundamentally a political one as to whether we are willing to press on down the integration road whatever that may mean for our national identity and independence. I would welcome a referendum as the way to debate the matter fully and reach a conclusion that might be accepted by all. As I am confident of the outcome I hope Mr Blair will chance his arm. There are more than enough reasons to vote against but giving him a come-uppance is a particularly attractive prospect.
KEEP THE POUND
In terms of timing the Blair New Labour Government has an interesting problem in its lap. It needs time to change public opinion, yet it won't want to hold a referendum too close to either the European elections due in June 2004 or the next General Election in 2005 or 2006. That suggests a window of spring to autumn 2003 or quite soon. Will our countrymen change their minds after one summer of holidays on the continent using euros? Somehow I doubt it, but just in case, we must keep on reminding them about the more fundamental reasons for keeping the pound.
IMPLICATION OF THE EURO FOR BRITISH BUSINESS (March 1998)
EXPERIENCE OF RUNNING A BUSINESS
For most of my life I have been a small businessman running a small family map publishing firm founded by my father Sir Francis Chichester in 1946, coincidentally the year in which I was born. I started as a trainee in the sales department and worked my way through pretty well every job in the business. The things I have had to cope with have included metrication of paper size and weight; decimalisation of the pound; introduction of VAT; launching a new product line; trying to save our principal supplier from going bust; new technologies in typesetting and printing; inflation accounting; new technologies in word processing, data base management and desk-top publishing; book-keeping and doing the PAYE; exporting to and doing business with the USA; doing battle with the Inland Revenue on numerous tax matters and so on. This is not to mention surviving three serious recessions since taking over the running of the business after my father died.
A DIFFERENT PERSPECTIVE
By way of counter-balance to all this practical experience I did economics at 'A' Level and am now a politician. So, you could say I have a number of perspectives on this vexed issue of economic and monetary union. I got another one last November (1997) when I was on an official visit to Australia. Down under they are creasing themselves that the Europeans have called their new currency after the bird that can't fly. In my book on the wildlife of Australia the Emu is described as distinctively stupid, endearingly droll and insanely inquisitive while it's defence mechanism is it's ability to run away at up to 40 miles an hour. I have seen one in the bush, and it did run impressively fast. But the diggers' mirth doesn't stop there because the Euro or walleroo can weigh up to 100 pounds, needs little water and thrives where most other large herbivores cannot. I kid you not, the euro is a species of kangaroo. Whether this means the single currency will go up by leaps and bounds or merely hit the deck running, I know not, but it does put the whole project in a different light!
CONSIDERING ALL OPTIONS
In order to address the central theme of this speech, the impact of EMU on UK business, I need to review the arguments for and against as well as the options open to us. I have drawn on a number of sources including a fine speech by William Hague to the CBI last November (1997); a speech by Adair Turner of the CBI delivered in January of this year (1998); three pamphlets published by The Treasury entitled 'The Pros and Cons of EMU', 'EMU - Practical information for Business', and 'UK Membership of the Single Currency - An assessment of the five economic tests'; and a Paper issued by the secretariat of the EPP-ED (the European People's Party-European Democrats, of which we Conservatives are allied members). Bearing in mind my opening remarks, I also draw on my own experience and instincts.
NOT QUITE TRUE
The first argument advanced for the single currency is that it will eliminate foreign exchange transaction costs in participating member states to the benefit of travellers and businesses that move or trade across national borders. I am not overly impressed by this because I am certain that banks and other financial intermediaries will simply find a different way of charging us so as to produce the same revenue by another means. Probably that will be through money transmission charges as they do in the United States.
BENEFITS OF A SINGLE MARKET
A much more plausible argument is that it will create a transparent single market throughout participating countries which should intensify competition which in turn should improve competitiveness and productivity leading to lower prices, better value and improved service for consumers. A third point is that it would create a single capital market in debt and corporate equity which should result in greater efficiency in capital allocation along with greater liquidity. In this context we could expect that the predominant financial centre in Europe, namely the City of London, would consolidate it's position regardless of whether the UK is in or out of EMU.
A fourth argument is that by removing currency uncertainty and the need for hedging forward, the single currency will encourage trade and investment flows within the currency zone. It will do so through a combination of stability, an essential pre-requisite for economic growth, and elimination of a significant part of the administrative burden. A fifth point is that through a single interest rate and monetary regime a low inflation, stable economic environment will be achieved which would accelerate the integration of the participating countries' economies as well as enforce fiscal responsibility on their governments. Personally, I am attracted by the notion of removing from politicians the power to print money, i.e. let the money supply rip, so as to inflate themselves back into office.
IN YOUR DREAMS
An argument quite favoured among my continental colleagues is that in creating a mega currency zone Europe will be able to confound the wicked currency speculators because it will be too strong for them. I fear they are doomed to disappointment because recent history has shown that even the dollar can be vulnerable to shifts in global sentiment and I hear there is upwards of a thousand billion dollars of cash available for those very same speculators to play the markets. Under similar reasoning they believe that Europe will have the financial strength to stand on an equal footing with the mighty dollar and exert comparable clout with the United States over trade issues and the like. This appeals in particular to the French vision of things since they are paranoid about the Americans and dream of leading Europe towards it's destiny of a sort of Etats Uni de L'Europe. The Anglo-Saxon response to that is, of course, in your dreams!
FLAW IN THE ARGUMENT
Anyway, coming back to EMU, I have reached the last argument in favour which is that it will stimulate growth and employment. In a sense the reasoning is a refinement of point number five because it says that through currency stability and balanced budget fiscal responsibility the right conditions are created for growth which will in turn increase employment. The flaw in this argument is that if the ECB - the European Central Bank - does it's stuff properly and is truly independent then interest rates will tend to be higher than they would be under the old regime of control by politicians which means growth would be lower and unemployment could actually be worse in the short term before it improves over the longer term.
INFLEXIBLE LABOUR MARKET
Furthermore it presupposes a flexible labour market such as we created in the UK through the 1980s and will continue to enjoy until New Labour implements it's minimum wage, the working time directive, the reversal of burden of proof in employment tribunals, and reinstates restrictive trade union privileges through enforced workplace ballots. It is fairly common knowledge that non-wage cost burdens on employment are much higher on the continent and that inflexible would be a more accurate description of labour markets in our partner states.
I now turn to the other side of the coin or the cons of the single currency. Let me start with an aspect that proponents tend to gloss over and that is the cost of the whole exercise from re-nomination of all balances in banks and other financial institutions through amending all legal and other documents where money is mentioned to the task of modifying all cash dispensers and coin operated machines. That cost is likely to be billions and the bill will be presented to the consumer or the taxpayer in some way or another. It is arguable that many of these costs would probably arise over time anyway and that the single currency would act as a concertina effect in bringing them forward but it is clear the work and cost involved will be considerable.
HOPE OVER EXPERIENCE
A second concern must be the risks inherent in the big bang approach of doing it all at once. Those risks include the possibility that currency speculators will blow the whole thing out of the water in the period from May 4th this year when the exchange rates of the first wave of participating countries are locked relative to each other. They include the possibility that the social and economic pressures of maintaining the stability pact could force governments to abandon fiscal responsibility to indulge in a bit of old-fashioned stimulus spending. Both scenarios look a little alarmist at present because the currencies in the exchange rate mechanism have been effectively floating within the wide range of 15 per cent bands without much fluctuation and because it is arguable that most of the pain of meeting convergence criteria has already been taken on the chin in terms of high unemployment and severe constraints on public spending, without a revolution breaking out. But you never know what might happen once those rates are fixed or if unemployment persists without a sign of any light at the end of the tunnel. Another cause for anxiety must be the skin-deep nature of convergence in some of the countries which are expected to be participants. Great efforts have been made to meet the criteria in the reference year by the likes of Italy yet there must be some doubt over their capacity and political will to stick at it in the long term. On the other hand it could be that a dose of external discipline will do the trick. It sounds a bit like the triumph of hope over experience to me.
Probably the most emotive argument against the UK going in to the single currency is the sovereignty issue that we would lose our pound and control over our exchange rate. I confess that I share that instinctive opposition. However, it must also be admitted that we have changed our currency and coinage in the past when it suited, without the roof falling in. Bring back the guinea. I say! However the loss of control over our exchange rate is a much more serious and practical objection particularly in the context of seeking to merge up to fifteen currencies in one step.
FLUCTUATING EXCHANGE RATES
It is not so much that we have such a poor record in allowing sterling to depreciate in terms of our main competitors over the decades since the war but that I question our capacity to cope with the pain of adjusting permanently to being part of a strong currency zone. The exchange rates of countries fluctuate as their relative competitiveness fluctuates and this is the mechanism by which changes in the strength of the economy can be accommodated. Without this instrument of economic management the adjustments take other less welcome forms such as loss of jobs and business failures.
Another serious objection is the loss of national control over interest rates inherent in joining the single currency. There is no doubt in my mind that this is a big problem for any economy which, like ours, has a business cycle at a different stage from our continental partners. The question is which economy do the governors of the ECB bear in mind when they set their interest rates and money supply targets? Might they not end up with the usual European compromise or fudge that would neither damp down buoyant consumer spending in the UK nor provide enough stimulus for growth in Germany at the same time? Would it matter provided the overall monetary regime was suitably tight to maintain low inflation? If we don't know the answers does it not indicate what a leap into the unknown this whole project represents?
A frequently voiced objection is that there is insufficient labour market flexibility to cope with the regional imbalances in competitiveness that the single currency will accentuate. In the USA labour mobility is high and adjustment relatively easy. In Europe there are language barriers, cultural barriers and differing legal systems which make comparison with the USA invalid. This objection could be overcome with time but not under the politically driven tight timetable of Maastricht. The other compensatory mechanism used in the USA to address this point about regional imbalances is not available to any significant degree in Europe either. I refer to fiscal transfers from better off taxpaying regions to less favoured or depressed ones. Presently within the EU one third of the European Budget goes on structural and cohesion fund measures and it must be recalled that the EU budget comprises only one and a quarter per cent of overall GDP. There is no enthusiasm among Member States to increase this proportion.
The success story of Ireland in raising it's GDP per capita as a percentage of the EU average from sixty odd to eighty plus is matched by less success in Greece but the point is that these are countries with relatively small economies where limited EU structural funds can have a significant effect. The scale of the potential problem is better indicated in Germany where transfers from the west to the new lander still amount to forty or fifty billion deutschmarks annually, partly funded by a surcharge of, until recently, seven and a half per cent on income tax in the western lander.
CONCERNS FOR DEVON
One of my particular concerns for Devon in all this is that in a hard currency zone capital and employment will migrate from the weaker, less competitive economies to the stronger areas. By definition, since we qualify for regional aid now and have a GDP per capita below the national and EU average, we are one of the weaker areas at risk. Ironically we face the prospect of being allocated significantly less structural fund assistance in the next round of programmes. Our circumstances are difficult within the UK sterling zone relative to other stronger regions and becoming part of the single currency would exacerbate matters and increase our peripherality.
COULD WE TURN BACK?
There are those who say a single currency implies a single government setting a single budget for a harmonised tax system. Indeed there some who say it can't work without political union. Well I don't agree as it would continue to be possible for governments to set their own revenue and expenditure measures. What they would not be able to do is print money or over-borrow. People are very concerned about the use of the word irrevocable in the context of joining the single currency. I share that concern but in politics words like never and irrevocable have a habit of coming back to haunt their author. What a democracy decides to enter it can decide to leave and the whole thing about the Institutions of Europe is that they can only function by consent. If we in the UK really wanted to leave, for the sake of argument, I have no doubt it would be possible. Difficult for sure but possible.
Another objection arises from the suspicion that the convergence criteria will be fudged so as to conform with the political requirement to include certain member states in the first wave. The objection is that public debt and borrowing in these countries will spiral out of control, despite the stability pact, and the stronger countries such as Germany will have to bail them out. I suspect that Italy thinks its finances will be transformed once inside the single currency low interest rate regime. Well I think the markets will smell that one a mile off and charge a premium to reflect the additional risk so the cost of servicing official debt in Italy would remain at similar levels or even go up.
GUARDING OUR PENSION PROVISION
Furthermore there is no bail out clause in the treaty and that should equally apply to that other concern over future unfunded pension liabilities. The OECD has estimated that these amount to 98% of GDP in France, 113% in Italy and 139% in Germany compared with 19% in the UK because the bulk of our pension provision is funded in the private sector.
Alarmists have suggested that these private funds could somehow be seized and used in another country to help pay for their pensions. This is bunk but it has frightened quite a few people. The origin of this particular euro-scare was the suggestion that the pressure of future funding needs for those future pension liabilities in parts of the single currency zone could push interest rates higher than they would be otherwise. Personally I would guess that every other country will be very keen to enforce the stability pact, enforce the no bail out clause, and contain the contagion. But it is a legitimate concern.
OVERHEATING IN THE HOUSING MARKET
A further objection is that the housing market in the U.K. is structurally different from continental countries with our very high proportion of owner occupiers and floating rate mortgage finance. If we participated in the low interest rate regime expected for the single currency, the argument goes, there would be a housing boom followed by rampant asset inflation which would make our previous experiences of such phenomena pale into insignificance. I think there could be such a danger if the changeover happened all at once without warning but more probably in the expectation of greater interest rate stability people would switch to fixed rate loans.
One final objection is that the member states are
underestimating the dangers of the millennium bug in computer systems and it is crazy to make the changeover to the single currency around the same time. This is a serious point but the problems with the millennium bug will surface a year later than the problems with implementing the single currency so let us hope that will be enough.
WAIT AND SEE
What are the options for the UK? Go in now, wait and see before deciding or never go in. We can't do the first for the reasons I have given. To say never is unwise and should not be an option. To wait and see is surely a matter of common sense. I note with interest that the New Labour Government has adopted a wait and see policy with the spin that if a new set of tests are met adequately they are in favour of participation. Those tests come under the headings of cyclical convergence, sufficient flexibility to cope with problems, the right conditions for inwards investment, impact on the competitive position of our financial services sector, and whether EMU would promote higher growth, greater stability and more employment. It seems to me that that leaves the jury well and truly out because because these conditions could be interpreted rigorously to keep us out or fudged to take us in because we just don't know the answers, or we can't prove it one way or another. Myself I err on the side of caution or scepticism and say that we should wait. If it works, and I don't have any suggestion as to how we measure that or over what length of time, then we would probably have to be a part of it.
LESSONS TO BE LEARNT
Finally my answer to the theme of this speech. For multi-national and big companies, particularly in the manufacturing sector, the single currency would be a plus because of removing the currency risk on intra Euro zone trade, because of lower costs in managing cash across borders and because of the larger market opportunities created by removing currency obstacles. Farmers, researchers and all others in receipt of funds from the European Budget would probably prefer the certainty of it. But for small businesses who predominantly trade within a tight local radius it will offer no advantages and significant additional costs. My parting thought is that I am amazed the government has been allowed to get away with failing to address one crucial element to this debate. That is at what parity might we enter and at what parities should we definitely not enter. Remember the ERM and beware.