Examine the main arguments for and against UK membership of the European single currency, the Euro.

Examine the main arguments for and against UK membership of the European single currency, the Euro.

In this essay I will be exploring the various reasons for and against the entrance of the United Kingdom into the European single currency. The positives of the proposal shall be explored, looking at the increased economic and trade possibilities which will result from entry, internal economic changes that will result, and the political necessity to enter and the lack of alternatives available. The negatives will also be looked at, with the lack of accountability in the European Central Bank, the potential economic pitfalls of entry and also the actual difficulty of making the jump into the Euro politically within Britain. Once all of these have been seen, it is hoped that an informed conclusion on whether one side prevails over the other can be made.

The issue, which since the signing of the Maastricht treaty in 1992 has been a thorn in the side of both Conservative and Labour governments, continues to be argued on the one hand with a fair economic and political assessment, and on the other with an emotional backdrop. The referendum on whether or not to join the Euro, which had been scheduled for 2003, has seemingly been put back until after the next general election due to the somewhat inopportune circumstances for the Government (especially with the various scandals surrounding the recent Gulf War and the death of the advisor Dr. David Kelly). The path to the referendum is apparently being paved – although referendum will probably not be seen until 2005 at the earliest.

The apparently obvious benefit of Britain’s entry into the European single currency, which is one of the most touted arguments in support of it, is the potential expanded trade that would result. Since most of the trade of Britain is done through Europe (especially due to the lack of import duties within EU countries, which is an apparatus already in place), the lack of needing to change currencies to trade should only serve to benefit the already massive trade going on between Britain and member nations. It is estimated that there would be a saving of over four and a half billion Pounds on the cost of converting Pound Sterling to the Euro. It would also eliminate the significant exposure to exchange rate fluctuations faced by business within the United Kingdom.

As such, the stability this would bring (in the perfect simulation) within Europe would promote tourism and investment. This stability provided by the move toward the Euro and the controlling influence of the European Central Bank would also lead to competitive pricing with the other member states. While serving the large industries with increased trade, this would also assist the consumer when it came to buying cars or consumables (although economic analysts are suggesting that the UK now has the second-lowest pre-tax prices for cars in Europe – Italy is believed to be the cheapest [Price Waterhouse Coopers, 2003]). A weaker Pound could also lead to expensive imports, and as such the elimination of the Pound and its’ potential instability would mean that imports may also increase as well. This, too, could help the average consumer, while possibly damaging certain markets and depriving certain industries.

The transparent currency boundaries, and the removal of the currently strong Pound Sterling (at the time of writing, the exchange rate was 1.4929 Euro to the Pound) would also lead to expansion of UK business into the Euro Zone. These factors, combined with the lack of trade barriers within the European Union, would inevitably lead to a boost in exports and an overall boost to British industry. In this sense, the new stability would bring success and swift benefits to the UK population.

However, all of these benefits hinge on the actual success on the reforms themselves, and success coming to the United Kingdom by entering the single European currency. This is by no means guaranteed, and the transition cannot be seen in any other way than as a gamble. The various setbacks and pitfalls must be considered before entry into the single European currency is even thought of. This is something that the Labour government has been mulling over since the beginning of their time in power.

Chancellor of the Exchequer Gordon Brown put down 5 economic tests back in October 1997 that had to be fulfilled if Britain was to ever enter the Euro and join the European single currency.

"In principle, the Government is in favour of UK membership of EMU; in practice, the economic conditions must be right. The determining factor underpinning any Government decision on membership of the single currency is the national economic interest and whether the economic case for joining is clear and unambiguous.” (Department of Trade and Industry Website, 2001)

The five tests outlined are, as described by the Government response to the April 28th 2003 Euro changeover assessment published on June 9th of the same year, a “stability guarantee.” They are in place to make sure the transition from the Pound to the Euro is a swift and seamless one (or at least, as swift and seamless as is possible). “To meet them would ensure that we will not put at risk our economy or our public services. At all times we will put stability and the national economic interest first.” (HM Treasury, p.1, 2003)

The tests, which place a great emphasis on maintained stability, are as follows (Nicoll and Salmon, p.259, 2001):

1. Convergence between the economies of Britain and those of the single currency nations; That is, whether or not the way business is conducted and normal life is conducted would conflict with European interest rates in the long term, and whether interaction between the two was possible (or rather, beneficial).

2. Whether there is sufficient flexibility to cope with economic change; Should the worst happen on the continent or in Britain and recession or other problems occur, could the government handle it adequately, or would the economy collapse?

3. The effect on investment; Would investment on the whole improve and increase, or would the conditions created from entering the Euro actually detract from investment in the world market, and also internally?

4. The impact on our financial services industry; With the increased trade coming from overseas, would the service industry in Britain be flooded with imports, or would it be able to survive intact?

5. Whether it is good for employment. Would the various resulting changes to the economy exacerbate employment, or reduce it?

The nature of these tests, by definition, is good. Should the criteria be met satisfactorily, although it has been noted that the questions are loose and up for debate, there is no reason why Britain should not enter the Euro – that much is clear. However, if they are not fulfilled, the test would be failed – and until such time as the test is passed, it would not be fitting to allow the country to join. At the time of the published analysis of 28th April 2003, while three of the tests have been passed, cyclical convergence had still not been completely managed (although ‘significant progress’ had been made), and flexibility in case of failure was at the time not present.

As such, three of the five important tests had been passed, but two had been failed. It could be argued that while measures can be undertaken to improve the United Kingdom’s position on the failed two, and already are (the response, made in July 2003, outlined recommendations to get nearer to joining the European single currency), the time is not right for such a move to be made.

It has been put forward by many politicians (most notably, Peter Hain and Gordon Brown, who voiced a pro-Euro opinion in the press in mid-late 2003) that there is a political imperative for the United Kingdom to enter the European single currency.

“It is essential we do not lose momentum in ensuring Britain remains, and indeed enhances, its role as a leading European power." (Leader of Parliament Peter Hain, Financial Times, 2003)

The view taken is that without entry into the single European currency, the United Kingdom’s ability to use its’ influence as a large state would be impinged. The United Kingdom, as more states join the Euro (and with the European Union having expanded since May 2004, this could become an increasingly important factor), would effectively be shunned in favour of those nations who are more in favour of the Euro and expansion of European influence.

This is already becoming the case. Decisions are being made which only include the Euro nations and the United Kingdom are largely excluded from the process (as are Denmark, the other country against European Monetary Union). This abstention also acts as a sign of total Euro-scepticism – it is believed that abstention from the single European currency is effectively abstention from the European Union itself (especially since the United Kingdom is a major player in the European Union), and this action may endanger the position of the United Kingdom in Europe. This is something that could prove quite unprofitable for both the European Union and the United Kingdom.

“In or out [of Europe] is the fundamental question. A no vote [against the single European currency] would mean Britain pulling out of the union.” (Trade and Industry Secretary Patricia Hewitt, quoted in the Sunday Express, 23rd May 2004)

This places the United Kingdom in somewhat of a conundrum. If the United Kingdom does reject the entry into the European single currency, and does leave the European Union (although with the extension of the EU in May, the UK is not the only nation who is not a member of the European single currency, giving it some form of protection), who would the United Kingdom look towards for trade? Their exclusion from the Eurozone will create a loss of trade, and the best way to make up that trade would be to try to join the North American Free Trade Area (NAFTA). In joining the NAFTA, the United Kingdom will have free trade agreements with the whole of North America, and hopefully open up new markets between the two regions.

Recent indications, however, have shown that the United States would rather see the United Kingdom as a bastion of support for US policy within the European Union as opposed to a member of NAFTA, where the United Kingdom would be of much less use politically. The “Special Relationship”, from a United States point of view, would better be served, and of course maintained, with Britain remaining in the European Union and voicing its’ support for US policy at key moments.

Total withdrawal from any trade sector (or membership in all of them) does not seem to be a decent answer to the problem either. If total withdrawal were to occur, then the ‘Special Relationship’ with the United States would be in a position to break down. Complete membership in both would require Britain to use the Euro as selected currency (working on the basis that being a member of the single European currency was a requirement for continued membership in the European Union), while also allowing free trade from the outside of Europe – this could prove very hazardous to both European and American industries alike, and this would and could not occur. As such, working with these principles in mind, and with no alternative road to go down, the United Kingdom would be best placed within the European Union and within the European single currency.

However, analysts have suggested that economic losses may occur within or without membership of the European single currency. Toyota caused a large row in August 2000, as they demanded that all the United Kingdom dealerships and factories work in Euros instead of Pound Sterling. They later dropped the point in March 2004, and admitted that this was a moot point since the factories within the United Kingdom would be closed within 10 years, instead favouring factories in Russia. (BBC News Online, 2000; Times Online, 2004)

Many other big names in industry have also voiced their support of the Euro, including Honda (who said they would stay in England and maintain their car factories in Swindon, Euro or Pound Sterling alike), BAE Systems, Unilever and Gillette. BAE Systems proved to be a big blow to the anti-Euro camp, especially since the military contracts BAE Systems take on usually draw in over £40 billion per annum. Unilever has been quoted as ‘suggesting’ that contractors bill them in Euros in a similar manner as Toyota before them, and Gillette are using both Euros and Pounds quite comfortably. BAE Systems, Unilever and Gillette are also providing large sums of money to the ‘Britain in Europe’ pressure group.

As a counterbalance, many companies have been leaving countries such as Germany in an attempt to receive higher profits as a recession in Germany continues. In 2003, it was reported that large companies whose traditional homes have been in Germany such as Siemens had been cutting jobs and started moving both industrial and administration out of Germany and out of the Eurozone into Asia to find greater rates of stability and profitability following downturns in domestic economy and world markets. 2,300 jobs were cut at Siemens following an announcement in July 2003 (BBC News Online, 2003)

The stability of the Euro and the ‘safety’ of joining the single European currency is something that is constantly being brought into question. One of the reasons cited for this lack of stability is the lack of accountability and independent manner the European Central Bank (ECB) controls the direction the Euro will head.

While the mandate of the European Central Bank has been and remains to be the maintenance of low inflation, its’ main problem is that the body acts on its’ own without any form of regulation from member states and which cannot easily be changed or ordered. The board that makes the decisions is formed from the heads of all the national bank member states, and as such, some nations will not get their way on certain ECB actions. Some nations will receive adverse results from the decisions of the ECB and will have no way of rectifying the situation within their own countries. The control of their own currency is effectively given to a multinational board that is based hundreds of miles away.

In a sense, this arrangement is something already in place within the United Kingdom. The Bank of England already has an autonomous control over the rates of inflation. However, if control were given to the European Central Bank, the Bank of England would effectively become a fraction of a decision making body, and many people within the United Kingdom would not be willing to give up that amount of self-control when it could prove unbeneficial. This potential problem is deepened when it is noted that the British economic cycle can be compared more to that of the United States than that of the Eurozone (thus promoting the convergence problems mentioned earlier when looking at the five economic tests laid out by the British government) – any change which could cause problems could then exacerbate any economic problems within the United Kingdom. (Verdun, 2003)

The current record of monitoring from the European Central Bank over the member states is also hardly encouraging. France, Germany and Portugal have all exceeded their deficits for national spending - a maximum 3% budget deficit is supposed to be adhered to at the end of each year, and all 3 nations have exceeded this limit (PALCUS, 2002). This is an action that demands the attention of the European Union through sanctions or other means, but none of the member states have faced any form of repercussion or reprimand. It is this tardiness in reprimanding the member states, and the practical inability for member states to make demands or changes to the European Central Bank, that has increased the already flagging legitimacy of those who control the destiny of the project.

Another argument given against joining the European single currency at this time (although not ruling out possible future joining) is the various current climates that may cause problems for the United Kingdom’s entry. First is the fact that two of the economic tests for entry have been failed as mentioned earlier. Continuing on from this, it was hoped that the time of the entry of the United Kingdom would coincide with the Euro being at a transfer rate of between 1.3 and 1.4 Euros to the Pound. This was reached mid-way through 2003, but has since gone up to 1.4929 Euros to the Pound as of the 25th May 2004 (XE.com, 2004). A strengthening in the Euro would bring this closer to the Pound once again, but at the time of writing it seems like some time before this will occur again, mainly due to continued recession within several member states.

It is also worth noting that the European sector is not considered to be an optimal currency area. A definition of an optimal currency area is a region where a single monetary policy and economic cycle coincides with a single currency to create an optimal balance between them, and optimal results are created. Since the arrangement between the member states of the European single currency is one where the currency itself is controlled by the European Central Bank, and where other economic issues are not controlled in co-ordination with them by a European Federal Government (and further, British economic cycles are out of synch with the rest of Europe), the area therefore cannot be considered an optimal currency area.

Taking this fact into account (and taking into account the literature of Robert Mundell), the move to enter the European single currency by the United Kingdom can only be seen as a political move, rather than an economic one. The differences between the synchronisation of the United Kingdom and the member states are too great, as are the differences in monetary policy (although these are growing closer to the European standard). By definition this is an unsound move – making economic actions in the name of politics has in the past led to major problems (the expenditure on the joint European design project for the Eurofighter, as of July 2002, had gone well beyond the £8 billion mark, was projected to reach £15 billion, and is now almost a decade overdue).

The difficulty of the conversion itself, at this time, would prove high. While the Labour government has been putting into place various measures to move us towards a potentially comfortable transition, it can be easily seen that the United Kingdom will face similar problems that the member states faced in 1999. Costs to small businesses will cause major problems, and subsidising the process may cost an estimated £35 billion, a figure never denied by the government after its’ publishing within a report created by the ‘no’ campaign. (Chantrey Vellacott DFK, 2002)

Another problem will be an inevitable rise in inflation as a result of the measures and the transition, similar to that faced within the member states as a result of the move to the Euro from their former currencies. As the transition was made, prices were rounded up in an attempt to capitalise on the consumer confusion that resulted. In Germany, official figures recorded instances of price jumps of as much as 51% on tomatoes and 33% on cabbages, and in mid-2002 the Minister for Consumer Affairs, Renate Kuenast, had to have emergency talks with catering and service industry representatives over ‘Euro profiteering’ (BBC News Online, 2002). It is expected that should the United Kingdom join the Euro the same again would occur, leading to inflation spikes. This is something the government would want to avoid as best they could.

Lastly, an argument which is often pushed to the wayside due to its’ personal nature is the individuality of the Pound Sterling and the affinity of the United Kingdom’s population to it. The personal element is often over-ruled by the economic or political factors, but the importance of the support of the United Kingdom’s population, if only for their familiarity to the Pound Sterling, is what will sway a referendum against the move towards the European single currency should one take place. Even before the 1999 transfer to the Euro and the problems that arose, many countries saw referendums with very close results – France, for example, only had a 51% majority after the French referendum of 1992 (The Telegraph Online, 2004). While the personal element is often the least rational, and often does not take into account the economic or political factors (and remains an uneducated position, to some), this position cannot be discounted, especially since this is one of the underpinning views of the anti-Euro camp.

The dispute, as has become clear, has good points on either side of the debate. Politically, it would seem, the entry of the United Kingdom into the European single currency is required for them to survive within the European Union and for the current international political position of the United Kingdom to be sustained. It is also clear that the Government, whatever the political party, will not enter the Euro without the support of a referendum in favour of entry. While the political and economic benefits may ultimately turn in favour of the Euro in the years to come, as has been the case in some other EU States, strong arguments will need to be put to the electorate to gain support so as to overcome the UK's affinity with the Pound. This will require astute political management on the part of the Government for it to succeed.

Economically, though, entry into the European single currency seems full of potential pitfalls from which the United Kingdom could suffer significantly, especially when the decision to join would be an irreversible one. The move, as with many economic decisions, would be a risk that the UK ultimately has to take to avoid being economically isolated.


BIBLIOGRAPHY

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