The Euro and Britain’s role
The introduction of the Euro was started way back in 1957 when the “Treaty of Rome declared a common European market as a European objective with the aim of increasing economic prosperity and contributing to “an ever closer union among the peoples of Europe”1.
From there on, the Single European Act (1986) and the Treaty of Maastricht (1992) introduced the European Monetary Union which laid down the stringent criteria which every country must pass in completion of joining the Euro2. These criteria includes “Government deficit and debts must be no more than 3 per cent and 60 per cent of gross domestic product respectively; inflation rates and long-term interest rates be within 1.5 percentage points and 2 percentage points of the average of the three countries with lowest inflation; and the currency has stayed within the Exchange Rate Mechanism bands for two years”. (The Financial Times (London), Nov 12 1996). This is collectively known as the Stability and Growth Pact.
On the 1st January 1999, the Euro was launched with at that time 11 countries joining. These countries are Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, Holland, Austria, Portugal and Finland. On the 1st January 2001, Greece joined to make it 12
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Three member states declined to join the Euro in 1999, these are at present; Sweden, Denmark and the UK. Even though these 3 countries are part of the European Union each country has its own stance over the Euro. Sweden last year had held a referendum to see whether they should accept the Euro, however this result came back negative and are still independent from the Euro. The result came back that 56% of Swedes did not want to join and only 42% did want to join4.
Denmark had a referendum in 2000, however 53% said the Danish public did not want to join and only 47% did. The Danish Prime Minister Anders Fogh Rasmussen remained confident that a new referendum would be held in 2004 or 2005 depending on the outcome on the Swedish one. The Danish currency is also linked in to the Exchange Rate Mechanism and currently is linked to the Euro with a 2.25% band linked in with the Krone5.
On the 1st January 2002, The Euro came into official circulation within the European Monetary Union. This meant that all countries with their national currencies e.g. German DeutschMark, were being withdrawn in a 2 month dual circulation period.6
On the 28th February 2002, after the 2month dual circulation period, all national currencies were now exempt and only could be exchanged at banks commission free.
A few months later on June 30th 2002, commission free charges were now invalid and banks could charge commission on national currencies charges7.
With a solid introduction, I am now in a position to discuss the implications for the UK economy if they joined, not joined, and decided to wait.
The implications for the UK economy if they were to join would help strengthen the Euro as a international currency and also strengthen the European Monetary Union as a trading bloc. The UK, which is the “worlds fourth largest economy” has experienced a growth of 0.9% in the last quarter of 2003 the fastest rate in three years. As a whole the UK grew by 2.1% in 2003 compared to Germany who shrank by 0.1%. (Reuters (London) 23 Jan 2004). This would help the UK gain a positive reputation and may persuade the likes of Denmark and Sweden to join the EMU.
“The Eurozone inflation fell more than expected last month, which has led to the European Central Bank becoming under pressure for a cut in interest rates. The Eurostat commented that the annual rate of inflation was 2% in December 2003. This is because of the Euro appreciating by about 20% against the dollar”. (Financial Times (London) Jan 22 2004, pg 9). Meanwhile the UK has also experienced a rise in its currency value, but met with a completely different response. “While the soaring euro has set alarm bells ringing in the Eurozone, sterling’s rally, also a flipside of the weaker dollar, seems to have been greeted with little more than a shrug by British officials.
Sterling has roared up to 11-year highs above 1.8 dollars recently, having jumped by almost 20 percent over the past year and by six percent in December alone” 8. The implications here are that if the UK were to join they would lose the right to control their own interest rates, which is set by the Bank of England. The control would be handed over to the ECB in Frankfurt, which in the statement above are looking to cut down interest rates.
The Bank of England has contributed to the success in the UK achieving the fastest economic growth in 3 years. “It sets interest rates which represents the level appropriate to the economic cycle”.9 The ECB would set interest rates, which may not suit the current or future UK economic conditions. For example if the UK were in a boom, the Bank of England would higher interest rates. While the ECB are looking in a similar position with the Euro, to lower interest rates. The implication being here, that the UK economy may suffer from overheating.
Another implication for the UK economy would be the further step in completion of the European Single Market. “The initial objective of the European Community, on its creation in 1957, was the creation of a common or single market for traders operating within its borders. In effect this has meant establishing the free movement of goods, capital and labour”.10 The UK would not be allowed to introduce new customs duties, or have permission to tax any goods entering the country from a member state within the Eurozone. The UK cannot also have trade regulations, which discriminate against other countries. This is known as the free movement of goods.
There is also free movement of capital. This means that the UK economy, if they join, may not be restricted in the movement of capital. This reduces any transaction costs that may appear.
The UK would also enter the free movement of labour. This means that “Workers can move freely within the European Community, but only if they are looking for remuneration”.11
There are a number of positive implications for the UK if they were to join the Single Market. The UK would be able to compete with international rivals that are already free of the constraints in which Europe labours. This may lead to a more competitive environment compared to the present environment, as the UK would be competing on a level playing field. According to Lehman Brothers economist Alan Castle, “The Eurozone is Britain’s biggest trading partner, accounting for 60 percent of its trade, against 20-25 percent with the United States”.12
For UK businesses it is also good to join the Euro. “This is because businessmen interviewed consider that there is more competition today both at national and European level than in 1993. This has resulted in lower prices, improved product variety and better quality. Although these effects cannot be exclusively attributed to the Single Market, since many other factors affect the markets’ development, the Single Market is seen to be acting as a catalyst. Some 45% of all companies interviewed think that more competition as a result of the Single Market has been positive or very positive for their business. Only a quarter of the companies perceive more competition negatively. As might be expected, the intensity of competition has been more strongly felt by the companies that have experienced lower prices in their markets and have seen their market share drop”.13
This has been felt in a recent survey by Reuters which indicated that 62% of large businesses would feel a positive impact if the UK joined the Euro. Compared with 60% of small businesses whom who do not want the UK to join.14 More results indicate that the implication for the UK joining now maybe a positive one. “The European currency is seen as beneficial by 63% of larger companies and 68% of British fund managers, in an annual survey for the information group Reuters. The main advantage of joining the euro lay in its impact on the cost of financing and valuations, said respondents to the survey compiled by Tempest Consultants. A quarter of big companies questioned said being in the system would reduce financing costs while only 3% thought it would make things more difficult. For 42%, euro entry would enhance company valuations while 4% thought they would be reduced. Fund managers were bullish about prospects of improving sales and profits through the euro: 54% said joining would improve sales and 45% said it would help profits”.15
Another positive implication for the UK economy is that businesses would benefit from a fixed exchange rate from its biggest single trader. It provides the companies the luxury to plan and budget for possible future long-term expansion. It helps the business to predict the costs for European Markets and does not take into account exchange rate costs between the pound and the Euro. In addition to this customers may experience price transparency among similar goods in different countries. Meaning if a similar good is cheaper in another country compared to another one then this is wiped out, leading to greater competition.16
As I have said above the UK admission may remove exchange rate volatility. However I disagree with this statement. To back this up, a statement by the ECB chairman Jean-Claude Trichet pointed out that the current exchange rate volatility is having an negative effect on the Euro: “The ECB is concerned in the present circumstances. We particularly stress stability and we are concerned about excessive exchange rate moves”.17
The economic consequences for UK adopting a policy for wait and see are continued exchange rate costs. This means that the UK will still have to pay transaction costs when dealing with the Eurozone. However, according to the Conservative Party, the UK would save around £36billion on conversion costs.18 I do not agree with this figure because, according to the website above, there has been no independent survey undertaken to find out how much it would actually cost. The Trade and Industry Select chairman Martin O’Neill made a statement that the cost of conversion would be around £30billion.19 I do agree however that the UK if they wait and see, would save on conversion costs.
Another implication for the UK economy would be continued exclusion from policies made by the European Central Bank. For example a policy made by the ECB currently is the setting of interest rates for all 12 countries who have the single currency.20
However the UK has done very well in consistently outperforming the EU. Since the UK left the ERM in 1991, when it was set fixed rate policies back then, it has seen a dramatic fall in its unemployment levels.
“Since the Euro was launched Britain has been creating over 25,000 jobs per month and unemployment is at its lowest”.21 In the last quarter of 2003, unemployment fell by 0.1% from 5 to 4.9%. An overall fall of 29,000 over the quarter.22 Meanwhile in the Eurozone, unemployment in September was 8.8% with the biggest economy within the zone, Germany, showing figures of 9.4%. 23
Economic growth within the UK has also comparatively prospered than the Eurozone. A survey of UK independent economists released by the Treasury pointed out that the UK economy had grown by 2.1% in 2003 compared to 1.7% the previous year.24
Meanwhile economic growth in the Eurozone posted an economic growth of 0.4% in the third quarter of 2003 propelled by a 0.1% growth in the second quarter. Eurostat also predict the economic growth within the Eurozone is likely to be between 0.3 and 0.7% in the first quarter of 2004.25 This justifies my point that the UK has consistently performed better outside the Eurozone and justifies UK stance thus far.
Another indicator in where the UK has consistently performed better than the Eurozone, is in its continued consolidation of inward investment.
The UK, in 2002/2003 netted 709 investment projects, which represented a drop of a mere 7% on the previous year’s figure. The projects came from a total of 35 countries, with US projects representing 40% of the total. Inward investment from the EU represented 27% of the total.26 However on this point there is some disagreement whether the UK is suffering from not being in the Eurozone. Figures released by the European Commission in June 2003 show that the UK share of foreign investment from outside the EU fell from 48% of the total in 1998 to 25% in 2001. There has also been a decline in the UK’s share of cross-border investment from other European countries.
There is also difference on opinions on this particular issue. A report by Ernst and Young indicated that inward investment in the Eurozone fell by 13%. However David Godber, chairman of Nissan Design Europe claimed that “bureaucracy is killing inward investment into the UK” and the “euro is the key barrier to further inward investment in the UK”.27
For the Bank of England, if the UK were to wait and see, would still remain in control in setting interest rates for the UK. The Bank of England sets interest rates, which reflect the UK needs. However the ECB has the problem in setting interest rates for all 12 countries. Meaning that some countries would not be happy if the ECB cut down interest rates. This leads to a popular phrase “One-size-fits-none” monetary policy.
For example, “as the economy in Germany slumped for its second recession in January 2003, the decision for designing a single monetary policy for all 12 countries becomes difficult”. Furthermore, “”The result is that Germany is having to cope with higher interest rates than it needs, and its economy is slowing as a result. And that’s affecting everyone across Europe. Even though Germany is the biggest economy in the Eurozone, “The ECB’s key interest rate stands at 2.75%, whereas economists say Germany really needs a rate as low as 1% to stimulate demand, investment, and growth”. (Delong, Bradford, J. (2003), “Economists failed to predict shift as the poor got richer”, ‘Wall Street Journal’, January 24). As I have said above, the German economy suffered a slump of 0.1% in 2003.28 Meanwhile in Spain, GDP grew by 2.3% in the second quarter of 2003.29 This backs up my point that the UK would be saved from a One-size-fits-all policy. If the UK were to join, they could lose their economic growth through setting of interest rates by the ECB.
The implications of the UK not joining at all, may lead them to join other trading blocs around the world. Countries in EFTA are Iceland, Liechtenstein, Norway and Switzerland. Also within EFTA, the four countries have recently concluded a free trade agreement area with countries worldwide. The UK would not miss out on much as the Eurozone also has this pact and the UK would be able to use their own currency.30