Britain has joined the ERM, and now the next big step is to establish a single currency. It may find the shock greater, writes David Smith.
In October 1990, after years of standing on the sidelines, Britain joined the exchange rate mechanism (ERM) of the European Monetary System. By October 1991, if present indications are anything to go by, a decision will have to be taken on the extent to which Britain participates in the moves throughout Europe to establish a single currency.
That sentence deserves thinking about for a moment. A single currency means that 12 disparate economies and a community of 320 million people will effectively become one economic unit. And while timetables have proved over-optimistic before, the current one assumes that the necessary changes to the European Community's Treaty of Rome will have been agreed, subject to parliamentary ratification, by the closing month of 1991. By that time a process will have been established leading to a single currency by the end of the century.
It is clear what the general attitude of business is. Most surveys of business opinion find solid support for a single currency, for many of the reasons outlined in a European Commission report, "One Market, One Money". Others dispute some of these claimed benefits. Karl Otto Poehl, the president of Germany's Bundesbank, fears that, far from producing price stability, a single currency would produce a long-run inflation performance no better than the Community average. The worry is that a European central bank, faced with conflicting demands from different parts of the Community, would have to settle for an inflation rate somewhere between low-inflation Germany and The Netherlands and high-inflation Greece and Portugal.
That said, there is no doubt that in a narrow sense there are many advantages for business in a single currency. Obtaining currency cover, particularly for long-term contracts, is expensive. Even with a single currency, such cover would still be required for trade outside Europe. But all of the indications are that the proportion of Britain's trade which is with Europe will continue to grow.
The downside, of course, is that economic policy loses an important element of flexibility. In the months after sterling's entry into the ERM, a debate raged over whether the Government, in choosing a central parity against the Deutschmark of DM 2.95, had opted for too high a rate. In the ERM there is scope for amending errors, by realigning parities. In a situation of full monetary union, and a single currency, no such scope exists. In such a situation the inefficient would be punished and low-productivity regions would suffer. The danger is that the regional disparities existing in most EC economies, such as those between the North and South of Britain, would be exacerbated, and operate on a European scale.
This is why there is a clear cost to the rapid establishment of a single currency. Unless EC leaders are prepared to see ill-favoured areas of the Community lose out further, they will be required to agree on a programme of regional assistance. One can already see some of those single currency benefits disappearing in the higher taxation needed to pay for it.
However, the establishment of a single currency is bound to involve a few casualties. Britain's approach stresses that economic convergence must precede monetary union and the creation of a single currency. In particular, this approach allows for the so-called hard ECU to circulate alongside existing national currencies, and possibly to replace them.
Whichever route is chosen to a single currency, it is clear that some countries will be ready for it before others. The core Community countries - Germany, France and the Benelux nations - have similar inflation rates and have had little difficulty in holding their currencies steady against each other over a period of several years. These could move to a single currency within, say, five years. Others, including Britain, Denmark, Ireland, Spain and Italy, will find it difficult to do so by the end of the century. For Greece, Portugal and some of the Eastern European countries that will be knocking on the EC's door, locking in to a single currency could be difficult even over a 20-year period.
This raises a possibility which is regarded by the British Government, and by British business, as only slightly less alarming than that of the rapid imposition of a single currency: the possibility of a two-tier or multi-tier Europe. Is it realistic for Britain and others to expect the fast-track EC economies to hold back? Probably not.
The single currency step is a big one. It is easy to see the advantages but it is also plain to see that there will be very many costs. The shock of ERM entry has been considerable. The shock of a single currency will be even greater. It will be a bold politician who can weigh up those costs and benefits and say, with hand on heart, that he has made the right decision.
(David Smith is economics editor of The Sunday Times.)