David Smith reminds us of the economic arguments which have been swamped amid talk of loss of sovereignty in the emotional debate on whether Britain should be part of a European single currency
Nothing is better calculated to raise the temperature of any political discussion than the introduction of the phrase 'European single currency'. The British attitude, I would judge, is one of healthy scepticism, even among businessmen, where the strongest support for it is said to be found. As an aside, it seems to me that politicians reserve the label healthy scepticism for public opinion they agree with, and cynicism for that which they do not.
Anyway, scepticism it is, and it is not hard to see why. Before Britain's ERM experience in 1990-92 most people, I would say, were either indifferent to or slightly in favour of a single currency. After it, the general view has swung to one which says that, if that was how things are when we fix exchange rates with Europe temporarily, we had better think long and hard before doing so permanently. Conspiracy theorists might say that John Major proved himself to be the most effective Eurosceptic of all by taking sterling into the ERM at the wrong rate and wrong time and turning the electorate against the idea of close monetary co-operation with Europe. Another point is that Eurosceptics have been more effective in marshalling their arguments in favour of continued independence than the Euroenthusiasts have in advancing their case.
Amid all the emotional debate the economics usually gets lost. Here, it is worth reminding ourselves of the economic arguments. From a Europe-wide, as opposed to a national perspective, it is recognised that the adoption of a single currency would be a trade-off.
On the positive side, the two main advantages are a reduction in transaction costs and an end to destabilising currency shifts within Europe. The gains on these fronts are difficult to quantify, particularly in an era where sophisticated hedges against substantial currency changes are available to businesses. But they have been estimated, admittedly in studies for the European Commission, to be around 5% of Community GDP. The argument here is that full benefits of the single market will not be realised unless or until there is a single currency.
The strongest economic argument against is that if you take a bunch of diverse economies, with very different structures, levels of efficiency, productivity, and inflation performances, a single currency straitjacket will pose enormous problems. The economic solution to bridging the differences between the German, Spanish (20%-plus unemployment) and Greek (10% inflation) economies is usually to subsidise the poor performers. The danger is not only that the subsidies might have to be enormous but also that they would be insufficient to prevent political and social dislocation.
In practice, the problem is unlikely to be quite as stark. The basis for the Maastricht criteria was that only countries that have met certain conditions, mainly control of budget deficits, government debt and inflation, will be allowed to go forward into a single currency. This means, initially at least, Germany, France, the Benelux countries and Austria.
For Britain, the economic pros and cons of a single currency are those that affect Europe as a whole, plus one or two special ones. The essence of the debate is whether policy independence conveys advantages that would be lost in any collective arrangement. Again post-ERM experience supports the view that, in the short term at least, to be a free agent is best. France, which had the chance to match Britain's course of action when the franc was forced out of its ERM bands, chose not to do so. The result was that, instead of a devaluation-based recovery, France has been stuck with high unemployment and slow growth.
But is this a classic case of British short-termism? Single currency advocates argue that British policy independence is simply a freedom to inflate over the long term. The chart, which shows sterling's external value (measured against the Deutschmark) against its internal value (the purchasing power of each pound at home), makes the point. A depreciating currency and a relatively high inflation rate have gone hand in hand. Of course, this does not answer the question of whether fixing the exchange rate would improve the inflation performance. It may be that there is something innate in Britain's higher inflation.
The trickiest question for Britain arises if the core countries decide to move ahead to a single currency anyway - on current plans, in 1999 - leaving sterling extant, but relegated to the second division, whether or not this is deserved. After all, as the Institute of Directors says, Britain has done much of the hard work in terms of supply-side reform, and more than the rest of Europe in beginning action to limit the public pension burden that an ageing population will bring. The IoD advances this as a reason for staying out of a single currency. The counter-argument is that, by remaining in the mainstream of the monetary union talks, Britain would be in a better position, not only to influence its shape, but also to bring pressure on the rest of Europe to introduce necessary reform.
For it could be that a single currency will never happen. The Maastricht treaty envisaged a minimum of two 'no-devaluation' years in the ERM before a country could be considered eligible for participating in the single currency. Europe's central bankers have warned that the changeover from national currencies could take five years. This is a huge problem. The two-year condition would be an open invitation to speculators to have 'one last go' at individual currencies. If successful, the country concerned would be back at stage one. The five-year change-over period would also be open season for destabilising currency shifts. In the meantime, Britain may be losing important bargaining power by not appearing keener than she is on monetary union and a single currency.