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The economic case

Against the EUro
The Government has said that the determining factor underpinning any decision on membership of the single currency is the national economic interest and whether the economic case for joining is ‘clear and unambiguous’. This document from the no campaign sets out fully and brilliantly the doubts that must be overcome and the arguments that must convincingly be countered if the economic case for joining is to be established. It is required reading for the Treasury when it assesses the Government’s five economic tests.”

Sir Alan Budd, Chief Economic Advisor to HM Treasury and Head of Government Economic Service 1991-97; Member of the Bank of England’s Monetary Policy Committee 1997-99
“This tract is a powerful and comprehensive polemic, and presents a formidable challenge to the proeuro lobby to refute its arguments. The advocates of joining EMU now on economic grounds have to overcome some serious intellectual hurdles to achieve even a ‘not proven’ verdict.”

Sir Douglas Wass, Permanent Secretary to HM Treasury 1974-83
This is a comprehensive and thorough review of the issues with a number of very telling points. The authors do not hide their own judgement on the euro but support it with solid evidence and arguments that those taking a different view cannot ignore.”

John Flemming, Economic Advisor to the Governor of the Bank of England 1984-88;

Executive Director of Bank of the England 1988-91; Chief Economist to the European Bank of Reconstruction and Development 1991-93
I warmly welcome this immensely impressive contribution to Britain’s

overdue and very necessary euro debate. It should help discussion to

be raised to a more serious level than has mostly been achieved

hitherto. For myself I am fully persuaded that a single currency implies,

before long, a single country. Therefore, British adoption of the euro

cannot, in the long run, be reconciled with British political independence. In

addition, the euro fatally prejudices Britain’s longrun international

competitiveness, on which our prosperity ultimately depends.”

Peter Jay, Economics and Business Editor of the BBC 1990-2001
The no campaign has produced a very

convincing argument why a rush to join the

euro could be economically very damaging to

the UK.”

Lord Croham (Douglas Allen),

Permanent Secretary to HM Treasury 1968-74
The economic case against the EUro

Edited by Janet Bush with research by James Frayne and Neil O’ Brien.

The no campaign

In September 2000, Business for Sterling and New Europe formed the no campaign - a non-party political campaign that represents the two-thirds of the British public and business that believes Britain should remain a member of the European Union and keep the pound.

We are an alliance of economists, diplomats, parliamentarians, leading figures in the arts and media and many of the most successful entrepreneurs and business leaders in Britain. We are internationalists and come from all political backgrounds. We have tens of thousands of supporters among members of the public and from business. We are officially supported by the Institute of Directors (over 50,000 members, and directors on the boards of three quarters of the Times top 1,000 companies) and the Federation of Small Businesses (over 150,000 members).
We believe that losing control of our economy by replacing the pound with the euro would cause higher unemployment, higher taxes, and lower standards of living, and that Britain will be more prosperous and powerful if we keep the pound and remain a self-governing nation in the EU.

The New Europe Research Trust

The New Europe Research Trust is an educational trust. It is dedicated to publishing research on a wide range of European issues and working towards a blueprint for the future development of the European Union.

Web site:
© New Europe 2001 All rights reserved
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the permission of the publisher. Published by New Europe on behalf of the no campaign,

56 Ayres Street, London SE1 1EU, United Kingdom.

Telephone +44 (0)20 7378 0436, Fax +44 (0)20 7089 3827


Web site
Such permission was obtained telephonically from two individuals on November 8th. 2001 by Greg Lance – Watkins for and on behalf of – The original .pdf layout has been retained on our web site however this version has been created with permission of the publishers as a more convenient and readily, printable version.
THE ORIGINAL .pdf version was Designed and produced by The Creative Element Ltd.

Contents Of the FULL Text of The Book which runs to well over 100 pages. – THIS TEXT is a summary in 17 pages

Introduction 5

Executive Summary 6

Life in the euro era 15

Britain’s performance outside the euro

The EurozoneÕs difficulties with the euro
The case for the euro 19

Transaction costs

Transparency of price comparison

Exchange rate risk, trade, foreign investment and the cost of capital

One market, one money

Concluding the case for the euro

Britain’s five economic tests 27

The first test – convergence 28


One size fits all and the ERM

The Maastricht convergence criteria

The TreasuryÕs convergence test

Cyclical convergence

Exchange rate convergence

Structural convergence

Optimal currency theory Ð the true test of convergence

Summary of first test

The second test – flexibility 43

The TreasuryÕs assessment

What kind of flexibility Ð labour mobility

A system of fiscal transfers

Labour market inflexibility in the Eurozone

Reform is going backwards

Lack of product market flexibility

Regulation and red tape


Pensions driving higher taxes

Why we would have to pay for the EurozoneÕs bankrupt pensions

Tax harmonisation

Fiscal flexibility

Golden Rule versus Growth and Stability Pact

Loosening the Growth and Stability Pact

Fiscal tranfers

The euro needs a bigger EU budget - a paper by Sir Donald MacDougall,

former Chief Economic Advisor to HM Treasury

EMU has has no stabilisation mechanism Ð and isnÕt going to get one

An economic government in stages

Single currency, single state?

Summary of second test

Why convergence and flexibility matter 67

Joining EMU Ð a return to British boom and bust

Tests 1 and 2: Flexibility and the costs in economic variability - paper by Patrick Minford, Cardiff Business School, Cardiff University

Full methodological and statistical tables in Annex 1 and 2 in PDF form on

or from no office
The third test – investment 79



Recent investment performance

Inward investment performance

Why has inward investment been so strong?

Future prospects for investment

Public sector investment

The fourth test –the City– A paper by David Lascelles, Co-Director of the 85


Why have a test at all?

The City today

What will determine the CityÕs success

The record so far

The dynamics of the Eurozone

The single market in financial services

Who runs the City?

Threats to the City

Going in

Staying out

The fifth test – will EMU be good for Britain overall? 97


Europe isnÕt working

Why the euro is bad for jobs Ð supply side problems

Why the euro is bad for jobs Ð demand side problems

Maastricht Ð institutional deflation

The European Central Bank

Monetary and fiscal policy Ð never the twain shall meet

Conclusion 103

Five additional tests for euro entry

Bibliography 105


This publication is dedicated to the memory of Sir Emmanuel Kaye

Particular thanks go to the authors that have contributed to this pamphlet, namely:

David Lascelles, Sir Donald MacDougall and Patrick Minford;

to others whose academic work has been such a valuable resource including:

Philip Arestis, Roger Bootle, Brian Burkitt, Martin Feldstein, James Forder, Warwick Lightfoot, Jonathan Michie, and Malcolm Sawyer;

and to those who read this manuscript and gave us the benefit of their wisdom including:

Douglas Allen, Kenneth Berrill, Alan Budd, John Flemming, Charles Goodhart, Bryan Hopkin, Peter Jay, Alan Peacock, Tony Thirlwall and Douglas Wass.


The question of whether Britain should join the European single currency is of undisputed importance. This decision is permanent. It is certainly the case that either a forced withdrawal from the euro in some future crisis, or the collapse of the euro itself, or indeed long-term economic instability or stagnation inside the Eurozone would be measured in jobs lost and families ruined.
That is why we must get this decision right and why the no campaign has compiled a comprehensive view of the economics of the euro decision. The economics matter if the Government is to attempt to ensure that British entry into the euro is not to put the long-term prosperity of Britain at risk.
The Chancellor said in a parliamentary debate on the euro in March 2001 that the Government did not rule out the euro on the basis of dogma or ideology. Neither do we. The no campaign does not say “never” to the euro. We are not in the business of putting up hurdles to entry for the sake of it. However, we believe that its institutional framework has serious flaws that threaten the long-term stability of the euro. To address these questions - and so help ensure that any decision to join the euro is sustainable - is not to be xenophobic or anti-European. We approach these questions within the context of committed support of Britain’s membership of the EU.
We also believe that, to attain the “success” that is the UK Government’s precondition for entry, the Eurozone needs a far greater degree of democratic and political cohesion than the EU currently enjoys. A single currency system, in the best of economic and political conditions, is a very hard act to pull off. The lack of genuine popular political backing for the project is a worrying element.
The no campaign does not prejudge the kind of economic model that is desirable for European economies. Governments, in a pact with their electorates, make their own choices about what economic priorities override others. Some countries prefer a relatively regulated model, sometimes with higher levels of taxation and a greater public sector. Others, such as Britain since the end of the 1970s, have opted for deregulation and a greater role for the private sector. Members of our cross-party campaign hold a wide variety of views on which economic approach is likely to work best. What is common to us all is that we believe that the ability to make these economic choices should be preserved. Our concern is that, within EMU, the choices are narrowed.
Even during the recent period of comparatively healthy growth for the world economy, British entry into the euro looked too risky a proposition. That is why opinion polls have consistently shown that some two thirds of the general public, businesses and trade unions have been opposed to euro membership. At a time of increased uncertainty in the world economy after the terrorist attacks on America on September 11 2001, it is vital Britain retains the maximum degree of flexibility in order to shield the economy from the turbulence ahead.

Executive summary

“In short, monetary union, in the manner and timetable envisaged in the treaty, is an economically and politically misconceived project.” (Ed Balls, Chief Advisor to the Treasury, Fabian Society pamphlet 1992)
We believe:

  • It is far from clear that the euro is “a successful single currency” now or will be a successful single currency for the foreseeable future - the first criterion for joining it.

  • The Treasury’s five economic tests have not been met.

  • They will not be met in a “clear and unambiguous” fashion within the next two years - the Government’s “standard of proof” and timetable.

  • Economic and Monetary Union (EMU) is only likely to work in the long-term if it is accompanied by a form of political union, including tax-raising powers.

  • We should only join if (a) a political union is created for the Eurozone countries and (b) this is acceptable to the British public. We do not think these conditions can be met within the next two years, this Parliament, or the foreseeable future.

    The Government’s policy on the euro states that not only do its five economic tests have to be met, but that the euro has to be “a successful single currency” before it would recommend entry and that the economic case for joining has to be “clear and unambiguous”.

    The five tests are:

  • Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis?

  • If problems emerge is there sufficient flexibility to deal with them?

  • Would joining EMU create better conditions for firms making long-term decisions to invest in Britain?

  • What impact would entry into EMU have on the competitive position of the UKÕs financial services industry, particularly the City’s wholesale markets?

  • In summary, will joining EMU promote higher growth, stability and a lasting increase in jobs?

    In October 1997, the Treasury published its own assessment of the tests which gives us a useful benchmark. It concluded that the tests - in particular the crucial ones of convergence and flexibility - had not been met. For each of the five tests, the Treasury’s conclusion was:

  • Convergence: “The UK is not convergent enough to commit to joining EMU in the first wave. Our economic cycle is not in line with others. But there are also structural differences in the UK economy - for example, in our trade patterns, oil, company finance and housing market.”

  • Flexibility: “There are weaknesses in key areas… Europe also needs to tackle its problem of high unemployment to make EMU work as a whole… We need to work further to ensure the EU economy as a whole is able to create jobs and respond to structural change.”

  • Investment: essentially the Treasury concluded that there could be advantages if EMU works in broad economic terms, but that this is not yet proved.

  • City and financial services: again, the Treasury concluded that the City may gain from membership, but “the best assessment at this stage is that the City is at least as well prepared as other centers and that legal and other barriers to trading in the euro in the City

  • should not arise.”

  • Employment: any gains from EMU could only be realised if Britain were “durably converged” and “sufficiently flexible”. Without these conditions, “there could be substantial economic turmoil… with serious harm to jobs and prosperity. At present, the UK economy is not synchronised with the rest of Europe. Structural differences have also been at workÉ Neither flexibility nor convergence are sufficient at present to make joining EMU in the near future desirable. Unless there is some profound change in circumstances, it is likely to be some years before we can demonstrate that we have achieved sustainable convergence.”

These tests throw up fundamental issues about whether EMU will be good for Britain. Slight changes in economic circumstances, such as changes in growth and inflation rates, are simply not enough to put these fundamental issues right and it is difficult to see how the Treasury could claim that there have been substantial changes since its 1997 analysis that would justify a positive assessment of the tests.

We believe that the Treasury tests are a welcome extension beyond the wholly inadequate Maastricht criteria that served for the 12 countries that have already joined EMU. However, we also contend that the tests are far too open to interpretation to suit the Government’s political objectives and do not provide a satisfactory blueprint for Britain’s membership of a “successful” single currency.

In this document, we have analysed the tests afresh. But we have also compiled a critique of the tests themselves and offered the Treasury a more comprehensive examination of what economic and political features need to be in place to ensure not only that the benefits for Britain could be Òclear and unambiguousÓ but that would help to ensure the long-term “success” of the euro.
We also take issue with the notion of the tests that has been sold to the British public: “Is Britain good enough to join the euro?” Instead, we believe the tests should answer the question: “How must the Eurozone change to make the euro a long-term success and are these changes acceptable to EuropeÕs peoples?”

Five additional tests for euro entry

We have, therefore, briefly articulated five further tests that we believe will help clarify fundamental flaws with the design of EMU. They are:
1. Labour market and other reform. We believe that the onus is on the Eurozone to make its markets more flexible to compensate for the inflexibility of a single monetary policy. The reform programme Ð discussed at the Lisbon and Stockholm summits - has, if anything, gone backwards. In advance of French and German elections next year, the Barcelona summit in March is unlikely to see significant advances. Significant progress is needed on all fronts before Britain should contemplate joining the euro. Labour markets have not been liberalised since October 1997.
2. Reform of the fiscal policy framework. A more intelligent fiscal policy framework has to be devised to provide more flexibility to compensate for the rigidity of a single monetary policy. In the long-term, no monetary union works without an automatic stabiliser, usually through providing fiscal transfers from a federal budget. The prospects of this currently are minimal because of political opposition but this is what is needed if EMU is to work. In the absence of such plans, fiscal policy is misguided and inadequate. Instead of tax competition at regional or state level which would give dynamism to the Eurozone, the push is for tax harmonisation which threatens the Eurozone’s competitiveness. Efforts to discipline national budgets through the Growth and Stability Pact are a muddle. At the very least, until a sizeable automatic stabiliser is put in place, the Stability Pact should be reformed to give more room to use fiscal policy counter-cyclically, within agreed rules, so that the Eurozone can cope with shocks.
3. Reform of the European Central Bank. It is far from clear that the monetary regime of the Eurozone enshrined in the Maastricht Treaty and carried out by the European Central Bank is better than, or even equivalent to, the monetary policy framework now in place in Britain which has a considerable degree of openness and democratic accountability. The ECB must become more transparent and accountable to democratically elected governments. It should adopt a UK-style symmetrical inflation target to give more flexibility in policy over the cycle. And it should establish a track record of success in meeting a sensible inflation target.
4. Exchange rate. The exchange rate must be made a central element of the Treasury’s First Test. A judgement has to be made about the level at which British business feels competitive against the Eurozone. This level should then be subject to a negotiated agreement with other Member States and made public before any referendum so that the public votes knowing the entry rate of sterling. In addition, the precise situation regarding the Exchange Rate Mechanism must be agreed and made public before a referendum. Must sterling be in the ERM for two years before joining the euro? Or is sterling just required to show a period of stability against other European currencies? These aspects must be clarified.
5. A constitutional settlement for the EU. We believe that a far more centralised economic government of Europe is needed to make the euro work in the long term. This has huge constitutional implications. In 2004, the EU is due to create a new constitution for itself. This is the opportunity to enshrine within the EU constitution safeguards to ensure that we do not find ourselves taken into a single European state against our wishes. We therefore believe that a referendum on the euro should only be held if these safeguards are put in place at the 2004 intergovernmental conference.

EMU – a democratic contradiction

These additional tests illuminate the central contradiction in the EMU project which lies at the crossroads between the economic and political. This is the fact that the Eurozone needs much further political integration if it is to work in economic terms. Yet this political integration does not have the popular support of the peoples of Europe, not least the British public.

The economic and monetary union that has been built has serious shortcomings but there is no political consensus in favour of policies that will put these design faults right.
Monetary unions take away the flexibility over economic policy normally enjoyed by national governments. Different forms of flexibility have to be found to compensate for the loss of control of the main levers of economic management. Otherwise, permanent strains can develop within the single currency zone with no way of righting imbalances between prospering and stagnating regions. America, the world’s most successful monetary union, has these forms of flexibility. The EU does not.
One source of flexibility is the mobility of labour so that people can move freely around a single currency zone to look for work and so iron out differences between high unemployment and low unemployment regions. Another is labour markets that react swiftly both to boom and recession through the adjustment of wages. In the case of the Eurozone, neither of these are present.
In the absence of these flexibilities, the best way of managing a monetary union successfully is to develop a system of fiscal transfers - payments through the tax system which move money within a monetary union from prospering regions to underperforming ones.
EMU will not work well - and perhaps not even survive in the long-term - without a large further transfer of political power to the EU so that taxes can be raised centrally and provide for the necessary fiscal transfers. At present, the EUÕs budget is only 1.27 per cent of total GDP. In America, up to 45 per cent of the federal budget is available for transfers. This, above all, has ensured that the American monetary union has been a success.
In Europe, there is no political backing for a large, centralized budget. Europe is attempting to build a monetary union on the basis of nation states with independent tax-raising powers. We do not believe that this will work. In America, people in one stateare happy to subsidise those in another state who are facing lean economic times because they share the solidarity of belonging to the same country. Until this same fellow-feeling develops in Europe, the necessary centralisation of the EU budget and a system of fiscal transfers will not be accepted and will create political tensions. In the American case, if Texas goes through bad economic times because the single US interest rate is wrong for its economy, it doesn’t seek unilaterally to leave the United States of America. In the case of Europe, a state which is permanently suffering within the monetary union may well want to leave, putting the euro’s survival at risk.
The transfer of political power that is necessary to manage a large monetary union is openly acknowledged on the continent. In Britain - because it is, at present, an unpopular political notion - it is denied.
Until we discuss the full implications of joining the euro – and what is needed to make it a success - the British debate will continue to be dominated by shadow-boxing, smear and slogans and we will not have done our democratic duty. Even more crucially, unless the Eurozone puts right its fundamental flaws, it will remain an unstable and skewed structure, incapable of adapting to the intensifying competition of a globalised 21st century economy.
In the absence of the necessary change, Britain should have no hesitation in continuing to rely on our independent currency and economic policy in combination with our established parliamentary democracy.

A new analysis of the economics of the euro

The euro record so far

Campaigners for British membership of the euro have continually warned that Britain would suffer terribly by staying outside. These predictions have failed to materialise. Britain has enjoyed the lowest inflation rate in Europe, one of the lowest unemployment rates, the lowest level of interest rates for 37 years and record levels of inward investment. The City, far from losing business to Eurozone financial centres, has thrived.
As Stephen Byers, then Trade and Industry, said in an interview with Sunday Business in February 2001: “It is a great irony that in terms of convincing the British people to join the single currency, one of the problems we will have is the success of our economy at the present time … People will ask: ‘you going to put all that at risk

by joining the single currency?’ “

Britain has continually confounded pro-euro pessimists. At the same time, the euro has continually disappointed its supporters. They said that the euro would be a stronger currency than the pound and would be a stable global currency that would soon rival the dollar. It has, in fact, been weak and unstable, reflecting the instability of the euro economies which have already failed to live successfully with a single interest rate and the already evident institutional tensions that have developed between the ECB, the European Commission and national governments.

The case for the euro answered

Transaction costs

The European Commission has found that, for countries with advanced banking systems such as the UK, there would be savings of around 0.1 per cent of GDP from joining the euro. The 0.1 per cent of UK GDP is the equivalent of about £1 billion a year. This is a fairly small sum, although, of course, it is a gain that could continue indefinitely, depending on the share of such currency exchanges in GDP. It seems rather likely in fact that these exchanges will steadily diminish in importance as credit card and other banking payment mechanisms penetrate ever deeper into tourist practice. A reasonable practical assumption might be that the savings on transaction costs remain about constant in absolute terms at £1 billion in today’s prices.

This saving has to be set against the one-off costs of changing currencies. There are different estimates of this, of between £10 and £30 billion. Unfortunately, the Government refuses to publish any estimates of its own on the subject. It is clear, however, that neither transaction costs nor changeover costs are decisive for either side.

Price transparency

Studies of price differences show that differences across Europe exist because of real differences in economic structures - particularly tax and regulatory levels - and joining the euro could have only a very marginal effect on prices in Britain. The argument that the euro means an “end to rip-off Britain” is false.

Even some in the pro-euro camp admit this publicly. In an article in the Independent on Sunday, Alison Cottrell, a member of Britain in Europe’s Council, said: “If the euro’s primary purpose in life were to allow consumers in Hamburg to spot a bargain in Capri and avoid hefty conversion charges, the whole exercise would scarcely have been worth the effort. The internet, credit cards and competition policy could have produced most of the benefits with none of the upheaval.” (September 2 2001)
Exchange rate stability
We are not joining a world currency but a regional currency. The Eurozone accounts for 43 per cent of our trade. The dollar is, overall, more important to the British economy than is the euro. The pound is far more stable against the dollar than the pound is against the euro, or the euro against the dollar.
Therefore, any stability for our trade with the Eurozone would be balanced by increased volatility for our trade with the rest of the world. Joining the euro is not just a question of balancing “gains” from exchange rate stability against a more unstable domestic economy. It is questionable whether there would even be a net gain from exchange rate stability with the euro.
A small number of exporters may be damaged by exchange rate fluctuations and therefore naturally feel inclined to speak publicly, but they should not be taken as indicative of the economy in general. The evidence does not suggest that trade in particular nor the economy in general are damaged by exchange rate shifts.
A wide range of empirical studies, including work commissioned by the International Monetary Fund, have found little, if any, impact of exchange rate volatility on trade.

One market, one money”

The pro-euro lobby argues that Britain must be part of a big market to thrive and that it must share the same currency as that market.

The first part of this argument is questionable. The richest state in Asia is Singapore - a small island with almost no natural resources; and the richest country in Europe is Switzerland, which is not even in the EU, never mind the euro. It is clearly not necessary to be big in order to be prosperous. In any case, Britain is already an integral and full member of the European Single Market.
The second part of the argument Ð the idea that free trade or a single market inherently requires a single currency Ð is clearly wrong. The US, Canada, and Mexico have created the North Atlantic Free Trade Area Ð and the new US administration has proposed extending NAFTA to the whole of North and South America. Nobody suggests, however, that such a free trade area requires a single currency.

The case for the pound

The Maastricht criteria
Britain meets four out of the five criteria set out in the Maastricht Treaty. It meets the inflation, interest rate, budget deficit, and public debt criteria. These criteria are not adequate tools to assess suitability for a monetary union. The USA also meets four out of the five criteria, yet nobody would suggest that America was ÒconvergentÓ with the Eurozone or suitable for monetary union with it.
Britain does not meet the exchange rate criterion and has not since its withdrawal from the ERM in 1992. The Maastricht Treaty states that euro members should be members of the Exchange Rate Mechanism. The Government has said that Britain will not re-join the ERM.
It is unclear how the exchange rate issue would be addressed were the Government to make a significant attempt to join the euro. There is no explicit reference to it in the Treasury’s assessment. The National Changeover Plan suggests the Government intends to negotiate the entry rate after winning a referendum, thus leaving the public to vote in ignorance of the rate. Some pro-euro campaigners have suggested that the Government negotiate the rate before a referendum. We think they are right.

The first test – convergence

Cyclical convergence: In October 1997, the Treasury concluded that “the correlation of the cycles between the US and UK tends to be higher than between the UK and Germany”. Using updated figures, it is clear that there has been almost no correlation between Britain’s economic cycle and the Eurozone cycle over the last decade. As an IMF report concluded in February 2001, inflation rates have continued to diverge both within the Eurozone and between the Eurozone and Britain, inflation and growth rates continue to diverge, and BritainÕs economic cycle continues to be more in sync with the USA than with the Eurozone.
If Britain had joined the euro in 1999, it would have suffered from lower than appropriate interest rates and higher inflation. The current weakness of the euro is also an indicator of the lack of cyclical convergence. Were the sterling exchange rate to be “managed down”, it would lead to higher inflation and require higher interest rates, thus taking us even further away from cyclical convergence.
Structural convergence: Our analysis of the structural differences between Britain and the Eurozone shows that substantial and serious structural differences between the two persist, with the position little changed since the Treasury’s assessment in October 1997.
The principle differences are:
Trade: the Eurozone accounts for only 43 per cent of British trade, and trade with the Eurozone is less important for Britain than it is for Eurozone members. In its 1997 assessment, the Treasury acknowledged that Britain did a higher proportion of its trade with countries outside the Eurozone, saying that, “the UK is vulnerable to changes in demand in non-European Union countries to a greater extent than other Member States”. However, the Treasury then suggested that, although a very high proportion of our trade was done outside the EU, “in time, the pattern of UK trade may change.”
However, recent research by Roger Bootle ( Britain’s trade with the EU and the rest of the world, June 2001) suggests that the differences in levels of economic and population growth between the EU and the rest of the world could see the EU account fall to under 35 per cent by 2050.
It is notable that UK exports to the Far East have grown almost twice as quickly as those to EU members since 1987, whilst over the last decade the EUÕs share of world trade fell by one quarter.
The fact that the mix of BritainÕs trade is different from most economies in the Eurozone means that Britain reacts to economic shocks - an attack on America for example Ð in quite a different way to EMU countries. This is a crucial structural divergence. It also makes the argument about going into the euro for the sake of currency stability much more ambiguous.
Interest rate sensitivity: British firms and households are more sensitive to interest rate changes than Eurozone countries because of a higher level of home ownership and a larger proportion of variable-rate mortgages.
Oil: Britain is the only net oil exporter in the EU, so any shift in the international price of oil would affect Britain differently from the Eurozone.
Pensions: Most Eurozone member states, and all four of the largest, have massive debts accumulating in the form of un-funded liabilities they owe to future state pensioners. The EurozoneÕs pensions problem is well recognised in Europe but little progress has been made in tackling it. In February 2001, Frits Bolkestein, European Commissioner for the Single Market, said: “Pensions payments could easily turn into a vicious circle. If pension spending were not reformed, but led to higher deficits, some countries would not respect their obligations under the growth and stability pact; which in turn could lead to inflationary pressures; which in turn would result in the ECB having to set higher interest rates with negative impact not only on investment, but also on growth and employment, which are the basis of sustainable pension systems… Clearly the reply to these questions - pay more, work longer, get less - is not an easy message to sell.”
The enormous levels of these debts will put EMU under significant strain. The two most likely “solutions” are fraught with difficulty: tax rises so workers pay the debts, or inflation to erode the value of the debts. Either of these would damage Britain were we part of EMU. Britain does not have this pension problem - indeed, Britain has more invested in private pensions than every Eurozone member combined.
This problem, of large deficits among fiscally sovereign states in a monetary union, is exactly what has caused previous experiments in monetary union to dissolve, and will certainly cause serious problems for the Eurozone in the decades to come, whatever action is taken now.

The second test – flexibility

“The single currency alone will not make Europe prosperous. The single currency plus fundamental reform in labour, capital and product markets and in our welfare systems can do so. Economic reform is crucial, not just to the success of Britain’s participation in the euro, but to the euro itself.” (Tony Blair, February 23 1999)
The two most important aspects of flexibility are flexibility in the labour market and the tax system. The Eurozone is deficient in both.
The Treasury acknowledged in the 1997 assessment: “In principle, the Treaty provides for full freedom of movement of both capital and labour. However, in practice while capital is highly mobile both inside and outside the EU, the extent of cross-border labour migration is low and tends to be focused on highly paid professionals. Social, economic and cultural barriers remain high.” According to the pro-euro Financial Times, the EU has six times less mobile labour markets than the USA.
The EU has publicly commented on the need for economic liberalisation for a number of years: for example, the Delors White Paper (1993), the Luxembourg process (1997), the Cardiff process (1998), and the Cologne process (1999). In Lisbon in 2000, a system of annual “economic reform” summits has been set up, the second of which was held in Stockholm in March 2001.
The process has not been a success, and in many areas, the Eurozone is less flexible than it was in October 1997. Frits Bolkestein, European Commissioner for the Single Market, said after Stockholm in April 2001: “It is particularly disappointing to see such poor performance in the first year since the Lisbon strategy was agreed. This shows that commitments made at European summits are not always translated into concrete action. A gap exists between rhetoric and reality.”
The seriousness of the lack of flexibility was underlined by the ECB’s Chief Economist: the lack of reform in the Eurozone poses ”an almost lethal threat to monetary union” (Dr Otmar Issing, Chief Economist at the ECB, March 17 2000).
A second crucial element of flexibility is in fiscal policy, but the institutional structure of EMU is seriously deficient.
Around 45 per cent of US federal taxes (19 per cent of GDP) are used to iron out imbalances. During the business cycle of the late 1980s and early 1990s, California’s marginal contributions to federal receipts fell from 17 per cent in the boom to just 8 per cent during the bust.
The EU budget is only 1.27 per cent, and there is no structure, as exists in the USA, for transferring money to compensate for the problems of monetary union and no political backing for one
America’s monetary union has been successful because of a combination of fiscal flexibility at a federal level, with a large automatic stabiliser, and flexibility in tax at state level, injecting dynamism and competition into the American economy. The Eurozone is pursuing a diametrically opposite system whose hallmark is rigidity: no automatic stabiliser at federal level and tax harmonisation, rather than competition, at state or national government level.
Overall, it is clear that neither the Eurozone nor Britain are any more flexible that they were in 1997 or earlier this year when the Prime Minister said the tests had not been met.
A new computer model of British entry into the Eurozone.
The no campaign has commissioned new work using computer modelling to assess how the British economy would respond to joining EMU. The Liverpool model shows that a combination of lack of convergence and lack of flexibility leaves the Eurozone - and Britain if it were to become part of the single currency area Ð far more prone to economic variability. Even improvements in the areas of flexibility, as illustrated by the Liverpool model, are not sufficient to counteract the damaging effect of living within a one-size-fits-all interest rate. Britain’s economic history is peppered with episodes of boom and bust with the damage being measured in mass unemployment.
The Liverpool model’s main findings are:
Britain would be far more vulnerable to a return to boom and bust if it joined the euro rather than staying outside and keeping the pound and control over its own independent economic policy.
Joining EMU would increase the variability of the economy - the boom and bust factor - by 75 per cent.
The instability of growth or output would be nearly a third higher inside the euro.
Swings in employment and unemployment would be nearly a fifth higher inside EMU.
Real interest rates would be more than four times more variable inside EMU.
Inflation would swing around 10 times more if Britain were inside the euro.
One key pro-euro argument is that joining the euro would cut out all exchange rate risk on trade with Europe and therefore make the British economy more stable. These results show that this alleged benefit is far outweighed by the cost of losing control over national interest rates which creates a far more unstable economic environment overall.

The third test – investment

Business investment as a share of GDP is now higher than at any time in the past 40 years, and is now higher in the UK than in the US, France and Germany. The obvious response is to ask why we need to undertake a fundamental change in macroeconomic policy?

Foreign direct investment (FDI) is at record levels. There is overwhelming evidence that inward investment is thriving whilst the UK resides outside the Eurozone. Latest figures show the stock of inward investment rose 36 per cent in 2000, whilst the number of new projects increased by 15 per cent.
There are fundamental structural reasons why the UK is such a magnet for inward investment. Strong investment is dependent on macroeconomic stability. The computer modelling analysis above shows that joining the euro will create a far higher degree of economic variability.
Long-term interest rates in the UK are now lower than in the Eurozone, reducing the cost of investment for UK firms, because of the success of the independent, but accountable, Bank of England. This removes the main argument that investment would benefit from EMU.
Three long-term developments significantly increase the future relative investment attraction of the UK. First, over the coming decades, population decline Ð especially working age population - will be much less in the UK than in the Eurozone. The magnitude of the prospective falls has severe implications for prospective EU GDP growth and will damage the Eurozone’s attractiveness as an investment location. Second, the un-funded pension crisis on the continent threatens to increase long-term bond yields and decrease investment as a result. Finally, if the UK were to join the euro area, potential tax harmonisation could raise corporate tax rates in the UK. This would be bad news for investment, because higher marginal tax rates reduce the returns to investment.
The incompatibility between the Chancellor’s Golden Rule – which allows government borrowing to invest - and the Growth and Stability Pact, is likely to reduce the scope in Britain for public sector investment. The Treasury have argued that the Golden Rule is necessary to prevent ”discrimination against investment”. Would the Chancellor be happy to curtail investment in new hospitals, schools, roads and railways in order to satisfy the Growth and Stability Pact?

The fourth test – the City

Far from suffering by Britain remaining outside the Eurozone, the City has thrived. Indeed, its interests would be jeopardised more by joining EMU than remaining outside.
After nearly three years of the new currency, there is no evidence of loss of business from the City. If anything, the movement has been in the opposite direction. Since the euro was launched the great bulk of international business in euros has originated or been transacted in London, not Frankfurt or Paris. The main location for “book runners” (i.e. organisers) of eurobond issues denominated in euros is London. London has also become the largest centre for foreign exchange trading in euros. Most of the large cross-border mergers and acquisitions over this period have been masterminded by corporate finance departments which are located in London. And London is second only to Germany in the amount of euros it transmits through the international payments system, well ahead of large Eurozone countries like France and Italy. Nor is there any sign of EU financial institutions deserting London since the euro’s launch. Between March 1998 and January 2001, their number increased from 238 to 350, a rise of nearly 50 per cent.
The real threat to the City’s success is membership of the euro. For a start, it would make it more vulnerable to harmonization pressures, and cut into its independence. The City is already under pressure to conform to continental preferences, and that pressure would grow if it was bound by the “mutual interest” ties of the Eurozone. The UK’s position outside the Eurozone is actually a strength: it makes it easier for the Government to take a stand against measures it does not like. The UK might even have had to give way on the withholding tax argument if it was inside the Eurozone. The City will not only do fine outside the euro. Its best interest lies in remaining outside.

The fifth test – the effect on jobs and British prosperity as a whole

The fifth test is the sum of all the others. Taken together, our analysis of the first four tests argues unequivocally that joining the euro is highly unlikely to promote “higher growth, stability and a lasting increase in jobs”. It is impossible to make the case that joining the euro would have “clear and unambiguous benefits”. It would be easier to argue that it would have “clear and unambiguous costs”, as EMU is currently constituted.
The fifth test is also the first test to mention jobs. Job creation is the ultimate yardstick of economic success or failure and the Eurozone has failed in this respect. Eurozone unemployment has been far higher than UK levels for some years. Eurozone unemployment levels have fallen only very slowly and are now rising again.
The pro-euro campaign has repeatedly claimed that Britain’s decision to remain outside the euro has cost our economy jobs. In fact, Britain has been outperforming the Eurozone on jobs despite the weakness of the euro which has made life hard for some British manufacturing exporters.
The fact is that UK manufacturing has performed substantially better than the Eurozone. Between 1992 and 1999, the most recent internationally comparable figures available, Germany lost nearly one in five of its manufacturing jobs and France one in ten as they tried to qualify for EMU. Britain in contrast saw a very slight decrease of less than 0.1 per cent according to figures from the US Bureau of Labor. Overall, Britain has created 842,000 jobs since January 1999, taking UK unemployment down to its lowest level since 1975.
It doesn’t matter from which economic tradition - or part of the political spectrum Ð that economists belong to. Few believe that EMU, as currently set up, can act as a motor for job creation. Free market economists point to rigidities in Europe’s labour market as the prime reason for mass unemployment. Keynesian economists put Europe’s poor job creation performance down to a lack of demand, with an ECB pursuing a strict anti-inflationary policy with no mandate to pursue growth and employment and to an overly rigid interpretation of limits on national budgets.
Overall, they argue, the institutional framework enshrined in the Maastricht Treaty, amounts to “institutionalised deflation”. There is, quite simply, no policy instrument in the Eurozone aimed at tackling unemployment.
The fundamentally flawed institutional design of EMU must be corrected if Britain is to contemplate joining the euro. Otherwise, there is no prospect that the Treasury’s fifth test – “a lasting increase in jobs” - can be met.
Much of the controversy on the euro is superficial and this comprehensive

study is a welcome contribution to a serious debate. It shows convincingly

that the euro is all too likely to cause severe tensions in Europe; and that, if we

joined, we should to a large extent lose control of our instruments of economic

management and so our ability to combat both unemployment and inflation.”

Sir Donald MacDougall, Head of Government Economic Service and Chief

Economic Advisor to HM Treasury 1969-73; Chief Economic Advisor to the

Confederation of British Industry 1973-84
This thorough review of the arguments shows that the advocates of UK entry to the euro have a formidable case to answer.”

Sir Bryan Hopkin, Head of Government Economic Service and Chief Economic Advisor to HM Treasury 1974-77
It is highly desirable to have both sides of the economic argument about euro entry put urgently and forcefully. This monograph does so most effectively for the ‘no’ side. Both the ‘yes’ side and the arbiters in the Treasury will need to take careful note.”

Professor Charles Goodhart, Chief Advisor to Bank of England 1980-85; Member of Bank of England’s Monetary Policy Committee 1997-2000
Joining the euro is the most important economic decision facing the UK for decades. Yet the professional debate has, so far, been surprisingly muted. This detailed analysis of the case against joining needs to be examined by every open-minded economist who is presently in favour. They will not find refuting it an easy task.”

Sir Kenneth Berrill, Head of Government Economic Service and Chief Economic Advisor to HM Treasury 1973-74; Head of Central Policy Review Staff at Cabinet Office 1974-80
To accept the aims of international understanding and co-operation between European countries does not require joining the euro and therefore eventually a European Federation. This report is without doubt the clearest, most carefully argued and comprehensive analysis available which supports this position.”

Sir Alan Peacock, Chief Economic Advisor to the Department of Trade and Industry 1973-76
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