A Single European Currency: Why the United Kingdom must say 'No'
The Rt Hon. David Heathcoat-Amory MP
Joining a Single European currency would have profound political and
economic consequences for Britain. Replacing 15 national currencies by a
single currency controlled through one central bank is an undertaking perhaps
greater than the original founding of the EEC. Under the terms of the Treaty
on European Union Britain must decide next year whether to participate.
Many advocate a single currency on political grounds. According to their
view the stalled process of political integration would be given a huge boost
by the creation of a European Economic State. The necessary concentration of
monetary and economic power at the centre is seen as a virtue. The Community,
founded as an economic entity, would achieve its political destiny through
another economic union, based this time not on trade but on a single
To these pilgrims, the political vision is all that matters. Economic
objections are trivial or surmountable, given enough political will. The
collapse of the Exchange Rate Mechanism in 1993 is blamed not on any inherent
defects but on a failure to control irresistible forces by means of a yet more
ambitious scheme - total monetary union.
The committed European federalist is probably impervious to economic
argument. This paper will only address the political argument by showing that
a single currency will have dire economic consequences which will create a new
division of Europe.
It is to a second group of believers in a single currency that this paper
is mainly directed. Their case, more frequently advanced in the UK, is that a
single European currency will involve a modest further 'pooling' of
sovereignty into a European Central Bank. In return the UK will participate in
a strong, inflation-free world currency and at the same time the Single Market
will be completed. In other words any political drawbacks will be outweighed
by the economic gains.
This paper looks at the economic case and finds that the gains are
illusory. An examination of single currencies in theory and in practice shows
that the European Union is an unpromising area for such an undertaking, and
that to proceed to the final stage of monetary union would be to court
disaster: exchange rate adjustments would be impossible; national interest
rate changes could no longer be made; and, there would be compulsory
restrictions on national taxation and expenditure powers. Thus, the normal
economic instruments available to government to use in regulating the economy
and responding to external events would no longer exist. Instead a huge
federal European budget would be required - on a scale so far considered as
being unrealistic or impossible.
There is nothing to be gained, politically or economically, from allowing
the argument about Britain's possible participation in a single European
currency to drift on. We know enough from conventional economic theory, from a
look back at history and from a reading of the Treaty on European Union to
understand what is at stake. When something is clearly wrong for this country,
we should reject it.
All nations of any size or importance have their own currencies. Indeed the
establishment of a single currency and a central bank is an essential
development after political unification.
In 1834 the German States formed a Zollverein (customs union) and this was
followed by a series of Acts to standardise their coinage, which was based on
silver. A variety of coins were minted and used by the states and only some
were commonly recognised. Bank notes were not legal tender.
It was not until the political unification of Germany at the end of the
Franco-Prussian war in 1871 that steps were taken to set up a central bank. In
1876 the Prussian Bank became the Reichbank, which controlled all coinage and
paper currency, and Germany switched to the gold standard.
In Italy, the economically diverse 19th century states were united much
more abruptly in 1861. The new Italian government then sought to centralise
the issue of paper currency, and it took another 32 years before the former
National Bank of Piedmont became the Bank of Italy. It is worth noting that
unification and the introduction of a single currency did nothing to halt the
continuing economic divergence between the prosperous North and the poor
The World's best known federation, the United States, had no unified
currency throughout its early history. Before the Civil War the banking system
consisted of a collection of state banks, each issuing its own notes which
traded at a premium or discount to each other. After the Civil War the Federal
Government asserted a degree of control through a series of National Banking
Acts, but it was not until 1914 that the Federal Reserve Bank was founded.
These examples and others show that the establishment of a central bank and
a single currency follows the creation of a federal state or complete
political union.1 The attempt by the
European Union to reverse this order and introduce a single currency before
the creation of a federal state is without historical precedent.
The fuse leading to full monetary union in Europe was lit in 1970 with the
publication of the Werner Report. This report, under the chairmanship of the
Prime Minister of Luxembourg, Pierre Werner, proposed full monetary union by
1980. In the words of the Report, the Community was to achieve the 'total and
irreversible convertibility of currencies, the elimination of fluctuation in
exchange rates, the irrevocable fixing of parity rates and the complete
liberation of movements of capital.'
The Werner Report emphasised the need for economic control to be exerted at
Community level. The size and financing of national budgets would be decided
by a body responsible to the European Parliament. As a child of its time it
also provided for a joint incomes policy. The report was adopted by the
Finance Ministers of the six Community countries and received endorsement from
the new candidate countries which were negotiating for entry, including the
The Werner Plan received a severe blow when the Bretton Woods system, which
had governed global exchange rate arrangements from the end of the Second
World War, collapsed in 1971. It was the first of many external blows to fall
on plans for monetary union.
The following year European leaders agreed to establish instead the
currency 'snake' whereby their countries' currencies would move against each
other within a 4.5% limit. This was part of a phased process of monetary
union, as explained by Edward Heath to the House of Commons in October 1972
when reporting the outcome of the Paris Conference on enlargement:
"The meeting agreed on the need for Community mechanisms to
defend the fixed but adjustable parities between Member countries' currencies
which will be an essential basis for economic and monetary union... The
Community should move to the second stage of economic and monetary union on
January 1, 1974, with a view to its completion by the end of this
Instead, the oil price shocks of 1973-74 caused the economies of
participating countries to diverge, and one by one their currencies dropped
out of the snake to float freely. The UK's membership lasted two months. Italy
and then France withdrew; and the non-Member States of Sweden and Norway - who
had at first associated their currencies with the system - were then forced to
withdraw. The Deutschmark was revalued three times.
Nevertheless negotiations were renewed in the late 1970s to try and design
a more stable European exchange rate system, and relaunch the concept of
monetary union. The European Commission, under the Presidency of Lord Jenkins,
strongly promoted these ideas and called for greater powers of taxation to be
vested in the Commission.
A significant development in this direction was the 6th VAT Directive,
agreed in 1977. This was a bold harmonising measure designed to bring the VAT
systems of Member States into line. It originally included a proposal to give
the Commission its own directly levied tax revenue but this was eventually
dropped. The scope of this Directive, coupled with ambiguities in the text,
have since been the source of endless litigation, both in national courts and
in the European Court of Justice.
In 1979 the European Monetary System was launched. Its central feature was the
Exchange Rate Mechanism (ERM) whereby a loose grouping of European currencies
and economies moved to an ever more rigid system of currency management with
fewer and fewer realignments. At the same time the European Currency Unit
('ecu') was made the system's accounting unit and the forerunner of a single
currency. The UK stayed out until 1990.
There were several realignments in the early years before the system
appeared to settle down. However, this stability was bought at the price of
German domination. Germany was accumulating large trade surpluses but the ERM
prevented a revaluation of the Deutschmark. Instead the currencies of the ERM
as a whole were dragged up higher than they should have been against the
dollar. This hit exports and growth at a time when unemployment in Europe was
The reaction, especially in France, was not to abandon the project but to
seek a new system which would prevent the Bundesbank effectively determining
monetary policy for everyone by replacing it with a more representative
institution. French political opinion came to view monetary union not as a
loss of national decision making but a way of regaining influence over events
which France had already ceased to control.
The French Finance Minister, Edouard Balladur, wrote in January 1988:
"The fact that some countries have piled up current account
surpluses for several years constitutes a grave anomaly. This asymmetry is one
of the reasons for the present tendency of European currencies to rise against
the dollar and the currencies tied to it. This rise is contrary to the
fundamental interest of Europe and its constituent economies. We must
therefore find a new system under which the problem cannot arise."3
Accordingly, the European Council meeting in Hanover in June 1988 agreed to
set up a committee, chaired by Jacques Delors, to examine how monetary union
could be achieved. The Report was published the following year and asserted
that the creation of a Single Market in Europe would require monetary union.
This was to be achieved in three stages: the first stage would involve a
greater convergence of economic performance; the second, the transfer of
responsibility for economic and monetary policy from Member States to the
Community. The final stage would start with an irreversible locking together
of exchange rates and be followed rapidly by the replacement of national
currencies by a single currency. With regard to national policies, the Report
was clear on the need to 'place binding constraints on the size and financing
of budget deficits'.
The Delors Report was discussed at the Madrid summit in June 1989 and the
Prime Minister, Margaret Thatcher, reported the outcome to the House of
Commons. She accepted the Report only 'as a basis for further work' and warned
that 'stages two and three of the Delors Report would involve a massive
transfer of sovereignty which I do not believe would be acceptable to this
House. They would also mean, in practice, the creation of a federal
The Delors Report formed the basis of the intergovernmental discussions
leading up to the Maastricht Treaty. The three stage process was adopted,
although the content of each step was modified. The Treaty laid down the
economic criteria for judging the readiness of Member States to join the third
stage. Other articles dealt with institutional aspects, and in particularly
the creation of a European Central Bank to take control of monetary policy
from the start of stage three. 1997 was specified as the start date for this
decisive stage, provided a majority of countries qualified. At French
insistence it was agreed that if this first date was missed, stage three would
start in January 1999 in any event, even if only a small number of countries
qualified. Spain succeeded in getting the EC budget amended to provide more
regional assistance and to set up a 'cohesion fund' to subsidise the efforts
of Spain, Portugal, Greece and the Irish Republic to meet the necessary
With great foresight the UK Government, led by John Major, obtained an
'opt-out' from stage three. Under a protocol to the Treaty, the UK cannot move
to this final stage without a separate decision to do so by the British
government and Parliament. Until this is activated, the UK has virtually the
same status with respect to the Treaty as any other Member State. However,
while this was being negotiated, external events were again making themselves
After the Maastricht Treaty was signed in 1992, but before it was ratified,
the Exchange Rate Mechanism (ERM) was thrown into turmoil. The cause lay at
the very heart of the system. German unification was financed with increased
public expenditure and higher borrowing, which the authorities countered with
higher interest rates in order to fight inflation. These were exactly what was
not needed by other Member States where low inflation and weak economic
activity called for lower interest rates.
This certainly applied to the UK which had finally joined the ERM in 1990
when it was widely thought to be the key to lower interest rates. By 1992
however the ERM itself had become the reason why interest rates could not be
lowered. There was therefore an increasing divergence between the domestic
policy needs of Germany and those of the rest of Europe. German unification
was an event which tested the existing ERM to destruction.
Growing instability and loss of confidence in the existing exchange rates
culminated in Sterling's exit from the ERM in September 1992 together with the
Italian lira. Other devaluations, suspensions and withdrawals followed but the
crisis was not resolved until the following year when the French and Danish
currency rates became unsustainable and the ERM was in effect suspended by
greatly widening the permitted fluctuation bands.
The consequences of the ERM debacle were very serious in terms of lost
economic growth and political damage. However, some attributed it to different
causes and drew different conclusions. The European Commission drew the lesson
that the reason for the ERM's disintegration was not too much monetary union
but too little. The difficulties were attributed to speculators and illogical
market reaction.5 The Commission's
solution was to press ahead faster and further with full monetary union.
According to this view, the problem of exchange rate instability could be
avoided by removing the exchange rates. Turmoil in the currency markets could
be ended by abolishing the currencies.
It remains a Treaty requirement that stage three of monetary union, the
irreversible locking together of exchange rates and the introduction of a
single currency, shall start on January 1, 1999. Under the terms of the
British 'opt-out' the decision on whether to join must be made in 1997.
The economic case for a single currency in Europe rests on claims that it
will lower transaction costs for traders and travellers, that it is necessary
to complete the Single Market, and that participants will acquire the mantle
of a strong, inflation-free currency with a reputation inherited from the
The European Commission has estimated that currency conversion costs amount
to about 0.4% of EC GDP per year, although there is some suspicion that this
calculation includes the cost of transferring the money to another country as
well as the actual cost of converting to another currency.
In support of the burden of such costs the example is often quoted of a
tourist setting off from one European Union (EU) country with £100, changing
it into the currencies of successive Member States and arriving back with £50,
the rest having gone in commission charges and differential exchange rates. In
the era of plastic cards, it is unlikely that such dim tourists actually
exist, but the image remains.
More important are the trading costs associated with variable exchange
rates. These are sometimes exaggerated. Businesses concerned about these risks
can hedge in the market for foreign exchange futures with costs measured in
hundredths of 1%. Many companies have internal treasury operations anyway.
Further it has never been demonstrated that exchange rate volatility inhibits
trade in practice. It has not been the Japanese experience that the marked
fluctuations of the yen relative to the dollar and the European currencies
have been a serious barrier to Japan's ability to increase exports. Nor has
the relative depreciation of the pound prevented the UK receiving about 40% of
the American and Japanese direct investment in the EU. This indicates that
even for investment, where exchange rate hedging is not a long term option,
fixed exchange rates are less important than other factors such as costs, tax
rates, labour relations, language and location. Also, the saving from a single
currency must be set against the large costs of changeover. The British Retail
Consortium estimates that converting to a single currency would cost retailers
alone over £2 billion.
The case for a single currency on Single Market grounds is often
overstated. The British Government actively promoted the 1992 Programme to
remove all barriers and hindrances to trade. A single currency was not thought
necessary for the project. The way to achieve further benefits from the Single
Market is by strict enforcement of the rules and by extending the market in
areas like energy and telecommunications.
It is sometimes suggested that the countries in a single European currency
zone might put up trade barriers against a country like the UK, if it stayed
outside. This would be contrary to the Treaty rules governing the Single
Market. In any case, since most EU countries run a trade surplus with the UK
it would be self-defeating for them to invite reciprocal action against their
There are many examples of free trade without single currencies. The United
States, Canada and Mexico are bound together in a free trade area, NAFTA. This
has no fixed exchange rates and no plans for a single currency. Trade is
increasing even faster between the Asian Pacific countries without any agreed
currency arrangements at all. Eight successive GATT rounds have progressively
lowered tariff barriers worldwide and they are now a fraction of what they
were when the European Community was founded in 1957. These moves towards
global free trade will have more influence on future trade patterns than new
single currency zones.
Given that over half of the UK's trade (visibles and invisibles together)
is with countries outside the EU, the benefits from joining a single currency
within Europe have to be balanced against the possibility that it
could deliver the wrong exchange rate for trade outside the EU. A
certain Euro exchange rate against the dollar, for instance, might be right
for a majority of Member States but not suit British trading conditions. Trade
with the United States could therefore suffer and since the UK does
proportionately twice as much trade with the US than any other EU country,
this would have serious consequences.
Arguments for a single European currency often rest finally on the hope
that it will usher in permanently low inflation, which has been the expressed
objective of British policy for some years. The benefits of low inflation are
beyond dispute. Markets work more efficiently, the quality of savings and
investment decisions improves, tax distortions are removed, and there is an
end to the arbitrary and unfair redistribution of income which takes place
It is also true that until recently the British record on inflation was
poor, certainly compared with the anchor currency of Europe, the Deutschmark.
The Treaty specifies that the primary objective of the European Central Bank
(ECB) shall be price stability. The decisions of the ECB will be taken by the
Governing Council, made up of the heads of participating central banks, all of
whom will be fully independent. How tough the ECB will be is difficult to tell
but it is fair to assume that it will want to adopt as much as possible of the
Bundesbank's reputation for stability and prudence.
On the other hand each member of the Governing Council will have one vote
and decisions will be by simple majority, so Germany will have no more formal
rights than any other country. In fact part of the enthusiasm for monetary
union in other Member States arises from a wish to end the de facto
dominance of the Bundesbank and get a seat at the table where interest rate
decisions are taken. The Treaty tries to ensure that the ECB decisions are
free of political interference but it remains to be seen if its members will
be as determined as the Bundesbank in sticking rigidly to the requirements of
price stability. For example, the Labour Party recently called for the Council
of Finance Ministers to be built up into a 'democratic counterpart' to
influence the ECB.
The UK's success in getting inflation down and keeping it down shows the
importance of political will and a commitment not to shirk unpopular
decisions. Those who seek the external discipline of a single currency and an
ECB sometimes talk as though it is a substitute for hard choices at home. This
is an illusion. Sustainable growth, high employment and permanently low
inflation require great determination on the part of government and
self-discipline on the part of economic participants. This determination
cannot be subcontracted to an ECB.
Countries which join a single currency agree to transfer monetary policy
permanently to the centre. In the case of Europe, interest rates will no
longer be determined nationally but by the Governing Council of the European
Central Bank (ECB), at which each national representative has undertaken not
to be influenced by the home government.
Interest rate and other monetary decisions would, of course, be taken for
the currency area as a whole. There could be no separate interest rates for
sub-groups or individual countries. National exchange rates would also cease
What, therefore, would happen if economic conditions diverge and one
country, or group of countries, found itself in different economic
circumstances? Is this likely to happen and what would be the
It was seen during the brief description of economic events since 1970 that
plans were often defeated by unexpected disturbances or shocks which affected
countries or regions in different ways. A shock which affects all members of a
single currency area in the same way (called 'symmetric') may be dealt with by
a common policy instrument such as a change in the single interest rate.
Others shocks ('asymmetric') affect them differently. For instance an increase
in commodity prices, such as oil, would affect producer countries differently
to those reliant on imports. Or a shift in world demand for manufactured
goods, or agricultural products, or financial services, would affect those
countries specialising in them.
A country within a single currency zone, experiencing a negative shock -
one that lowers output and employment - cannot, of course, devalue. Nor can it
lower its interest rate: control over that has been transferred to the ECB
which can only respond to the needs of the currency area as a whole.
The necessary adjustment must therefore either take the form of a
migration of labour away from the relatively depressed country to others
experiencing higher relative activity or local wages and prices must
decline in real terms.
There have been many studies of the mobility of labour within Europe
compared with other single currency areas such as the United States.6 They show that labour mobility is significantly
lower within individual European countries than in the United States or
indeed, Japan. Mobility between European countries is lower still,
reflecting the barriers to movement created by, among other things, language,
culture and differences in social security systems.
Nor does the EU officially encourage the idea of labour migration. Instead
the reassuring notion of 'community' holds out the prospect of work being
provided on site. The Commission described regional mobility of labour as
'neither feasible, at least not across language barriers, nor perhaps
That leaves reductions in real wages and prices. This could be a most
painful process. If inflation was low, it might have to include actual,
nominal wage reductions. That this is unlikely to happen is shown by the
experience of Britain's return to the gold standard in 1925, attracted by the
prospect of sound money. The rigidities of the labour market meant that
although retail prices fell from 1925 to 1929, earnings rose and the strain of
an overvalued exchange rate was taken by the traded sector of the economy with
consequential loss of market share and a steep rise in unemployment. In 1931
Britain left the gold standard, permitting an exchange rate adjustment.
In the EU today the development of the Social Chapter, and indeed the whole
thrust of Community social and employment legislation, creates the same
rigidities and even less prospect of the wage-price mechanism adjusting
readily to external disturbances. A minimum wage has the same effect. The
European Socialist Group has called for even more restrictive employment laws
as a condition of its support for a single currency.
Thus the necessary conditions for a single currency - mobility, flexibility
and a smoothly functioning wages market - are actually being eroded. This is
being done by the very institutions - the Commission, the European Parliament
and left-of-centre parties - which are most in favour of a single currency.
Seldom can there have been a more contradictory muddle of policies and
It is sometimes argued that increasing economic integration will iron out
the differences between EU countries and make it less likely that shocks will
affect countries in different ways. This is not borne out by experience. Trade
is not necessarily a levelling influence. On the contrary what drives trade is
comparative advantage, in other words differences, and the workings of the
market lead to specialisation. This could actually increase differences
between Member States.
For example, in the United States the production of automobiles is much
more regionally concentrated than in the EU. There is no doubt that the US
market is more highly integrated than the EU market. This evidence suggests
that when the European Single Market moves forward to completion, automobile
production will become more concentrated in fewer Member States.8
Even without new differences, the existing economies of the EU show great
variety and diversity. Some countries have large agricultural sectors, Germany
has a particularly important manufacturing sector, and the UK has a larger
financial sector than the others as well as being the EU's only oil exporter.
External shocks will therefore often affect different countries in different
ways. It is important to bear in mind that these shocks do not have to be
sudden or dramatic like an energy crisis. It is part of the dynamism of the
world economy that there are constant changes in the supply and demand
patterns, productivity growth and the behaviour of real wages. Thus, the
Japanese yen appreciated in real terms in the 1960s and 1970s to offset rapid
productivity growth in Japan's export sector.
In a single currency area, without the possibility of internal exchange
rate adjustments, it is the local wage and price level that must take the
strain of readjustment. As noted above, such prices are notoriously 'sticky'
downwards and the notion that wage bargainers would automatically adapt their
demands to the requirements of a remote central bank is, at best, highly
Differences between the UK and continental Europe are particularly
significant. Not only is this country a large oil producer but its pattern of
trade is distinctive, being much more dependant on invisible earnings
(services and investment income) than other EU countries. Trade in these
invisibles has grown half as fast again as visible imports and exports since
1970, and the UK has a much higher degree of inward and outward direct
investment (relative to GDP) than any other major country. The surplus on such
investments, and earnings from services, helps to offset the visible trade
deficit but it is striking that the invisible surplus is earned
outside the EU. The UK has a trade deficit with the EU in all
categories. This illustrates the importance of global trade to this country,
and also underlines that we are particularly affected by world economic
Disturbances, or divergent trends, could also be made worse by the way
different economies respond differently to the same influence. For
instance an interest rate change by the ECB would have a differential effect
on Member States. The UK has a high level of variable mortgage debt. Other
countries rely more on fixed interest loans. Therefore, an interest rate
change would have a more direct and immediate effect on the UK economy.
A further difference is that the UK business cycle is not closely
synchronised with other Member States. We entered the recessions of the 1980s
and early 1990s sooner and emerged from them earlier, so common policy
prescriptions might have had an exaggerating rather than a counter-cyclical
The plain fact is that Europe is very diverse. There is no 'European
economy'. Constituent countries show great variety in their financial and
capital structures, labour markets, productivity rates, industrial
specialisations and social security systems. Forcing them into the same mould
of a single currency is hardly rational.
In summary, disturbance or shocks are a feature of the world economy. They
are by definition unpredictable but have occurred often in the past and since
1970 have derailed most of the plans for monetary union in Europe. In addition
there are slower acting but constant shifts in productivity, costs and demand
for goods and services.
Many of these changes impact on countries differently, and the diversity of
European economies makes this unsurprising. The structure and trade patterns
of the UK economy are particularly distinct.
In a single currency area the option of exchange rate adjustment is
permanently removed. Monetary control is transferred to a single Central Bank
which determines a single interest rate. This then applies indiscriminately to
all participating countries.
The adjustment mechanism for these changes therefore falls either on labour
mobility, which is low in Europe, or on price and wage adjustments which would
have to be downwards in a country negatively affected. There is plenty of
evidence that such adjustments do not take place, and certainly not quickly or
easily. Moreover, the whole thrust of EU social development has been to
inhibit labour market flexibility. Faced with this impasse and deprived of
normal economic levers, national politicians would come under great pressure
to find other ways to respond, particularly in an enduring recession.
When monetary policy has been eliminated as a nationalresponse, what is
left is fiscal policy; that is changes in taxation and expenditure. Attempts
by governments since the war to 'fine tune' demand in the economy through
changes in taxation and expenditure have generally been unsuccessful. The
result has been inflation, and very often unemployment too. The present
government therefore believes that fiscal policy should be focused on
achieving sound public finances, while interest rates are the main instrument
for influencing demand and the inflation rate.
If national interest rates were abolished, governments wishing to manage
demand in their economies would be obliged to make greater use of fiscal
policy. Even if they rejected the use of an active fiscal policy, they would
want the normal stabiliser mechanism to work. In a recession, tax receipts
drop and government expenditure on, for example, unemployment benefit rises.
Thus there is a cyclical rise in the budget deficit which tends to counter the
recession. The opposite happens in a period of excessive demand when tax
receipts increase and benefit expenditure falls. This helps to moderate the
peaks and troughs of the economic cycle, without the need for governments to
Unfortunately this mechanism would be put at risk by monetary union. The
Maastricht Treaty lays down strict rules on government deficits and debt
ratios, and sets up an 'excessive deficit' procedure whereby errant
governments are identified and brought into line. In stage two of monetary
union, at present, these are no more than recommendations. From the start of
stage three they are binding and may be backed up by penalties and
The reason for strict rules governing national deficits is because
over-borrowing by one country affects the whole single currency area. With
national currencies, governments which run up large debts have to live with
the consequences of high inflation. In a single currency area the consequences
are 'exported' and all participants share the cost. The penalties against
excessive deficits laid down in the Treaty are not thought tough enough by
Germany, the country with the most to lose from inflationary behaviour by
others. The German Minister of Finance, Theo Waigel, has proposed a 'stability
pact' under which the Member States must limit their budget deficits to 1% of
GDP, not 3% as proposed in the Treaty. Moreover, he has proposed that the
financial penalties for running an excessive deficit would be automatic and
draconian. For example, under this stability pact, the UK would have been
fined over £10 billion in respect of the 1992-94 deficits. These ideas are
still being discussed at the Council of Ministers and it is not clear how they
fit in with the legal requirements of the Treaty but they indicate that the
eventual controls over the tax and spending policies of participating states
are likely to be stricter than originally envisaged.
These controls would prevent a government from boosting its economy in a
recession by cutting taxes and raising expenditure. Unfortunately they would
go further. As already described, in a recession the budget deficit rises
automatically. If this was near the permitted borrowing limit, a government
facing a local recession might well have to raise taxation and
cut public expenditure. So instead of acting as an in-built
stabiliser, fiscal policy could actually accentuate the problem.
Also the democratic question arises again: if loss of an autonomous
monetary policy is followed by loss of an autonomous fiscal policy, what is
the function of nationally-elected politicians? These powers go to the root of
what a parliament is for and their loss must call into question whether such a
country is in any real sense self-governing.
Faced with the uncomfortable point that tax and spending powers would not
only be tightly controlled but might actually make matters worse, advocates of
a single currency sometimes take refuge in the example of the US Dollar.
Surely economic disturbances, different rates of development and different tax
rates exist in the USA but no one argues for separate state currencies
The states and regions of the USA do indeed diverge economically from time
to time. Sometimes it may be the financial services and computer sciences of
New England that are in relative demand. The oil states could be doing well;
or the steel and car making states that may be experiencing changes in demand
whether up or down; or the states dependant on military orders or world food
prices could be relatively affected.
These states or regions cannot, of course, use the exchange rate to adjust,
but other mechanisms do work. Labour mobility is far higher than in Europe,
helped by a common language and a historical background of labour migration.
The price mechanism, of goods, services and labour is more responsive and the
financial sector treats the country as a genuine unit.
There is another very important ingredient. The US fiscal system works as
an automatic stabiliser on a federal scale. People in a state experiencing an
economic downturn send fewer dollars to the Federal government and receive
back more in transfers as unemployment rises. A state experiencing a relative
boom does the opposite. It is estimated that about 40% of the relative changes
between two states or regions will be evened out in this way.10
Nothing comparable to America's fiscal system exists in the EU, where
virtually all taxes are paid to national and local government. The EU budget
is far smaller and half of it is still spent on agriculture. Most of the rest
goes on 'structural' support which is supposed to correct economic imbalances
but which is not responsive to changes in output and employment - and
certainly not quickly or automatically.
Comparisons between the proposed European and the actual US single currency
must therefore recognise the important structural and historic differences,
and the fact that the US is a federal state with a large central budget and
powers of direct taxation.
Something similar to this federal budget would be required in Europe. In
1977 the Commission published the report of a Study Group under the
chairmanship of the British economist Sir Donald MacDougall. This estimated
that as a minimum a budget of 5 - 7% of Community GDP would be required (as
against 1.2% today). The Report envisaged a scheme in which national
unemployment schemes would be taken over by the federal budget and financed by
a Community-wide tax.
Later, writing in 1992, Sir Donald spelt out his belief that the loss of
exchange rate adjustment would make essential larger transfers between Member
States. He concluded: 'I fear that an attempt to introduce monetary union
without a much larger Community budget than at present would run the risk of
setting back, rather than promoting, progress towards closer integration in
Any such increase would be extremely controversial. It is a big step for a
national parliament permanently to hand over a proportion of its tax revenue
to an outside body beyond its control. The agreement to increase the size of
the Community budget from 1.2% to 1.27% of GDP by 1999 was very reluctantly
accepted by the House of Commons. The UK's net contributions to the budget
since 1973 already total £38 billion at today's prices and are continuing at
some £3 billion per annum.
It is not surprising that advocates of a single currency ignore the
findings of the MacDougall Report and the logic which would require a further
very large increase in budgetary transfers.
The Delors Report of 1989 recognised that a central budget of this size was
not at present politically feasible and referred instead to the need for
'solidarity' to iron out 'the economic difficulties or the surges in
prosperity of individual states'.
In other words, the absence of a large enough EU budget would be
compensated for by co-ordinating the use of national budgets. For this to have
any chance of working the control would have to be swift, automatic and
compulsory. Federal powers would initially replace the need for a federal
budget. The Delors Report was understandably reticent about drawing the
necessary conclusions from its own analysis.
A single monetary policy cannot deal with the differences, divergences and
cyclical variations in the European economies. National currencies provide an
adjustment mechanism, and allow governments to use interest rates to respond
to events. A single European currency would remove these options. Instead, a
single European interest rate, set by the European Central Bank in Frankfurt,
would apply indiscriminately to the whole single currency area. This creates
the problem of how a participating country could adjust to a shock or economic
development specific to that country.
The labour market in the EU is neither mobile enough nor flexible enough to
take the strain of adjustment. Indeed the EU spends much of its time
legislating to make the European labour market even less adaptable, as shown
by the unacceptable level of structural unemployment in the EU.
Nor could EU governments rely on their national budgets to alleviate a
local or cyclical recession. The Treaty lays down strict compulsory borrowing
limits. An active policy of cutting taxes or increasing public expenditure
could lead to penalties and fines. Even a passive policy of allowing the
budget deficit to rise during a recession could breach the limit and require
tax increases and expenditure cuts. So instead of stabilising the situation,
the effect would be to compound the problem and create more unemployment.
With monetary policy given away, and these restrictions on borrowing,
countries in a single currency would be left with transfer payments between
Member States. At present these transfers, in the form of structural and
cohesion funds, are used to subsidise the poorer EU States. The UK is a very
substantial net contributor. In a single European currency transfer payments
would take on the much larger task of trying to compensate for changes and
shocks affecting the various economies of the currency area. The present EU
budget, at 1.2% of GDP, is far too small for such a role.
Advocates of a single European currency who point to the success of the US
Dollar are in fact making this point. The US federal budget, through its
direct taxation and expenditure powers, exerts a powerful stabilising
influence on the varied states and regions of the USA. A single European
currency would require an equivalent EU budget, many times larger than has
ever been officially recognised.
A single European currency is, in economic terms, highly unlikely to work.
To have any chance of success, it would require the completion of a federal
European state with its own budgetary powers. This time, Parliament and the
electorate must be aware of the real implications of joining a single European
We must say 'No', and say it now.
- For a discussion on this subject, see A European
Central Bank?, edited by M. De Cecco, Cambridge University Press,
- Hansard, 23/10/72, col. 792.
- Quoted in House of Commons Library, Research
- Hansard, 29/6/89, col. 1107.
- European Commission Economic Paper No. 108,
- See, for example, Policy Issues in the Operation
of Currency Unions, Mason & Taylor, Cambridge University Press, 1993;
and, Relative Prices and Economic Adjustment in the US and the EU,
Bayoumi & Thomas, IMF Working Paper, 1994.
- One Market, One Money, European Commission,
- The Economics of Monetary Integration, Paul
de Grauwe, Oxford University Press, 1994.
- Treaty on European Union, Article 104c (11).
- 'One Money for Europe? - Lessons from the US
Currency Union', by B. Eichengreen, in Economic Policy, April
- 'Economic and Monetary Union and the European
Community Budget' by Sir Donald MacDougall in National Institute Economic
Review, May 1992.