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The Bruges Group spearheaded the intellectual battle to win a vote to leave the European Union and, above all, against the emergence of a centralised EU state.
The Bruges Group spearheaded the intellectual battle to win a vote to leave the European Union and, above all, against the emergence of a centralised EU state.

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 currency.

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.

A Look Back

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 South.

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 Story So Far

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 UK.

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 decade."2

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 rising.

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 Europe'.4

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 economic criteria.

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 felt.

The Unexpected Happens Again

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.

A Single Currency
The Case For

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 Deutschmark.

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 own exports.

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 through inflation.

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.

The Case Against

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 to exist.

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 consequences?

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 desirable.'7

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 aims.

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 optimistic.

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 trends.

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 effect.

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.

Tax Policy and the European Budget

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 act.

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 fines.9

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 there.

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 Europe'.11

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 currency.

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, 1989.
    Hansard, 23/10/72, col. 792.
    Quoted in House of Commons Library, Research Paper 95/20.
    Hansard, 29/6/89, col. 1107.
    European Commission Economic Paper No. 108, July 1994
    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, August 1990.
    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 1990.
    'Economic and Monetary Union and the European Community Budget' by Sir Donald MacDougall in National Institute Economic Review, May 1992.

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