"Britain wasn't the world's fastest growing major economy, but it outpaced the rest of Europe," A. Kaletsky in The Times, 24th December 2002 - Is this sufficient justification for the UK to resist a switch to the Euro?

University Degree Business and Administrative studies

Question:

“Britain wasn’t the world’s fastest growing major economy, but it outpaced the rest of Europe,” A. Kaletsky in The Times, 24th December 2002. Is this sufficient justification for the UK to resist a switch to the Euro? Consider the impact of your answer on UK firms and the economy as a whole.

Of the European Union's fifteen member states, three—Sweden, Denmark and the UK—have not adopted the euro. As with the UK firms and all important large-scale economic decisions there are many advantages and disadvantages to the UK of joining the Euro and therefore the important conclusion to come to is whether it is sufficient justification for the UK to resist a switch to the Euro.

People argue that joining the Euro would reduce transaction costs for traders, with savings estimated at around £2 billion annually(www.staruk.org.uk). These savings come from not having to pay commission or maintain hedge funds to guard against currency instability.

There is another argument is that although the exchange rate between sterling and the euro will fluctuate from day to day, it would be wrong to think of the euro as “just another foreign currency”. As the currency of 12 European countries and 300 million people, many business, small as well as large, are now beginning to feel the impact of the euro on how they do business. The tourism industry could be particular affected after 1 January 2002; travellers within the euro area are expected to quickly realise the benefits of using a common currency and may expect businesses outside the euro area to follow suit.(Annual Report for 2001 from BTA)

If Britain has the euro as its currency, holidays here will be cheaper because it will be easy to compare prices between all of the European countries. Britain will be forced to reduce its prices in order to remain competitive. This will make holidaying in the UK more popular with people in other countries because prices will be lower. At the moment Britain has a reputation for being very expensive in comparison to other European countries. Lower prices will mean that the tourist industry would get more foreign business.

UK firms would probably enjoy reduced borrowing costs, encouraging investment and growth, as British interest rates fell to European levels, and UK home buyers would enjoy cheaper mortgages. It is true that industrial investment in this country has been persistently handicapped by the short term use of interest rates against inflation, but even the present level of interest rates in the UK appears to have set off house price inflation in the south.

So far, the Euro-project has not had to deal with a recession. If it does it will cause cracks and fissures in the Euro ruling classes.

There is a ...

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So far, the Euro-project has not had to deal with a recession. If it does it will cause cracks and fissures in the Euro ruling classes.

There is a danger that if Britain is not actively involved and committed at this early stage, other nations will benefit from having created the terms of the union in their favor. This could leave Britain straggling behind if the union is a success, and marginalize her influence within Europe. Joining later, having sat out until the success of the project could be guaranteed.

Providing that the Euro does complete its launch successfully, it is difficult to see how the UK can afford to remain outside the Euro not only for promotion reasons, but also economically and politically. It will risk being marginalized in the EU if it fails to join within a few years. At present the public opinion in the UK is against joining the Euro, and for keeping the pound.

British economy is different to the Euro zone and needs different policies. More trade are done (57 percent) with countries outside the Euro zone, and large amounts of the investment are received from the US. The Bank of England currently sets interest rates according to the needs of the British economy. In side the euro they would have to accept a single interest rate set by the European Central Bank in Frankfurt, which sometimes would not match them. Changes in interest rates are the most effective means of adapting to economic fluctuations. With no control of interest rates, the strain would be felt in other parts of the economy such as prices, wages and employment levels. This is what happened during our disastrous membership of the ERM, when interest rates were raised to maintain the link between the pound and European currencies rather than cut to suit Britain’s own needs. Euro zone members are already suffering from the fact that the ECB cannot simultaneously set the right interest rate for twelve different economies. In this case the problem would be particularly acute due to the distinctive nature of the British economy.

Britain’s economy is out of step with the Euro zone: Britain’s business cycle generally moves more closely in line with that of the US, than with those of the main European economies. So for example, Britain might often be growing strongly when the euro countries are slowing down, meaning the needs for different policies. If join the Euro, this would highly volatile against the dollar, which can destabilize British trade. Thus a single currency reduces some of the uncertainty associated with trade when exchange rates are not fixed.

The euro is a weaker currency than the pound. This means that if sterling is allowed to continue getting stronger it will make people want to go on holiday abroad rather than in England. This is because prices will be cheaper abroad and people will choose to take their holidays in other countries.

The unemployment doubled and 100,000 businesses were lost in the Exchange Mechanism (1990-92), in which UK linked their currencies with Europe. But now, unemployment is at the lowest level for 25 years and almost half the Euro zone average rate. Since leaving the ERM in 1992 and resuming control of our monetary policy, Britain has created over 2 million jobs.(travel.guardian.co.uk)

There is a high cost for joining the Euro. IT systems and coin machines, and training staff, have been estimated at up to £36 billion. These costs would be encountered by UK firms after their competitors in the existing Euro-zone had bedded in the new systems, and thus UK firms would be at a competitive disadvantage for a couple of years after joining in addition to paying the capital cost. Although derided by Gordon Brown as "not worth the paper it's written on," this estimate seems not unreasonable and no alternative estimate has been offered by the proponents of entry.

The 1997-2001 Blair government established five conditions, which must be satisfied before joining.(travel.guardian.co.uk)

   1.Convergence of business cycles, enabling the UK to be comfortable with Euro interest rates
   2.Enough flexibility in the Euro system to deal with problems
   3.The impact on firms choosing to invest in the UK
   4.The impact on the competitive position of the UK financial industry
   5.The impact on growth, stability and jobs

It can be seen that the majority of these tests are subjective questions, which perform a political rather than economic function; that is, they allowed the government to put off a decision which was likely to be unpopular. Several of the "tests" are unquantifiable matters of opinion, and will probably be subjected to anecdotal rather than scientific evidence in any referendum campaign.

Where a positive economic judgment is possible, it is still capable of interpretation. For example, on the question of whether the UK could be comfortable with euro interest rates, we have to remember that convergence may be temporary. Two railway trains approaching each other in opposite directions are converging, but unless they are the same track they will shortly pass each other and then diverge equally rapidly. The brief moment at which they are alongside would not be a good time to try coupling them together.

The UK economy is structurally different from that of the Euro zone. Its pattern of external trade links is still different, though progressively assimilating, and the transmission mechanism connecting the financial system to the real economy is seriously different, particularly because of the importance in the UK of the domestic housing market. This tends to make the UK more sensitive to short term interest rate movements than is the Euro zone.

Taken as a whole, the Euro hasn’t had a deal with the recession, joining the Euro would lead to greater harmonization of taxes across Europe, The governments lose their ability to set monetary targets, and single currency reduces some of the uncertainty associated with trade when exchange rates are not fixed. Thus it is still sensitive for UK to join the Euro.

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