UNLESS disaster befalls either the Labour government or Europe's single currency, a referendum will be called in Britain shortly after the country's next general election. Probably in late 2001 or early 2002, Britons will be asked whether they want to scrap the pound in favour of the euro.
The question is in large part a political one. Indeed in France, Germany and other euro-zone countries, monetary union was mostly sold as an economic means to the political end of “ever-closer union”. But in Britain, by contrast, the government has tried to narrow the question of entry to economics alone. Tony Blair says that he sees no constitutional reasons not to join the euro. The British will be invited to vote on entry only if monetary union meets five “economic tests” set out by the government.
There has been poll after poll of British business opinion, with both pro- and anti-euro camps claiming to have a majority on their side. But what do the country's economists think? The Economist has asked them—or, at any rate, a lot of the leading ones. We asked the Royal Economic Society, in effect the professional association of British academic economists, to draw up a list of all economics professors in the country's leading universities (full professors, as Americans would call them). To this we added Fellows of the British Academy (economics section) not picked up in the RES list. This yielded 256 names in all.
We asked them whether they thought it would be in Britain's economic interest to join the single currency within the next five years. Respondents were also asked to list their specialist areas of research, and were given the choice between having their opinions published and remaining anonymous. (Just under half chose to vote anonymously, with the Yes voters slightly more likely to choose this option.)
The results are shown in the table. Of the 256 sent the questionnaire, 164 (or 64%) replied. A comfortable majority, 65%, was in favour of switching from the pound to the euro. The table also breaks down the replies according to the economists' research interests—an inexact business, given that some economists' interests straddle several fields, and that the boundaries between some areas are indistinct. The surprisingly small number who mentioned the European Union, European integration or monetary union as a research interest was split 73% to 27% in favour. Macroeconomists were in favour by 67% to 33%, and specialists in international economics (including trade, exchange rates and foreign direct investment) by 64% to 36%. The one striking exception was monetary economists: by a majority of two to one, they said that joining EMU would be a bad thing for Britain.
A simple tally of ayes and noes, however, does not tell you very much. Some thought that the arguments on one side were very much stronger than on the other. Others said that their judgment was finely balanced. (Indeed, two respondents split their votes: one came down 0.7-0.3 in favour, the other 0.6-0.4 against.) And more important than the crude totals are the arguments on either side. We interviewed economists on both sides of the question, to get a sense of the debate.
Those in favour
Start with the case for joining. First, several economists argued that inside the euro Britain would benefit from a more stable exchange rate. Although British companies would still be vulnerable to changes in the value of the euro against the dollar, yen and so forth, the pound would be irrevocably fixed against the euro, whose 11 members now buy over 50% of British exports.
This stability could not be achieved in any other way. If the pound were retained, but pegged against the euro, it would still be open to speculative attack, says Anne Sibert of Birkbeck College, London. “I don't see that there's any sensible alternative [to joining the euro],” she says. Mark Taylor of Oxford University says that Britain's dilemma is part of a broader international question, because of the speed and ease with which capital flows can cross borders. Just look at the collapse of various pegged exchange-rate regimes, and the consequent talk of creating a big dollar block in the Americas. “The major international economic issue”, he thinks, “is what to do about capital flows and exchange rates.”
Second, some economists argue that by staying outside the euro Britain would put at risk its enviable record in attracting foreign direct investment (FDI). In recent years around 40% of the FDI coming into the European Union has come to Britain. Ian Wooton of Glasgow University says that Britain has proved itself an attractive home for multinational companies wanting to serve Europe's single market. But if Britain sticks with sterling, firms investing in Britain will be lumbered with transaction costs and exchange risks that they would not face elsewhere, for example because they would be paying their workers and some suppliers in pounds and selling in euros.
Fine, says the anti-euro camp, but can't exchange-rate risks be hedged? Yes, says Mr Wooton, but only at a price: in effect, firms would have to buy insurance against currency movements for the privilege of locating in Britain. And, adds Anton Muscatelli, another Glasgow professor, although hedging can protect investors in the short term, long-term investments cannot be hedged.
Third, argues George Zis of Manchester Metropolitan University, some companies are going to use euros instead of sterling in any case. So the Bank of England's ability to control economic activity and inflation using British interest rates will be curtailed. Now that the euro has been created, Britain will find it much harder to pursue an independent monetary policy, whatever the formal arrangements.
Fourth, says Richard Portes of the London Business School, if Britain stays outside the euro it will have no influence on the continent's monetary and financial institutions. This goes beyond formalities: Britain, he says, risks exclusion from the capital market of the euro-zone, which “will soon become the most dynamic aspect of European integration.” Euro-zone companies will find it relatively easier, says Oxford's Mr Taylor, to develop trading relationships with each other than with British ones. There will be an increase in takeover and merger activity, for which the advisors will be based in Frankfurt rather than London.
Fifth, advocates of joining the euro stress microeconomic as well as macroeconomic arguments. Some of these, says Bruce Lyons, a professor at the University of East Anglia, are pretty unimportant, such as the savings on foreign-exchange transactions. But others, such as the increase in transparency brought about by a single currency, matter much more. It will, he says, be harder for companies to hold up prices by segmenting markets: it will be immediately obvious if prices are higher in one country than another, creating an incentive for competitors to move in. “We know that the single market isn't at all single now,” comments Richard Layard of the London School of Economics.
None of this implies that advocates of EMU think the single currency flawless. Consider a forthcoming paper (“Alice in Euroland”, Centre for Economic Policy Research, London) by Willem Buiter, a Cambridge professor and a member of the Bank of England's monetary policy committee (MPC), which sets British interest rates. Mr Buiter, the only member of the MPC we polled who was willing to put his vote on the record, is a well-known proponent of a single currency. Yet his paper is an attack on the European Central Bank's (ECB) institutional arrangements. It is too secretive, he says: the minutes of its meetings will not be published for 16 years and the voting records of its governing council never will be. Its inflation target is too vague, and its inflation forecast is never published. It is not sufficiently accountable to the European Parliament.
In essence, Mr Buiter argues, the euro would be on a much sounder footing if in some respects the ECB looked more like (you guessed) the Bank of England. The Bank has a clear, published inflation target, and publishes its minutes and the votes of MPC members within a fortnight. The MPC is grilled from time to time by a committee of MPs. All of this could have been said by a critic of the single currency. The difference between the two sides is that Mr Buiter thinks the flaws can be sorted out, whereas the euro's critics think that they are either irremediable or not worth remedying.
In the red-white-and-blue corner
As for the No camp, its composition is every bit as striking as its arguments. Just as the political opposition to a single currency spans both socialists and the free-market right, says Victoria Chick of University College, London (a self-described “left-wing anti”), so the economic Noes contain both old-style Keynesians and Marxists on the one hand, and monetarists on the other. However, says Ms Chick, left and right have different reasons for opposing a single currency. For instance, she and economists like her think that the ECB has an in-built bias towards being too tough on inflation—which is unlikely to concern the right.
That said, the two wings have some objections in common. The left-wingers say that the ECB lacks democratic accountability. So, from the other flank, does Patrick Minford, a monetarist at Cardiff Business School. “The idea that credibility requires unaccountable central bankers is wrong,” he says. “Central bank independence has been oversold.” Far from making the ECB an exact copy of the German Bundesbank as is often supposed, he says, the new bank's designers forgot how much the Bundesbank relied on its political legitimacy.
Besides this, the anti camp—left, right and centre—have two main objections to joining the single currency. First, they say, monetary union has imposed a “one-size-fits-all” monetary policy on the euro-zone: in booming Ireland and slumping Germany alike, interest rates are 2.5%. To complicate matters, thanks to variations in the structure of economies, a given change in interest rates may have quite different effects in two different countries. Britain's housing market, says Andrew Hughes Hallett of Strathclyde University, is dominated by variable-rate debt, making British consumption and housing expenditure far more sensitive to changes in interest rates than elsewhere in Europe. Meanwhile, German corporations' reliance on debt rather than equity finance makes the supply of capital more sensitive to interest rates than, say, in Britain.
On top of this, there is little scope for fiscal policy to cushion the effects of economic shocks affecting different countries in different ways. The stability and growth pact limits national budget deficits to 3%. And the EU budget is not big enough for international transfers to take the strain instead.
This leads to the second objection: that Europe's labour and product markets are too inflexible to deal with the strains that EMU will put on them. If interest rates, exchange rates and fiscal transfers cannot be called on to deal with economic shocks, then wages and prices will have to do the job. “The consequence of one-size-fits-all”, says John Flemming, warden of Wadham College, Oxford (and a former chief economist at the Bank of England) “is that the strain is likely to be taken by unemployment.”
In the United States, “asymmetric shocks” (ie, changes in economic conditions that affect one part of the country more than another) are partly dealt with by a highly mobile labour force. But sceptics doubt that European workers will be as adaptable. “That's where the analogy between the United States of Europe and the United States of America breaks down,” says David Greenaway of Nottingham University. “Over there, people move across the country and when they get there they find the same language, the same TV, the same hamburgers. I can't see that happening between, say, Britain and Sweden.” And if anything, says Mr Hughes Hallett, some European labour markets are becoming less flexible: indeed, the introduction of the 35-hour working week was in part a sop for the macroeconomic pain of getting France into EMU.
How do the pros respond? As Mr Buiter's paper indicates, they readily accept, for example, that the ECB is insufficiently accountable. But for the most part they argue that the worries of the antis are overdone. Many argue that, within Britain, people readily accept a single interest-rate, despite marked regional differences. The LSE's Mr Layard argues that the stability and growth pact will not constrain the role of fiscal policy in stabilising the economic cycle, because the British budget is in balance.
But there is also a difference, if you like, in the competing economic models of the two sides. In essence, the pros acknowledge the rigidities in European labour markets, the differences in economic cycles and so forth, but believe that the creation of a single currency will cause these costs to diminish. The antis think that the obstacles will change only slowly, if at all.
Thus Birkbeck's Ms Sibert thinks that continental countries will have to make their labour markets freer and that Britain's housing market will also adjust. Indeed, more Britons are taking out fixed-rate home loans. Yes, says Strathclyde's Mr Hughes Hallett, but the stock of existing home loans (as opposed to the flow of new ones) is still mostly at a variable rate. Mr Minford agrees with the pro camp that labour market rules may be modified by EMU—but in the wrong direction. If Britain goes in, he thinks, it may be coerced into harmonising its system with the continentals'. Oxford's Mr Taylor thinks that EMU will bring cycles and the use of debt more closely into line and that Europe's labour markets will become freer. But, he admits, no one really knows: “It's uncharted territory.”