May 30, 2003

Another British Economist Scared of the Euro

Sam Brittan crosses the aisle and now opposes replacing the pound with the euro:

A case for currency freedom - Samuel Brittan: New Economy 06/03: ...I have never regarded the direct economic effects of euro membership as terribly important one way or the other. The main reason why I formerly supported it was that it seemed for many years the most likely way of establishing an operationally independent central bank. The independence of the European Central Bank was established by treaty on the lines of the Bundesbank in Germany and seemed pretty safely ensconced. But since the incoming Labour government took many people by surprise in 1997 by unilaterally establishing operational independence for the Bank of England - and still more because of the favourable track record of the new regime - that particular argument for the euro goes out of the window.

The case I now wish to make is a positive one, not against the euro - still less against the European Union - but in favour of a floating exchange rate which the UK now enjoys and could not continue to have inside the euro. A floating exchange rate automatically balances a country's overseas payments - current and capital account taken together - without the need for cap-in-hand official overseas borrowing and without the need for inflationary or deflationary distortions of domestic policy.

A fixed rate of exchange produces two problems. The first is the threat of a balance of payments crisis and runs on the currency. The recurring feature for decades or even centuries of British economic history has been the needless crises brought about by futile efforts to maintain a fixed exchange rate. When in 1931 a Conservative-dominated national government floated the pound which its Labour predecessor tried so hard to save, the former Labour minister Margaret Bondfield remarked: "Nobody told us we could do this."

The foreign exchange crises which bedevilled British economic management through the 1940s, 50s, 60s and 70s are legendary. It would be foolish to argue that the UK has had a smooth ride since the pound floated in 1971. The last of the sterling crises, the "IMF" one of 1976, took place when sterling was already floating. In retrospect, this was quite an unnecessary crisis, due to the fact that policymakers had insufficient experience of market-determined exchange rates. There were all kinds of fears that the pound would "go through the floor", whatever that meant. But once the government had taken action to reduce the budget deficit and control money and credit, as it had largely done by the time of the IMF visit, the rest could have been left to the market, which indeed produced in 1977 a bigger "recovery " of sterling than anyone had bargained for. The then Chancellor, Denis Healey, actually used the IMF negotiations to gain support for policies that he in any case favoured.

It should in all fairness be said that the balance of payments threat is largely removed either by a floating exchange rate or by membership of the European Monetary Union. There cannot be a run on the pound if sterling no longer exists. The only run can be on the euro as a whole, which is a pretty far fetched proposition - at least so long as the euro is managed by a cautious and independent European Central Bank.

But there is a second problem which would not be removed by joining the euro. That is the possibility of unemployment due to money wages which make British goods uncompetitive compared with those of other countries. If the UK joins at too high an exchange rate many industries would become uncompetitive and unemployment would rise until wages were pushed down to a lower path than that of partner countries. An exchange rate adjustment to reduce them is no more possible in the euro area than it would be now for Yorkshire or Lancashire. ..

Posted by DeLong at May 30, 2003 11:20 AM | TrackBack

Comments

So a UK economist is rightfully concerned that adherence to tight money and a strong currency might hurt the macroeconomy by lowering net exports but the U.S. Administration is preaching a strong dollar even though the U.S. trade deficit is $500 billion and the U.S. economy is below full employment. I would hope Bush might ask Blair for this UK wisdom on the international macroeconomy while at the G8 summit.

Posted by: Hal McClure on May 30, 2003 11:54 AM

Does anybody know if Sam Brittan ever apologised for being so totally wrong about British membership of the ERM in '90-'92?

Posted by: PJ on May 30, 2003 12:42 PM

PJ - It seems a bit unfair to single out Sam Brittan.

The decision to put the Pound into the ERM in 1990 was carried by verging on a UK consensus at the time. To all appearances, most on both sides of Parliament, the CBI and the TUC (respectively, the main employers' and labour union representative organisations) all expressed approval. As I recall, the one economist with profile in Whitehall who remained critical was Alan Walters, Mrs Thatcher's personal economic adviser, but he tended to be ignored.

Perhaps understandably, nowadays few of those who warmly supported the decision in 1990 like to be reminded of it. The tragedy is that there was too little prior economic analysis of contingencies - such as what might happen were the UK's inflation rate or change in unit labour costs to diverge too sharply from those of the economies of other currencies in the ERM, which is what happened, leading to the famous speculative attack on the Pound's exchange rate in the ERM in September 1992 and the inglorious exit, which proved so beneficial to the UK economy for the rest of the 1990s. By end 1995, the UK's standardised unemployment rate was lower than in France, Germany or Italy and a higher percentage of working-age people were in jobs.

There is a highly topical relevance of all this which tends to be persistently overlooked. Were a future referendum to approve Britain joining the Eurozone, as part of the transition route it would first be necessary to put the Pound back into the ERM for at least two years prior to entry of the Pound into the Euro at an "irrevocable" exchange rate. That requirement is specified in the Maastricht Treaty and was confirmed in the evidence of a senior European Commission official to the HoC Treasury Select Committee as recently as February this year. Occasionally, it has been suggested that some alternative joining route might be negotiated. However, as a departure from the Treaty provisions that would need the unanimous consent of all EU member state governments, a prospect which seemed a tad uncertain given the hiatus in European relations over the Iraq war.

Posted by: Bob Briant on May 30, 2003 02:41 PM

PJ - It seems a bit unfair to single out Sam Brittan.

The decision to put the Pound into the ERM in 1990 was carried by verging on a UK consensus at the time. To all appearances, most on both sides of Parliament, the CBI and the TUC (respectively, the main employers' and labour union representative organisations) all expressed approval. As I recall, the one economist with profile in Whitehall who remained critical was Alan Walters, Mrs Thatcher's personal economic adviser, but he tended to be ignored.

Understandably, nowadays few of those who warmly supported the decision in 1990 like to be reminded of it. The tragedy is that there was too little prior economic analysis of contingencies - such as what might happen were the UK's inflation rate or change in unit labour costs to diverge too sharply from those of the economies of other currencies in the ERM, which is what happened, leading to the famous speculative attack on the Pound's exchange rate in the ERM in September 1992 and the inglorious exit, which proved so beneficial to the UK economy for the rest of the 1990s. By end 1995, the UK's standardised unemployment rate was lower than in France, Germany or Italy and a higher percentage of working-age people were in jobs.

There is a highly topical relevance of all this which tends to be persistently overlooked. Were a future referendum to approve Britain joining the Eurozone, as part of the transition route it would first be necessary to put the Pound back into the ERM for at least two years prior to entry of the Pound into the Euro at an "irrevocable" exchange rate. That requirement is specified in the Maastricht Treaty and was confirmed in the evidence of a senior European Commission official to the HoC Treasury Select Committee as recently as February this year. Occasionally, it has been suggested that some alternative joining route might be negotiated. However, as a departure from the Treaty provisions that would need the unanimous consent of all EU member state governments, a prospect which seemed a tad uncertain given the hiatus in European relations over the Iraq war.

Posted by: Bob Briant on May 30, 2003 02:48 PM

Quite. I wasn't singling out Sam Brittan because he was grotesquely wrong. I was myself grotesquely wrong on that issue. But I was testing his intellectual honesty and ability to recognise the blatantly obvious by asking if he'd admitted being wrong.

Posted by: PJ on May 31, 2003 01:25 PM

... and the fact that he referred to 1976 as "the last of the sterling crises" makes me doubt it.

Posted by: PJ on June 1, 2003 02:26 AM

... and the fact that he referred to 1976 as "the last of the sterling crises" makes me doubt it.

Posted by: PJ on June 1, 2003 02:27 AM

PJ - Good point.

Btw strange how both of us seem to have had problems posting here. The first time I posted and waited the screen suddenly showed page unavailable. I later came back to see if the post had nevertheless taken but it wasn't there so I reposted. Later, I found both messages here. The interesting coincidence is that I often run into problems of one kind or another elsewhere posting sceptical messages about the Euro.

Posted by: Bob Briant on June 1, 2003 04:45 AM

Why ever should any sane Britain want to adopt the Euro just when it appears the governing requirements accentuate the already difficult economic conditions in Germany? Why not have Canada and Australia also adopt the Euro and depress other healthy economies in a world that needs faster growth?

What could be stuffier and stodgier than being completely beholden to the EUC governing legislature?

Posted by: anne on June 1, 2003 08:29 AM

anne - I agree. But see this claim by Emeritus Prof Robin Marris reported at:
http://news.independent.co.uk/uk/politics/story.jsp?story=411268

I've been aware of his views but haven't so far been able to find more than newspaper reports - should anyone know better, a posted link here would be appreciated. As best I can tell, the "economic" case being made on behalf of Britain joining the Euro could also be deployed in favour of having a single world currency or for Canada adopting the US Dollar. At that stage I get sceptical.

By implication, Prof Marris doesn't rate loss of national monetary autonomy as significant. I then look at the spread of unemployment and inflation rates in the Eurozone economies (stats annex in The Economist) and start to wonder how the European Central Bank's refinancing rate can apply across such a diverse range without causing unacceptable inflation rates in some national economies or economic stagnation in others. The facts are that Britain's unemployment rate is 5.1%, as against 8.7% in the Eurozone and with more than 10.5% in Germany. As for Inflation, on the official EU Harmonised Consumer Price Index, Britain's annual inflation rate was 1.6% when I last checked, as against 2.1% in the Eurozone. Evidently, the Eurozone has both higher unemployment and inflation rates than Britain. As testimony to competence in economic management that doesn't look impressive to me but I would much like to read what Prof Marris has to say.

BTW I phoned up my local education authority (LEA) in London last week to find out if they knew of, or were putting on (part-time) adult education courses relating to the Euro or the European Union, seeing as how these were news issues virtually every day and by many accounts Tony Blair wanted a referendum on the Euro at the earliest.

To summarise what turned out to a series of calls since I kept being passed on: (1) the LEA had no relevant courses and none were planned for the next academic year, (2) the only relating course in adult education in their reference guide for the whole of London was at Birkbeck College - which happens to be Prof Marris' affiliation, (3) it was said that I was the very first person to ask (!), (4) local colleges providing adult education courses were uneasy about putting on courses about the Euro because it is controversial (!) and there is a problem finding "unbiased" tutors, although that had not inhibited them referring me to the Birkbeck College course.

Posted by: Bob Briant on June 1, 2003 11:58 AM

Frankly, another British economist, or whatever in fact, against the Euro or the EU is nothing new.

As for unemployment, I suspect that most Germans workers will prefer to remain unemployed to work in the condition of British workers. That the employers think otherwise is a given, they'd love to have cheap slaves.

DSW

Posted by: Antoni Jaume on June 1, 2003 01:09 PM

"As for unemployment, I suspect that most Germans workers will prefer to remain unemployed to work in the condition of British workers. That the employers think otherwise is a given, they'd love to have cheap slaves."

That's worth an extended response.

(1) Back track. Britain's GDP per capita was surpassed by Germany's in the late 1950s or early 1960s and by France's in the late 1960s or early 1970s at the latest, all before the UK had acceded to the European Economic Community in January 1973. Quite why that happened is challenging. Many factors contributed to Britain's relative economic decline - likely including greater defence spending, traditional attachment to slower growing export markets, failing systems of education and vocational training opportunities for most of the population and an embedded tradition of fractious industrial relations.

(2) Growing industry sectors in both France and Germany could draw on labour supplies from large agricultural sectors whereas Britain emerged from WW2 with only 4% of employment in agriculture. Post WW2, unemployment rates were very low in Britain through to the 1970s - arguably the outcome of commitment by successive governments to fine tuning demand to maintain a high level of employment. The implication was that demand for additional workers by expanding sectors could only be met by the contraction of declining sectors which successive governments and the labour unions were disposed to resist. In the '50s, W Germany benefited from the inflow of millions of mainly well-skilled political refugees from eastern Europe. As the result of that and the larger agric sector, labour markets in Germany were then more flexible and, of course, Hitler had destroyed the labour unions. Notoriously, working days lost through industrial action were far lower in Germany than in Britain through to the legal reforms in Britain in the 1980s. The evidence is that Britain's productivity gap with W European economies was closing in the 1980s - see Nicholas Crafts: The Conservative Government's Economic Record: an End of Term Report (ISBN: 025536413X)

(3) It is often suggested or hinted that by joining the Euro productivity in Britain would improve to German levels although the actual linkage from the one to the other is seldom, if ever, spelled out.

(4) Nor is it explained why unemployment in Germany is so high and rising. The main explanations are relatively straight forawrd - the Deutsche Mark got locked into the Euro at an over-valued exchange rate. The evidence is Chart 2 in http://www.bls.gov/fls/flsichcc.pdf As shown there, employment costs in Germany are way out of sync with those of its main trading partners. Economists in Germany were aware of the problem in 1998 and said that conditions were not right for Germany to join a single European currency: http://www.internetional.se/9802brdpr.htm But they were ignored. Germany's economy is significant in what happens in the Eurozone because it contributes about a third of the zone's total GDP - if the German economy stagnates that exerts a depressing influence on the rest of the zone. Schroeder's government in Germany is trying to redress the problem right now by market liberalisation measures and pushing through reform of Germany's welfare system:
http://news.bbc.co.uk/1/hi/business/2849187.stm
http://news.bbc.co.uk/1/hi/business/2850139.stm http://news.bbc.co.uk/1/hi/world/europe/2954392.stm

(5) All that said, it is not transparently obvious why Britain's loss of national autonomy in determining monetary policy to suit national conditions - and potentially loss of autonomy in economic policy as well if the current draft proposals for a new EU Constitution go through - would be adequately compensated by the gains from transactions costs savings and avoiding exchange rate uncertainty on intra-Eurozone trade, as well as from greater transparency in making cross-border price comparisons. On joining the Eurozone, most businesses in Britain would incur switching costs but accrue no direct benefits from joining.

(6) There are credible and even likely scenarios in the short term in which joining the Eurozone could seriously destabilise Britain's economy. Suppose the Eurozone economies were significantly depressed by continuing appreciation of the Euro, leading the European Central Bank to cut interest rates, while rising growth in Britain pushed the Bank of England into raising interest rates to curb inflationary pressures. What then?

(7) The fundamental is that the rates of both unemployment and inflation are lower in Britain than in the Eurozone. That matters for most folks.

Posted by: Bob Briant on June 1, 2003 04:58 PM

Just my two cents: Brittan uses a lot of unnecessary verbiage to make the obvious argument that by joining the Euro zone, the UK would lose the ability to engage in independent monetary policy. Given the current conservative bent of the ECB as well as the fiscal stability requirements of the Euro zone, I have to agree with him on this occasion.

However, if there comes a day when the ECB is less dogmatic about price stability and European governments are given more fiscal discretion, then the main disadvantages of joining the Euro zone will vanish. I haven't read his full article, so I'll have to check if he mentioned this possibility.

Posted by: andres on June 2, 2003 12:06 AM

Bob -

"The interesting coincidence is that I often run into problems of one kind or another elsewhere posting sceptical messages about the Euro."

Yes, in particular on the BBC's website. They take my postings on many subjects, but never on the European Union. The best way to get people to take postings I think is to mention the Euro obliquely, or by implication. You're far more likely to get something accepted if you write it on Argentina's crisis, and then close with a paragraph drawnig parallels with the Eurozone, than if you directly slag off the Euro. I'm not by nature a conspiracy theorist, and I used to think it's because they've got enough rants against the Euro from England, but I'm beginning to wonder if somebody in Brussels keeps an eye on the Internet.

Posted by: PJ on June 2, 2003 02:56 AM

PJ - Thanks. I follow news on the BBC website but seldom contribute to discussion threads.

The background to Robin Marris on the benefits to Britain of joining the Eurozone is here:
http://www.no-euro.com/mediacentre/dossiers/display.asp?IDNO=1281 Evidently, it was written to brief government ministers who want Britain to join but need to know why in order to counter the Treasury's brief to the cabinet which says: Not yet.

It looks more than a coincidence when the leading economics columnists in the broadsheet press have come to be sceptics about the Euro.

Posted by: Bob Briant on June 2, 2003 01:13 PM
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