In this article I examine the growing acceptance of economic and monetary union, and hence a single currency for the EU, by leading strategists within the Labour movement. Although the adoption of a single currency may be logical for some EU member states, we argue that profound structural differences in the UK economy indicate this to be a hazardous path for Britain. Moreover, it is likely to negate the aspirations of the Labour Government with respect to goals such as full employment and social justice.

Brian Burkitt is a Senior Lecturer in Economics in the Department of Social and Economic Studies at the University of Bradford.

Gordon Brown’s statement on Labour’s European Monetary Union (E.M.U.) policy on 27^th October was a masterpiece of short-term political tactics. The combination of a commitment to the single currency in principle with a pledge not to enter in the lifetime of the current Parliament was a double-whammy sufficiently about to silence critics on both the pro – and anti – E.M.U. wings of the party. It also possessed the additional bonus of re-opening Conservative divisions. However, its value as a statement of long-term government strategy is dubious, particularly when Gordon Brown stresses the need for "a mainstream, pro-European, national consensus – stretching across the country and in particular the world of business". Indeed, behind an ostensibly neutral stance, an unspoken bias towards participation in E.M.U. ‘if it works’ is manifest.

A number of influential ‘New Labour’ figures have argued that the consequences of ‘EMU’ are potentially beneficial and should therefore be embraced by Labour; for instance, Cook (1995), Monks (1995), Corry (1996), and Mandelson and Liddle (1996). The arguments deployed to support this position vary; Monks stresses ‘ the vigour and discipline’ required by a single currency, Corry sees EMU as a protection against international currency markets, Mandelson and Liddle emphasise the gains to be derived from a co-ordinated European Union (EU) – wide monetary policy, whilst Cook claims that progress towards EMU could significantly improve the international economic performance of the EU. Moreover, the TUC (1996) published a

comprehensive report on the EU’s moves toward EMU. It is a detailed document that provides much information about the procedures of the Maastricht Treaty. In addition to compiling the facts, it does not disguise its support for the process of EU integration; for instance paragraph 23 states that, "the European trade union movement (ETUC) has generally seen EMU as a necessary and legitimate goal in the EU. Underlying support for EMU is the conviction that European, as opposed to just uncoordinated national, economic management is needed".

The problem that arises from such statements is that they pronounce upon the desirability of EU integration without considering its precise form. The latter in practice decisively determines its desirability. Consequently, a dilemma emerges at the heart of the TUC document, which is never resolved, between what the Maastricht Treaty actually stipulates and what EU integration could potentially be within a social democratic framework. Given the difficulties of ratifying the Maastricht Treaty, it is difficult to believe that many members (particularly those in favour of further integration) would wish to open the Pandora’s Box of renegotiation. Therefore realistic assessment of EMU can only be based on the provisions contained within the Treaty. Hopes of restructuring the integrationist project are irrelevant until detailed strategies are forthcoming for transforming it, particularly given its starting date of 1^st January 1999. No such strategy has emerged, from the TUC report or elsewhere within the Labour Movement.

Once the current route to EMU established at Maastricht is analysed in detail, it is seen to impose certain and heavy costs upon the UK, which will prevent the Labour Government from pursuing its traditional objectives of full employment and social justice. These costs comprise two major components; the deflationary burden of meeting the Maastricht Fiscal Convergence Criteria (MFCC) by 1999 and of maintaining them thereafter, plus the problems created by an EU-wide single currency once it is established. When these phenomena are allied to the present cost of EU membership, the scenario for Britain under EMU that emerges is far removed from the optimistic hopes entertained by the TUC and other New Labour proponents of further integration.

As a background to the analysis it is important to emphasise the losses imposed on the UK by EU membership. Of the easily measurable costs over the decade from 1985 to 1995, the UK has:

1. suffered an overall £89 billion trade deficit with other EU members;
2. made a net contribution of £16 million to the EU budget
3. incurred an estimated lost £68.2 billion as a result of its ERM membership between October 1990 and September 1992 (the loss arose from a 4% rise in unemployment, a 3% increase in real interest rates, a fall in output below its trend growth rate and the sterling expended in the doomed bid to defend the exchange rate);
4. found its business facing a bill amounting to 8% of GDP to meet EU directives emanating from the Commission in Brussels.

Additionally, the National Consumer Council (1995) estimated that the Common Agricultural Policy adds £20 per week to the food bill for a family of two adults and two children, whilst the cost in highly-paid ministerial and civil service time of attempting to co-ordinate EU member states’ policies is substantial. In the Ministry of Agriculture 70% of the workload is now estimated to be Brussels related. At Environment and the DTI, it is around 30%; in the Treasury; 15%. These statistics demonstrate the damage wrought by EU membership upon the UK economy and process of government. However, the future burden imposed by EMU is likely to be far higher; it consists of two elements, the consequences of maintaining the Maastricht fiscal convergence criteria over the economic cycle and the impact of a single currency once it has been established.

To reach the fiscal convergence criteria laid down by the Maastricht Treaty; member states must reduce their current budget deficit to 3% of GDP and their gross debt to 60% of GDP. The EU-wide deflationary effect of reaching these targets for EMU is draconian. Holland (1995) calculated that, if the twelve member states before the 1995 enlargement each met the 3% deficit objective by the end of 1999, across the EU unemployment already at 18 million would increase by a further 1 million. Bill Martin of United Bank Securities estimates that ‘E.M.U.espirant’ countries suffered a loss of around 4.5% if their G.D.P. during the 1990s by pursuing the Maastricht criteria. If an international authority compelled such a diminution of wealth, the cry of ‘Danegeld’! The EU, however, voluntarily accepted this unprecedented loss.

The requirement to comply with the Maastricht criteria is not a one-off entry ticket to E.M.U., but is a long-term commitment which must be fulfilled in cyclical troughs as well as peaks, so that U.K. budget deficits will be allowed to expand beyond 30% of G.D.P. even during a deep recession. Consequently present British complacency about qualifying E.M.U. is an inadequate response to the enormity of the Maastricht commitment. The behaviour of the U.K. economy during the two recessions of the past decade emphasises the point. Government finances moved from a 5.3% deficit at the depth of the 1980-1981 recession, before recovering to a surplus of 3% of G.D.P. at the height of the 1988-1989 boom. However, the next cycle generated a budget deficit, which exceeded 8% during 1993-1994, which if Gordon Brown is correct in his latest predictions, will improve to a 2% surplus by early next century.

Observing public finances over these cycles illustrates two crucial considerations. First, the budget is now weaker than in the early 1980s, because the later deficit was larger and the predicted surplus smaller than during the earlier cycle. Second, the large oscillation in the budget amount, measuring 8.3% of G.D.P. during the 1980s cycle and 10.0% during the recent period, demonstrates the extent to which government finances need strengthening if Britain has any hope of attaining the Maastricht targets during the next recession.

A policy to ensure that the U.K. budget deficit remains below 3% G.D.P. at the trough of a recession, given the cyclical variation in government finances of 8.5% to 10% of G.D.P, recognises that the U.K. budget surplus at the peak of the boom should be approximately 6.0% to 7.5% of G.D.P. This objective necessitates tax increases or public expenditure cuts in the region of 4.0% to 6.5% of G.D.P., on the assumption that the Chancellor’s predictions are largely accurate. It would impose tax rises or public spending reductions between £28.3 and £46.1 billion at current price levels. The savings needed to achieve the Maastricht criteria continuously are of the same magnitude as the entire level of public sector borrowing in 1993-1994, at the end of the second deepest recession since the Second World War. Reducing

aggregate demand by such an amount will impose severe cuts in output and employment, in addition to the negative impact of tax rises upon living standards or deterioration in the quality and quantity of public series.

Even for those who support EMU on political grounds, the Maastricht process must constitute the most disastrous possible route of achieving it. Not only its economic, but its political, implications are grave. Higher unemployment breeds nationalism and racism, as the electoral fortunes of ‘extreme right’ parties in European Parliamentary elections demonstrate (Burkitt, et al., 1994 and 1995). Thus the restoration of full employment, obstructed by the Maastricht Treaty, becomes still more crucial.

The 1994 document, "Economic renewal in the European Union: the UK Labour Party and the Delors White Paper on growth, competitiveness and employment", said; ‘Labour supports progress towards economic and monetary union and believes that it could significantly improve the economic performance of the entire European community. However, we strongly believe that convergence of the real economic performance of member states is a vital pre-condition of any moves towards economic and monetary union. Labour believes that the EU must consider further steps to promote such convergence’. Such statements indicate that ‘New Labour’ has learnt the message of economic theory; ‘Optimum Currency Area’ analysis, which addresses the

question of whether geographical areas should proceed with monetary union, demonstrates that a single currency between nation states can yield benefits if they possess very similar economic structures, but will be detrimental if these structures are different (Burkitt, et al., 1996).

However, one is entitled to ask if the Labour Government has considered how long-term and far-reaching those ‘further steps’ must be if they are to promote ‘real economic convergence’. The latter is indeed of primary importance compared to the Maastricht fiscal convergence criteria if EMU is ever to be attained, but the momentous task of achieving it between, say, Germany and Greece; France and Portugal; Sweden and Spain; has not even been contemplated. Should the EU enlarge towards Eastern Europe, the task will grow in magnitude.

‘Real economic convergence’ needs precise definition. The Treasury Document (1997) supporting Gordon Brown’s statement slips between, but never specifies, two different concepts of convergence: -

1. cyclical, the belief that a single currency is only beneficial, when the trade cycles of its members is synchronised.
2. structured, the belief that a single currency requires its national participants to possess homogenous economic structures and international trading patterns.

The two are inter-related, but refer to a different time-span. A determined government could potentially achieve cyclical convergence temporarily over two five-year parliaments through appropriate fiscal and monetary policy changes. The more fundamental structural convergence would require a focussed strategy over generations. Neither national governments nor the E.U. Commission has ever devised, let alone implemented, such a complex programme. Therefore, none will be forthcoming as far ahead as one can foresee so that the conditions for a successful implementation of a single currency will not occur.

Corry (1996) argued that EMU will deter speculators from ‘picking-off’ individual currencies, as in the exchange rate mechanism crisis of 1992 and 1993, by replacing them with one EU-wide money backed by the combined reserves of participating central banks. Thus governments would possess greater scope to pursue policies at variance with the interests of currency dealers. In an international economy where around £190 billion currently flows daily across the London Forex market, 90% of which are speculative funds unrelated to trade (Jones, 1995), such an argument has appeal. However, the EU is not global; it is regional. Corry ignores the crucial facts that most speculation originates outside the EU, that a single currency could become the focus of speculation against the dollar or yen, that other measures such as transactions tax can curb speculation (Tobin, 1994), and that EMU imposes heavy, certain costs upon the UK. It is these that we now analyse.

The UK’s economic structure is sufficiently different from those of most other EU members that a single currency is unlikely to generate economic benefits. It’s international trade less integrated with other EU countries. 57% of UK visible exports go to the EU, but only 36% of its invisible exports, which now account for half of Britain’s overseas earnings, possess the same destination. As the UK is relatively more efficient at producing services, which are growing faster, the distinction is crucial. Only 30% of UK exports (visible and invisible)  flow to the ‘core’ EU of Austria, Benelux, France and Germany. British overseas investment follows a similar pattern; only 30% goes to the EU ‘core’ and 39% to the EU in total, whilst 16% of inward investment to Britain originates from the ‘core’ EU and 18% from the EU overall.

A further consequence of the UK’s economic structure is that, when subject to asymmetric shocks (i.e. nation-specific disturbances), a different response is required in comparison to other EU members. A detailed econometric study by Bayoumi and Eichengreen (1992) isolated the aggregate demand and supply shocks that impact upon national economies. For the period 1960 to 1988 they found that the correlation of both demand and supply shocks affecting the UK with those that effect Germany was low (around 0.15). They also demonstrated that, in addition to being weakly associated with those of Germany, the size of these shocks is relatively large.

Such results for Britain are unsurprising when it is recognised that the UK economy differs from that of other EU countries in fundamental ways: -

1. the UK and the Netherlands are the only significant producers of oil and gas. An oil price shock therefore exerts a different effect on these nations than on the rest of the EU states and so requires a different policy response.
2. the relative size of manufacturing and service sectors varies substantially between the UK and the German economies. Manufacturing is more important in the latter, accounting for 30% of GDP compared to 23% in Britain, but the relative size of the finance and media sectors is much greater in the UK than in Germany, or indeed most other EU members.
3. the UK, Spain and Italy rely least on other EU countries for external trade. Consequently movements in the dollar (or yen) Euro exchange rate will impact more substantially on these countries. Thus depreciation of a single EU currency amounts to a greater relaxation of monetary policy in Britain than, say, in Belgium.
4. The UK holds a much higher proportion of debt, both in the household and corporate sectors paid at variable interest rates, than does the rest of the EU. Moreover, household debt is more significant as a proportion of GDP in the UK, reflecting the different nature of the housing market in which variable interest mortgage debt is equivalent to around two-thirds of UK household disposable income compared to under half in Germany and less than a quarter in France.

These structural differences give rise to asymmetric shocks that lead to changes in member states’ relative competitiveness. However, if any country becomes less competitive, as is frequently inevitable in a dynamic world, it could not restore balance of payments equilibrium under EMU by altering its exchange rate. If exchange rate flexibility is removed, a lock of competitiveness becomes difficult to remedy. Within a single currency area, such problems no longer lead to a balance of payment deficit, but takes a different form. Unless relative costs can be reduced or productivity increases, output and employment will fall; high unemployment and a depressed level of income might become chronic.

An analogy can be drawn between the UK’s position under a single currency and that of Scotland and Wales within the UK. Throughout most of the twentieth century, Scotland and Wales experienced greater unemployment and lower levels of per capita income than the South of England but their competitive disadvantages cannot be ameliorated by devaluation because they share a common currency with England. The same difficulties would confront Britain, located on the geographical periphery of the EU and with a history of productivity rising more slowly than in some of its neighbours.

The problem of persistent unemployment looms large across the EMU-zone, which lacks the equalisation mechanisms that exist in nation states. One of these is the mobility of labour. A common culture and language makes migration from high to low unemployment regions, at least across generations, a relatively easy procedure. Moving from the UK to other EU member states in search of work is a more formidable undertaking. The EU Commission found that regional migration between member states in the first half of the 1980s was just 29% of migration across the USA states in the same period. Consequently labour mobility is unlikely to equalise across and EU-wide single currency area.

Even more important is the role of government. In a unitary state like Britain, and to a lesser but still significant extent the federal nation like the USA, the activities of central government exert a major impact on the regional pattern of output, income and employment. These government equalisation activities are possible only because of the size of government budgets (typically 40-45% of GDP in unitary advanced industrial economies and 20-25% in federations). By contrast, the EU budget is currently 1.2% of GDP. The 1992 Edinburgh Summit agrees an EU budgetary increase to no more than 1.7% of GDP by the year 2000. It is hard to envisage the existence of the political will to raise this figure in the foreseeable future. Therefore, after the implementation of a single currency, increased unemployment is the only way a national economy could adjust to a fall in competitiveness, given the absence of a large growth in labour mobility and/or in the scope of the EU budget.

Consequently it is impossible to imagine the circumstances under which Labour’s nirvana of ‘real economic convergence’ could ever occur. Crucially, however, if by some miracle it proved attainable, different national trends in productivity and technical progress (inevitable without Stalinist-central planning) would undermine it immediately. So too would the imposition of an EU-wide monetary police. Should an EU central bank impose a uniform charge in interest rates across all member states, the immediate expansionary or deflationary impact will be greater in the UK.

A Centre for Economic Policy Research Report (1994) showed that interest rate variations exercise most of their impact in Britain within two months, compared to six months in Germany and Italy. In Britain, the impact of interest rate movements on economic activity is four times the EU average.

The Labour Government must restore full employment if it does not wish to create social catastrophe. Labour would be perverse to deflation by maintaining the fiscal criteria by the Maastricht Treaty, which over the trade cycle will cause economic growth to slow and will destroy jobs. Moreover, significant structural differences exist between the UK economy and those of most EU member states. Consequently, Britain faces country-specific shocks, which are large in number and magnitude. There seems little reason to suppose that EMU will reduce such

shocks, but many phenomena suggest that they will increase. Under these circumstances, the cost to the UK of operating a single currency, in terms of lost output and employment, will be significant and will grow over time.

Grandiose, but totally unspecified, dreams of avoiding this outcome by achieving ‘real economic convergence’ amongst fifteen (or more) member countries do not evade harsh reality. EMU will undermine any attempt to advance social conditions and improve performance. Nor can it be reformed from within EU structures; even in the unlikely event that the EU adopts the Swedish goal of full employment, it would be a purely declaratory statement, unlike the legal commitment established at Maastricht to achieve price stability. The convergence criteria are a recipe for deflation and unemployment, after as well as before 1^st January 1999. The Labour Government should remove all doubts about its intentions by stating clearly its opposition to EMU and a single currency.

Brian Burkitt

University of Bradford

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