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Last Updated: Monday, 9 June, 2003, 17:11 GMT 18:11 UK
Assessing the euro assessment
Analysis
By Tim Weber
BBC News Online business editor

The chancellor says the UK economy does not yet meet the conditions to join Europe's Economic and Monetary Union (EMU). But what facts does he base his argument on?

Gordon Brown's conditions for Britain's eurozone entry were tough: The economic case for meeting his five tests for euro entry had to be "clear and unambiguous".

John Bull impersonator tearing up a 10 euro bank note
The euro is not for Britain - at least not yet
And here lies the problem in assessing the Treasury's assessment.

Economics is often called the "dismal" science. Put three economists in a room and you will get four forecasts - or so the joke goes.

The Treasury's studies prove the case. Take the analysis of the impact of EMU on trade.

Monetary union could boost UK trade by 5% to 50% during the next 30 years, the study says.

If you think this forecast sounds vague, take a look at the hard economic facts.

The euro has already boosted trade in the eurozone. But by how much? Somewhere between 3% and 25% say the economists quoted by the Treasury.

Or to quote another of the Treasury's 18 studies: "A fully quantified cost-benefit analysis... is not feasible, for reasons of data availability, reliability and complexity."

As the economics is neither clear nor unambiguous, the euro tests are ultimately a matter of political judgement.

So how does the chancellor tally the numbers?

The five tests fall into two categories:

  • What are the costs of joining - does the UK economy fit into the eurozone, and can the country cope with any economic turbulence?
  • And what are the benefits of joining - will the UK get more investment, more jobs and a boost for the City if it joins the eurozone?
1. Convergence

Monetary union can go horribly wrong if the business cycles and economic structures of the UK and the eurozone are not compatible.

Newly built Ford shipping station in Germany
Will foreign investors love the euro and shun the pound?
So do they fit? In recent years, the UK economy did well while the eurozone performed poorly.

That in itself is not a problem. Different regions in the United States - a prime example of monetary union - "have highly idiosyncratic business cycles", argues the Treasury, and "monetary union can survive and prosper" regardless.

And anyway, the chancellor argues that UK and eurozone economies and interest rates are converging.

But the UK has one thing that sets it apart: its housing market is highly sensitive to interest rate changes.

Unlike the eurozone and the US, most British homeowners have mortgages with variable rates. When inflation and thus interest rates rise, they suffer.

The chancellor is right: Joining the eurozone's one-size-fits-all interest rate policy could do more harm than good as long as mortgages with long-term fixed interest rates are not popular in the UK.

The government wants to change this, but for now Gordon Brown has put a fail mark on this test and he is right to do so.

2. Flexibility

"Sustainable long-term compatibility" is the chancellor's other watch word.

In other words: Should things go wrong, is the system flexible enough for the government to be able to deal with any problems?

Mr Brown could not help but pat himself on the back.

In economic theory, flexible labour markets translate into low unemployment. The UK has it (thanks to the government's policies, says Mr Brown), but the eurozone has not.

So reforms are necessary, and the chancellor wants most of those reforms to happen in the eurozone.

Inflation is another worry. The Treasury predicts higher "inflation volatility" inside the eurozone, and says flexibility in the UK alone is not enough to save the day.

And that translates into another fail mark in the euro tests.

A point well made? That's difficult to say. Who is to say when, for example, labour markets are liberalised enough?

But for starters, the chancellor says he will adopt the inflation target used both in the US and the rest of the EU, which is a step towards euro convergence.

3. Investment

So would the UK benefit from joining the eurozone?

European Central Bank headquarters
One interest rate for the eurozone - but does it fit the UK?
Mr Brown started his speech pointing out how UK business could gain billions of pounds by joining the eurozone.

Small and medium-sized firms would stand to win the most, he argued.

Among the quick wins listed by the Treasury are easier access to capital and export markets, and lower currency costs.

These points, the chancellor believes, will not be lost on foreign investors. He argues that there is already evidence that they might give the UK a wide berth the longer the country stays outside the eurozone.

Despite all this, and rather curiously, Mr Brown still awards a fail mark to this test. Only passing test number one - convergence - will guarantee high quality investments, he says.

This may be the case, but it is not well made.

4. Financial Services

Can the City of London flourish outside the euro?

Past evidence says yes, and most agree that it could do even better once the UK has joined monetary union.

The chancellor says this euro test has been met, and few would argue.

5. Growth and employment

This is the point where it is hardest to weigh costs and benefits.

The Treasury's studies are full of economic theory and data that suggest that monetary union is good for you.

The potential benefits, the chancellor says, are "significant".

But just as in test number three, Mr Brown believes that the UK is not quite there yet.

Once again, he worries about a lack of "sustainable convergence and sufficient flexibility".

Without those, he says, the UK cannot realise the "benefits for stability, jobs and investment".

For the chancellor, this translates into yet another fail mark - the fourth out of five tests.

The result

All this means that the UK really has to meet just two tests: convergence and flexibility.

Once they are achieved, all other pieces of the economic puzzle will fall into place.

But how does one recognise truly converged and flexible economies?

It is certainly not something that can be left to the economists.




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