The Conservative leadership's thinking about Europe depends on one central perception. They think that the European Union is seeking to create a "large, expensive, protective superstate", as John Redwood puts it.

Written by Chris Huhne MEP and published in the Independent on Mon 11th Jun 2001

The markets are clearing away the biggest obstacle to British adoption of the Euro: the high exchange rate of sterling. Many economists have long thought that the pound would retreat to a sustainable level when the markets saw that the Government was serious about joining. We were right. The pound is falling merely on an increased probability of entry in the wake of the general election.

However, the big debate between the Chancellor and the Prime Minister is unresolved. Within the Treasury, some influential voices argue that Britain does not lose by delaying. Surely it makes sense, they say, to see how the system survives in bad times as well as good before deciding to go in, especially since we have a carefully negotiated opt-out.

This is always a tempting argument. It combines the Whitehall doctrine of unripe time with the natural instinct of the cautious politician to delay any decision that will alienate someone. However, it is surely wrong. There are real economic and political costs in delay.

First, British consumers will continue to miss out on the benefits of lower continental prices. The Euro completes the single market for the twelve countries and 301 million people in the Euro-area. Businesses are aligning their prices, generally at the levels of the lower priced markets. They know that, if they do not, wholesalers will set up supply lines from cheaper sources in the Euro-area.

This is a powerful force. The internet is no substitute, because the uncertainty of foreign exchange movements stops businesses from exploiting those price opportunities fully. One recent study showed that a Canadian province trades twenty times as much with another Canadian province as with an equidistant US state despite free trade and a common language. Currencies are an obstacle to trade.

Secondly, British businesses are losing market opportunities. That price alignment within the Euro-area is forcing efficiency improvements to protect profits. Big companies are able to centralise production without adding to exchange rate risks. Invoicing for the whole Euro-area can be happen in one place. For the first time, European companies can begin to operate with US-style scale advantages.

These trends are dramatic. They are going on within European companies, and between them. The Euro has been a major contributory factor in what is becoming a vast restructuring of the European economy. For each of the last two years now, the value of European company mergers has exceeded $1.5 trillion, more than six times the previous annual peak of any European mergers boom.

This has dangers for Britain. Some of the biggest British businesses, often participating in the mergers boom, may slowly emigrate to their biggest market in the Euro-area, effectively becoming Euro-area companies. But medium sized British businesses will not have that option: they will continue to suffer the disadvantage of incurring costs in a currency different from the currency of their biggest export market.

Although these businesses can hedge their revenue - selling future euro revenue for sterling - they cannot hedge their costs. If sterling rises, they become less competitive even if they make a profit on their forward contract. It still makes sense for them to sack workers, which is why we have lost 397,000 jobs in manufacturing since March 1998. Far from being a useful policy lever, sterling is buffeted by footloose capital flows that make the currency more like a wrecking ball.

Even if sterling now falls sharply, and then stabilises, there will be another problem. British business will not face the gradually intensifying pressure of competition within the Euro-area as the twelve economies integrate fully. When sterling is stable, it acts like a tariff barrier. That is comfortable in the short term, but in the long term it is disastrous. Remember the price we paid in accumulated inefficiency when we stayed outside the liberalising European Union from 1958 to 1973.

There is another problem. Any American or Japanese company, examining the advantages of investing in Britain or the Euro-area, is going to assess many factors such a labour flexibility, skills and language. But if they are producing for the whole European market - as most in manufacturing do - the Euro-area now has an enormous advantage as a location. Costs are in the same currency as revenues. For many, this will tip the balance.

All of these factors - migrating big companies, protected medium sized companies, discouraged foreign direct investors - are costs that are already beginning to accumulate. The longer Britain is outside, the greater the adjustment that Euro-area companies will have made by the time we join. The further ahead companies in the Euro-area will be. And the nastier the cold shower when we join. Since the costs of joining will increase, and the benefits are available immediately, it makes no sense to defer the investment.

There are political costs to delay too. The much greater cross-border integration of business in the Euro-area - for example, as companies shop around for cheaper bank loans in Euros - will mean that business reality in Britain increasingly diverges from that of our partners. And that in turn increases the risk that they will want some EU law that reflects their needs, rather than ours.

They will have no trouble legislating for that law, since single market legislation, thanks to Margaret Thatcher's Single European Act, can be passed with 71 per cent of the votes in the Council of Ministers and the assent of the European Parliament. Both necessary majorities exist within the 12 EU members of the Euro-area. We may find it increasingly uncomfortable being in the EU - which regulates much of the private sector's single market - but outside the Euro-area.

If our continental partners see a Government with a majority of 167 ducking the decision, they are unlikely to believe that Mr Blair and Mr Brown are really committed even to the principle of Euro membership, as they claim. As the discussions on the final shape of the European Union are due to begin in 2004, this would be a fatal impediment to our negotiating position. Why make concessions to a country that is not a full participant? And if our needs and desires are ignored, what would be the impact on opinion in this country?

The history of Britain's relations with the European Union has repeatedly been characterised by delay. Our failure to join in 1958 meant that we did not shape the Common Agricultural Policy and the Common Fisheries Policy, and had to accept them when we joined. Our delay in joining the exchange rate mechanism led to entry at the wrong rate, at the wrong time, and in the wrong way. Our failure to join the Euro-area meant that Frankfurt, not London, became the seat of the European Central Bank. Delay has real costs even for myopic politicians. It is not a soft option.

Chris Huhne MEP is the economic spokesman of the European Liberal Democratic and Reformist group. The revised second edition of his book 'Both sides of the coin: the case for the Euro' (with James Forder writing the case against) is published on 2nd July (Profile £8.99).