The Case for the Euro: Why Britain is Missing Out

Speech by Chris Huhne MEP delivered to the Association of Corporate Treasurers on Tue 16th Apr 2002

Britain is missing out by not joining the Euro. We are missing opportunities for trade, investment and jobs. Those missed opportunities are mounting, and are becoming a real and measurable business cost. We must not delay.

Look at prices. Britain's membership of the Euroarea would make British markets more competitive. We would open the door to businesses to sell more cheaply here, and reduce prices for consumers. That is the only way to end the phenomenon of rip-off Britain where a recent survey by the city firm Dresdner Kleinwort Wasserstein found that we are paying 16 per cent more for a basket of branded goods like Levi Jeans, and Sony Playtstations. We pay double what the Spanish pay for a can of Coke. And I have not yet mentioned the most famous example of all: the fact that we pay through the nose even for standard cars. The price of a Ford Focus is 32 per cent higher than in the Netherlands. The price of a BMW 318 is 18 per cent higher.

Lower prices would mean that incomes go further, and living standards rise.

This is a powerful force, but the eurosceptics say that it is unnecessary because the internet will do the same thing for us. Certainly, the internet helps price comparisons and competitive tendering. The internet is commoditising markets. But the internet is no substitute for sharing a common currency, because the uncertainty of foreign exchange movements stops businesses from exploiting those price opportunities fully.

The second key advantage of Euro membership is therefore business certainty. Certainty in the exchange rate with the trading partners with whom we conduct half of our trade, and nearly two thirds of the goods trade that is most price sensitive. The idea that currency risks can be hedged and therefore than sharing a currency would not help trade is clearly nonsense. Many businesses work on such narrow profit margins that the risks are not worth taking, or the hedging costs outweigh the margins.

This is why trade is increasing so quickly in the Euroarea. Trade with the rest of the EU is up from 27.2 per cent of GDP in Germany in 1998 to 32.2 per cent. And in France it is up from 28 per cent to 32.2 per cent. Overall, there is an average 3.3 per centage point rise in trade shares in the Euro-area with no sign of any falloff in trade with the rest of the world.

But in Britain, there has been a declining trade share in GDP since 1998 both with our EU partners and elsewhere. Overall, the out countries have seen their trade shares stagnate.

And the trade boom in the Euroarea could go a lot further. One recent study, in the august American Economic Review in 1995, 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. This result was so surprising that another study was undertaken to see whether the first researcher had made a mistake. The results were confirmed. Particularly encouraging for the Euro is that there was no difference in the trade patterns between Quebec as a French speaking province and the others. The US border mattered more than language or culture. Currencies are an obstacle to trade.

This trade creation is worth serious money. A good rule of thumb is that a one percentage point rise in trade shares leads to a third percentage point rise in GDP. France and Germany are probably already 1 per cent better off each year as a result of their sharing the euro. And this merely tells us something that we surely know instinctively from spending time in the United States: if we want a big, efficient, competitive and productive market, we need a single currency.

So we are missing out on opportunities within the Euro-area. We are also suffering costs from our self-imposed isolation. Each year the accountancy firm Ernst and Young surveys inward investment into the EU, and it has found our share dropping from 28 per cent in 1998 to 21 per cent in the first half of 2001. And now down to 19 per cent.

For the first time, France is attracting more manufacturing projects than we are, which is certainly not because of the ease of French or lower social charges. But don't believe me: just look at what our inward investors are saying. Ford, Siemens, Nissan, Samsung and Matsushita are just a few of the businesses to warn that being out of the euro may mean being out of investors' minds.

Moreover, these estimates of our falling share of American and Japanese investment in the European Union underestimate what is really going on. They measure how well we are doing with a small subset of total cross-border EU investment. We are missing out on the explosion of foreign direct investment within the Euroarea from one member state to another now that there is no currency risk.

The official figures show a marked divergence between booming inwards investment in the Eurozone and sluggish inwards investment in the non-eurozone members of the EU. Investment from one eurozone member to another rose by 343 per cent between 1998 and 2000, the latest figures. Only one other category of investment increased even more quickly, and that was the 866 per cent increase in the investment of non-eurozone companies in the eurozone. By contrast, total inwards investment into the non-eurozone countries rose by only 50 per cent. This pattern is exactly what one would expect, since in effect the Euro gives a free hedge for investments in other member states. Risks are reduced, so that there should be more investment being undertaken.

The extra price competition 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 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. In the last three years since the launch of the Euro in January 1999, the total value of European company mergers has exceeded $3.7 trillion, more than the cumulative total of the previous decade. Indeed, both 1999 and 2000 saw merger volume at six times the annual rate of the peak year of the previous European merger boom in 1990.

Both investment and acquisition activity have been boosted by another factor created by the euro, namely the new financing opportunities in the integrated capital markets of the euro-area. Short term interest rates have tended to be lower, and real interest rates are also lower. And the securities markets are growing quickly. The Euro denominated corporate debt market is exploding: up from outstandings of €476 billion at the end of 1998 to €1.2 trillion at the end of 2001. That is a spectacular increase of 156 per cent, a near doubling in the share of non-bank corporates in the total up to 15 per cent. We now have a real corporate bond market, able to raise serious finance in spectacularly short periods of time.

What is more, there was a new record last year. The private sector now accounts for more than half of all euro-area bond outstandings for the first time in living memory. The equity market has also expanded, disregarding the recent lull. There are more share listings. More volume.

My own view is that the best is still to come. Just look, for example, at the volume of share trading in New York at nearly £21 trillion a year compared with just £7.2 trillion if you add London, Paris and Frankfurt together. If the Euro-area financial markets gradually grow to resemble those of New York - in depth, liquidity, size - the potential gains for the securities markets over the next few years are enormous. They could literally treble in size. If they were to do so, they would generate additional commission income across Europe of some £14 billion. And that too could become a great missed opportunity for the City of London. For if the City does not get the lion's share of that growth, it will go to other financial centres in the Euro-area that will increasingly come to rival the City's capabilities.

So there are great opportunities - perhaps particularly for Britain, with our relatively flexible, financially oriented economy - in euro membership. And there is also a cost to our isolation from the Euroarea. Look at the lost cost competitiveness of British trading business whether in manufacturing, farming or tourism, as businesses in this city of all cities will know so well.

On the OECD's figures, our cost competitiveness has deteriorated by no less than 41 per cent since 1995.We have lost more than 400,000 jobs in manufacturing in the last four years. Of course, there are job losses to low wage areas. That is a fact of life that all developed countries have to live with. But that trend applies with even more force in the high wage and high social cost countries of the Euroarea, yet their manufacturing employment has gone up.

In truth, having a separate currency with a separate interest rate is much less of an advantage than the eurosceptics suggest. For every case where the exchange rate has been a useful tool to stimulate the economy - perhaps 1967 and 1992 - there are four others where it has merely been a means of communicating an external shock into the economy. Nor has this necessarily had anything to do with bad policies at home. Remember that Nigel Lawson when Chancellor had to raise interest rates very sharply in 1985 just to avoid the pound sinking below $1.05, its low point. And the pound had been as high as $2.39 in 1980.

This 'one size fits all' argument implicitly assumes that sterling is always a useful lever for achieving happy outcomes. But if you had to associate one single word with 'sterling' over the post-war period, it would be 'crisis'. And don't believe that the existence of an independent Bank of England will shield us from the vagaries of the markets, because they are quite capable of spectacular trends and overshooting up and down whatever the policy framework of the country concerned.

And if Britain is indeed incapable of sharing a currency with our 12 partner countries and 301 million people, then we have to follow the same logic. Any part of the United Kingdom whose economy exhibits a lesser relationship with the UK than the UK does with the Euroarea should self evidently have its own currency, and that applies for starters to Northern Ireland and East Anglia. And why stop there? Why not let the Mayor of Doncaster devalue the Doncaster pound to price his citizens back into work?

And here I come to the secret weapon of the 'yes' campaign, for the Eurosceptics have been leaving a trail of ludicrous claims behind them which are now seen to be wild exaggerations that fatally undermine their own credibility. In the summer of 2000, for example, the no campaign was predicting all sorts of dire results for Ireland on the grounds that its economy was overheating. Professor Patrick Minford predicted in his column in the Daily Telegraph that Irish inflation would rise from the then 6 per cent to 10 per cent, and continue at that level for three years. Instead, Irish inflation gently subsided to below 5 per cent and the recent Eurobarometer poll shows that the Irish are the most contented members of the Euro-area.

Then there was the scare story from Michael Portillo and others suggesting that we would have to spend £35 billion to convert pounds to euros, or more than 4 per cent of GDP. Now we know, because twelve countries have converted, that not one of them spent more than 0.8 per cent of GDP. I know that we have a national genius for going over the top on technophobia. The millennium bug proved that. But not even we could seriously spend five times as much as the least efficient member of the Euroarea in conversion costs.

Then there are the wild claims that joining will mean that we have to pay for other countries' unfunded pensions, despite the clear no bail out clause in the Treaty. And despite the evidence now over many years that the Euroarea countries are reducing their state liabilities in exactly the same way that we reduced ours in 1979, when Margaret Thatcher delinked the old age pension from earnings to prices. In Italy, for example, two big rounds of pension reforms have already nearly halved the likely peak cost of the state pension system.

Nor is there any reason to suppose that there either is a superstate in Brussels, or that there might be one as a result of the Euro. All the European institutions employ 23,000 people, which is fewer than half the number of Birmingham City council. The total budget represents 1.1 per cent of EU GDP, whereas all other levels of governments spent 43.9 per cent of GDP. And we have even been repealing as much legislation as we have been putting on the statute book for the last ten years, and the Commission is now committed to cutting out still more.

The idea that the Euro requires a substantial increase in political integration simply disregards history: Belgium and Luxembourg had a monetary union from 1921 without any political layer, as did Britain and Ireland from 1921 to 1979. Look at the CFA franc zone. Look at the Gold standard. None had political machinery, yet all survived as monetary unions.

And then there is the argument that joining the Euro will be like joining the exchange rate mechanism. Or even worse, that we could become like Argentina. In fact, exactly the reverse is the case. In a fixed exchange rate system, there is bound to be uncertainty about whether the link is sustainable. When that uncertainty mounts, so does the risk premium on the securities in that currency. That was the deflationary impact of the Euro: we imported German monetary policy, not Euro-area monetary policy. The deflation did not arise because of sterling overvaluation, since the effective exchange rate index was virtually unchanged after we joined. The deflation was due to the lack of credibility of the link: we paid an extra premium because the markets saw that sterling was overvalued. Within the euro, there is no risk premium from one member state to another. The ECB is committed to maintaining the same interest rate throughout the area. So the ERM and the Euro are like chalk and cheese.

I have dealt with some of the most common scare stories about the euro. On Ireland, wrong. On pensions, wrong. On the superstate, wrong. On the ERM, wrong. On conversion costs, wrong. But my main point - on which I want to end - remains the mounting missed opportunities as we stay out.

Don't underestimate the historic importance of this project. Don't underestimate its economic significance. Don't underestimate how much of an obstacle to business, trade and investment a separate currency really is.

The parallel is with the missed opportunities of the period from 1958 when we failed to participated in the community of the original six members, and 1973 when we finally joined. In between, tariffs disappeared for the six. Their trade soared. Competition increased. Their businesses strengthened as a result. Their businesses succeeded better in world markets.

Meanwhile, British business stumbled until we faced the catharsis of the seventies and EU membership in the much less favourable circumstances of the first and second oil price shocks. We lost whole industries: motorcycles for example. And ultimately we also had to accept policies that had been put in place with no consideration for British interests, such as the Common Agricultural Policy and the Common Fisheries Policy. By common consent, our failure to participate was the biggest single policy error of the entire post-war period.

And here we are again, making the same mistake with the Euro. History is a good teacher, as George Stigler once said, but there are inattentive pupils. Let's much sure that our generation do not repeat the mistakes of our parents. Let's join, and let's prosper.