[PEN-L:29850] the eurozone

["Ian Murray" <seamus2001@xxxxxxxxx>]

Blair faces big problem in currency debate

Larry Elliott
Monday August 26, 2002
The Guardian

Well, has it happened? Did you experience a Damascene conversion when you paid for your drinks in
euros rather than francs or pesetas? Are you convinced that it is time for Britain to join the
single currency?

Tony Blair hopes you are. His planned autumn push for a referendum relies on a shift in stubbornly
negative opinion polls after a summer in which the electorate has fingered all those lovely new euro
notes and coins. This may be what will happen, but it has to be said that things are not going
entirely to plan. Closer physical acquaintance with the euro, according to a poll conducted by the
City firm CSFB last week, appears have had the opposite effect to the one the government expected,
perhaps because eurozone retailers exploited the changeover to slip through price rises.

No matter. Blair, it is said, is a persuasive guy and could turn things round in the course of a
vigorous campaign. Again, the government could be disappointed. Blair is out of touch with public
opinion over Iraq, GM foods and the private finance initiative, and a euro referendum held in
mid-term might provide the electorate with an opportunity to give him a bloody nose without risking
the return of the Tories.

Even that, though, might not be seen as an insurmountable problem provided that the referendum can
be portrayed as a straight left-right fight. Who could possibly doubt that a campaign fronted by
Tony Blair and Gordon Brown would knock seven bells out of one fronted by Iain Duncan Smith and
Michael Howard?

Sadly for the prime minister, there is a problem here, too, and it could prove to be the biggest of
the lot. The euro is not, and never has been, a straight left-right issue. On the left, there has
been a solid phalanx of greens, Marxists, Keynesians, Gaitskellites which has viewed monetary union
with extreme suspicion. Now, it seems, the mood in the trade union movement is swinging that way,
too. Of the big trade unions, only the GMB could now be expected to line up solidly behind the yes
campaign in the event of a referendum. The T&G has always been agnostic, Unison is concerned about
the impact on the public sector and Amicus has just kicked out the most pro-euro trade unionist of
all, Sir Ken Jackson. The man who beat him, Derek Simpson, is none too happy to find that Sir Ken,
in addition to banging the drum for the euro at every opportunity, has been bankrolling Britain in
Europe, the umbrella group for the yes campaign, with union funds.

An increasing number of trade unionists, particularly the new breed of young, sassy anti-Blairites,
are taking a long, hard look at the euro, and they do not like what they see. They have ceased to
see Europe in the way that the TUC did in the late 1980s, which was a means of liberation from
Thatcherism, but rather as a continent beset by high unemployment and pressure for public spending
cuts - much like Britain under Thatcher, in fact.

Bob Crow, general secretary of the Rail, Maritime and Transport union, said in a letter to the Times
on Saturday that the "deflationary policies enshrined within the European Union's misnamed stability
and growth pact, which governs economic policy within the eurozone, had led to ballooning
unemployment and negligible growth levels". Millions of trade unions, he added, were concerned about
the way economic policy was being conducted in the eurozone and opposed "this country being reduced
to a rate-capped county council run from Brussels".

To be fair, not everybody on the left sees it this way. David Clark, Robin Cook's former special
adviser, said in this paper last week that the economic data pointed to the dangers of delaying
entry. "After three-and-a-half years it is clear that the eurozone is benefiting from significant
increases in internal trade that are feeding through into higher growth and investment." There is
only one problem with this analysis: it is not true. You would think from Mr Clark's comments that
the eurozone is growing at a fair old pace; the reality is that it expanded by 1.4% last year and is
on course to grow even more slowly this - the first time since the recession of 1992-93 that it has
grown by less than 2% a year in two successive years. Unemployment is 8.4% and rising, while
domestic demand - including investment - has been on a downward trend since the start of 2001,
leaving Europe heavily dependent on the US as a source of growth. It may be that intra-eurozone
trade is rising as a percentage of GDP, but this is a strange measure of economic success. On this
basis, Comecon is to be emulated, because it led to higher internal trade flows between eastern
Europe and the Soviet Union.

None of which is to say that the British economy is without its problems. Self-evidently, that is
not the case. Nor do a couple of generous spending settlements for health and education mean that
public services in Britain are as good as those in many parts of the eurozone. There is a lot of
ground to catch up. Britain's deficit in public sector investment is the cumulative result of
several decades in which growth was much lower than in countries such as Germany and France. More
rapid growth led to higher tax revenues, which in turn funded a bigger stock of public sector
investment. Over the past 10 years, continental Europe has stopped growing faster than Britain and
is now living off the fat laid down in the good years. Germany, the hegemonic economy of the
eurozone, has been a particularly poor performer, and growth this year is on course to be below 2%
for the ninth year out of the past 11.

One problem is the one-size-fits-all interest rate, which is quite inappropriate for Germany's
needs. Using a methodology known as the Taylor rule to test whether interest rates are optimal,
Maurice Fitzpatrick, chief economist for the City firm Tenon, found that Germany's interest rate
should be 0.8% rather than the 3.25% prevailing in euroland, while the higher levels of inflation in
the neighbouring Netherlands suggest the rate there ought to be 6.5%.

Far from this policy leading to greater convergence between two similar economies, Fitzpatrick found
that once a country was saddled with the wrong rate the divergence tended to become more pronounced.
Nine months ago, Germany's optimal interest rate was 1.6%, he said.

If this were not bad enough, the rigidity of the stability and growth pact ratchets up the
deflationary effect of monetary policy. A common interest rate means that those countries where
rates are too low have stonking budget surpluses, those where they are too high suffer from budget
deficits. The SGP then reinforces this by putting pressure on deficit countries to return to budget
balance, putting further downward pressure on growth. Plans for Europe to return to balanced budgets
by 2004 are the economics of the madhouse.

There are three possible escape routes for Germany: the European Central Bank could cut interest
rates and raise its inflation target, there could be a long and painful period in which Germany
makes up for its overvalued currency by having lower wage increases than the rest of Europe, or the
SGP could be abandoned. The first course of action looks unlikely, the second politically untenable,
leaving it up to Europe's politicians to say enough is enough and force the SGP to be radically
reformed.

That, then, is the backdrop to a possible referendum campaign over the coming year: a Europe mired
in stagnation and with a crisis looming in the SGP. The smart approach for the pro-euro campaign
would be to back Gordon Brown's calls for a crash rethink of the eurozone fiscal policy regime,
because only that is likely to assuage the fears of those on the left that it is a recipe for
spending cuts. On past form, however, they will prefer to argue that in "this blessed plot, this
earth, this realm, this Europe" everything is for the best in the best of all possible worlds. If
that is the case, Blair can expect some tough questions from Labour's awkward squad during a
referendum campaign, if he takes the plunge. One question, in particular, springs to mind. Why, if
the euro is such a rattling good idea, is the eurozone doing so badly?

larry.elliott@xxxxxxxxxxxxxx