How Long Can the Euro Last?
A Special Report
By
John Mills
John Mills is Secretary of the Labour Party Euro-Safeguards Committee and the author of a number of books - including: Managing the World Economy (published by Macmillan 2000)
As the
time when euro notes and coins are issued to the public approaches, and as Tony
Blair gives further indications that a referendum on the euro may be in the
offing, it is easy to assume that the Single Currency will be there for ever, as
its proponents have always suggested it would be. Of course it is true that the
Maastricht Treaty makes no provision for any state to re-establish its own
currency. Every EU Member State which has joined is bound by the Treaty's
clauses which make it clear that the abolition of national currencies is
permanent and irrevocable. History, however, has a way of making a mockery of
supposedly permanent and irrevocable arrangements, and it is not nearly as clear
as enthusiasts might lead us to believe that the future of the Single Currency
is anything like as secure as is often assumed that it is.
A useful
starting point is to survey briefly all the past attempts which there have been
to establish currency unions which are not the preserve of what are clearly
unitary states - a category into which the European Union does not yet fit,
however much some powerful groups would like it to assume this role. The record
is one of almost unrelieved failure. Perhaps the most celebrated example is the
Latin Union, established by treaty between France, Belgium, Italy and
Switzerland in 1865. France, which took the lead, hoped that Britain would also
join, bringing in Germany in train. Both The Times and The Economist
welcomed the prospect of monetary union on the continent, The Times,
somewhat extravagantly in the light of subsequent events, describing the
proposal as "the most important step in the progress of civilisation".
Interestingly, however, despite their enthusiasm, both publications advocated
that Britain should not join. This turned out to be good advice, for the same
reasons which have bedevilled all currency unions - their innate instability.
In the
case of the Latin Union, the immediate reason for its collapse came in the form
of the Italian government's handling of a budget crisis. The inability of the
authorities to collect sufficient taxes to meet the state's outgoings led to the
introduction of a paper currency in which there was less confidence than in the
silver coins it replaced. The result was that everyone tried to buy silver coins
with the paper currency, driving the metallic currency out of the market.
Eventually, in 1883, the Italians withdrew from the currency union, but by this
time the other participants, including Greece, had also had enough of the
monetary crises which the Union had generated. Amid much recrimination, the
Union collapsed.
Many
subsequent attempts to establish currency unions have met the same fate. These
have included three major initiatives within what is now the Commonwealth to
achieve common currencies, in East Africa, Central Africa and the Caribbean.
Egypt and Syria tried a common currency at about the same time, as did the
Philippines, Malaysia and Indonesia, all of them with equal lack of success.
Meanwhile other areas previously covered by single currencies, but where the
states to which these currencies corresponded had broken up, all established
their own new forms of money. The most numerous examples were in the successor
states to the Soviet Union. An interesting case closer to home was the Czech
Republic and Slovakia, where the original intention had been to keep the same
currency operating in both successor states. Within weeks of the separation this
arrangement had broken down. Current attempts by Argentina to lock its currency
irrevocably to the US dollar look just as likely to withstand the test of time
for only a limited further period. Finally, we should not lose sight of the
eventual collapse of the two earlier attempts made to lock currencies together
in the EU, first in the Snake from 1969 to 1975, and subsequently with the
Exchange Rate Mechanism from 1979 to 1993.
The lesson
to be drawn from all these experiences is that over any reasonably long period
of time, the differential pressures which build up within sovereign states in a
single currency area whose policies are not held in lockstep by a central
government with substantial powers to tax and spend have a very powerful
tendency to destabilise currency unions. It is hardly surprising that this
should be the case. The political pressure to do whatever is necessary to keep
the economy on track in any country is very strong. Once maintaining currency
parities becomes too costly in terms of balance of payments problems, deflation,
unemployment, and slow or even negative growth, the temptation to throw over the
single currency traces becomes overwhelming. Sometimes, it takes quite a number
of years for this to happen. The British and Irish pounds were locked together
for decades before they parted company. The exchange rate between the Austrian
schilling and the German Deutschemark had also been very stable for a long time
before they both joined the euro together. Cases like these, however, tend to
involve economies with common languages, similar cultures and a high degree of
interdependence. Even then - as in the British and Irish case -
the union was not permanent.
How likely
is it that these sorts of problems will eventually overwhelm the euro? Few can
doubt the determination of those who have established the Single Currency to
make sure of its long term success, so the political commitment to its
permanence - at least among the political elite currently in power in the EU -
is not in doubt. On the economic front, however, it is much less clear that all
is going to be plain sailing. Inflation, although relatively low nowadays by
historical standards, is not as muted as all that, with quite significant
differences in the rates at which prices are rising in Single Currency Member
States. This may well betoken the sorts of
variances in economic performance, as the cost base for export industries
in some euro countries becomes higher or lower
than in others, that in the end sank both the Snake in the 1970s and the
Exchange Rate Mechanism in the 1990s. World events, such as major changes in
energy prices, may well have sharply different effects on Single Currency Member
States, further aggravating variations in economic performance. Over a period of
a few years, these pressures are usually relatively easy to contain. They have a
painful tendency, however, to get cumulatively worse as time goes on - exactly
as happened with the ERM. If the outcome is that some countries suffer
cumulatively worse from economic decline, this may wash over into political
extremism, which could add another heavily destabilising influence.
Faced with
the accumulation of problems of this sort, what could the EU do to contain them?
There is a simple answer, and one which would not be unwelcome to many leading
politicians on the continent. The EU should become a unitary state. It would
then be much more likely to be able to assume the sorts of powers required to
raise taxes and to disburse public spending on the scale required to hold the
Single Currency together. This was calculated by the MacDougall Report,
published in 1977, as being at least 7.5% to 10% of GDP, on the assumption that
the EU budget concentrated much more heavily than before on both reducing
geographical disparities in productivity and living standards, and the
cushioning of temporary fluctuations. This estimate may well, however, turn out
to be too low. The average EU state has about 45% of its GDP in government
hands. Even the USA has 25%. The proportion for the EU is currently only 1.27% -
a far lower figure. Meanwhile of the EU's existing budget, almost 50% still goes
on the Common Agricultural Policy, which does not redistribute resources between
Member States in any way designed to counterbalance overall disadvantage. There
is therefore a huge amount of ground to be made up.
What then
would need to be done to augment the EU's resources to a point where
realistically it could expect to hold the Single Currency together when the
going got rough? The answer is that there would have to be a massive transfer of
taxation and spending powers from the national governments to Brussels.
Candidates for expenditure would be programmes such as Social Security and
Defence, and possibly Education. And this is where the shoe could really begin
to pinch. Not only in Britain but in many other Member States, there would be
massive opposition to transferring responsibility for these core programmes to
the EU machine, which simply does not, in most peoples' eyes, have either the
political credibility or the democratic legitimacy to be trusted with this sort
of responsibility.
Perhaps there will be a period of ten or twenty years, during which massive problems of this nature do not materialise, giving the Single Currency time to bed down to long term credibility. Perhaps also during this period the EU will reform itself to a point where sufficient democratic confidence in its institutions is developed for huge fiscal transfers to Brussels to take place with widespread agreement. Both history and experience, however, suggest that neither of these requirements is likely to be fulfilled. As long as this is the case, it may well not be wise to bank on the Single Currency still being with us, at least in its present form, in a decade or two's time, whatever the Maastricht Treaty may say.
John Mills
9th October 2001