Select Committee on Treasury Eighth Report


WEDNESDAY 26 July 2000

Members present:

Mr Giles Radice, in the Chair

Mr Nigel BeardMr James Plaskitt
Mrs Liz BlackmanMr David Ruffley
Mr Jim CousinsMr Brian Sedgemore
Mr Edward DaveySir Michael Spicer
Mr Michael FallonSir Teddy Taylor
Mr David Kidney

  The Committee deliberated.

* * * *

  Draft Report [Economic and Monetary Union], proposed by the Chairman, brought up and read.

  Draft Report, proposed by Sir Teddy Taylor, brought up and read, as follows:


1. The Committee commenced its studies into aspects of Economic and Monetary Union in the Spring of 1998 before the Single Currency was established by eleven member states on 1 January 1999. In the course of these studies, it has had visits to Europe, has met the Chairman and members of the European Central Bank, and has taken evidence from a wide range of academic and business opinion. It is no secret that the Committee has strong and differing views within its membership about the merits of the UK joining the Single Currency; and in these circumstances, it considered that the most helpful advice it could give to Parliament was to draw attention to certain significant issues of fact which have emerged from our discussions.

2. The decision on whether or not to join is obviously a significant and fundamental one for the United Kingdom, because unlike the UK's experience with the ERM, when we had to pull sterling out of the currency link after a period of massive borrowing, higher interest rates and additional unemployment, a decision to join the Single Currency will be "irreversible and irrevocable". The other factor which must be borne in mind is that similar previous single currencies have always collapsed; there have been two examples within Europe, namely the Scandanavian Currency Union and the Latin Currency Union. Although it would be wrong to condemn the Single Currency simply because such an experiment has never worked before, we should bear in mind that single currencies for any area only appear to work when, as in the USA, there is one Government, one Treasury and a feeling of nationhood.

3. The first point which we all noticed as a Committee when visiting Europe before the currency was launched was that there was astonishing optimism about the Euro. The business community, in particular in France and Germany, appeared to consider it as a disciplining mechanism which would prevent irresponsible national governments introducing measures which were unfriendly or unfair to business and commerce. Although it was not very clear how they expected these dramatic changes to occur, there can be no denying that their feeling of optimism was remarkable. It was also clear that within the banking community there was a strong feeling of optimism that the Euro would speedily become a world currency to compete with the dollar and that it would be a strong and powerful economic instrument. It would, we were advised in enthusiastic terms, "go like a rocket".

4. The second point which must be made is that the Euro currency has had a very disappointing and at times embarrassing start. Instead of being strong, it has been weak and has fallen considerably by comparison with the dollar, the yen and the pound. Despite the endeavours of the other nations in the world to boost confidence in the new currency, the fact is that its basic performance has been disappointing. Of course this fall in currency could be argued to be the consequence of the initial level being too high, but what is probably the more worrying aspect of the decline has been the amount of investment which has poured out of Europe. Just as worrying has been the fact that the basic flaw in all previous single currencies has emerged speedily within the Euro block, namely the emergence of some areas like the Republic of Ireland as unduly prosperous with high levels of inflation and optimism while other areas have demonstrated the seeds of depression. Another factor which cannot be ignored is that while all other nations have been doing what they can to promote the Euro, with Japan being a particular enthusiast, it is worrying that the analysts indicate that the failure of the Euro to rally may reflect the structural flaws in the European economy.

5. The third point which we feel should be considered is that despite all the negative and worrying prophecies being made about Britain's future if it remained outside the Euro, the disasters have never emerged. The City of London, for example, was warned that its business would fade away, but the reverse has happened. And trade with Europe, despite the consistent deficits since the UK joined, and the problems of dealing in trade with a weak currency, has actually improved.

6. The fourth point which we believe should be considered, by both those who support and those who oppose Britain's membership, is that there is a danger of being influenced by propaganda and special situations. What we should be doing is looking at facts. For example, discussions of the perplexing problems of the car industry have given the impression that Japanese investment is flowing away from the UK. However, the facts show that in the first twelve months of the Euro, 50 per cent of all Japanese investment in Europe came to the UK. Perhaps more significant, the survey done by the Japan External Trade Organisation showed that while 15 per cent of Japanese companies in the UK saw large merits in joining the Euro, 15 per cent identified large demerits and a staggering 41 per cent said that there were "no business benefits" in joining the Euro.

7. A similar reservation needs to be made on the many reports on our trade with Europe. Reference is often made to 58 per cent or 60 per cent of Britain's trade being with Europe. But this relates only to goods. If services and income are taken into account, only 40 per cent of our exports go to Europe, and the total is declining and in deficit. Sixty per cent of our exports go to the rest of the world and are increasing and in surplus.

8. The final point which the Committee should wish to stress is that a decision to join the Euro would involve a great deal of expenditure by industry and commerce. The British Bankers Association provided the Committee with some alarming figures about the cost of changeover to banks, and public services in general would have to spend a great deal. We believe it is important that the nature of these costs should be publicised. Likewise, there is always the danger of opinion being misrepresented by enthusiasts. For example when the London Chamber of Commerce did a survey of 100 foreign banks in London, they were advised that UK involvement in the Euro was 2lst out of the 23 factors influencing location.

9. Of course the final decision on whether Britain should join the Euro is not one on which we would wish to express an opinion. We have listened to the opponents who warn us against joining up more with an over-regulated and overtaxed area with bankrupt pension systems which will create a crisis; and we have heard those who argue that it would be madness for Britain to subject industry and commerce to a Euro interest rate which might have no relevance to the UK. We have also listened to the enthusiasts who have argued that Britain would be stronger and fitter if it became truly involved in the united Eurostate. The only view we would express is that the decision will be a vital one, which should be given the most careful consideration.

Draft Report, proposed by Mr Michael Fallon, Mr David Ruffley and Sir Michael Spicer, brought up and read, as follows:

1. We are unable to agree with the proposals in the Chairman's draft Report on Economic and Monetary Union.

External value of the euro

2. There has been much debate about the weakness of the euro, normally in relation to US dollar. But using the European Central Bank's (ECB) calculation of the euro's nominal effective exchange rate against 39 trading partners the euro declined by 11.3 per cent from its launch in January 1999 to June 2000. It appears to us that the euro's weaknesses owe much to the following:

      (a)  Failure of structural reform in the euro-area economy leading to inflexibility. There is a strong market perception that structural rigidities are not being tackled adequately, leading over time to reduced economic growth expectations. We agree with the Institute of Directors' evidence that "given the lack of major labour, tax and social security reforms ¼ in Euroland, it is difficult to see the euro as a strong currency".

      (b)  Statements from the ECB and national policy makers have sometimes been in conflict, confirming doubts and generating uncertainties about the fledgling currency.

      (c)  The decline in investment in euro assets has been caused by the replacement of eleven currencies with one: investors have fewer possibilities to diversify investment. These possibilities derive from the different characteristic of countries' individual monetary policies.

      (d)  There is scepticism in the markets about the fiscal prudence of certain euro area countries. Italy's announcement in June 1999 that it would raise its borrowing levels caused a fall in the euro's external value.

      (e)  The euro was overvalued at its launch. This was suggested by Commissioner Solbes himself when he said at the end of 1998 that the ecu was "too high". This reinforces our grave concerns about the possibility of finding the "right" or appropriate rate at which to lock in currencies.

European Central Bank

3. The governance of the ECB causes us concern. At present the ECB takes monetary policy decisions by consensus, not by majority voting, and this has contributed to confusion surrounding the appropriateness of ECB interest rate decisions. Under the present arrangements every member state's central bank governor sits on the Governing Council. We are concerned that with enlargement the Governing Council would become more cumbersome and further undermine decisive policy making. We note that any reforms to the Governing Council arrangements would involve changes to the Maastricht Treaty.

4. We are also concerned about the openness with which the ECB discloses the deliberations of the Governing Council. Full minutes of the kind made available by other central banks are not published by the ECB and this undermines a proper understanding of ECB monetary policy making. We do not accept the Economic Secretary's argument that it would be "difficult" for the ECB to publish voting records.

5. We are concerned that the ECB defines, on its own and without reference to any democratically elected body, precisely the means by which the primary objective of "price stability", as set out in the Maastricht Treaty, is to be delivered. That is, the ECB has decided that price stability means "year on year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2 per cent" over the medium term. The problem is that there is no lower limit or floor and the concept of medium term lacks proper definition. We note the claim that the ECB has fulfilled its inflation remit. However, given lags in the transmission mechanism between an interest rate change and that change working through finally to the macro and microeconomy, it is at least arguable that it is too early to properly assess the ECB's performance to date.

Structural Reform

6. We agree that structural reform must assume a greater importance due to the loss of monetary policy independence and the constraints placed on fully independent fiscal policy among euro area members. However, we believe that there is convincing empirical evidence showing that the necessary structural reforms in relation to tax, labour and social security systems are not in fact being implemented adequately, if at all. The evidence points to resistance to structural reform in, for instance, Germany. The German Finance Ministry were unable or unwilling to detail specific measures they had implemented or proposed to implement. Members of the Bundestag were more forthcoming, suggesting that such reform would be very difficult, owing to opposition from trade unions. In our view the UK Government is doing little of practical value to insist on the delivery of meaningful structural reform in euro-area states.

Fiscal Policy

7. Coordination of EU fiscal policy is currently operated through the Stability and Growth Pact and the Broad Economic Policy Guidelines. We note that the Guidelines set out so-called "general orientations" to all EU countries as well as country-specific recommendations (ECB Monthly Report, July 2000), which are not at present backed by the force of either Treaty or directive. We were not persuaded by the Economic Secretary's statement that the importance of these guidelines was as a means of encouraging structural reform among EU members. Given the enthusiasm of the Council of Ministers and the European Commission for greater tax harmonisation across the EU, the Pact and the Guidelines could be the means by which EU states have their freedom to set national taxes curtailed. Whilst they are non-binding at present, we are concerned that the Pact and the Guidelines could be imposed by the back door. The Economic Secretary was unable to say what action the Government was taking to prevent further steps towards tax harmonisation, damaging to the UK's interest, taking place in furtherance of economic and monetary union.

8. We are extremely concerned by the Government's complacency about proposals from euro area members (the Euro 11 Group) to call meetings which will be held separately from ECOFIN members and so exclude the UK from policy making meetings on fiscal policy. The Economic Secretary indicated that this was not something that concerned the Government, because the Euro 11 would "meet informally ¼ to discuss issues connected with their shared responsibilities for the single currency." However, in her evidence she blatantly ignored evidence emanating from the German Deputy Finance Minister Koch Weser who has stated that the Euro 11 would go ahead with discussions, without the UK, on financial market integration, financial services and monitoring the quality of public expenditure.

9. We note that the Government said in evidence that it would not be able to veto steps taken by the Euro 11 to exclude the UK Chancellor from such separate discussions.


10. Whether the qualifying criteria for joining the euro can be fudged was a question raised by the decision for Greece to enter into Stage 3 on 1 January 2001. The ECB itself in its own 2000 Convergence Report on Greece stated that "there must be ongoing concern as to whether the ratio of Government debt to GDP will be 'sufficiently diminishing and approaching the reference value at a satisfactory pace' and whether sustainability of this fiscal position has been achieved." Whilst it is acknowledged that the Greek economy constitutes about 1 per cent of EU GDP, in our view the fudging of the criteria in Greece's case for apparently political reasons sets a damaging precedent for the future. It raises the prospect of other accession countries in the enlargement process, especially former eastern European communist states, being allowed to join even though the strict economic criteria of Maastricht have not been adhered to.

UK and Euro entry

11. We note that there is a consensus that the UK meets all of the Maastricht Convergence Criteria, save for exchange rate stability. On this subject the UK Government appears incoherent. The Treasury, whilst accepting that "exchange rate stability is an important part of preparation for EMU", has argued "what matters for exchange rate stability are sound economic fundamentals. For Britain, the best way to achieve this is through the monetary and fiscal framework which we have set in place." (Government Reply to EMU 1998 Inquiry). We agree with most commentators that it is likely that, in the absence of an explicit policy to manage the level of sterling within certain bands, exchange rate convergence could only be achieved by accident. In our view the Chancellor's policy on exchange rate convergence can be summarised as "It'll be all right on the night." In this respect we have sympathy with the view that, in his current statements on the exchange rate, the Chancellor is being economical with the truth. We believe that supporters of UK entry to the euro should explicitly state that a decision to join Stage 3 will involve exchange rate stability replacing price stability as the primary goal of monetary policy during the transition period before full membership. We note the evidence of Professor Willem Buiter, former MPC member, to the effect that "if the Chancellor and the Government decide that joining is going to be a serious objective then the exchange rate has to become the overriding nominal target. You cannot be a little bit pregnant in these things. You have to do it seriously and have a formal change in the [Bank of England's] mandate." That is to say those advocating UK entry to the euro should make it clear that entry requires the Bank to no longer set interest rates—as it does now—in order to hit the inflation target of 2.5 per cent. Instead the Bank would, following an instruction from the Chancellor, have to set interest rates in order to hit an exchange rate target for sterling.

12. We are surprised that the Chancellor has not raised this controversial issue as a matter of public debate, given the critical impact it is likely to have on the level of interest rates and inflation in the UK.

The Chancellor's Five Economic Tests

13. We share widespread suspicion of the Chancellor's five economic tests. Many witnesses have questioned the extent to which they were truly objective measures of the economic case for entry. We believe they are purely subjective tests which lack proper economic precision. It appears they were designed by the Chancellor to arrogate to himself the fullest possible discretion to decide at some unspecified date in the future whether the UK should join. In our view this is no basis whatever to decide one of the largest economic and political decisions this country has faced in generations. In particular, we note that many witnesses from the financial services sector were agreed that the City of London as a global financial centre has benefited from the UK's position outside the euro. We further agree with Business for Sterling's view that in the foreseeable future unemployment would rise were we to join the euro "because the Euro-zone is chronically over-regulated and over-taxed".

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