Nothing could be further from the mind of David Cameron than leading the UK into the euro zone. In his recent speech on Europe, the British prime minister dismissed the possibility of joining the single currency. He wants to give Britons a referendum on quitting the European Union altogether. It may make political sense to be hostile to a currency used in just about half of the UK’s foreign trade. The economics argue the opposite.
Even if Cameron were tempted, the idea of joining the euro today is impractical. The UK is not permitted to do so until the ratio of its sovereign debt to GDP has fallen from the current 88 percent to 60 percent. The decline won’t pick up speed until the fiscal deficit – about 6.2 percent of GDP over the last four quarters – is something closer to the new euro zone members’ upper level of 3 percent of GDP.
Still, the reasons for the last official judgment of euro membership in 2003 are no longer valid. The finance ministry concluded in a 246-page study that a “decision to join now would not be in the national economic interest”.
The writers of the assessment would probably have been surprised by the subsequent British record. Compared to its European peers, the UK has suffered a more durable recession, its currency has been weaker and its fiscal position consistently more fragile. The government’s “Golden Rule” to control fiscal deficits, much vaunted in 2003, is in tatters, and the financial crisis has severely damaged the Bank of England’s reputation. The best claim an Anglophile can make is that the British authorities were not any more incompetent than the EU and European Central Bank.
The sorry historical record justifies a revision of the marks on the five tests, imposed by the UK government on itself, discussed in the 2003 document.
1) Economic convergence. The main reason to reject membership was the supposed divergence of euro zone and UK business cycles, which would often make euro monetary policy inappropriate for the UK. But convergence seems to have arrived – the recession and weak recoveries have been simultaneous. Besides, the UK’s monetary autonomy has brought the country no clear advantage. If anything, a weak pound has led to undesirably strong inflation.
2) Flexibility. The 2003 assessment assumed that the EU was inflexible and the UK was supple. The judgment looks backwards. The ECB and EU authorities changed policies and stretched principles in the crisis, strengthening the euro and increasing financial integration. The British have been unable to take much advantage of their 20 percent currency devaluation.
3) Investment. The original finance ministry study concluded that membership would improve the quality and quantity of foreign investment into the UK. Since then, the euro zone has become more united, so the UK’s wilful currency isolationism is more of a disadvantage.
4) Financial services. In 2003, the ministry acknowledged that euro zone membership would be good for the City of London. Now though, non-membership looks distinctly bad for the country’s financial trade.
5) Growth, stability and employment. Back then the British government could support “the direction in which the EU macroeconomic framework is evolving”. The question now is whether the UK has a viable economic framework at all, let alone one that is better than the euro zone’s. A possible triple-dip recession is evidence of the stagnation that characterises the UK economy.
In sum, all five tests now suggest that the UK would benefit from joining the euro once it has got its debt down. If George Osborne, the current Chancellor of the Exchequer, were to repeat the exercise, he would add a sixth test: will joining the euro zone improve Britain’s global economic position? The answer is clear. As the euro zone becomes more of a single economic force and as China’s global economic power increases, the position of a country that accounts for less than 3 percent of global GDP and runs a persistent trade deficit can only weaken.
Whatever the political and cultural virtues of British nationalism, Cameron’s flirtation with leaving the EU altogether makes no economic sense. It may be a political non-starter, but if prosperity is what Cameron is after, he should be moving in the opposite direction – towards the single currency.