From Ems To Emu

Elsewhere, the EMU has been a political issue for much longer. The most reluctant country to join the EMU has been Britain. I suspect this has more to do with British currency notes than with economic reasoning. British coins and notes have borne the profile of the King or Queen for centuries. The British rather like the youthful likeness of the present Queen wearing a crown on their notes and coins; by contrast, the circle of stars that will adorn the Euro is rather insipid. Human beings have remarkably clever brains; once they make up their minds in favour or against anything, they can invent the most amazing arguments for their view. Thus it is that the British and other Europeans construct a sophisticated case against the EMU. The conservatives had a very powerful Eurosceptic wing which could not be vanquished, and had decided to stay out of the EMU. Labour boasts greater economic sophistication, and is more impressed by the costs of staying out of the EMU: basically, the EMU is going to create even

 

more trade, and is going to be very good for financial businesses in which Britain excels. So staying out of it is not such a clearly good idea. Also, the conservatives have left British public finances in such good shape that Britain can easily qualify for membership of the EMU, without having to go through the agonies of France, Germany and the Latin countries. But Labour did not want to court unpopularity by announcing itself in favour of the EMU. So diplomatically it promised the electorate a referendum. This is not so simple as it sounds. Britain has never had a referendum. British political theory ascribes to politicians special expertise in governing. The public does not have that expertise, so it elects a government and expects it to govern. The decision to join the EMU, according to this theory, is a decision for the elected government to take, and not for the public. However, the idea that politicians know more than the public on every subject is questionable; and expertise on its own does not

indicate a decision for or against the EMU.

The qualification for joining the EMU is a fiscal deficit under 3 per cent of GDP in 1997 and a debt-GDP ratio under 60 per cent. The only country with sound enough public finances to qualify automatically for membership of the EMU is Luxembourg; it has a fiscal surplus, and negligible debt. Finland is the other country which would have little trouble: its fiscal deficit is about 2 per cent, and its debt ratio just under 60 per cent. It is easier to reduce the debt ratio within limits than to reduce the fiscal deficit. Debt can be reduced by selling off some assets, for instance, public enterprises; the approach of the EMU has led a number of countries to privatise telephone companies, airlines, post offices etc. Fiscal deficit can be sustainably reduced only by raising taxes or reducing expenditure. Members of the European Union levy three main taxes income tax, social insurance contribution and value-added tax and their levels are so high as to make them politically highly sensitive. Their

expenditure is mainly on social services, and hence again politically sensitive. Hence reduction of the fiscal deficit is hard. From this point of view, Austria, Denmark, Sweden, Netherlands, Portugal and Ireland are relative front-runners: their fiscal deficits are below 3 per cent, and they only need to reduce their debt. France, Germany and Spain are not much worse off in terms of debt, but need to reduce their fiscal deficit. Italy and Belgium need to reduce their deficit somewhat; their debt ratios are over 120 per cent. Greece is Europes India, with a deficit of over 5 per cent and a debt ratio over 100 per cent.

The EMU will be introduced in two phases. On 1 January 1999, the exchange rates of all member countries will be irrevocably locked into the Euro: for instance, the Euro will be equal to two Deutschmarks, or six-and-a-half Francs. From that time on, the Euro and the local currency will become interchangeable; and since it would give them a larger market, governments and companies will begin to float securities in Euro. On 1 January 2002, the Euro will enter retail circulation; in a year-and-a-half it will have replaced the Lira, the Franc, the Gulden and the Peso.

Why is the European Union going through all this travail? The unspoken final aim is to dissolve the European nations so that they can never make war against one another; after centuries of warfare ending in two World Wars, Europe is on way to abolishing warfare within itself. To this end it abolished all tariffs in 1968. It tried to create its own international currency in the Ecu. However, the Ecu is only a weighted average of member currencies, and has never caught on in business. It tried to abolish exchange risk through the European Monetary System (EMS) which was tried out in the 1980s. The idea was to lock in exchange rates in what came popularly known as the Snake. The Snake, however, was destroyed by Britain in 1992. There was a run on the Pound, and British reserves were vanishing fast. The British Chancellor of the Exchequer had invited Manmohan Singh to lunch. He was late. Every few minutes one of his equerries would sidle up to the Indian finance minister and whisper that the Chancellor was on his

way. He never turned up, for that afternoon he announced that he had gone off the Snake and let the Pound float.

Britain did extremely well out of that devaluation. It has had a sustained boom since 1992 and has registered growth that had made it Europes envy. The devaluation gave Britain a competitive advantage within the European Union which it used to great advantage.

So the European countries have learnt their lesson: they have invented a system which no country will be able to leave. Once, by 2003, all member currencies have been dissolved, no country will be able to devalue its currency and gain competitive advantage. Member countries will be allowed to run a deficit of up to 3 per cent. But if they run up a high debt and mismanage their finances, the market will punish them by pushing up the interest rates on their debt. This happens even now; the interest paid by feckless governments like those of Italy or Spain far exceeds that paid by Germany or France. But the interest spread partly reflects varying rates of inflation. Once a common currency comes into being, inflation will not vary: a higher rise in prices in one country will lead to a flood of imports and local deflation. The opposite of what happens in India, where all parts of the country have to inflate prices at the rate set by the central government.