Where were the Economists in 1998?
Ben van Vlymen | 27 March 2017

1998 was the year when the final deciding arguments for and against the UK to join the Eurozone were being put into place. After many negotiations and the trial of the European Accounting Unit (ECU), the Maastricht treaty was signed on 7th February 1992 with the goal of creating an economic and monetary policy union by 1999. When the Euro finally came into existence in January 1999, why was the UK not a participant?


Currently, many look upon the Euro as being a fairly positive creation. Nevertheless, now that Germany’s growth is teetering ever so close to decline, suspicions are that the rest of the Euro will collapse without its predominant power. Around the time of my birth in 1998, the benefits of joining the Euro were being outlined and the ideas laid out seemed to have promising effects. The idea that by having a large area with one central currency, transaction costs from consumers having to exchange currencies would be removed and so the European market would be more explicitly free trade. So naturally, goods would be consumed at much lower prices due to more competition between inter-Euro corporations and no tariffs imposed on imports.


Another main point was that there would be price-transparency throughout Europe and so consumers would ideally have the same costs imposed on different products. Prices should therefore be kept under control as no monopoly can be formed, while consumers can also find the cheapest supplier with ease.


Arguments, such as high degrees of price stability and no exchange rate fluctuations increasing the volatility of markets within the Euro, were also being pushed forward and were met with little criticism from countries in continental Europe. Although, when the terms on which the Euro’s monetary policy and economic objectives were to be founded were discussed, problems started to arise.


The Euro was originally conceived to be a partnership between west European countries at roughly the same level of economic development, but as compensation for Germany having to give up its beloved, very strong, deutschmark for the Euro, Germany demanded that the European Central Bank (ECB) be based in Frankfurt and monetary union be on German terms. France fell into this trap thinking that the euro would bind Germany to its European partners thus neutralising the threat they presented to them.


Germany consequently took advantage of the Euro and other countries’ economic weakness by capitalising on the artificially low exchange rates that they fashioned onto the Euro, which helped strengthen their exports and keep them highly competitive by keeping them cheap. As a result of the ECB being based in Germany, interest rates were largely controlled by the Germans, but one size does not fit all as high interest rates that matched high German growth did not suit the countries with lower inflation like Portugal and Greece and so this dislocation lead to an amplification of their economic problems in the form of a huge trade deficit. Whilst the German current account balance stands at +5.6% of GDP, Portugal and Greece’s now stand at -9.7% and -10.4% respectively – an impact that makes both Portugal and Greece’s economies hugely overstretched and unbalanced.


The fact of the matter is that a high German surplus led to a vicious circle with the less well-off Portugal and Greece economies which may well have been a factor in causing the need for bailing out both of the countries.


Price transparency was also a benefit that never occurred in some countries, the example of Portugal is a prominent feature of why micro-governing policies leads to national economic setbacks. Due to the lack of a political union within the Euro and despite the unification of currency being a political decision, Portugal imposed a tax on imported cars, thus causing the prices of cars to be driven up and so a car becomes much harder for the Portuguese people to afford. This is only the example of one market, but the same principle can be applied to many other goods, this leads to an increase in the cost of living in countries where incomes were also diminishing. One only has to walk through countries suffering from this to see the damaging effect this is having upon these economies.


The cause of failure for the Euro from what I have said so far, may seem to be unlimited German control and a lack of subsidy for those who cannot afford the currency, however, this is not entirely fair. When the plans for the Euro were originally formulated, not all of the economic needs for success were met. For example, not all countries were at the same economic stage and some had large deficits upon entry. The failure of the Euro may in fact lie in the mistakes of the contract – the European Central Bank needed not to be German but European pro and a political union needed to be formalised before an economic union in order to make some targets possible. As a few economists are realising now: to make the Euro so susceptible to political decisions has caused most of the problems, a political union was necessary before an economic one.


So why did the UK not join the Euro? In a trial of fixed interest rates to prepare for currency unification on September 16th 1992, known now as black Wednesday, the British pound was forced to withdraw from the system due to a rapid fall in its value – in a time of crisis Britons reacted completely differently to other nationalities. So maybe we didn’t join the Euro because we are an unpredictable nation, or perhaps because the UK had a 32% share in all foreign exchange at the time accompanied by a wealth of knowledge in the field. English economists had predicted the fate of the Euro whilst in other nations the idea came under less intense scrutiny.

James Routledge 2016