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The case for British adoption of the euro is stronger than ever

By Dick Leonard. Source: The European Voice

After ten years in which the British economy was outperforming that of the eurozone, according to most economic indicators, it now appears distinctly shaky. A recent report by the Lehman Brothers bank said that there was a 35 per cent probability of a full-blown recession over the next two years.

After ten years in which the British economy was outperforming that of the eurozone, according to most economic indicators, it now appears distinctly shaky. A recent report by the Lehman Brothers bank said that there was a 35 per cent probability of a full-blown recession over the next two years.

Meanwhile, there are gaping deficits, both in the domestic budget and in the balance of payments, inflation is sharply rising and house prices are beginning to fall after a decade of uninterrupted growth. The value of the pound against the euro has declined sharply to an all-time low of 1.25, representing a loss of more than 11 per cent since last August.

Would it help the British economy if, at this point, the country was belatedly to join the eurozone? I put this question to economist Daniel Gros, Director of the Centre for European Policy Studies (CEPS), and a world authority on the euro.

He replied that it would have no immediate effect, but that the case for British membership was now much stronger than earlier, not least because of a growing convergence between the British and continental economies, that of Germany in particular. In the long-term it would be greatly in the British interest to join.

Gros's view is that the optimum time for British accession would be in two or three years' time. The trouble is that if this were to happen the preparations should begin now. This is true, particularly in respect of the necessity to meet the four conditions contained in the Maastricht treaty.

One of these is that an applicant country should have been in the narrow band of the exchange rate mechanism "for at least the preceding two year and had not been devalued during that period". The UK has not been in the ERM since the disastrous episode of 'Black Wednesday' in 1992, when the then government under John Major was humiliatingly forced to pull out because of its earlier obstinate refusal to agree a negotiated realignment of the pound.

Italy pulled out at the same time, but soon resumed its membership, which the British could also have done, but the political fall-out from the debacle was such that neither the Major government nor its Labour successor dared to contemplate this step.

It is far from clear whether, under the treaty it would be possible for this condition to be waived, but other conditions, concerning inflation, long-term interest rates and "excessive budget deficits" would have to be met, and it would only be prudent to take preparatory steps to ensure this during the two years before the projected membership.

Has it damaged the British economy to be outside the eurozone during its nine years of existence? This is difficult to say, according to Gros. His view is that manufacturing and trade have certainly suffered, but this could be balanced by gains in the financial sector which does much of its international business in euros, and benefits from being a sort of offshore facility for the eurozone.

The fact remains that Britain suffers two huge disadvantages from its self-imposed isolation, which deprives British-based companies of the opportunity to compete on a 'level playing field' with their counterparts in the eurozone.

All exports to, and imports from, the zone suffer the penalty of currency transaction costs, which also fall on every British traveller (business or tourist) to any of the 15 countries currently in the zone.

The second handicap is that interest rates in Britain are permanently higher than in the zone, largely because of anxiety to maintain the value of the pound – something which it has conspicuously failed to do during the last nine months.

There is little doubt that some day the British will take the plunge – but it remains hesitant because of the ill-considered pledge, made back in 1997, to hold a referendum on the issue. Unlike the somewhat weaker promise made over the aborted Constitutional Treaty, there seems no way in which this can be by-passed.

In the face of constant misrepresentation by most of the popular press, and opportunistic opposition by the Conservative Party, the government seems highly unlikely to act before the general election, which may not now be until June 2010. More's the pity.

Dick Leonard is author of The Economist Guide to the European Union.