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Andrew Balls: The Sixth Test
When Eddie George, governor of the Bank of England, was quoted as agreeing that unemployment in the north of England was an acceptable by-product of policy to curb inflation in the south, there were a few half-hearted calls for his resignation. And plenty of red faces at the Bank. The remarkably successful US economy has also experienced a split in recent years: between strong growth in the service sector and tough times in manufacturing. Elsewhere, the one-size-fits- all monetary policy in the euro-zone has been uncomfortable for some: while the German and Italian economies have stumbled, Ireland and Portugal are over heating. All monetary unions, even relatively small ones like the UK, produce tensions. While there can be gains overall, some parts of the economy bear more pain than others. So political legitimacy is crucial for such unions to be successful. Imagine that, in a few years time, the UK has joined the euro-zone. And Wim Duisenberg, president of the European Central Bank - if he is still there - declares that rising unemployment in the UK is a price worth paying for euro- zone inflation at an annual rate of perhaps 0.6 per cent, a rate which would be perfectly consistent with the ECB's target of less than 2 per cent. What would happen? It is likely that there would be more than a few red faces. There might even be protests in the streets. Why? The explanation lies in the economic and political legitimacy of the central bank. The public by and large realises that there has to be one short-term interest rate for the whole of the UK. Moreover, it is willing to accept that the UK will be better off with an independent Bank setting rates (rather than politicians trying to exploit a short-term trade-off between unemployment and inflation). The same goes for finding a balance between all parts of the economy. So far at least, the independent Bank of England has done a good job, both in terms of policy and in explaining its decisions. The same legitimacy does not yet exist in the euro- zone, at least when viewed from the UK. What is more, the stakes are higher in a much bigger economy, with far greater potential for divergence. If the UK does join the euro, there is a reasonable chance that over the long term its income per head will be higher than if it stayed out. But nobody knows for sure. Rigorous forecasts are impossible. What is certain is that if the UK decides to adopt the euro, interest rate policy will not always suit the UK's needs. The significant difference is that the political legitimacy of the ECB is, to a large extent, established in Germany. At last week's 39th Young Königswinter Conference in Berlin, organised by the Deutsch-English Society, which promotes greater understanding between the two countries, it was clear that the German belief in deeper integration in Europe is not exclusively held by the Senior König swinter generation. There is widespread enthusiasm among younger Germans for this goal. By contrast, only a few Euro-idealists believe the same level of public support for economic and monetary union will develop in the UK any time soon. The pursuit of the European dream does not look like a winning strategy in a future British referendum. Thus the Treasury concentrates on its five much discussed (and much criticised) economic tests. These are: whether the UK has achieved sustainable convergence with the euro-zone economy; whether there is enough flexibility in the UK economy; whether joining the euro would help companies to make long-term decisions; the impact on the City of London and the financial services industry; and whether joining would be good for employment. From the government's point of view, concentrating on economic tests now is also a good way to defuse a political debate that could have dominated Labour's first term in office. But it also serves to reverse a British tradition of forcing economics to take second place to politics in such matters. That is what happened when Britain decided to return to the Gold Standard after the first world war, in the battle against devaluation in the aftermath of the second world war, and with the Thatcher government's decision to join the Exchange Rate Mechanism. In none of these cases was the results particularly glorious. The UK government seems to have taken on board the lesson that - since public support for the joining the euro-zone is not overwhelming, to say the least - it had better concentrate on getting the economics right. Establishing economic convergence should limit the need for any sacrifice if the UK does join the euro. It may help, in part, to build political support for the single currency by concentrating on the economic benefits. The economic tests are not perfect - far from it. The Institute of Directors this week suggested some alternatives. They are more rigorous than the government's. But though less amenable to fudging, it is hard to avoid the suspicion that their primary purpose is to delay the time when they will be met. Yet the government should be glad of any criticism of its criteria. It locates the discussion, at least on the surface, in the economic sphere - just where the government wants it to be. For political reasons, both good and bad, the government wants to focus the debate on the economics of the euro. But a referendum will not be won (or lost) on economics alone. The role, success and legitimacy of the European Central Bank lies right at this intersection between economics and politics. How unfortunate then that the ECB's unwieldy governing council is so unappealing, especially when compared with the Bank of England's relatively nimble monetary policy committee. Its governing council includes a representative from each of the 11 countries, as well as six representatives from the ECB's executive board. No wonder its decision-making has proved so sluggish. There may be sound political reasons for giving every country a vote, but in economic terms it is pretty daft to give Ireland and Portugal - which account for 1 per cent Europe's gross domestic product apiece - a seat on a the governing council. Perhaps this is why the ECB chooses to be so secretive in its deliberations. The governing council meetings are held behind closed and bolted doors, with the curtains drawn. Explaining decisions to the public is clearly a low priority. The ECB refuses to publish its minutes and voting records. Such is its respect for open policymaking that it marks its growth and inflation forecasts "Top Secret". The model is the Bundesbank which enjoyed overwhelming economic and political legitimacy in Germany. Indeed, much of Europe took its lead from Frankfurt, including the UK - in the late 1980s and early 1990s. But the ECB cannot automatically inherit the Bundesbank's mantle. Indeed, monetary policy has become far more transparent in the UK, thanks to the rules for the operational independence of the Bank. If the government wants to approach Emu as an economic question, it will have some real difficulties explaining why the UK should close down the Bank of England's monetary policy committee and put its trust in the ECB. Moving from greater to less transparency will be a hard sell - especially if the workings of the ECB are not reformed. Arguing for reform from outside the euro-zone will not make the task any easier. Once again, the UK will be arriving late at the party - if it ever joins. Changes in the ECB will also mean revisiting the Maastricht treaty. But if the UK is to adopt the euro, it must be a requirement that over time the public develops trust in the ECB. This is important as any other economic test. Reform of the ECB should be a prior condition for the UK adopting the euro. |