Why Britons Fear the Euro
The Wall Street Journal - February 5th 2002
The euro is more than a month old now and reams of copy have been written about it - about the historical significance of its launch and how it has come off with only minor glitches - but one large question remains unanswered. Will Britain, Europe's second largest economy and home to its pre-eminent financial center, the City of London, join or stay-out? The decision rests with Britons, but what Continental Europeans do with the single currency will help decide the outcome.
So far their leaders have not helped make the case for the euro. On the contrary, as long as they continue to make it clear that they want to go beyond the control of just monetary policy, they will drive Britons away.
The evidence is rife that the current batch of continental Europeans leaders want to harmonize taxes and impose a direct levy from Brussels. Here are just two comments: On Jan. 1, 1999 German Chancellor Gerhard Schroeder said: "The era of solo national fiscal and economic policy is over." Last March Didier Reynders, the Belgian Finance Minister, said: "I am pleading for real genuine tax harmonization."
And now that the euro is out, the evolution in this direction has only gathered speed. Just last month German Finance Minister Hans Eichel was reported to be planning to enlist the European Court of Justice, which can overrule national vetoes under the guise of competition law, in the effort to speed up tax harmonization.
The reason behind the harmonization bandwagon drive is simply that once exchange rate risks are stripped out of investment decisions, capital naturally gravitates to the country with lowest tax rates. This natural effect gives rise to accusations of "unfair tax competition," as jobs and investment shift around and the tax base is threatened. That is why Socialist European leaders want to "harmonize" taxes, which means giving all euroland countries one, high tax rate, and why we in Britain are wary of joining.
The Brussels-based tax would be justified by the need to have fiscal transfers across euroland. There is a genuine debate over how the strains within an economic area as large as the Eurozone can be managed under a one-size-fits-all interest rate that can generate inflation in Ireland and recession in Germany at the same time. There is the additional risk of an unpredictable asymmetric shock hitting a particular country or region in the zone (witness the recent disproportionate loan exposure of Spanish banks to the Argentine economic crisis) which will require federal transfer payments to rescue any massive economic divergence.
As it is now the EU's budget would not be sufficient. In 2000 payments totaled a meager 1.11% of the Gross National Product of the 15 EU member states, compared to a U.S. federal budget of up to 20% of GDP. The EU's McDougall Report into the financial implications of a single currency zone concluded that transfers would have to be at least 5% for the zone to be stable, requiring a much increased budget of the order of 7%. The political implications of this have not been fully addressed, not least the fact that the risks of an asymmetric shock will only grow after enlargement, with as many as 12 new countries with different historic links and business cycles joining.
Improved labor mobility in the EU, where it is lacking, will not address the problem. Unlike the U.S., which benefits from a single language and polity, European labor markets still remain structurally unreformed under the protective European Social Market Economy model. That is why calls for a much bigger EU budget and direct EU taxes to set-up bail-out funds for areas hurt by asymmetric shocks will only grow.
No doubt with these concerns in mind the French Finance Minister Laurent Fabius in a speech to the German parliament's finance committee last month argued that the governance of the euro zone must be improved, proposing the chairmanship of the finance ministers' Eurogroup (which excludes euro opt-outs UK, Denmark and Sweden) should swap hands less frequently. Even more radically, he called also for a global budgetary target to be set for the 12-country eurozone alongside national goals. Setting a budget limit for the eurozone as part of a coordinated approach with the ECB would be a huge further transfer of power to Brussels beyond the Stability and Growth Pact as national governments would have to tailor their own budgets accordingly.
The naturally cautious position we hold as British Conservatives ensues from these (and other) fears. We have no doubt that this currency is primarily intended to bolster a pan-European identity as a stepping stone to further political integration, as admitted by everybody except perhaps Prime Minister Tony Blair.
Over the last few years opinion polls have consistently shown that a significant majority in the U.K. are opposed to joining the euro and share our skepticism, although, paradoxically, the same polls also show that a majority believe it ultimately to be inevitable. By contrast the polls in Sweden and Denmark have become more euro-friendly.
One of the reasons we remain skeptical is that we fear an inevitable rise in taxes that would come from harmonization, particularly in the corporation tax and in the social security contributions that finance the continent's costly social model. The continental high taxes and inefficient labor markets are in fact what accounts for Britain's relative success as the world's second largest recipient of inward direct investment.
Again, don't take my word for it when we say we fear the continentals want to impose both these maladies on us, and would if we joined the euro. French Prime Minister Lionel Jospin was quite candid on the subject when he said last May, "combating tax dumping is one immediate priority; it is not acceptable for certain member states to practice unfair tax competition in order to attract international investment and offshore headquarters of European groups. Ultimately, the corporate tax system as a whole will have to be harmonized."
None of this need happen. I take heart that there are other lone voices, such as Finnish Finance Minister Sauli Niinisto who in an interview last week said he remained optimistic that the European Union will push ahead with economic reforms and he would allow free competition between Union countries of their tax levels. I know too that it is quite possible to have a de facto currency union and maintain political independence, as the examples of the U.K. and Ireland until 1979 and Belgium and Luxembourg show. The dynamics of the EU I have just laid out, however, suggest that the euro is yet one more important stage towards an effective European superstate whether that is called a confederation or a federation, and whether or not it has a single seat at the U.N.
Ultimately, then, the question is whether the British people, who voted 26 years ago in a referendum to remain members of the European Economic Community as it then was, on the grounds that Britain was joining a free-trade area with no implications for sovereignty erosion, will be prepared to transfer their allegiance from a nation state based on common language, culture and history to a wider polity. Tony Blair will try to pretend that joining the euro is at heart only an economic decision, but the truth is that it is much more than that.
See also this editorial from the same edition.