CHARLES GOODHART: What kind of Emu will be born in 1999, and how well or badly do each of you expect it to perform-economically and politically-over the next five to ten years?
BERNARD CONNOLLY: I think there will be a "wide" 11-country Emu. The Bundesbank will have one last go at trying to keep Italy out, but it will be a half-hearted one. How will it work? For the first couple of years it is going to look great. To the peripheral countries, such as Spain or Portugal, it will seem as if they have died and gone to heaven. They will have strong growth, falling interest rates, low inflation, and business and consumer confidence will be high. France and Germany will have monetary policy set-broadly speaking-in their interests and will continue a sluggish sort of recovery. But by 2001 the boom in the periphery will go bust. These countries will not be able to devalue their currencies; their budget deficits will grow rapidly. There will be a conflict with the stability pact rules; I suspect the pact will be suspended. The likeliest outcome from this crisis is the ejection of at least some of the peripheral countries and a solidifying of the core, with much stronger elements of political union. France will then have to make a final decision on whether to join a core dominated by Germany.
GAVYN DAVIES: The British have had a habit of first denying that Emu was ever going to happen and then saying that it was going to break up as a result of currency speculation in the transitional period. Now people are falling back on a third position: that Emu will break up shortly after its launch. On the contrary, it will be extremely difficult for it to break up in anything other than Armageddon circumstances. I also think it will start with 11 states, although Italy may be kept out for a year or two.
I think the nature of the European central bank (ECB) within a wide Emu has been misunderstood in the financial markets. People think that having Italy and Spain on the ECB board will weaken its counter-inflation policy. If you had ever met the central bank governors of Italy or Spain, you would not say this. They are counter-inflation hawks and will sit on the board of the most independent central bank yet devised by mankind. If anything, the currency is going to be too strong for the good of the European economy.
The stability pact will create a deflationary bias, similar to the pressure on governments to reduce their deficits in the run-up to monetary union. This is almost wholly to the good-as long as you have an enlightened central bank offsetting this bias with an easier monetary policy. But it is not, admittedly, clear that we will have such a central bank. Even the much admired Bundesbank has proved itself fallible in recent years. It caused the European recovery to derail in 1994 by allowing the Deutschmark and German interest rates to rise unnecessarily high.
The longer-term weakness of Emu will be the effect of Italy's and Spain's membership. But whatever happens, ways will be found to keep Emu together. The financial markets will not be able to break it apart in the same way as they did with the ERM. Whether it is a success depends on what happens to labour markets, whether the ECB is enlightened, and so on-questions which are too difficult to answer right now.
ANATOLE KALETSKY: For the next five to ten years, the Emu story is quite a benign one. This does not, in my opinion, justify the project, because the preceding ten years have been disastrous ones. The pre-Emu phase, which began in about 1987, has been the worst period of under-performance in the history of Europe this century. From a period in which Europe had been catching up with-and in some ways overtaking-the US and Japan, Europe has unequivocally fallen behind in the past ten years.
What kind of Emu will it be? I agree with the previous two comments, that it will be a wide Emu. I also think it will be a soft euro: it will be a relatively weak currency against other world currencies. But from the European point of view it will be a perfectly satisfactory hard euro because it will be a non-inflationary currency.
The people on the ECB, at least the first generation of them, will be reasonably pragmatic central bankers; and I think they see this distinction between domestic and external currency strength quite clearly. So, for the first few years anyway, they will follow a relatively easy monetary policy, which is still compatible with low inflation because of the extremely depressed state of the European economy.
The more serious threat is that Emu will engender political tensions between the nations of Europe. The single currency project will be a natural scapegoat for politicians in every country. As soon as difficulties are encountered, the French will blame the Germans, the Germans will blame the French and they will all blame the ECB. I do not think Emu will break up, but if it does, it will be for political reasons. Or it will be because of an external disruption such as war, oil shock or financial meltdown.
WILL HUTTON: I remember coming back from Maastricht in December 1991 and writing a passionate column for the Guardian about what a disastrous decade of deflation we now faced. Those political decisions have been exacerbated, as Gavyn said, by some arrogant and foolish behaviour by the Bundesbank. Still, having got this far it seems a great mistake to let the prize slip. I think the policy regime which Emu will bring will basically be very benign. It will sponsor five to ten years of impressive growth, similar to the effect of the Treaty of Rome in 1957.
I think that there will be particularly significant booms in Italy and in Spain. And, given the relationship of both those markets to the German Mittelstand, there will be a significant boom in Germany too. I do not accept the idea that a necessary and sufficient condition for job creation is a flexible labour market, so I do not see that the inflexibility of French and German labour markets will necessarily be an obstacle to employment generation. As the Emu boom gets under way, the European model will cease to be an object of scorn and will again become something to be admired and copied.
I am increasingly struck by the underlying structural convergence within the European economy. Nevertheless, as everyone knows, it is not an optimal currency zone. At some stage in the next ten years there will be a sharp rise in nominal rates in response to an inflationary danger-perceived in Frankfurt-which does not exist somewhere else in the Emu area. I suspect the response to that will be to strengthen the political structures within the core-precisely what the sceptics fear.
DAVID MARSH: I have heard a bit too much wishful thinking around this table. First, can I break with the consensus and say that there will not be a wide Emu-I think Italy will be excluded-and I still think there is a significant chance of postponement. Not just because of German politics, but also because of Dutch politics.
There is a paradox at the heart of all this: we have already had a monetary union for ten years within the core group. The French/German exchange rate has been unchanged for a decade; France, the Benelux countries, Austria and a few other countries have been in a monetary union run by the Bundesbank. If Emu is going to lead to economic Nirvana-as a result of less uncertainty for cross-border trade and investment and so on-why have we not seen this in the past ten years?
What will happen after 1999? My biggest worry is that expectations are too high and varied. There are those who think that it will prevent war in Europe, there are others who simply want more transparent goods markets and deeper, wider capital markets. Some say that it will solve unemployment, others say it will not make a blind bit of difference. More specifically, I think there will be a conflict between the people who expect monetary union to produce jam now, particularly the French, and those who know that it won't, particularly the Germans. The proposed stability pact will not work. It is going to be impossible to fine large countries great sums of money for overshooting budget targets which seem to be set down by a group of mandarins. Maybe you could get away with fining Luxembourg, but you certainly won't be able to get away with fining Italy, France or Germany.
CHARLES GOODHART: One of the points of agreement so far seems to be that when you get a single currency, the pressures from financial markets and speculators die away, but the pressures of making the whole thing hang together fall much more on the politicians. Giles, do you think the politicians can keep the show on the road?
GILES RADICE: Yes, they can. Continental European politicians deserve a lot of credit for bringing us this far. It is really astonishing how the whole Maastricht programme has worked; and the politicians have led it. Think how many commentators-some sitting round this table-said it would never happen.
CHARLES GOODHART: But will monetary union create pressure for more harmonised economic policies within the Emu area? And is it likely to-indeed, should it-lead on to greater political unification?
GILES RADICE: We will have greater fiscal co-ordination, but there will still be quite a lot of room for countries to tax and spend as they want. There are bound to be demands for the ECB to give an account of itself. There will have to be some mechanism for the central bankers to have a dialogue with the people. This could be done through the European parliament and also, perhaps, through the EU committee of finance ministers (EcoFin).
DAVID MARSH: Making the ECB a bit more accountable, as Giles suggests, is not enough. I do think that there is a danger in having a supra-national monetary authority when the people of Europe are evidently not ready for political union. Also, it is dangerous to imagine that you can smuggle in political union through the backdoor once Emu has been established.
CHARLES GOODHART: Assume that Bernard Connolly's worst fears come true and that either one country or a large part of a country becomes uncompetitive as a result of Emu. Unemployment starts to rise rapidly, the politicians start screaming. What will happen?
WILL HUTTON: That's the $64,000 question, Charles. Something like this is going to take place between years three and four and years seven and eight. But you have to remember that in Italy and Spain, the two countries where this is most likely to happen, there is a powerful commitment to European integration, not just from the elites. There will be crises, but on balance it will boxed and coxed through.
ANATOLE KALETSKY: The real weak link in the chain, both economically and politically, is not going to be Italy or Spain; it is going to be Germany. Germany is now the most uncompetitive country in Europe-I disagree with those who think that the Deutschmark is a highly competitive currency. We will see big economic problems in Germany caused by uncompetitiveness, high wages and so on; but everything will be blamed on Emu, just as over the past five years Germans have blamed unification.
GILES RADICE: But they are going to live with unification, and they will live with Emu.
ANATOLE KALETSKY: But will they? The difference is that German unification was the fulfilment of a longstanding political goal which most Germans shared. Emu is nothing of the sort. Emu was foisted on them from above, by Kohl and other politicians. If they see that France, Italy and Spain are doing well, while Germany is not, there will be a backlash-even a move to the xenophobic right or left. You can already see this in a small way with the questioning of Germany's contribution to the EU budget.
CHARLES GOODHART: This argument that Emu will drive politics towards the extreme is often used by Eurosceptics. How do you reply to it, Giles?
GILES RADICE: The danger is exaggerated. Germany, just like Italy, needs a bit of external pressure to be virtuous. And one of the good things about Emu is that some of the overdue reforms in Germany will now take place, with the support of the entire political class, probably through a grand coalition of Christian Democracts and Social Democrats. I am in favour of the German social market, but it needs radical modernisation-the euro should help.
CHARLES GOODHART: So what about Britain? Emu gets off with a tremendous swing and then the problems start to arise just about when we are likely to enter. What should we do?
GAVYN DAVIES: What the government is proposing to do makes a lot of sense. By stating so clearly that it is, in principle, in favour of entry, it hopes to limit the political damage caused by staying out for a period. Kohl's suggestion, a few weeks ago, to keep open an ECB seat for Britain suggests that this part of the strategy is working. On the economic front, we need our cycle to come more into line with the core countries; but we also need some deeper convergence. If we are going to join a system with no monetary flexibility, we need labour market flexibility; we need to adjust our housing finance and even our system of corporate governance. We will also need instruments to replace the short term interest rate as an adjustment mechanism for our economy. That is a five year task. Gordon Brown's statement began to shift the thinking in that direction, but we have a lot further to go. Incidentally, I do not accept the rather pessimistic view, which has been expressed here, that there is no way for the peripheral economies within the euro zone to adjust. There are ways of adjusting other than simply flexible exchange rates. There will be some scope for fiscal adjustment; it has not been wiped out completely. There is scope for fiscal sharing across the EU for loans, grants and so on, to countries in trouble, to buy them time. There is some real wage flexibility. It isn't perfect but it is there. And for the large countries, I think there will be some monetary policy adjustment as well: the ECB will not ignore a recession in a country that accounts for 15 or 20 per cent of GDP in the Emu group. These adjustments can prevent the project busting up. Obviously we want to strengthen all of them. We also need to adjust our economy so that the need for those policy adjustments later on will be minimised. Over a five to ten year period, we can achieve this.
CHARLES GOODHART: Bernard, can Britain possibly afford not to join after the next election?
BERNARD CONNOLLY: Well, we should be very grateful that early entry has been ruled out. But by the year 2002/2003 I think the initial euphoria about Emu will definitely have died away. We shall be in a position where it becomes clear that-at a minimum-in order for Emu to work, the adjustments which Gavyn has talked about will have to be made. They all involve further surrenders of sovereignty. At this point, it will no longer be possible for British politicians to close their eyes to what all continental politicians say that this project is about-political union. Let no one believe that monetary union, or for that matter the EU itself, is a special purpose association for pursuing common interests. It is not. It is a way of producing political union via a single currency.
CHARLES GOODHART: But has that not always been the long-term objective of the European Union?
BERNARD CONNOLLY: Well, one has to draw a distinction between the early history of the community and what we are seeing now. Whatever the rhetoric of the founding fathers, for 30 years the EU was an organisation for pursuing common interests. Monetary union is different. As well as one exchange rate, interest rate and central bank, we are talking about one interest, a community interest. National interests will have to be forgotten.
CHARLES GOODHART: Is joining really such a Rubicon?
Will HUTTON: Yes, it is a Rubicon; and I am happy to cross it. I think it will be good for Europe. Emu will also enable Europe to play a vital role in the new forms of governance for international financial markets which we require.
ANATOLE KALETSKY: I agree that Emu does represent a significant step towards political union. On the other hand, it is doubtful whether the EU is capable of forming such a political union in the foreseeable future. I think there is a contradiction between the idea of a euro zone which moves step by step towards some kind of United States of Europe on the one hand and, on the other hand, the idea that the EU is going to be expanded from 15 to 20 states, then to 25 or more states.
CHARLES GOODHART: So is the logical euro area a narrow one?
ANATOLE KALETSKY: The 11 countries which are now grouping for the first stage of Emu form a fairly plausible United States of Europe of the future, including Italy and Spain. But this leads to the question of whether Britain belongs or not. This argument may, in part, be settled by the rather short-term performance of the economy. If the British economy is performing well in 2002-which I think is quite likely, if the Emu boom scenario comes to pass-then I think Britain will be under no particular pressure to join Emu. If, on the other hand, the British economy appears to be in trouble, then we will join.
GAVYN DAVIES: Certainly it is a Rubicon. The scoundrels who argue that it is not-such as Ken Clarke and Michael Heseltine-do so for internal party political reasons. Gordon Brown was essentially saying, in his celebrated Emu statement, that we accept a further significant ceding of political sovereignty to the EU if we deem it to be in our economic interest. This is the Rubicon, and as Gordon says, no British politician in government has ever said this before.
WILL HUTTON: Alistair Campbell then wrote a piece for the Sun saying that the pound is safe in our hands!
CHARLES GOODHART: But what do you think will actually happen when we hold a referendum?:
GILES RADICE: British public opinion is far weaker against Emu than it appears. If you look rather more closely at the opinion polls, 75 per cent of the public think they can be persuaded to join, if they think it is in their and in Britain's interests.
BERNARD CONNOLLY: It depends partly on what people are going to be told. Just about everyone in political life-not just Ken Clarke-says yes, we will lose control of interest rates, but we still set our own fiscal policy, our own social policy, environmental policy, industrial policy and so on. But in reality all of this will have to be closely co-ordinated with other Emu members. This is exactly what is now being negotiated in Brussels; commission papers are being circulated. But this fact has not yet been explained to the British public. Nor, for that matter, to the publics of other EU countries.
Another important implication of this co-ordination concerns the reform of the German model which Will and Giles were talking about. Ultimately, I think, most Germans will be convinced of the need for change. But if the German economy suddenly becomes much more competitive, it will be a serious blow to France. So the French will try to pre-empt any such move by ensuring that social, employment and labour market policies are co-ordinated, as far as possible, at European level. So everyone will modernise at the pace of the slowest member.
DAVID MARSH: I want to bring the discussion back to Britain, to challenge this idea that we shall be marginalised if we do not join in the first few years. Our trade with other EU members is greater even than Germany's in terms of percentage of total trade. There is no reason to think that this will change radically. Chancellor Kohl's extraordinary offer of a contingent seat on the ECB for Britain suggests that Kohl thinks Britain will still be "convergent" in a few years time. Although, incidentally, by dispensing seats as if this were the annual banquet of some small town B?germeister, he undermines his own goal of ECB independence and also revives fears of German domination.
GILES RADICE: But David, as you say yourself, it is not in his gift to offer this seat; in any case the important decisions are going to be taken on the Emu council, and we have not been offered a seat there. So there is a political cost from not being in the first wave. The longer we stay out, the more we will be marginalised politically in the EU, and in the rest of the world too. There will be a G3 not a G7.
ANATOLE KALETSKY: I don't really accept this dichotomy between either being "in" or set adrift. It is quite possible that the EU will fragment into a core group of Emu countries and a group of quite large, important countries around the edge, including Britain and the Scandinavian countries.
GILES RADICE: It is not our destiny, in my view, to be out there with Greece and Sweden. I think we need to be in there, making the decisions.
Bernard Connolly: But we will not be making the decisions, even if we are in. Look at the ECB. It is supposed to represent the area as a whole, not individual countries. But it is perfectly clear that the Bundesbank expects the ECB to set rates in the light of German and, to some extent, French conditions.
GAVYN DAVIES: I disagree completely. I do not see how the simple majority voting system for the central bank governors on the ECB will allow German dominance. If anything, it will overstate the interests of the peripheral countries. There will be a significant evolution of power away from Germany in the new central bank, probably from France, too.
BERNARD CONNOLLY: Well, in the Brussels game a simple majority is never simple. Some countries are more equal than others. Emu is not primarily about economics. The ECB will initially set rates too low for the peripheral countries and it is difficult to see how they can avoid boom-and-bust.
DAVID MARSH: The economics of this can be put very simply. There will be a problem if Germany gets its way: it will mean inappropriate monetary policy for some other countries. There will also be a problem if Germany does not get its way: it will destroy the ECB's credibility as an anti-inflation hawk.
ANATOLE KALETSKY: We have drifted away from Britain again. I want to suggest that the question we will have to decide in the referendum is whether Britain wants to be a Canada or a California.
CHARLES GOODHART: I know which one I would choose.
ANATOLE KALETSKY: You are not allowed California's climate! Of course, if our economy is doing very badly, it will appear like a choice between being a Mexico and a California. But I think the choice is Canada versus California: it will be a genuine choice; both avenues will look plausible and reasonably attractive. On balance, people will choose the Canada option: Canada may not be a very important country but the prime minister of Canada has more influence in the world than the governor of California.
CHARLES GOODHART: Assuming that we join Emu by 2005, as a majority of you seem to believe, will we be required (and will we accept) to join the ERM for two years in advance of entry?
GAVYN DAVIES: No way. This is of such huge political importance that such a technicality cannot stop it.
DAVID MARSH: The two years in ERM only applies to those who join before 1999. Thereafter you can make it up as you go along: Maastricht will no longer apply. But, with or without ERM, there will be a problem-or rather a paradox-over British entry. If the core of the European economy benefits from the first wave of Emu, Britain may want to join, but its cycle will be even further out of line; so it will not be able to. On the other hand, if the European economy suffers, Britain will be able to join but may not want to.
CHARLES GOODHART: I want to sketch a final scenario. There is an election in the year 2001, Labour is returned but with a sharply reduced majority. The Conservative leader then states that he will not accept joining the euro, and would consider taking us out. Why, in these circumstances, would our continental colleagues want to accept us?
GAVYN DAVIES: Because it would be settled in a referendum. The Conservatives were against Scottish devolution until the referendum came out overwhelmingly in favour; then they changed their minds. The real question is whether William Hague can sustain his sceptical line even in opposition.
WILL HUTTON: A Tory party which has more than half of the country's top 100 companies against it on an issue of this importance is in quite a mess.
GILES RADICE: The interesting thing which has happened over the last three months has been a major shift in business opinion. You ought to have seen the pressure in the weeks before Gordon Brown's statement, on him and No 10. It was amazing.
ANATOLE KALETSKY: But just as public opposition to Emu is quite weak, business backing for Emu is also quite weak, and could fragment. Small business, for example-which is more important to the Tories than the CBI-is often hostile. The fact is that staying out will not be a disaster for business. There is no evidence to suggest that companies based in Switzerland such as Nestl?nd ABB suffer from not being inside the EU, let alone the euro zone.
BERNARD CONNOLLY: Businesses might also be unhappy if you tell them that we have to join at DM3.10 to the pound. Do not believe that Britain can just walk in at DM2.40 or even DM2.60.
GAVYN DAVIES: Then we can't join-tough luck. If we can't join at DM2.60, I would say don't join.
ANATOLE KALETSKY: But let's say the market rate in three years time is DM3 to the pound. Do you think the government will be able to turn around and say, sorry, we want to join at DM2.60?
GAVYN DAVIES: If we can't we will just have to wait a little longer.
CHARLES GOODHART: We can't wait any longer-we will have to stop there. Thank you.
