Potency Tips

As many leading figures such as Peter Sutherland have suggested, the 5 economic tests which determine the suitability of the UK joining the Euro are possibly outdated.Examining the European Commission’s October 2008 forecasts for 2009 comes to the conclusion that the United Kingdom would still meet the public debt criterion -but probably not in 2010. Aside from this the United Kingdom would easily pass the inflation test – 1.9% versus the average of 1.9% for the three best performing EU members (Sweden, France and Spain/Austria). So the 1.5 percentage points of leeway against these nation states would not have to be used at all. The long-term interest rate criterion versus those states’ bonds is also met very comfortably. But the United Kingdom ostensibly fails two importantcriteria: the budget deficit is likely to be three times the limit and it would be difficult to argue that sterling is stable – regardless of being in the ERM or not. However this is the Standard economists’ reading of the Maastricht Treaty text. Importantly, the writers of this left the political leaders some scope for interpretation. The reports on the economic numbers will be drawn up by the European Commission and Central Bank in accordance with the formulae but the Finance Ministers only use them as “the basis” for their “assessment” of whether an “excessive deficit” exists on the basis of “planned” deficits. That assessment is passed to the Heads of Government who then “confirm which Member States fulfil the necessary conditions for the adoption of the single currency.”

Why might the political leaders of the Eurozone be persuaded to take such a risk? It could well be that in fact they are now nervously looking at the economic implications for their own countries of this massive sterling depreciation. So a major recession in Britain is manifestly bad for the volume of the Eurozone’s exports, but the real problem would be a cost competitiveness which cannot be compared in third country markets. Based on current exchange rates, the UK’s competitiveness is now at about 74 versus the Eurozone 15 or EU 27 – matching the extreme cost competitiveness of the mid 1990’s (see Figure 2). Unit labour costs for the whole British economy have exceeded the Eurozone average by 1.4% annually between 1997 and 2006, but have slowed to about the same as the Eurozone since. This explains the steadyloss ofcompetitiveness that has progressively manifested itself in the ever burgeoning current account deficit. So it would be easy to suggest that the first phase of sterling weakness to say mid-2008 was just a necessary counterbalance to our reduced competitivess.