Revisiting Europe

Whilst the economic debate on EMU remains somewhat muted and confused, with euro sceptics as diverse as Martin Feldstein (an American economist) and Jonathan Redwood (a British politician) slamming the common currency; whereas its adherents (including many European economists and politicians) continue to sing its siren song.

The recent slump of the euro against both the American dollar and the Japanese yen have added more fuel into the flame for critics; yet proponents argue that the strength of the currency is far removed from (bah) trifle indicators such as the exchange rate. Who, then, is the common man to believe?

I put forward three main gains that I believe have been realised, and three caveats to consider:

Strike 1. Credibility. The attempt by inflation-prone nations such as Ireland and Italy to 'import' the credibility of the fearsome German Bundesbank has been largely successful. Although convergence on the January 1st, 1999 might have meant some clever accounting on the part of some countries, credibility works on people's beliefs, and subsequent inflation and interest rate data indicate that the euro just might have pulled this one off. Which leads naturally to the next point.

Strike 2. Inflation. Price stability as an aim has been largely realised. Nations have stayed within the band of the 2% inflation ceiling. A point to note here is that much of the impressive inflation performance of the euro-zone in its first year harks from a fall in fuel prices. It will be interesting to examine data for the first quarter of 2000, with OPEC production quotas and oil prices rising to the heavens.

Strike 3. Transparency. This works in line with the proliferation of the Internet. The Internet revolution has allowed improved comparison-shopping; indeed, web start-ups have already moved to take advantage of the euro's increased transparency to hawk goods that have traditionally experienced pricing to market, such as cars. The high-profile mergers of Vodafone Airtouch with Mannesmann and the Paris, Amsterdam and Brussels stock exchanges.

Yet there are also several areas that remain disconcerting.

Ball 1. Productivity. Statistics shows that German productivity continues to tower over the other countries, in spite of rapid improvements on the part of countries such as Ireland and Spain. If German productivity growth continues to increase over and above the rest of the euro-zone, unsustainable asymmetries in the real exchange rates will occur, ultimately threatening monetary union.

Ball 2. Labour. This is the most common argument amongst opponents to the euro. European labour markets are just too rigid to make the loss of exchange rate policy (revaluations/devaluations) a wise choice. The most common comeback line has been that even within countries, labour has not been mobile; hence, the imposition of a common currency would make scant difference between countries. Nonetheless, I would argue that the free movement of labour is a good thing, and microeconomic reforms should aim at that objective.

Ball 3. Politics. Many European policymakers continue to shy away from discussion of this point, but on the basis of the examination of currency unions in history, the ones that have made it have generally been those that have experienced political union as well. And in itself, this may or may not be a good thing. Europe has been the hotbed for the two world wars, and political union might just signal the start of a new era for Europe. Of course, given the stubborn independence of Europeans and their strong nationalistic and cultural pride, this is far easier said than done.

So what is the common man to believe? The jury, it seems, is still out on this one. Until and unless we see some real changes in Europe, the entire process might very well fail - though given the investment that has been made into monetary union, this does seem unlikely. My advice is - if you're a non-European, investment in Europe has become far more tempting; if you're European, then just sit back, and for what it's worth, enjoy the ride.

This article is unpublished.