Times p 35 Mar 2 2003

Recently, the British and Euro economies have been converging. Have they gone far enough to support the views of people like myself who believe the sooner we get in the better?

If we stick strictly to economics, there are three fundamental criteria for the decision: the exchange rate, the interest rate the business cycle, the first being by far the most important. But first let me clear away two distractions - European Unemployment and the state of the German Economy.

The average unemployment rate in the 12 current members of the Euro is 8.5%. For the UK the figure is 5.5%. There is no doubt that this is a large difference. There is also no doubt about the explanation of it. It is not, by and large due to the existence of a weaker general demand for labour over there than over here. Much research, but most especially a brilliant recent paper by Steve Nickell, LSE Prof and member of the MPC ('A Picture of European Unemployment', December 2002 -available on Bank of England website.) has led to that conclusion. Nickell's detailed statistical study shows that the cause has been the result of collective political choice. Over the years the elected governments of the countries concerned have gradually softened the conditions for unemployment benefit, and have developed various other modes of job protection, so that the 'excess' unemployed over there are not genuinely looking for work.

Whether this 'European' way is good for Europe is an interesting question. (One thing we do know is that European countries, especially France, offset the cost of their excess of 'non-employed' people by the fact that those who are employed produce at a much higher rate per hour than is the case in the UK.) But how relevant is the question for the UK decision about entering the Euro? The answer, I suggest, is 'not at all'. If we enter the Euro at a sound exchange rate, in what way will Euroland's labour-market practices harm British business?

The same conclusion applies to the condition of Germany. The erstwhile tiger economy first smelt trouble as long ago as 1993 and currently the German GDP growth rate is down to half of one per cent a year, compared eg to the lusty figure of 1.5% which optimists expect for 2003 in Britain. The causes of the German troubles are much discussed. They are largely internal (German exports are doing quite well) and they seem to have something to do with a special link between the German banking system and Wall Street. What is absolutely certain is that the German troubles would have been just the same if the Euro had never been created. By the same token, they cannot affect the benefits of entering the Euro to British business.

Turning away from Germany the key news is that the Euro/Pound exchange rate has fallen to Є/Ј 1.45 (other way round, 69 p per Euro). Furthermore the Є/$ rate has fallen healthily to a few points below par. All this is good news for Europe, for the Pound and for the British economy.

On Tuesday, Sir Eddie George told the Commons Treasury Committee that the pound's decline had taken it closer to a viable entry rate for the Euro. But he also said he had no idea what such a rate might be, 'Heaven knows.It is a real art and you can come to lots of different answers'. I am sorry to have to say it, but the great man is misled. There is overwhelming evidence that a healthy entry rate lies in the range Є/Ј 1.35-1.45. According to the OECD, the 'Purchasing-Power Parity Rate' - ie the rate which equalizes the price levels in the two zones, is Є/Ј 1.37, and the OECD ('The Pound's Fair Value, Economic Survey of the UK, January 2002) found that the median figure from no less than 20 academic studies using various methods was Є/Ј1.35. If you want to say that the PPP rate of Є/Ј 1.37 would be ideal, then we only need a further devaluation of 5%, which would almost certainly occur naturally on the market if British entry became seen as certain.

Next question, what about interest rates? After the recent cut, British Bank Rate became 3.75%. The European Central Bank Rate is 2.75%, so we are currently a point adrift. Suppose we entered the Euro tomorrow and overnight experienced a one point drop in our actual short term interest rates. Would there be hyperinflation? Would the ceiling of St. Paul's Cathedral fall down? I doubt it. In any event, the question, however exciting, is superfluous. In a recent lecture, the very distinguished Professor David Begg (for copy apply to the Centre for Economic Policy Research) applied a technique known as 'Taylor's Rule', to the interesting question of what the Eurozone interest rate would be be if the ECB responded to the European economy in a similar way to the observed pattern of the Federal Reserve in relation to the US economy. Begg's conclusion was around 2.5%, ie a quarter point below the current level. When asked what would be the result of applying the same analysis to the UK, he refused to be drawn. Inevitably, however, other fingers have been moving on keyboards. The general conclusion is that now that the housing market has turned, UK Bank Rate needs to come down the best part of three quarters of a point. The apparent miraculous conversion of my old pupil, Mervyn, from his old high-rate bias, makes this benign scenario, I think, quite realistic. On that calculation the propsective UK-Euro interest-rate gap is down to half a point, which is surely good enough.

Finally the Business Cycle. The OECD has a statistic, called the Output Gap, which measures the extent to which the current level of output in a national economy deviates from the estimated long term trend. If output is above trend, the 'gap' is said to be plus; if the other way about, minus. The latest figures can be found in last December's Economic Outlook. For last year the whole Eurozone is put at -1.3%, Germany at -1.9%. At a rough calculation that puts the Eurozone without Germany at around -1.0%. What about ourselves? For 2002 we were 0.8% and I shall be pleasantly surprised if this figure does not rise in the near future. So, again, there is nothing in this. For evidence of Convergence, what more could one ask?

As is well known Gordon Brown has his own approach, known as the Five Tests, to the problem, the results of which he will publish in June. They comprehend my basic criteria and some others. For reasons I have given elsewhere (for details see my website robinmarris.com) I think they are rather confused. Or, to put it another way, if Gordon Brown in June reaches a different conclusion from the one I have set out above, he will be wrong. And please remember reader, I am completely ignoring the political situation. I am talking about the short term economics of a long term question which will be affecting the welfare of the British people long after, hopefully, Sadam Hussein and even Bin Laden are forgotten.