Stories never told: Britain and the Euro
Following the announcement of Tony Blair's resignation, newspapers have been filled with pages upon pages discussing his 'legacy' on public services, on foreign relations and on the economy. One of the things invariably mentioned is Britain's decision not to be a founding member of the European Monetary Union, the group of countries that abandoned their currencies and joined the Euro.
Given the current mood to reflect on the events and decisions of the Blair decade, I can't help but bring up an issue that struck me as inexplicably absent from public debate at the time.
Picture a group of friends getting together to start a new company. They have an ambitious business plan ready and they invite you to join them as an equal partner, taking the same risks and being entitled to the same rewards. As an investor, you evaluate the proposition, gauge whether the potential benefits outweigh the risks and make your decision. So far so good: if Bill Gates and his gang had approached you back in 1976, you would have to think long and hard as to whether their profit potential outweighed the risks of investing in an upstart with the ambition to revolutionize an industry still in its infancy.
Now picture a slightly different scenario: here are the same friends, with the same business proposition. This time, however, you are allowed to join whenever you want on the exact same terms as on the original offer. Would any investor bet on an upstart when, without losing out on potential returns, she can wait and see whether it turns out to be a disaster? If a spotty Bill Gates had given you the option to buy Microsoft shares at 1976 prices at any point in time you liked, making the right investment decision would be no trouble at all. You would have essentially been given the opportunity to avoid facing the significant early risks for free.
The EMU project was unprecedented, and many pundits today forget the very real fears at the time that the project would turn out to be a disaster. As with a business upstart making waves in unchartered territory, the risks of forging a monetary union between countries with widely differing public finance profiles and monetary policy needs are significant. Things turned out well - but it could have been very different.
The way I see it, Britain never really faced a tough choice. There was no penalty for late entry into the Euro, no sticks to force the UK, Denmark and Sweden to stand up and face the music if they wanted to have a share in future success. The decision to avoid facing the risks of a grand monetary experiment was right, but no-one seemed to point out the real reason why.
Interesting that despite the fuss at the time on optimal currency areas it's not even a particularly interesting economic debate, which Charles Bean dismissed as a storm in a teacup (see Bean (1992)). Floating regimes cushion asymmetric real shocks, fixed regimes cushion asymmetric monetary shocks so as Willem Buiter (e.g. Buiter (1997)) points out it's ultimately just an empirical issue of which is more prevalent, but in the context of fixed regimes only being possible over long periods with a single currency.
Most of the fuss within economics on optimal currency areas (oddly revived mostly by American academics at the time rather than European) was a red herring and most of the debate outside economics was about emotive issues like having the queen's head on our currency, fears of a European super state and whether we liked people from other countries (in the UK we mostly don't).