SPEECH BY RUTH LEA Head of Policy Unit, Institute of Directors TO THE THIRD CONGRESS FOR DEMOCRACY, 10 December 1999

Keeping the Pound: Good for Business

 

(I) Introduction

"Keeping the pound: good for business" I shall be very much keeping to economic and business arguments in my speech. I shall not be touching on the political/democratic issues - even though I do regard the euro, as indeed do continental politicians, as an overwhelmingly political project: part of the creation of a United States of Europe.

(II) The Single Market

Before I go on to discuss the euro, perhaps I should emphasise that the IoD is in favour of Britain’s membership of the Single Market which, though far from perfect, does bring business benefits. We are pro-Single Market membership - both for trade and for attracting inward investment:

• The trade issue is relatively straightforward. However you define "trade" the EU is a very important market for the UK. For example, nearly 50% (though only nearly 50%) of our current account transactions are with the other countries of the EU. There would be disadvantages for our exporters if we pulled out of the Single Market - not least of all the Common External Tariff.

• Concerning inward investment, I spent four years in the DTI and one of my jobs there was in "The Invest in Britain Bureau". We were promoting Britain as a place for overseas companies to come and set up business. There were several factors we quoted in trying to sell Britain including: (I) the English language, (II) the relatively light regulatory and tax burdens (though undoubtedly getting worse and has been noted by some potential inward investors), (III) the pro business Government, (IV) the low social on-costs (low wage costs rather than the relatively low wages - though increasingly less relevant as the pound is so strong), (V) the flexibility of the labour market (but now getting worse) and (VI) the vastly improved industrial relations. (VII) And another very important factor was that the UK was in the EU and that the effective "home market" for any company setting up here was the European market. It was interesting to note that in a recent Daily Telegraph story about vehicle multinationals they made it very clear that Single Market membership was an important reason for investing in the UK (the story had originally been reported as vehicle multinationals saying membership of the Single Currency was an important reason for investing in the UK - but was then corrected).

So before I start my promotion of the pound, please do not think I am in favour of withdrawing from the Single Market.

(III) Conditions necessary for Business to thrive

We never tire of saying that for business to flourish, government must satisfy two main requirements:

• firstly, it must maintain a stable, low inflation macroeconomic environment - no more destabilising "booms and busts" [see (IV)].

• secondly, it must introduce taxes and regulations on business in a business-friendly way which minimises the costs and burdens on business. And it must only introduce these taxes and regulations when necessary [see (V)].

If government successfully delivers these requirements then it can leave businesspeople to create the jobs and the wealth which sustain our prosperity and, through taxation, provide all the vital public services including education and health. And let us remember that we do have a prosperous and large economy (the fourth or fifth largest in the world) with outstanding global connections. Membership of the euro will certainly affect the former if not destroy it. And membership of the euro has serious implications for the second - even though they are not as clear cut as the first.

(IV) For economic stability the UK should keep the pound

(IV/1) Economic stability: introduction

Starting with the need for macroeconomic stability and the absolute requirement that there is no return to "boom and bust". There is no doubt in my mind that if we replace the pound with the euro before sustainable economic convergence the economy would be back on a roller-coaster.

Let’s just remind ourselves of what joining the euro would mean for the economy and for enterprise:

• Joining the euro means that British institutions would no longer decide the appropriate economic policies for Britain. British institutions currently control, within the international context, the British economy. The nation’s finances are doing very well, the economy is performing well (not least of all because of the 1980s tax reforms, labour market reforms and privatisation) and the Bank of England doing very well;

• Instead you would have non-democratic EU institutions (mainly, at least currently, the European Central Bank) deciding what is right for Euroland’s economy. If the ECB could decide our interest rates effectively for the UK economy then OK (perhaps) - but it can’t because our economy is different.

• The wrong interest rates would destabilise the economy and we would return to "boom and bust". So farewell to the low inflation macroeconomic stability which is a prerequisite of business prosperity. Farewell to the first requirement. Joining the euro before proper convergence would be a huge and unacceptable threat to our economy and business.

• Our economy is different: cyclical differences. The UK economy is hopelessly adrift from the Continental European cycle. Indeed it behaves more like the 51st state of the US than a continental economy. For this reason the UK needs different interest rates from the continent. But with a "one-size-fits-all" interest rate there’d be little chance that the UK would have the right interest rates. If the ECB decides interest rates should go up then up they go - whether or not we’re languishing in recession. Remember the ERM. And if the ECB decides rates should go down then down they go - whether or not we’re in an inflationary boom. And the "stability and growth" pact could put major restrictions on what we could do with taxes and public sector spending - in other words with fiscal policy.

• Even if we managed to pull our economy into line, for example, with Germany’s would it stay there? (And note that Euroland’s economies are diverging, with Germany and Italy lagging France and peripheral economies leaping ahead. These economies need different interest rates - "one size doesn’t fit all in Euroland".) In other words, would the cyclical convergence be sustainable? Well this would be extremely difficult also. There are significant structural differences which would probably prevent this.

• our economy is much more sensitive to changes in short term interest rates and, once in the euro, we would of course have to take the interest rates (and therefore changes) decided by the European Central Bank (ECB).

• Britain’s more diverse trade patterns. As already stated, only 50% of our current account transactions are with the other countries of the EU. And we still have nearly 15% of our visible trade with North America. If the euro against the $ appreciated then our trade would be hit harder than, say, Germany’s.

• When will these differences be resolved? Well your guess is as good as mine. And not for the foreseeable future. And (I) there’s nothing of any substance coming from the government to help convergence and (II) it’s highly unlikely the differences will have gone sufficiently by the early years of the next Parliament - when I still believe the government plans to take us in (if the political background looks right - ie Labour is returned with a sizeable majority) despite the increasing euroscepticism (see British Social Attitudes Survey). Incidentally the EU Commission’s latest forecasts show that the UK will still have much higher interest rates than Euroland’s by the end of their forecast period (end 2001).

(IV/2) The Government’s tests and the IoD’s position

It is probably worth spending a few minutes on the Government’s convergence criteria because they deserve at least two cheers (as we said way back in October 1997 when Gordon Brown unveiled them - hostage to fortune?). In the IoD we have attempted to put quantitative meat on the qualitative bone - but Gordon Brown’s criteria were undoubtedly a good start. The five criteria were:

• Cyclical: Are business cycles and economic structures compatible so that we and others could live comfortably with Euro interest rates on a permanent basis?

• Flexibility: If problems emerge, is there sufficient flexibility (labour and product markets) to deal with them?

• Investment: Would joining EMU create better conditions for firms making long-term decisions about the UK?

• Financial services: What impact would entry into EMU have on the competitive position of the UK’s financial services industry, particularly the City’s wholesale markets?

• Employment and growth: In summary, will joining EMU promote higher growth, stability and a lasting increase in jobs?

And in February 1999 the PM beefed them up in the National Changeover Plan by adding:

• the ECB should have performed well by steering a course between deflation and inflation. How do you judge this, given the divergent nature of Euroland’s economies: interest rates are arguably currently too high for, eg, Germany and Italy and too low for, eg, Ireland and Spain;

• There should be reform of the EU’s product, capital and labour markets to, presumably, make them more dynamic and entrepreneurial. Well, this is a farce. The Social Chapter is a recipe for euro-sclerosis. And Schroeder’s recent interventions in the German economy (Holzmann, Mannesamann-Vodafone), which have contributed to the not entirely welcome weakness of the euro, and his accusations that it’s Britain’s fault the euro is weak (by not agreeing to the withholding tax) clearly show there is no real sign of the necessary reforms in Euroland’s major economy - Germany. And this was acknowledged by ECB President Wim Duisenberg last week.

In other words we cannot see any meaningful economic convergence in the foreseeable future. And at the very least the UK should not replace the pound by the euro for the "foreseeable future". It is vital for economic stability - and hence vital, not just good, for business’s prosperity - that we keep the pound for the foreseeable future.

Moreover, this position is fully backed by our membership. In a recent IoD poll of members 55% wanted to stay out for the foreseeable future (defined as beyond 5 years) or for the tougher "never" (a surprisingly high 30%). Only 43% of our members supported entry over the next 5 years. And the majority of our members say no to the euro. If you hear Britain in Europe’s (BiE’s) Simon Buckby say that IoD polls support their stance (ie "keeping options open" and being in favour "in principle"), this is simply not true. The man is dissembling. Our polls clearly say we have ruled an option out and that is joining for the foreseeable future. Moreover, the matter of being in favour "in principle" is nonsense. Our approach is a pragmatic one about whether euro membership would help business or not - after all businesspeople are pragmatic people who have to make decisions about what it is best for their businesses. All this "in principle" is humbug!!

Final words on the National Changeover Plan:

• Unacceptable that businesses should be expected to prepare for UK entry into the euro when the referendum may say no.

• Unacceptable that taxpayers’ money should be spent when the referendum may say no.

(IV/3) Disadvantages of staying out

There are, of course, advantages for business for British membership of the euro and it’s only fair I list them. But none weigh up to the huge loss of economic sovereignty and control that would follow from replacing the pound by the euro. The "advantages" are:

• The UK would still be subject to transactions costs within the EU area as well as outside the EU area. The annual savings from the ending of intra-Euro transactions costs are very modest for the UK - probably only 0.1% to 0.2% of GDP. It is worth noting that a country like Canada would probably gain considerably more in terms of transactions costs savings by subsuming the Canadian $ in the US $ because its trade links with the US are so close. But it doesn’t. It chooses to live with the transactions costs and exchange rate risks and run its own economy. The Canadian analogy is a very useful one.

• British traders in the EU would still be dealing in at least two currencies and so would not gain the benefits of "transparency" in pricing in the euro area relatively unimportant. People can use calculators now.

• The pound would remain flexible against the euro - which can be difficult for British exporters and importers dealing with the rest of the EU. But, even if the UK were to be in the euro, there would still be volatility with non-euro currencies and you shouldn’t have a fixed currency with others when your economy is so different. Flexibility has advantages as well as disadvantages.

• Some commentators claim that the City of London would face a serious challenge from Frankfurt or Paris for the role of the "Financial Centre of Europe" if the UK were out of the euro. But most commentators (and now Peter Levene!), say otherwise and London has had a bumper year in 1999 if the bonuses are anything to go by.

• There has been much speculation that inward investors could be discouraged if the UK doesn’t join the euro. Well, the IBB said the year to March 1999 was another record year and investors knew we wouldn’t be in the first wave - and may not be giving up the pound for the euro.

• There has also been much speculation that the euro members will introduce protectionist policies against the "outs." But this barely seems credible. France and Germany have at least as much to lose as the UK (if not more) if barriers to trade with the UK are erected. And, in any case, such barriers are quite against the law and spirit of the Single Market.

(V) Euro membership could bring more tax and regulatory burdens

My second condition for business thrive is that governments should keep a light tax and regulatory burden. Now I believe that this is also under threat if we were to replace the pound by the euro. May I highlight three areas:

(V/1) The pensions time bomb

There is little question that in Germany, France and Italy pensions remain alarmingly underfunded in comparison with the UK. According to recent OECD projections, by the year 2030 state pension expenditure as % of GDP will be just 5.5% in the UK, but 13.5% in France, 16.5% in Germany and a whopping 20.3% in Italy.

Now with the inexorable moves towards further integration in the EU, it seems barely credible that these individual countries will be left to fend for themselves in paying for these pension liabilities. Given that Economic & Monetary Union (EMU) cuts off the escape routes for member countries of short-term interest rate and exchange rate changes (and the Growth & Stability Pact arguably limits the scope for fiscal action), there will surely be moves towards expanding the EU "federal" budget (which is currently limited to 1.27% of GDP) to help those with public sector funding difficulties. The Maastricht "no bail-out" clause which specified that no country should financially bail out another in fiscal trouble will surely come under pressure. Almost inevitably there will be increasing pressure for a higher tax contribution to fund countries in fiscal difficulties. The pensions time bomb will, I suggest, be such a trigger for fiscal difficulties. And the UK would inevitably be the loser.

Now what has this to do with whether the UK is/is not a member of the euro? After all won’t the integrationist agenda go ahead with or without our membership of the euro? Well, yes and no. Yes, because the forces for integration are very strong as articulated by Messrs Schroeder, Jospin and Prodi. But our absence from the euro and other aspects of our semi-detachment (the withholding tax is a very good example) does inevitably slow developments. Witness Prodi’s exasperation with the UK last week over the withholding tax and the threat to drop national vetoes on tax issues.

Joining the euro, in other words, would probably accelerate moves to further economic integration and an enlarged EU federal budget. On current projections, the UK, whether individuals or businesses, would end up subsidising Continental Europe’s pensioners. The tax burden on business would probably rise.

(V/2) Tax harmonisation

My second area is that of tax harmonisation. I have already mentioned the withholding tax which the City rightly fears will damage $3 trillion London eurobond market. The British Government has I feel at long last acknowledged just how serious the threat to London is of the withholding tax - business would simply go to Zurich or New York and not just the UK would lose out but so would the EU.

But it’s not just the withholding tax, this iniquitous tax on interest paid to individuals in EU member states from other EU member states, that’s at issue here. Already there is significant harmonisation in the area of VAT and other indirect taxes. There is a 15% "standard" rate of VAT and VAT on the imports of art products was imposed in 1995 - helping the New York and Geneva art markets at the expense of London.

And the Commission’s attention is now geared towards company taxes with plans for a voluntary Code of Conduct on Company Taxation which the UK signed in 1997. Now the thinking behind these plans is to banish "unfair, harmful, artificial tax competition", "avoid tax dumping" and get a "level playing field" (with Ireland’s extraordinarily low taxes as an example). And who could disagree with anything which sounds so eminently reasonable? Well, it’s thin end of wedge time as far as I’m concerned. Endemic in so much of Commission thinking is a fear of competition. Though they would deny it, they regard competition as all a bit unfair and the free working of markets all a tad suspect. Schroeder’s intervention in the Holzmann and Vodafone-Mannesmann cases is symptomatic of a much bigger problem. We regard the EU’s interest in company taxation with some alarm as our tax rates are relatively competitive and our regime relatively clean of tax breaks for "this that and the other". And the consequences of tax harmonisation for business could be serious indeed.

And what has this to do with the euro? Well, my line of reasoning would be the same as for the pensions time bomb. British membership of the euro is all too likely to accelerate tax harmonisation with all its potentially damaging implications for business.

(V/3) Labour market harmonisation

Finally, I turn to one of my favourite subjects - labour market regulations and labour market harmonisation. Suffice to say the current Government’s labour market agenda is stifling and strangling business in Red Tape. Not all is from the EU (not the NMW, WFTC, compulsory TU recognition, most of the increases in individual rights etc). But much is: the Social Chapter (parental leave, European Works Councils, extra rights for part-time workers, changes to the burden of proof in sex discrimination cases etc) and the Working Time Directive. I feel exhausted just enumerating these horrors. Can you imagine what it’s like for businesses (especially small businesses) to have to implement them? So much for the enterprise agenda and the promotion of competitiveness!

And there’s more to come though the Social Chapter - not least of "Compulsory Information and Consultation Procedures" ("Works Councils") for firms with 50+ employees. The jargon alone is enough to give any businessman or woman a headache.

Behind the Commission’s social/labour market harmonisation is the need to avoid "unfair labour competition", the prevention of "social dumping", the need for "level playing fields". Sound familiar? Yes, the same concepts as for tax harmonisation. And the same fear of competition and competitiveness. And the same potential amage for the UK economy and business as we are (still?) relatively lightly regulated.

And the euro? Again I believe that British membership can only accelerate integration. This is not being neurotic and alarmist. This is being realistic.

(VI) Conclusion

So all in all. Keeping the pound is not just good for business. It’s vital:

• We must retain control over the economy; business would be severely damaged by a return to booms and busts. We must only start to consider euro membership when we are convinced the economic conditions are right - at the very least;

• And on tax and regulatory burdens coming from the Commission we should be aware that euro membership would be all too likely to:

• accelerate a potential agenda on budgetary expansion triggered by the pensions time bomb and;

• accelerate the existing anti-competitive tax and labour market harmonisations (and I haven’t even mentioned the environmental regulations) which so damage business.