SHOULD THE UK JOIN EMU?

Michael Artis [*]

The Review is pleased to give hospitality to CLARE Group articles, but is not necessarily in agreement with the views expressed. Members of the CLARE Group are M.J. Artis, T. Besley, A.J.C. Britton, W.J. Carlin, J.S. Flemming, C.A.E. Goodhart, J.A. Kay, R.C.O. Matthews, D.K. Miles, M.H. Miller, P.M. Oppenheimer, M.V. Posner, W.B. Reddaway, J.R. Sargent, M.Fg. Scott, P. Seabright, Z.A. Silberston, S. Wadhwani and M. Weale. Drafts of this article have been discussed among members of the Group, but responsibility for the views expressed rests with the author alone.

This article considers the economic case for UK membership of EMU. Traditional optimum currency area (OCA) analysis provides only a weak case for membership: the UK is located among the periphery and not in the core. Considerations of the possible costs of isolation (the risks of trade discrimination and the dangers of a volatile currency) together with some pertinent qualifications of OCA analysis (the possible endogeneity of the OCA criteria) serve to strengthen the case for joining. Whilst it is not overwhelming, the final verdict is positive.

Introduction

The European Monetary Union (EMU) is up and running. The choice the UK faces is whether to join and, if so, when. Public opinion, business opinion and professional economists are divided on this issue, as are the main political parties. It is clear that the decision is a political one and that political arguments are critically important in this debate. Monetary unions are usually, after all, preceded or accompanied by political union. Nevertheless, monetary union is an economic issue and economic analysis is vital.

In this article we attempt to set out such an analysis. The next section begins with some factual background; what would have to be done if the decision were taken that the UK should join; what the constitutional situation is; what the state of public and business opinion is; what the government's 'five tests' are; and so on. Economic analysis offers 'optimal currency area' (OCA) theory as a framework for the discussion of the pros and cons of monetary union. So, in the next section, we go on to discuss what optimal currency theory suggests. Finding, as we do, that the verdict to be obtained from OCA theory is somewhat lukewarm, we proceed to probe its possible weaknesses. This helps to reduce the negative quality of traditional analysis -- but without, in our view, transforming the picture completely. So we seem to be left with a balance sheet of economic costs and benefits that is more or less neutral. But of course it is one thing to evaluate the proposition for EMU, so to speak in the abstract, and anothe r to evaluate the case for joining (or not) an already existing organisation. It is the latter that is now the relevant question. So, to complete the analysis, it is necessary to investigate the pros and cons of a decision to stay out of EMU -- what we can term 'the Canada solution'. We do not find such a solution to be in any way an infeasible nor clearly undesirable solution on economic grounds -- as the title we have given it of course implies. Yet there seem to be some risks in such a solution that help tip the balance of advantage a little further towards joining. Something depends on whether non-participation in EMU places the UK's participation in the Single Market at risk. And a great deal depends, all round, on whether exchange rate flexibility and monetary independence provide insurance from external shocks or simply provide an additional route through which destabilising forces can exert themselves. For large developed countries, with well-managed financial systems, the balance of advantage on this score is not obvious.