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The Great Euro Debate – September 2003
What should the Island do in the wake of Jersey’s curve ball?
The Island’s europhobes have latched on to Jersey’s hint that an independent Channel Island pound or a US dollar connection cannot be ruled out if the UK eventually opts to throw its lot in with the European single currency. The Manx Government, however, is sticking to its opinion that the Isle of Man is faced with no option but to follow suit if the UK joins the euro.
Stephen Carse, the government’s economic advisor, as good as totally dismisses the possibility of the island linking to another currency in the event of the UK dropping the pound – a development which he believes is some way off.
He points out that such a move would make life difficult for the Island’s companies with UK and Irish parents.
It would not safeguard the Island’s sovereignty and there was always likely to be greater economic convergence between its economy and that of the UK – compared with say the United States or Switzerland. Mr Carse does not expect the UK to have a referendum this Parliament. He believes it is more likely that such a vote will take place during the middle of Labour’s next term in office, assuming it wins the general election.
Then the key question would be how closely aligned the UK’s economy was with the eurozone. Given the relative strength of the UK economy at present it would be difficult to sell the benefits of joining the single currency to the British people. However, he says it would be unwise to underestimate the sway of the UK government’s propaganda machine should a referendum be held.
Mr Carse believes that Chancellor Gordon Brown is not personally opposed to entry into the euro – his economic advisors, however, are, and the bank of England would be extremely loath to abdicate its power.
Mr Carse says there would be no point in having a referendum on the Island unless there was a real alternative to following the UK into the Euro.
He says a Manx government report drawn up when the UK first considered the possibility of joining the euro in the late nineties is still relevant. Looked at from the Isle of Man’s perspective the report concludes the following:
The microeconomic benefits – reducing risk and uncertainty
The scale of the microeconomic benefits to be had are likely to be only small when aggregated. The vast majority of Isle of Man trading companies, by number, if not size, are supplying the island’s domestic market only. To them the direct currency benefits are an irrelevance as they are for those who are dealing only with UK companies and individuals and with partners outside of the euro area.
‘It could be concluded then, that the total benefits from the removal of the currency risk that would arise from the adoption of the euro by the UK government are small, since the Island’s trade is overwhelmingly with the UK or beyond Europe.
‘With the former there is no direct currency risk anyway: with the latter [ignoring the potential …. Text missing
still remain. However, the economic risk of being outside the EMU area would still be a consideration.
The macroeconomic aspect – more stability, less national sovereignty
To the extent that the ECB operates a strict monetary policy and achieves financial and economic stability throughout Europe then clearly the IoM economy would benefit from the adoption of the euro.
IoM companies would also benefit from a greater tendency for companies in euro member states to avoid exchange risk and deal with each other and from the added attractiveness of the euro area to foreign investment.
The IoM has long been in monetary union with the UK and does not have an independent currency or the powers to effect interest rate and exchange rate changes. So there is nothing new here. However, the IoM and UK economies have closely synchronised business cycles and closely aligned general economic conditions.
Text missing…interest rates – ideological differences and errors of judgement aside – are appropriate to IoM circumstances. It could be doubted that an EMU-wide interest rate would be generally as suitable, at least in the short to medium term.
The elimination of exchange rate risk and interest rate variations between EMU countries will remove two significant obstacles to the cross-border movement of investment funds and business investments.
It can be expected therefore that decisions concerning where to invest and where to locate will focus even more on tax advantages. Should Britain enter EMU then the IoM could become more attractive to inward investment and the Island’s ability to maintain its low direct tax will be even more critical. Clearly, however, there is great potential here for conflict to arise in the future between EMU membership and, as seen in some European eyes, ‘harmful’ tax competition.
Should EMU not work to the advantage of the IoM, then under the terms of Protocol 3, the island could not become the recipient of any ‘compensatory’ EU funding.
The Key Points
This week the Chancellor Gordon Brown announces whether the UK has met the five economic tests which were laid down in 1997 for entry into the euro.
He is widely expected to say that the tests have not been satisfied. Commentators single out the first test, relating to convergence, as being particularly out of kilter.
Although in a number of crucial areas such as inflation, growth and interest rates the gap between the UK and the eurozone has narrowed since 1997, in other respects the differences remain significant. In particular, as HSBC’s Mark Berrisford-Smith notes, the pivotal role of the housing market in the UK economy implies that there are risks associated with adopting a one size fits all monetary policy.
The combination of high rates of owner-occupation, record levels of consumer debt, and the proportion of mortgage lending at variable rather than fixed rates implies that any change in interest rates is likely to have a greater effect on consumers in the UK than those in the eurozone.
As Mr Berrisford-Smith points out, the rate at which sterling could lock into the euro is a critical issue. Setting it too high or too low could cause lasting economic damage. ‘Which exchange rate?’ is, in effect, the sixth economic test.
Sterling’s recent fall against the euro has brought it to a more comfortable level for British exporters. But with the UK economy now heading for choppy waters and with the pound likely to experience further volatility, this would be an inopportune moment to give up exchange rate flexibility.
What our people say
Chris Gledhill, managing director of PDMS:
I believe the Manx Government should explore other options but going it alone would probably be unrealistic considering we do not have central bank facilities. From the UK’s perspective, I have moved from a pro-European presumption to being distinctly sceptical – not about the euro but about whether Britain should be in it. In terms of free trade within Europe the euro fits in very effectively. The problem is that separate issues are interwoven in the whole European debate; there is certainly a federalist agenda but there is also a trade agenda. Adoption of the euro by the Island would make very little difference to PDMS’s operations.
Nick Williamson, director of Deloitte & Touche:
Following the UK into the euro, if and when the euro is adopted by the UK, is the path of least resistance.
As our economy is more closely linked to the UK than any other country, it makes sense for us to follow, particularly in respect of interest rate alignment and avoiding currency exchange rate fluctuations. From a practical perspective we could piggyback on the UK’s changeover. Many of the finance houses, insurance companies and other substantial business organisations have parents in the UK and so it would be less problematic to change at the same time: i.e. adopt their timetable and process.
Jersey’s stance, however, is interesting and is worthy of consideration. Not joining the euro would be tantamount to abrogation of sovereignty and effectively a strike for independence.
Given that much of Euroland is buried in red tape and has become a very high-cost centre for business, there are attractions in not joining. Whether the Isle of Man has the courage and considers itself of sufficient maturity to step out of the coattails of the UK is a very big question but one that should be contemplated. Maybe there is merit in considering a formal pact with Jersey as the United UK Offshore Islands?
Mr Williamson says his views are not necessarily those of Deloitte & Touche.
Clive Parrish, HSBC area manager:
can only comment from a personal point of view. I would agree with the Isle of Man Government’s stance that if the UK goes in – and with Ireland already in – the Island would have little choice but to follow suit given the level of trade between the three jurisdictions.