Scrapping the Pound

Wednesday, October 30, 2002
Illustration by Taylor Jones for the Hoover Digest.

Britain is beginning a national debate over abandoning its beloved currency, the pound sterling, in favor of the new euro that began circulating in 12 European countries in January. There is speculation that Britain will hold a national referendum on the issue sometime in 2003. Public opinion polls have long reported that a majority of the British electorate is against the euro. The two dominating figures of British politics, Prime Minister Tony Blair and Chancellor of the Exchequer Gordon Brown, are Europhiles who would like to find a way to adopt the euro for a variety of political and personal reasons. Yet they are even more interested in avoiding political damage. How they are dealing with the question of the pound versus the euro makes a fascinating story.

A Half-Century of Indecision

Whether Britain will adopt the euro is the latest issue in a decades-long succession of arguments in Britain about how it should relate to its continental neighbors and think of European economic and political union. Nearly 50 years ago Britain decided against joining the European Community—EC (now known as the European Union—EU). There was a strong feeling that Britain had for centuries benefited in its political and economic development because of its island isolation. Wars and political instability occurred across the “moat”—the English Channel. As a result, Britons long saw further engagement in Europe only as a liability.

By the 1960s, public opinion had shifted for the first time toward joining the EC because it seemed that membership might help the beleaguered British economy. However, French president Charles de Gaulle vetoed the application, remembering Britain’s earlier reluctance and fearing that British influence might challenge France’s position of leadership in the EC.

Only after de Gaulle left office in the early 1970s did his successor, Georges Pompidou, accept British membership. Britain’s first national referendum approved British membership by a two-to-one majority, certainly the historical high point in British public support for the EC. Over the past three decades the British have had to confront an EU that is remarkably more unified and committed to extending its economic cooperation into outright political and economic union.

The first time the British specifically approached the question of joining a common currency was in 1979. The Thatcher government decided to join the European Monetary System (EMS), which pegged each country’s currency within a 6 percent range of a European currency unit (ECU), essentially a noncirculated proxy currency made from a basket of other European currencies. Until 1990, Britain charted its own path with a fully convertible pound that, though outside the EMS, carefully followed monetary targets that shadowed the German deutschemark. Unfortunately for the Thatcher government, by late 1989 the pound was under a lot of pressure as inflation was increasing and economic growth stagnating. Finally, in 1990, Mrs. Thatcher allowed the pound to fully join the EMS in order to associate it with the anti-inflationary policies of the deutschemark.

This strategy worked poorly, and Mrs. Thatcher’s handpicked successor, John Major, suffered the political consequences as the contracting monetary policy drove unemployment to a politically unacceptable level—above 10 percent. In these difficult conditions, the Major government in September 1992 withdrew Britain from the Exchange Rate Mechanism (ERM), which was meant to keep European national currencies within a strict trading range, thus putting the pound outside the European orbit yet again.

Although Britain was outside the ERM, the Major government did accept further European integration in a number of ways. Importantly, Major committed Britain to the Maastricht Treaty, which created the European Union (from the European Community and Common Market) and pledged thereby to work toward further political and economic union. This included the creation of a European Central Bank and agreement to a common currency. It also included agreements supporting the development of common security and foreign policies. Thus, even while the pound remained firmly outside the ERM, the Major government had signed onto the framework that led directly to the current question about Britain adopting the euro (which 12 of the 15 EU members had adopted by 2002).

Labour’s Strategy

In June 1997—following 18 years of Conservative rule—the “New” Labour Party finally entered office in a landslide. The political cost of the Major government’s economic mismanagement, including withdrawal of the pound from the ERM, had been enormous.

Led by its dominating political leaders, Tony Blair and Gordon Brown, the Labour Party entered office committed to “putting Britain back at the heart of Europe.” Saying that the Conservative government had cut Britain out of important European decision making, Blair and Brown promised to reestablish British influence. Thus, one of New Labour’s first actions after taking office was to adopt the European Social Chapter of the EU, which the Conservatives had opted out of and branded as too costly for British businesses.

However, Brown also indicated that the government would proceed cautiously in deciding whether to adopt the euro, knowing this was a political hot potato. There were political gains for Labour if the issue could be handled successfully, but there were significant political perils if things went wrong.

The overhanging political problem is that the British public is not in favor of adopting the euro. For many, the pound is the essence of British sovereignty and democracy, whereas the euro represents something foreign—in the worst sense. Thus Brown and Blair decided that, in order to win adoption of the euro, they must plot a careful and long-term strategy that would be politically protective. Labour needed to frame the question so that the decision was transferred away from the political context in which it had previously been posed.

First, the euro issue had to be postponed until after Labour’s first term. In 1997 Labour was preoccupied with a domestic agenda it felt it needed to accomplish in order to set up the right conditions for reelection.

To allow Labour the domestic breathing time it needed and to begin building a public consensus in favor of the euro, Brown came up with five economic tests that would have to be met before the Cabinet would even consider the issue, confirming that adopting the new currency would be in Britain’s economic best interests. Further, ultimate approval would be in the hands of the British electorate in the form of a national referendum. (During the mid-1970s, Prime Minister Harold Wilson had solved a raging argument inside the Labour Party about whether Britain should be a member of the EC by holding a national referendum. A coalition of Labour, Conservatives, and Liberals worked beautifully to convince two-thirds of the voters to endorse membership. That referendum protected Wilson’s government from political liability by making it an all-party issue.) A quarter of a century later, Brown looked for a way to gain the same advantage on the issue of the euro.

In October 1997, just a few months after becoming chancellor of the exchequer, Brown officially presented his five tests to the House of Commons:

1. Can there be sustainable convergence between Britain and the economies of a single currency?

2. Is there sufficient flexibility to cope with economic change?

3. Is the effect on investment positive?

4. Is the impact on Britain’s financial services industry positive?

5. Is it good for employment?

Further, Brown announced that, as chancellor of the exchequer, he would manage the tests and the evaluations needed to properly assess them. Indeed, Brown and his Treasury Department alone would decide whether the tests had been met. This would ensure, he insisted, that a nonpolitical determination would be made regarding the euro, using technical and economically sound measurements. In the end, Brown insisted, it would be up to members of the electorate to decide whether they wished to adopt the euro in a national referendum.

Political pundits, leading economists, and leaders of the opposition Conservative Party ridiculed Brown’s approach. They objected that the five economic tests were an illusion designed to give Brown strong political control and that in reality they were highly subjective and difficult to measure. Brown was unmoved by all this criticism. Today, more than five years later, Brown’s strategy is still solidly in place.

Given the obvious advantages his strategy has yielded, it is hardly surprising that Brown holds onto this approach. For example, whereas Brown in effect kept the euro decision in the political deep freeze during Labour’s first term, the Conservative Party engaged in a destructive civil war between its (minority) pro-European and (majority) anti-European wings. This intraparty war proved quite helpful for Labour in winning its second term in a landslide June 2001 election and has since kept the Conservative opposition quite weak.

In addition, while fending off all attacks on his strategy, Brown has succeeded in actually legitimizing his approach for a broader audience, setting up potential political advantages for both him and Tony Blair as the issue of the euro moves to the forefront. For example, it is now broadly recognized that Brown is entitled to control the timetable and shape of the euro debate. In contrast to the usual course of long-running policy issues slipping from leadership’s control, Brown has actually strengthened his control over the debate with the passage of time.

In addition, by putting the final decision in the hands of the electorate, Brown is setting up an insulating device for the government. He can decide to go forward when the time seems right, but if public opinion in the end cannot be swayed, he and his Labour colleagues can greatly reduce their political exposure by insisting that “the people have spoken.”

The Personal Stakes

This good strategic situation may have importance for Brown’s and Blair’s political futures. In Brown’s case, he wants to be the next Labour Party leader and therefore Tony Blair’s successor as prime minister. He has been a very successful chancellor, but the euro poses a special challenge. He badly wants the issue to proceed well in order to enhance his leadership credentials. This will not be Brown’s first bid for leadership, but it is likely to be his last. When John Smith died suddenly in 1994, leaving a vacancy in the Labour Party leadership, Brown and Blair waged a bitter struggle to become party leader. When it was over, the two were rumored to have met in a London restaurant and agreed to a deal in which they would work together to get Labour into office—with Blair as prime minister—and then, perhaps after a couple of terms, Blair would do his best to hand off the leadership to Brown. Brown’s stewardship as chancellor is obviously critical in the assessment of his fitness to succeed Blair.

For Blair, the stakes are different. He apparently has his eyes on a different career goal: a personal leadership role in the EU. Political observers believe that Blair is eager that the euro be adopted as part of an effort to follow his time as prime minister with a move into an enhanced EU presidency. Obviously, Blair would not have much of a chance at European leadership if his country is still outside the euro.

 

Whatever the political calculations at work, the euro is the most important issue for this generation of Britons. Those outside Britain should carefully watch the debate unfold because it focuses attention on important questions for all democracies, where issues such as national identity, economic sovereignty, and self-determination are weighed and balanced against the movement toward increased integration and further globalization.