Stay out, miss out

Written by Chris Huhne MEP and published in the Financial Times on Wed 10th Apr 2002

Growing cross-border trade in mainland Europe shows the price of being outside the eurozone, believes Christopher Huhne

For some time, advocates of the euro have argued that separate currencies are an obstacle to trade. Opponents maintain that currency volatility does not deter commerce, as risks can be hedged. This crucial debate should now be settled. The trade figures for the eurozone show an impressive growth in cross-border commerce among the participants. Britain and the other "out" countries are not participating in this growth.

The creation of the euro has clearly removed a barrier to trade. The share of trade in national output is normally one of the most slow-moving economic series. But Germany's goods exports and imports with other European Union countries have risen from 27.2 per cent of gross domestic product in 1998 - the last year before the euro - to 32.2 per cent in 2001, according to Eurostat. The French share is up from 28 per cent to 32.2 per cent. Overall, the average rise in trade shares in the eurozone countries is 3.3 percentage points.

By contrast, the British trade share with the rest of the EU has fallen back from 23.4 per cent of GDP to 22 per cent. The average trade share of the three "out" countries is unchanged.

This trade creation within the eurozone should in itself spur growth. One rule of thumb is that there is a rise of one-third of 1 per cent in national income for every 1 percentage point rise in trade share. If so, German and French GDP is already some 1 per cent higher than it would otherwise have been - merely thanks to the single currency.

How far could this trend continue? Perhaps the most pertinent study was published by John Macallum in the American Economic Review in 1995. It took advantage of Canada being the only big industrial country to have internal trade figures to examine the trade between Canada's provinces compared with their trade with US states. It found that trade between Canadian provinces was 20 times as great as trade between a Canadian province and an equidistant US state.

Although the Canadians and the Americans mainly speak the same language, and have long enjoyed free trade and a mechanism for dealing with non-tariff barriers, something about the border is a real obstacle. There may be legal, cultural and taste differences. But the volatility of the Canada-US exchange rate is the only serious contender as an explanation of relatively low cross-border trade.

If cultural and linguistic differences were a crucial impediment to these trading relationships, Mr Macallum would have found that Quebec's trade patterns were different from those of the English-speaking Americas. But he found that they were consistently close to the national average for Canada as a whole. Language and culture mattered less than the US-Canada border.

Whatever the magnitude of the increase in trade due to the euro, there is one clear conclusion: there will be many more years of high trade growth before the eurozone reaches some new equilibrium in which all the opportunities of a world free from currency risk have been exhausted.

This change in trend is of great significance to Britain, as it demonstrates the mounting costs of staying out of the single currency. This trade within the eurozone is being accompanied by a substantial restructuring of businesses and their supply chains to take advantage of lower costs. Low profit-margin businesses were previously inhibited from trade either by the prospect of currency risk or by hedging costs that exceeded margins.

The mergers boom in western Europe was in part a response to the increased competition and opportunity within the eurozone. The total volume of European mergers over the past three years exceeded the combined total of the previous 10, and the annual volume in both 1999 and 2000 was more than six times the peak of the previous mergers boom. Yet British businesses cannot form part of currency risk-free chains as continental businesses can.

The competitive dangers for British businesses are clear. There is a consensus that the most significant postwar error of economic policy in Britain was the failure to participate in the common market in 1958. Much flowed from Britain's exclusion until 1973: the loss of trading opportunities as tariffs were abolished among the original six members, plus the putting in place of agricultural and fisheries policies inimical to British interests, but which ultimately had to be accepted as the price of membership.

The key lesson of these trade figures is that there is a real and growing cost to Britain's self-exclusion from the eurozone. We are repeating our error of the 1960s. Given that such increases in trade, output and welfare would dwarf potential short-term inconveniences flowing from a single interest rate - the so-called "one size fits all" issue - the government cannot afford to delay UK euro membership beyond this parliament.

The writer is economic spokesman for the European Liberal Democrat and Reformist group in the European parliament.