Hamish McRae: It's not the economy, stupid

So the Treasury does not believe in its own economic tests for joining the euro and thinks the decision will be a political, not an economic one.

So the Treasury does not believe in its own economic tests for joining the euro and thinks the decision will be a political, not an economic one. Wait, wait, wait – that was certainly the story. But you don't want to believe everything you read in the papers, particularly on such a charged issue as the euro.

Back in November, Gus O'Donnell, the senior Treasury official in charge of making the assessment on whether Britain should adopt the euro, made a speech at an undergraduate recruitment seminar. In it, he apparently argued that economic issues were never clear-cut and cited the euro tests as an example, so the judgement would ultimately have to be political.

Phrased like that, his remarks would be pretty unremarkable. It is the proper, apolitical approach you would expect from an honourable civil servant. As for the cartoons he is said to have shown, representing the Chancellor and the Governor of the Bank of England in harmony over policy, in contrast to their counterparts in the eurozone, well, he was trying to show the Treasury was a fun place to work, wasn't he? But the value of the spat is that it will focus our attention on these tests. They are:

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

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

3. The effect on investment.

4. The impact on our financial services industry.

5. Is it good for employment?

Well, there is a problem here with all of them. Convergence? We don't want to converge down to the eurozone's growth rates. Flexibility to cope with what sort of change? Investment? What matters is the quality of investment, not the quantity, as Japan has discovered. Sure, the financial services industry matters but so do other industries. And as for employment, in the past couple of years there have been divergent trends within the eurozone. As the top left graph shows, France has been much better at creating jobs than Germany.

Intellectually, those five tests are mushy. Try this alternative set, noting that they all involve looking at what is actually happening in Europe, rather than what might theoretically happen here.

1. There should be some evidence in the eurozone of micro-economic advantages from the single currency – greater efficiency among companies from clarity of pricing, for example. So if the more competitive European companies start to do better in a couple of years – gaining market share, boosting profits and giving customers a better service – that would be a bull point for the euro. If not, why bother?

2. There should not be serious macro-economic disadvantages from some countries having the wrong interest rates. Since there has to be a common interest rate for a divergent region, there will always be places where rates are too high and places where they are too low. The common interest rate is now too high for Germany; for France it is about right; and for the Netherlands and Ireland it is too low. The European Central Bank is doing a better job than many believe in controlling inflation for the zone as a whole (top right graph) but individual countries are suffering.

So the test should be: does Germany manage to achieve decent growth over the next couple of years despite having the wrong interest rate, and do the Netherlands and Ireland escape high inflation?

3. Does a single currency make it easier to carry out much-needed changes to the eurozone's structural problems? Lots of things need to be done. In the next few years most eurozone countries need to sort out their public pension provisions; they also need labour market reforms to cut unemployment. These are tough: tough politically and tough economically. Having greater economic clarity across the region ought, in theory, to make the choices more explicit and the problems easier to solve. But we need to know whether this happens in practice.

4. Is there any evidence that the single currency will help narrow the gap between the economic performance of the US and the EU. True, you would expect the US to outperform in the long run because it has faster population and labour-force growth (bottom left graph). But as the recovery gathers pace you would expect the EU to do reasonably well, certainly better than it has in the past five years.

5. Do Europeans like the single currency? That may not sound like an economic test at all, but I don't mean "Do they say they like it when the pollsters ask them?". I mean "Do they spend it or do they save it?". If people feel comfortable with the change, their lives continue as usual. If they get frightened, they will cut their spending, even switch part of their savings into other currencies such as the dollar. If they spend it, policy makers can relax; if they hoard it and the eurozone growth falters, the policy makers should worry. Already we know the single currency has not protected the eurozone from the global recession (bottom right).

When the Treasury's five tests were drawn up, there was no practical experience of the euro. Now we are going to see for real whether it works for the people who have to use it. Gus O'Donnell is a sensible chap. He and his colleagues have to make the best fist they can of the tests, but there will have to be a large element of judgement. We voters have the luxury of being able to look at the eurozone's practical performance, rather than having to puzzle about something that may never happen. If the euro seems to be working well, we have to take it seriously. If, in a couple of years, the eurozone is in an economic mess and we are doing OK, we should thank our lucky stars to be out of it.