Why the ranters are right about EMU

When the politicians and the ordinary people disagree, trust the ordinary people.

And so it will be with the "Euro", the new European currency, the name of which was agreed last weekend. A grand battle is beginning in earnestbetween the common-sense instincts of ordinary people and the plans of Europe's most important politicians.

There is enormous momentum behind those plans, for the government machines of Germany and France (plus, of course, the European bureaucracy) support them. Even here in Britain, the most semi-detached of the large European Union nations, the leaderships of both our main parties do not dare to say publicly that Europe's plans are mad. And much of the British business Establishment not only supports a common currency, but would like Britain to join in the plan.

By contrast, opposition to monetary union is fragmented and relatively inarticulate. It exists, of course, as is evidenced by strings of opinion polls. But within the European establishment the pockets of opposition are either muzzled, or can be dismissed as representing sectional interests.

Thus, while the "pros" appear to be the measured and responsible insiders; the handful of politicians with access to the media who put the counter case - people such as John Redwood - too often come over either as extremist ranters, or nostalgics, or as driven more by personal ambition than rational analysis.

Because it is only rarely that the sensible case against monetary union is set out, there is a grave danger that ordinary people will allow themselves to be persuaded that the measured men are right and the ranters wrong.

In fact there is a powerful case to be made that a currency union is technically the incorrect form for the European economy, and an absolutely overwhelming case that it is unnecessary for Europe's economic prosperity.

The technical case has been made this week - ironically, a couple of days after the christening of the Euro - by the OECD, the economic "club" of the world's richest nations. Its latest Economic Outlook gives a cool assessment of the difficulties Europe faces. It starts, reasonably enough, by outlining the theoretical advantages of a common currency: removing the risk and costs of having exchange rate adjustments would make cross- border trade easier and allow companies to concentrate on spotting opportunities based on changes in demand, tastes, and so on.

This takes up 20 lines of text. There follow 140 lines on the problems. Some of these are transitional. But the OECD highlights a further set of problems that would occur once the common currency was in place. At the moment countries can adapt their monetary policies to local needs: they can meet recession by dropping short-term interest rates and if necessary allowing the currency to depreciate. With a common currency they would not be able to do this. Instead, they would have to adjust by cutting wages, or by encouraging workers to migrate to another part of the EU, or by having the more buoyant parts of Europe transfer funds (taxing the richer parts and subsidising the poorer ones).

The United States does make just such adjustments through migration and fiscal transfers, but within Europe migration is much more limited (and causes considerable tension), while the relatively tiny transfer of taxes by Brussels is politically very unpopular. Without those mechanisms there would have to be swings in money wages, "and there are limits," the OECD says, "to the speed with which nominal wages are likely to adjust."

You can see the point. If people can move around in search of jobs and if rich areas subsidise poor, then you can have a single currency and single monetary policy. If not, you can't. Provided the European economy operates as a single entity,responding in the same way to economic forces from around the world, then a common monetary policy will adapt to its needs. But if different parts of the European economy are affected in different ways, then monetary policy cannot cope. The key question is: to what extent does the European economy behave as a single entity?

Some parts do: Germany, the Netherlands and Austria are almost completely integrated economies. But the rest of the EU is not. For example, if world oil prices rise, the impact on the British balance of payments is positive, but on virtually the whole of the rest of the EU it is negative. If there is a boom in the world demand for machine tools, Germany benefits, but the impact elsewhere is muted.

There are also differences in financial structure between the various European economies, such as the size of the owner-occupied housing sector, the importance of short-term borrowings, the importance of stock-market finance. A single change in interest rates will produce different effects.

And look at the current economic cycle. The Anglo-Saxon economies - the US, UK, Canada and Australia - have all moved a clear 18 months ahead of continental Europe, where monetary policy was determined by the needs of German unification.

That particular experience is not going to occur again, but other shocks will. And once a common currency is established, breaking up is hard to do.

Besides, we don't need EMU. The presumption that the European economy ought to become more integrated is wrong. It is quite true that the great burst of prosperity in the last 30 years has been associated with each country specialising more and more. In every EU member the proportion of exports to GDP rose between 1960 and 1994.

But think what specialisation means. It means turning over more and more of the economy to imports, and relying increasingly on exports to pay for these. At some stage we are going to reach the point where there is not much to be gained by increasing trade between similar countries; wealth will be generated more by trade between dissimilar countries.

Europe may be reaching a point where it can no longer get richer by boosting its internal trade (particularly since, for demographic reasons alone, it will be a slow-growing region); instead, it can get richer principally by increasing its trade with the rapidly growing countries of East Asia and its own economic hinterland of Eastern Europe.

If that is where the EU's prosperity lies (and I believe it is) then a single currency is an irrelevance.

Besides, countries such as Hong Kong and Singapore, tiny by comparison to most EU nations, have managed to achieve European living standards without the need to be members of a large currency union, while two of the richest European nations, Norway and Switzerland, have decided to stay outside the EU altogether. Ireland, one non-core EU member that might opt to join EMU, chose to break its currency union with Britain in 1978, and subsequently (thanks in part to EU subsidies) has grown faster than the UK. Clearly prosperity can be achieved by small countries that run their own currencies.

If there are all these rational arguments against a currency union, why is the EU marching on towards one? It is a big question and deserves a big answer. I think it is one of those cases where rational individuals behave in a collectively stupid way. Heavens knows, there are plenty of examples in European history, the most extreme being the mixture of arrogance and madness that led to the First World War, and the weakness and vacillation that led to the Second. For supporters of monetary union, their dream is almost a compensation for these past failures, an atonement: if we do not move forward we will slide back.

Not true. We can reach a plateau: a level of cultural and economic unity that recognises diversity and respects it. If, on the other hand, politics pushes beyond economic reality, it does risk disaster. The UK will probably be saved by its opt-outs, but my fear is that France and Germany will indeed achieve a currency union in the first decade of the next century. If they do, it will will break up acrimoniously in the second and will come to be judged as a grand historical error. We will wonder how sensible people came to be so stupid.