Euro-zone Economy

– in the House of Lords at 1:39 pm on 12 October 2006.

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Photo of Lord Dykes Lord Dykes Spokesperson in the Lords (Europe), Foreign & Commonwealth Affairs 1:39, 12 October 2006

rose to ask Her Majesty's Government what assessment they have made of current developments in the euro-zone economy.

My Lords, there has not been a major debate on the euro as a subject for some time in this House, probably for over a year, so I welcome this chance to ask the Government to respond on some of the salient issues in this won't-go-away debate. I am grateful to the Minister for giving his time and coming to the House today to respond.

It also noteworthy that there are very few European matters on our radar screens anyway—partly, no doubt, because of the French and Dutch referendums on the draft constitutional treaty. I presume that gradually there will be a revival of issues next year with the period of reflection and as the EP elections approach in 2009. But for many of us, and indeed for the country, how frustrating it has been that the Prime Minister's reckless energies have gone into the disastrous adventure in Iraq, and now the disturbing and unplanned second phase of the war in Afghanistan. How depressing that a Chancellor of the Exchequer has rather narrow-mindedly totally discouraged any discussion of the euro as an asset for Britain. We need to seize these moments and press some important questions. After all, the famous five conditions, coupled later with the addition of the exchange rate, remain "back of the envelope" opportunism except as generalised objectives. Mr Blair went back on his solemn commitment to have a campaign on the euro and a referendum. He unwisely chose subservience to perhaps the most disappointing president in recent American history rather than a central role in the courageous creation of monetary union in Europe.

Incidentally, as the German and other leading economies are now recovering from sluggish growth rates, the British press are not crowing so loudly about the Anglo-American economic model being the only success in town. How right they are now becoming. Without a shadow of doubt, European monetary union, a momentous step of staggering bravery by the countries that launched it in 1999, has been a very great benefit to the euro-zone members, large and small. The UK Government sadly did not have the necessary courage to join in. The British Treasury, as we now know, was fearful that the British economy could not cope, even if we were able to devalue, perhaps modestly, before any entry. The German currency discipline model, as originally constructed, was introduced for the 12 member states and, even in these early stages, we can see the internal and external advantages emerging.

Germany was the only country giving up a highly successful strong currency. What has happened there since is vital because many Germans are understandably very nostalgic about the great deutschmark. The internal growth rate there is now accelerating, although most growth still goes virtuously into staggeringly successful high-tech exports on a very large scale. In contrast, we, unfortunately, have a very large trade deficit; they have a mighty surplus. Germany has managed a high level of public sector investment spending over a lengthy time span. Its infrastructure does not creak and groan precariously, as the England fans noticed in large numbers in the summer. Even modest Belgium, with an economy about 12 per cent of the size of Germany's, is doing well in EMU, as its central bank governor, Guy Quaden, asserted in June, referring to the marked rise in the country's business confidence indicators—a reflection of its close trade links with other euro-zone countries.

I am sure that if more and more members of the public here—individuals and families as well as some company directors and finance directors—calculate exactly how expensive it is for us to pay both much higher interest charges and outrageously excessive aggregate charges on bank and credit cards and bank account transactions between us and the euro-zone, resentment will build up against this myopic Government. We should think again about the main advantages of a strong, integrated currency representing a high-output single market. Not only are import prices kept lower, which helps domestic prices to remain low, but rates of interest remain very low, acquisitions overseas are facilitated, international confidence in the currency grows and internal transactions aid greater cohesiveness of the marketplace.

The euro is becoming one of the most successful world marketplace currencies without, like sterling, having to be propped up by artificially high interest rates to attract bond buyers for the Government. It is backed by an internal trading area of high exports and strong surpluses. If you take the seven or eight key criterion comparators that the experts take, the dollar and the euro are now roughly in pole position. In Austria, for instance, the effects on interest rates of joining on 1 January 1999 were striking. Nominal rates on the 10-year benchmark bond fell from 6 per cent-plus to 4.75 per cent. The level of real interest rates fell even more, from 4.8 per cent to around 3 per cent. This trend was seen in the whole euro area. Your Lordships will recall the hysteria in the Sun and other newspapers in Britain that Ireland could not possibly cope with the euro because of property inflation. What happened? The average Irish central inflation figure remained lowish but the greater Dublin property rate of inflation and the Cork property rate of inflation remained higher than this figure. So what?

Of course, in Austria the schilling's setting in the high and strong currency syndrome simply carried on into the euro system, as was the case in Germany. This was easier for the strong currency countries than the transition for weak currency entrants. France is a halfway house example but on the plus side because its political leaders, with the exception of the communists and the National Front, have had the courage to sell the franc fort policy for many years prior to 1999 and 2002. So France is a very good example. The best example of a large country coming from a weak currency, like Britain's, to a strong currency success is Italy. It is a spectacular example of a weak currency being succeeded by a hard euro.

In January 2004, the respected former central bank governor and then president of the republic, Carlo Ciampi, said that,

"the euro is essential for economic growth".

A month later in India he asserted that Italy had changed its old bad habits and could now use the euro as a source of strength. Just like the UK, Italy's Ministers would regularly devalue the lira post-war to get out of a crisis and boost exports. But the entrepreneurs always told them that the advantage was temporary and shortlived. I recall that the debauchment of the pound and the lira against the deutschmark over those years was fairly similar.

The scare recently in the Italian press that price rises had been very sharp because of euro entry turned out to be wholly mistaken. The excess measurement covered only so-called boulevard prices—cafes, restaurants and fripperies. The average price rise in Italy remained modest. You will notice that if you read the research of Del Giovane and Sabbatini in the Bank of Italy economic research department report of May 2005. Then we had the hilarious suggestion from one eccentric Forza Italia Minister that they should go back to the lira after all. However, his colleague, Signor Siniscalco, the Finance Minister, said that that would add some €80 billion to the administration's debt interest costs. Not surprisingly, the idea died away. Everywhere one assesses the euro effect, the conclusions appear to be judged as highly positive for the countries involved. Coming back to Ireland, the country has experienced very strong growth since 2002, with 2007 forecasts of 5 per cent-plus for GNP and GDP. It was described last year by the Governor of the Central Bank, Jean-Claude Trichet, as a "magnificent performer" in making the case for structural modernisation in the euro-zone economies.

The Paribas bank concluded in an in-depth study in March 2005 that the,

"huge turbulences caused by the 9-11 terror attacks, the financial and accounting scandals in recent years [not only in the United States] deflation jitters [here, there and everywhere] oil supply and price shocks" and other negative factors had all helped the euro gain its position as an anchor reference point and a magnet of stability, helping the Union to escape the kinds of disasters such as Black Wednesday in the UK in 1992, and the crisis of leading EU currencies a year later, which was, incidentally, dealt with much more skilfully than by the Treasury and Bank of England's clumsiness. Paribas also noted wryly that the euro's weak post-launch start and its subsequent strong recovery in world money markets after 2003 were both criticised by the press here in exactly the same terms. The euro was being attacked not because it was weak or strong but because it was European and therefore wicked. Even the Independent—although I believe that this occurred only once—had a ridiculous article saying that the euro could not survive. However, as the Spanish central bank representative on the ECB board said in Malaysia in July last year,

"not only is the euro an (internal) currency, its international status is gradually increasing. (It) already plays an important role in world bond and forex markets, and for settlement and invoicing, and as an anchor".

Indeed, as Pascal Blanqué from Crédit Agricole stated,

"the euro's launch has changed the world financial landscape by creating the new duopoly of the dollar and euro. The latter is more and more considered as the alternative to the US dollar".

Repeated studies have proved, as we know, that the euro has not caused sharp price hikes, quite the contrary, except in some property price eruptions in Ireland and Spain, for example. John Monks has repeatedly reminded us of the success of the euro in counteracting the adverse growth in household debt—as would have occurred in Britain, had Britain been a member—and of how Spain has done so well in resisting the excessive debt that we have experienced in this country.

There are other myths, as was shown in Charles Wyplosz's excellent research in the compendium study on the consequences of saying no to the euro. I wish that I had time to go into them. Speaking in Mannheim before the summer holidays, Dr Axel Weber, president of the Bundesbank, dismissed hostility to the euro anywhere as absurd, described it as a monumental success and rejected as foolish the notion that rejection of the constitutional treaty in two countries was going to affect the euro, which is a truly bizarre idea. I await with interest and impatience the Minister's response to those points.

Photo of Lord Harrison Lord Harrison Labour 1:50, 12 October 2006

My Lords, I very much welcome the debate introduced by the noble Lord, Lord Dykes, and I thank him for that. I also thank him for the 50 Moldovan lei that he leant me last week to buy a drink on a parliamentary visit to Moldova. Unfortunately, I did not have any euros with me so I had to borrow some from him, but I will repay that debt with five euros after the debate.

It is a timely debate. The euro-zone is prospering, and I note with interest that the recent oil price hike did not disrupt the euro, as has often been predicted by those who are opposed to it. I am not ecstatic about it now, as I was not despondent when the growth rate was flat, because the essential point of the euro is to service the single market. Prosperity comes from other reforms; labour market reforms, financial and product market reforms and of course the completion of the single market. On that point, the easy way to present the single currency to the British people is to remind them that the four countries making up the United Kingdom already operate as a single currency. Mind you, two countries of our Union are not able to use their notes here in England; but never mind.

Everyone agrees with a single currency operating a single market; the question is which one. The euro has been an outstanding success in its creation, its launch and the progress despite the gainsayers such as the former Prime Minister John Major, who likened those who advocated the euro to those dancing a rain dance in terms of the hope they had of success. Recently in the Daily Telegraph Ambrose Evans-Pritchard said gaily:

"The disintegration of the euro may well be drawing nearer".

The fact is that it is secure and it will be secure for the future.

Nevertheless, there are issues about the future and the governance of the euro which need to draw our attention. I very much support Trichet as the ECB governor, and he must be supported in defending the independence of the ECB as opposed to some political moves by Juncker and others to interfere with that independence. Nevertheless, Monsieur Trichet should be reminded—as his predecessor Duisenberg possibly was not—that part of the statute of the euro was that once price inflation had been conquered and sustained there was the ability to do something about the exchange rate to stimulate job creation.

I possibly share the concern of others that the Commission used unaccountable inflexibility recently to bar Lithuania, which in every other respect has fulfilled the criteria to join, simply on the count that the inflation rate was 0.07 per cent above the requirement. Britain is outside the euro, but potential problems are being veiled by the outstanding success of Gordon Brown at the Treasury. Nevertheless, there are causes for concern. Take the yo-yoing pound against the dollar; $1.40 some months ago and now $1.85, but it could well be on the climb to $2 to the pound. That may be very good for British tourists going to New York to do their Christmas shopping, but it is not healthy for British manufacturing; neither the rate nor the uncertainty that is introduced by not being part and parcel of a bigger single currency area such as the euro. The pound sterling now lies uncomfortably on the fault line of the moving tectonic plates of the dollar and the euro. To avoid earthquakes and floods in the future, we need to be inside the euro. Gordon Brown's success means that currently the euro is off the political agenda, which I regret. I am worried about this phoney war, and I am worried that all is too quiet on the western front for Britain bordering the euro-zone.

I conclude with a series of questions for my noble friend. First, we are not inside the euro-zone, but we have to adhere to the broad economic guidelines. Will my noble friend report how successfully we are doing that, and perhaps incorporate an update of the situation with respect to our budget and debt criteria? Secondly, when will the next assessment be made by the Treasury of the five economic tests? Has the Treasury undertaken any kind of assessment of the cost of the United Kingdom remaining outside the euro? That work should be done profitably. Has there been an update of the 2003 national changeover plan? When you think of the changes that have happened in the way that the euro has established itself, it surely must be the case that there will have been changes to be reflected in that changeover plan that take account of what has happened in the interim.

I shall consider some other sectors. What about local authorities, for instance? I understand that on 21 September there was meant to be a meeting of the people who are managing the preparation plan and local authorities. Did that meeting take place? What was the result? I would be interested to know what was discussed. They will play a crucial role if the euro comes into play here in the United Kingdom. Why is there no separate budget for the Euro Preparation Unit under the Treasury budget as a whole? Is it not important? Why have its personnel been cut year on year from 17 full time equivalents in 2002, whittled down to nine? I regard that as unfortunate.

Have the 18 EMU studies been updated, developed and expanded? Why are there no analyses of certain sectoral areas? For instance, I have in mind the small business sector. Have we considered its worries and concerns, or those of the tourism industry? I do not just mean by that preparation for joining the euro. What has been the good or bad effect of staying outside the euro-zone? Apropos of that last question, does my noble friend agree that Britain's banks are failing British business with the lack of a competitive euro banking service? That is alluded to in the euro preparation Managed Transition Plan under information on existing retail banking services.

I conclude with one example of where one business, namely Cash Bases Group Ltd, of Newhaven in East Sussex, employing some 230 people, is successfully negotiating being outside the euro. It seems to me from what it reports that it has difficulties to overcome, which would not be the case of a business in the euro-zone. I quote:

"With our capability to price and invoice in euro now well established, we are using our considerable euro income stream to buy raw materials in France. This matching operation between sales and purchases allows us to 'hedge' the exchange differentials".

Good luck to it if it is able to do that; not everyone is able to do that. Here is an advantage:

"We have also used the euro to service the mortgage on part of our company's base here in Sussex and we plan to take out further loans in the currency. This move is to take advantage of currently lower mortgage rates in euro compared with those quoted in sterling".

It is my strong desire that the Government conduct a campaign to explain the advantages of being in the euro. It is good that British business is accommodating itself, but nevertheless it faces problems that incapacitate it in driving itself forward within the single market.

The time is coming soon that when Europe as well as America sneeze, Britain catches a cold.

Photo of Lord Newby Lord Newby Spokesperson in the Lords, Treasury 2:00, 12 October 2006

My Lords, I congratulate the noble Lord, Lord Dykes, on initiating this debate. Not surprisingly, I absolutely share his general thesis that Britain would be better off within the euro-zone. However, I fear, looking at recent international events, raising that question is a bit like asking, "Should Beckham play for the England football team?". It is clear that as long as we have the current manager, he won't be. Equally, as long as we have the current Chancellor, who is a possible Prime Minister, the chances of Britain joining the euro-zone are almost as negligible.

The noble Lord, Lord Harrison, reminded us of the golden age in euro preparations, when a whole raft of committees were examining them. Euro preparation plans were produced every few months and there was a sense of real momentum. I feel sorry for those few remaining souls whose job is to work on euro preparation, because one wonders whether, when they go to bed or go home at the end of the week, they feel they have achieved something and are part of a great, positive enterprise.

The debate is not going to go away and, when it is revisited from time to time, our starting point will be whether the euro-zone has been a success in its own terms and whether the economies within the zone have done well out of it. There are a number of signal successes. The euro-zone has achieved one of its central purposes of maintaining inflation at a low and apparently sustainable level. The growth and stability pact that underpins the euro-zone, despite various vicissitudes, has undoubtedly helped to rein in what would otherwise have been unsustainable levels of public expenditure among a number of euro-zone members. As a result, that has avoided the kind of boom and bust in public expenditure with which we have associated some of those economies—and which may become a feature of our own economy.

Figures produced at the end of last month have even led to the suggestion that the euro-zone now enjoys a Goldilocks recovery—neither too hot nor too cold. Inflation across the zone in September was 1.8 per cent; growth in the second quarter exceeded that of the US and it looks as though that figure will be some 2.5 per cent over the whole year. A recent Eurostat survey showed that economic sentiment among businesses and consumers across the euro-zone was at its highest level for five years.

These figures are underpinned by productivity improvements in the first half of the year—up by 2 per cent, compared with an average rise of less than 1 per cent over the past five years. Since the euro-zone was created in 1999, some 7 million new jobs have been created and the employment rate across the zone as a whole has risen from 63 to 66 per cent. Looking at some of the countries within the euro-zone, rather than the aggregate of the whole zone, there have been some remarkable improvements.

Germany has been extremely interesting, because it has adjusted to euro-zone membership by having very low real-wage growth over the past six years, directly as a result of recognising that the country would be locked into a stable currency with its principal trading partners in Europe. That has produced a discipline that has enabled negotiators to rein in real wage increases. In turn, that has helped fuel a big rise in German trade and current account surpluses. Perhaps partly because of that long period of low real-wage growth, it is not surprising that confidence in the German economy was at a 15-year high when it was last measured.

In France, the picture has been more mixed. However, in June, unemployment was at its lowest level for four years and the stability and constraints that the euro-zone has provided have helped to turn the economy around. Of course, given that the euro-zone is a multifarious area, some successes are distinctive to the countries that have been able to achieve them.

The Greek Government recently announced a 25 per cent upward revision in GDP, because Greek statisticians realised that they has failed to take account of some fast-growing areas of the service sector, of which money laundering and prostitution were singled out in the popular press. One wonders what research was undertaken by the Greek statisticians that enables them now to measure those sectors of the economy with greater precision. One can only be grateful and pleased for Greece that its new-found wealth, albeit from surprising sources, means that it can bring its budget deficit below the 3 per cent GDP ceiling, as required by the growth and stability pact.

Given that we are discussing the economy and Europe, it would be mistaken to take the view that everything has been plain sailing and will necessarily continue to be so. I strongly agree on a political level with the support given by the noble Lord, Lord Harrison, to Monsieur Trichet for the independence of euro-zone institutions, so that there is no political interference to underpin the reasons for the key success of those institutions—keeping their eyes focused on a clear, non-political target; namely, the inflation rate. I remember that Monsieur Trichet made a speech here in London before the euro-zone was established about how he was a firm supporter of it, even though he was governor of the Banque de France, because it would impose discipline on the French economy and help reform—which it has.

That is the down side of the current situation, a general sense that reform has not gone far enough, whether in relation to taxes on business, labour costs as a result of social payments, or generally inflexible labour markets. There is an argument, with which I am not sure I wholly agree, that the euro-zone has created a false sense of security for its members in that they believe that, because they have the security blanket of the euro-zone, perhaps they do not need to reform as much as they might in those areas. However, failure to do so only slows down growth.

But even taking into account those issues—and we see how reform is undertaken in a number of countries and remember how difficult it was to reform many of our own labour practices and the great rows that took place, particularly in the 1980s, over reforms that we now extol internationally—reform is taking place and pressure to reform is continuing. In the member states which have newly joined Europe and are struggling to reach a position whereby they can join the euro-zone—Hungary or Poland, for example—for different reasons there is a consensus that euro-zone membership would improve the management of their macro economies making it less likely that high, ongoing budget deficits are maintained and making those countries less vulnerable to international economic shocks.

As for the argument that the euro-zone might unravel because Italy, in particular, has difficulties from time to time, first, that is highly unlikely; and, secondly, does anyone really believe that the long-term interests of the Italian economy would be served by being outside the euro-zone? I think not.

In the UK, there are strong economic arguments in favour of being a member of the euro-zone, including that mentioned by the noble Lord, Lord Harrison, regarding the dollar. The key argument, which we should have been and, it is hoped, will be honest enough to address, is a political one about whether Britain wishes to be at the heart of Europe and whether it wishes to play a full part in moving forward the European economic reform agenda as a whole. So long as we are outside the euro-zone, we are simply not sitting in the meetings which would enable those reforms to take place. There is undoubtedly a big economic cost in not being in the euro but, in my view, there is an even bigger political cost.

Photo of Baroness Noakes Baroness Noakes Shadow Minister, Treasury, Shadow Minister, Work & Pensions 2:10, 12 October 2006

My Lords, the enthusiasm of the noble Lord, Lord Dykes, for the European project is well known in your Lordships' House and he has not disappointed us this afternoon. It will not surprise him that I find it difficult to agree with anything that he said, and in that I feel somewhat alone among those who have chosen to speak in this debate.

The noble Lord's Question refers to the euro-zone economy, but of course there is no such thing. Adding together the economies of the 12 countries that have committed themselves to economic and monetary union does not make them one economy. It is just possible that if the 12 countries had exhibited genuine and sustainable economic convergence prior to the creation of economic and monetary union, we could now be looking at something that resembled a single euro-zone economy. But the truth was that the politics of the euro were stronger than the economic facts, and so various wheezes and fibs allowed economic and monetary union to proceed on the basis of economies that were, in fact, very dissimilar.

We have seen the truth of divergence in the different economic performances post-economic and monetary union, with Ireland at one end of the growth scale and Germany at the other. That has been the case not just in terms of growth; it will also be found in workforce statistics and in income per person.

The truth is that there is not one euro-zone but 12 economies moving in different ways. That is not just a comment on the smaller countries within the euro-zone; it is true of the core countries of France and Germany. For example, in the past few years, one has done startlingly well at increasing its exports in goods and the other has fallen back. One has a growing trade surplus and the other a growing trade deficit. That helps to explain why Germany has recently turned its economic performance around more than France.

This divergent performance throughout the euro-zone has, in turn, illustrated the fallacy of a one-size-fits-all instrument of economic policy—namely, the single interest rate tuned to a euro-zone-wide measure of inflation. That interest rate policy has, until recently, held rates at levels designed to suit the sluggish German economy. But of course the real impact has been an inflationary boom in other economies, such as those of Ireland and Spain, on the back of negative real interest rates. The overall statistics for the euro-zone never tell the truth for any individual country within it.

For several years, euro-zone growth has lagged behind that of the UK, the US and practically anywhere else you care to mention. There has been some good news on euro-zone economic performance this year, largely on the back of an apparent recovery in Germany. But a number of factors—for example, the World Cup effect and the imminent changes in VAT in Germany—have flattered those statistics in Germany. Yesterday, we had the news that business confidence in Germany had slumped dramatically. The noble Lord, Lord Newby, said that it was at a 15-year high, but I suspect that he did not read yesterday's news, which showed that it was again in serious decline. Indeed, yesterday's view from the European Commission was of lower, perhaps even zero, growth in the first quarter of next year. That rings true. A potential world economic slowdown on the back of high oil prices and a slowing US housing market, as the IMF has warned, will not bypass the euro-zone.

The relative lack of success of the euro-zone is not a Eurosceptic narrative. No less than the Conseil d'Analyse Economique, firmly rooted in the French Government, concluded in a recent report:

"Economic integration has stagnated and no longer promotes growth. The Euro's creation has not produced the knock on benefits expected. The Eurozone area's macroeconomic framework has become obsolete".

The only thing that is extraordinary about that quotation is that it is predicated on a belief that economic integration has, at some stage, in some way promoted economic growth, and I do not believe that there is a jot of evidence to support that proposition. The extraordinary thing about the report overall is that the solution to this failure is more economic integration, but of course there never has been any accounting for the French.

The plain facts remain that some of the euro-zone economies have avoided deep and meaningful reform, especially in their labour markets. We have to single out Germany, France and Italy as the principal culprits. French labour laws are Byzantine by any standards and they probably vie with Germany in their cost. The World Bank, for example, has estimated that in Germany it costs an average of 67 weeks' pay to get rid of each worker. That does not promote flexibility in the economy.

Once upon a time, the failure of the single currency and the consequent implosion of the euro-zone was the prediction of only some Eurosceptics. For those, it was just one more reason why the UK should keep well clear of economic and monetary union. If the euro-zone fails to hold together, that will be messy and costly, not just for the countries concerned but also for countries that have significant trade balances with the euro-zone. That, of course, includes the UK, although we are not, by some margin, the country most affected. That is why the failure of economic and monetary union was not something that any UK citizen, Eurosceptic or not, could rejoice in predicting.

But those Eurosceptics have recently been joined by the distinctly pro-euro think tank, the Centre for European Reform. This think tank has concluded that the single currency now risks becoming a,

"source of economic dislocation and political division".

Italy may well be the closest to the edge in triggering a crisis but it is not alone, with Portugal, Greece and Spain joining it in the possible departure lounge.

I have a number of questions that I hope the Minister will deal with when he responds. First, does he agree that the countries within the euro-zone have not, overall, prospered from their membership? Economic performance within the euro-zone has been disappointing, with the one-size-fits-all policies harming rather than helping those economies. Secondly, and following on from that, does the Minister agree that the Chancellor's determination to keep the UK out of economic and monetary union has been a wise and sensible stance from the perspective of the UK economy?

Thirdly, and more importantly, will the Minister update the House on the Chancellor's current thinking on the UK and economic and monetary union? The likely move of the Chancellor to No. 10 at some stage when the Prime Minister finds it convenient makes this especially important. The Chancellor has strong Eurosceptic credentials and many of us hope that, if he is allowed to move to No. 10, he will take those credentials with him.

Fourthly, will the Minister remind the House when the next assessment of UK membership will be made and will he outline the terms of that assessment? The noble Lord, Lord Harrison, also asked that question. The timing of that assessment against the background of the Labour Party's succession struggles makes this an important issue. The way in which the assessment is carried out is also important. The right result was achieved last time but I am sure that I am not alone in thinking that an assessment carried out behind the closed doors of the Treasury is not a transparent and respectable way to conduct major government business. Will the assessment next time be a more open process?

Lastly, and even more importantly, will the Minister confirm that there will be no question of the UK joining the euro without a referendum, with the UK approving that move? Economic and monetary union has not been a success for the economies that are locked into it. Serious cracks are now appearing and, while we may well struggle on without an implosion, it is not a system that a successful economy, which I believe our economy broadly is, should want to join. I hope that the Minister will confirm that the Government continue to believe that the British people will be the best judge of that if the question ever arises again in earnest.

Photo of Lord McKenzie of Luton Lord McKenzie of Luton Government Whip, Government Whip 2:20, 12 October 2006

My Lords, this has been an interesting and useful debate, and I thank the noble Lord, Lord Dykes, for initiating it, and all noble Lords who have spoken this afternoon. There has been a spread of views—not an identity of view—on this issue, which is not surprising.

At the heart of our debate must be the assessment that despite Europe's and the euro area's current cyclical recovery, structural problems persist. Europe's low growth in the past five years—2001-2005—coupled with a persistent lack of resilience highlight continuing structural policy weaknesses. To be fair, that is a different picture from that painted by the noble Lords, Lord Dykes and Lord Newby, and, to a certain extent, my noble friend Lord Harrison. If anything, the current recovery must be seen as a rare window of opportunity for Europe and the euro-zone to exploit the upswing and commit to making Europe a dynamic and knowledge-based economy capable of sustainable economic growth and creating employment.

The right policy response—to which several noble Lords referred—is therefore the continued pursuit of structural reform to raise labour participation, boost productivity and increase flexibility in labour, product and capital markets. Economic and monetary union puts a premium on structural economic flexibility, as to be successful in monetary union countries need additional flexibility to adjust to change and to unexpected economic events.

Alongside EMU, the challenges of globalisation and demographic change place additional emphasis on the importance of rising to the reform challenge. We are part of a rapidly changing global economy that brings significant economic challenges in terms of a changing balance of economic activity, increasing global integration and intensifying global competition. Declining birth rates and rising life expectancies are interacting to produce a dramatic change in the size and age structure of Europe's population. If unaddressed this will markedly increase the dependency ratio in countries, with serious negative implications for trend growth and pronounced increases in public spending. To address this challenge Europe needs to review its pension, long-term care and health systems and aim to raise labour utilisation underpinned by an adequate and transparent macro-economic framework as well as sound public finances.

To improve its economic performance relative to the US and consistently match the recent growth rates of other successful developed economies, Europe must take urgent action to promote employment and boost productivity. The Lisbon programme of economic reform has recently been refocused by EU leaders on promoting growth and employment. They are the areas in which Europe most needs to succeed in order to compete in a global economy that puts a premium on skills, innovation and flexibility.

With regard to Europe's current economic performance, which was the subject of a number of contributions, although it is currently undergoing a cyclical recovery and the majority of member states are performing relatively well, with strong out-turns, particularly in the first half of this year, Europe still needs to make up much ground in comparison with key developed economies, while unemployment remains relatively high and persistent. As the noble Baroness said, we cannot look at this in total; we have to unpick and see what is happening in individual countries.

The current recovery is still not sustainably entrenched, with greater uncertainty beyond 2006, while the recent economic stagnation highlights remaining structural problems. On the issue of growth, since 1996 annual average growth in GDP in the euro area has averaged about 1.2 per cent less than in the US. Indeed, in 2005, real GDP growth in the euro area was less than half that in the US.

Stronger growth in non-euro area countries, such as Sweden, the UK and also the new member states, boosted growth for the EU25 as a whole to about 1.75 per cent in 2005, compared to 3.25 per cent in the US. Europe's growth rate still lags behind those of its main competitors. As a result, the gap in living standards between the US and the EU15 has widened back above 30 per cent.

Analysis suggests that Europe's labour market performance explains about two-thirds of Europe's gap in living standards with the US; the remaining third can be attributed to Europe's lower productivity levels. Despite recent efforts to boost employment and marked success in some member states, particularly in raising female employment, inactivity rates remain high, with more than 90 million inactive people of working age across the EU25.

The employment rate of older workers remains especially low and well below that of major competitors like the USA and Japan. Moreover, at around 8 per cent, Europe's unemployment rate is considerably higher than that in the US and Japan—and the UK—leaving 17.5 million people unemployed.

Raising productivity levels will also be crucial for Europe to improve its long-term economic performance and living standards. The euro-zone underperforms against the US in terms of both output per hour and output per worker, and the gap has been widening since the mid-1990s, reversing the trend of catch-up with US productivity levels during the three decades following the war.

Recent analysis suggests that the underlying causes are largely structural, reflecting in particular a failure to boost services productivity. The relatively small size of the EU's "knowledge services" and ICT-producing as well as high-productivity ICT-using manufacturing sectors particularly present challenges. This points to a clear need for further action to promote the key drivers of productivity, increasing product market competition, enhancing the EU's frameworks for innovation and enterprise, and upgrading the skills of both existing workers and new entrants to the labour market so that they can exploit the opportunities of new technology.

The advent of EMU is itself a driver for pursuing structural reform and enhancing economic flexibility, especially in the euro area. To be successful in monetary union, countries need even more flexibility to adjust to change and to unexpected economic events once the ability of countries to vary their interest rates and exchange rates has gone and the euro and the single European interest rate are in place. EMU membership therefore puts an additional premium on ongoing reform of EU labour, product and capital markets.

In this context, the Government continue to argue that employability, flexibility and stronger competition policies must be a top priority, so that EMU can be a sustained success. Enhancing the flexibility and dynamism of the European economy and building on the achievements to date are important if the full benefits of EMU are to be realised. This is particularly important as EMU expands to take in the new members that joined the EU in 2004.

Several questions were posed and I shall try to deal with them all. Perhaps I may start by reaffirming the Government's policy. The Government's policy on membership of the single currency is unchanged. It remains as set out in the Chancellor's Statement in the House of Commons in October 1997, and again in the Chancellor's Statement on the five tests assessment in June 2003. The Chancellor announced in Budget 2006 that the Government do not propose a euro assessment to be initiated at the time of this Budget and the Treasury will again review the situation at Budget time next year, as required by the Chancellor's 2003 Statement.

In principle, we are in favour of UK membership of EMU, but in practice the economic conditions must be right. A decision on the membership of the single currency will be based on whether it is in the national interest to join and whether the case is clear and unambiguous. Overall, the Treasury assessment is that since 1997 the UK has made real progress towards meeting the five-year economic test, but on balance until the potential benefits of increased investment and trade, a boost to financial services, growth and jobs are clear, which addresses the point made by my noble friend Lord Harrison, we cannot at this point conclude that there is sustainable and durable convergence, or sufficient flexibility to cope with any potential difficulties within the euro area. Despite the risks and costs, which clearly exist, of delaying the benefits of joining, a clear and unambiguous case for UK membership of EMU has not yet been made and a decision to join now would not be in the national economic interest.

My noble friend Lord Harrison asked about the EPU. It maintains a network of experts with stakeholders as part of the regular programme of activities on EU preparations. The meeting with local authorities took place on 21 September and discussed European preparation issues of relevance to local authorities. There was a question about the separate budget for the Euro Preparations Unit. The costs of the euro preparations in the Treasury are met from within Treasury department expenditure limits.

An update on the national changeover plan was asked for. The third outlying national changeover plan was published in June 2003 and sets out the possible timetable for changeover, its management and the impact on consumers, business, financial services, and the voluntary and public sectors. Since then, the EPU has worked with stakeholders from across the economy to develop a suite of supporting planning documents, including a draft management transition plan and a draft consumer protection framework. Details of these can be found on the website.

On banks, the UK is committed to encouraging competition in both the UK and EU markets. EU competition authorities are currently looking at the state of competition in retail banking markets, and will be reporting shortly.

The noble Baroness, Lady Noakes, posed some questions about the Government's position on the euro, and I think I have set that out. She referred to the Chancellor continuing to be wise, and I can confirm that I am sure he will. I have dealt with when the next assessment is due. No assessment has been made in relation to the last Budget, and the matter will be reviewed at the next. The position on the referendum remains unchanged: we would not go into the euro without one.

The noble Lord, Lord Harrison, raised issues about public finances. UK public finances are fully consistent with a prudent interpretation of the stability and growth pact, which takes into account the economic cycle, long-term sustainability of public finances and the role of public investment. Both the Treasury and Commission projections show that the UK deficit will reach the reference value of 3 per cent in 2006-07, and fall thereafter.

I am reminded that time is up, so I shall briefly summarise. Although Europe is currently bouncing back, enjoying a cyclical recovery and, encouragingly, some of the major European economies are seen to be turning a corner, many problems remain. Europe continues to lose ground in comparison with key developed economies. Structural problems persist. Unemployment remains high, particularly long-term and youth unemployment, while productivity and innovation is low. Europe's recent growth record and its marked lack of resilience to shocks are worrying. The underlying factors contributing to Europe's slow growth and economic performance stem from structural policy weaknesses. The right policy response is therefore the pursuit of structural reform to promote employment, raise productivity and increase flexibility in labour, product and capital markets.

Photo of Lord Evans of Temple Guiting Lord Evans of Temple Guiting Government Whip, Government Whip

My Lords, I beg to move that the House do now adjourn during pleasure until 2.39 pm.

Moved accordingly, and, on Question, Motion agreed to.

[The Sitting was suspended from 2.33 to 2.39 pm.]