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Would joining the euro zone improve Britain's global economic position? My colleague Edward Hadas sets that question as a wise sixth test which might be said, rather like Tolkien's ring, to bind together all the five membership tests the U.K. formulated a decade ago. His positive answer, however, is wrong. The euro's inherent flaws have not been rectified. The U.K. will continue to fare better outside the single currency.
Though crisis has calmed for now, the euro remains an experiment in difficulty and most euro zone economies look frail. As in the U.K., GDP in France and in the Netherlands remains below its pre-crisis level. But, if official forecasts are right, the Netherlands will contract further in 2013 and France barely grow, while the U.K. will grow faster even than Germany – the only euro zone economy that can be said to be doing reasonably well. The euro periphery is doing far worse than the U.K. The already hammered Spanish, Italian, Greek and Portuguese economies will contract significantly further this year.
The ailing Dutch economy highlights one of the currency bloc's flaws. The altruistic Dutch acted as guinea pigs for Britons in the euro experiment. They, like the British but unlike the Germans, like to buy their homes rather than rent them. The Dutch enjoyed a house price bubble on interest rates better suited to Germany than to them. They and their banks continue to pay the price. Recession lingers.
The U.K. had a huge and indeed even bigger house price bubble. That was the Bank of England's foolishness. Interest rates were too low – and yet often double the euro zone level. It is frightening to think how much larger the U.K. house price bubble would have been had the U.K. joined the euro. The U.K.'s banks would have bankrupted themselves more completely and bankrupted the country, too. Could the euro zone have survived that disaster in an economy of the U.K.'s size? Probably not. Europhiles should thank British euroskeptics. They saved the euro.
That's the past, not the future, it might be said. Now the euro zone has the German-favoured fiscal compact to deter budgetary excesses, the beginnings of a banking union and the still unused Outright Monetary Transactions of a European Central Bank willing to act as a lender of last resort. Regrettably, none of these new creations is a solution to the euro's fundamental flaws.
Fiscal policy is not the euro zone's central problem. Spain and Ireland had among the best fiscal and debt positions in Europe when they plunged into crisis. What sank them was a monetary policy appropriate for savings-oriented, low-inflation Germany and entirely inappropriate for them.
Monetarily, nothing has changed. The euro zone still has a single interest rate. The euro zone periphery needs lower interest rates and a looser monetary policy now and is not getting them. The ECB finds it impossible to address different countries' needs.
The future holds further big monetary threats. If Germany grows and inflates while the periphery continues to languish, interest rate rises to contain German inflation will crush any incipient periphery recovery. "One size fits all" is working for Germany, and not for other zone economies. Differences in propensities to spend or save, or to buy a house or rent, as well as big gaps in educational levels and competitiveness will remain huge problems for the common currency.
The German fiscal straitjacket could make matters worse. Should countries such as Spain, with unemployment at over a quarter of the work force, be tightening fiscal policy further? The U.K. government has delayed attainment of its fiscal policy targets. The euro zone seems impervious to such concerns.
It is all a huge disappointment for a currency launched with the aim of ending so-called euro sclerosis and bringing greater competitiveness and prosperity. Instead, as the euro zone struggles simply to survive – growth in Europe is lagging further behind that in the U.S. and Asia.
The U.K.'s independent monetary policy, freedom of choice in fiscal policy and unfettered currency remain the best choice. Going further, and exiting the EU, its main trade partner, would be foolish. But Britons are better off watching events in the euro laboratory from outside.