For Many, Though Not All, Governments in Europe, What Happens at the European Level, However

1

NEW LABOUR AND THE EURO: THE PRIMACY OF ECONOMICS AS A POLITICAL END[1]

Paper for “The UK and Europe” Panel of the colloquium 'Que reste-t-il de Cool Britannia?

Le Royaume-Uni après huit ans de gouvernement Blair', CÉRIUM, Universitè de Montréal, 4-6 May 2005

David Hine ()

Department of Politics and International Relations

University of Oxford

Draft: please do not quote without permission

Introduction

For many, though not all, governments in Europe, what happens at the European level, however important, does not have dramatic partisan domestic ramifications, given broad cross-party agreement on EU matters. Even when European policy disappoints, this is often seen more as an uncontrollable, exogenously-determined matter, than a failure of the national authorities. Not so in the UK. Parties make political capital out of perceived failures in UK European policy. Parties can become hopelessly split by European questions. Parties in government generally bear responsibility for European policy alone, unlike many continental counterparts, who share burdens with coalition partners. And because a large part of the press is virulently euro-sceptic, and governments court real dangers if they stray too far from its values, parties are at constant risk of getting out of line with public opinion.

This paper is about how New Labour dealt with the issue of euro membership: the central problem of EU policy after 1997. During its time in office the party has faced several big EU-related issues: the euro, constitutional reform, and the challenge of finding a common attitude towards the war in Iraq. The last of these ended in unequivocal failure for the EU as a whole – unquestionably the EU’s most serious split on foreign policy. Constitutional reform in the shape of the Nice Treaty and the Convention and subsequent IGC are cases where the jury is still out, though it may return another damning verdict on May 29 2005. The euro is somewhat different. Views can differ on whether in the current state of economic convergence the euro represents an optimum currency area. It probably does not, and there is an outside chance that its fate could yet hang in the balance if confidence in the wider EU project started to ebb under the pressure of constitutional stalemate and excessive enlargement ambitions. But that looks unlikely. No-one in the EU pretended in the early 1990s that monetary, let alone economic convergence was going to be easy, or that it would not take at least a couple of decades to make the euro an area of real area of economic convergence. But by most technical counts the project was delivered on time, with astonishing success: the locking of currencies, the introduction of notes and coins, and the range of countries (most notably the southern European economies) that joined the project at its outset or shortly thereafter. It was delivered in an environment of falling interest rates, and delivered spectacular debt-servicing and hence budgetary gains to hitherto high-debt governments. True, the currency has been subject to major concerns, first about under-valuation against the dollar, and more recently over-valuation. And its Stability and Growth Pact has been under acute pressure, and shows signs of unravelling. But for all that, the euro is seen across the EU as a success, most of all because of its political value. It appeared in the 1990s to be the policy that would lock European integration in for the next generation. Member-states that subscribed to it demonstrated their commitment to the European project. They had a claim, even the more geographically peripheral ones, to be “at the heart of Europe”.

But at its inception in 1999 four member-states were missing: Greece, because it was not ready (though it joined soon after), Denmark and Sweden, where the mainstream parties and the economic establishment were in favour, but public opinion was and remains hostile and where referendums on membership have been fought and lost with unfortunate consequences, and most importantly the UK, where both elite and mass opinion was more divided than anywhere in the EU, where the debate in the 1990s was most intense, and experience most coloured by the impact of the collapse of the ERM in 1992.

New Labour thus came to office facing a difficult legacy. Its leaders had carefully weaned the Party away from the hostility to European integration that had reached a peak in the early 1980s. From the 1992 ERM debacle onwards Labour had seen an opportunity to exploit Tory divisions during the hopelessly divided Major government by gradually assuming the mantle of a moderately-pro-European party, spurred on by hostility to the British opt-out negotiated over the Social Chapter. By the time of its 1997 election victory, New Labour was broadly committed to the euro project (and at the time the differences between Gordon Brown and Tony Blair on this matter were non-existent – if anything Brown was probably keener than Blair). Labour had become the main pro-European UK party, and was elected on a platform that aimed to put the UK “at the heart of Europe”. But right from the outset, the difficulties of delivering on the euro project were considerable. Public opinion was divided down the middle. The press, especially the Murdoch press, was implacably opposed. And most importantly of all, the economic case was uncertain. The UK had no very high stock of debt to service, so did not enjoy the massive budgetary gains from declining debt-servicing costs that some other EU economies enjoyed. Its trade and other economic connections, including cross-border investment patterns, were in global terms more diversified than most of its EU partners, and most important of all, the structure of its financial markets, and the special dependence of the housing market on variable-rate debt, made the economy peculiarly vulnerable to interest-rate variations. The real fear – with UK interest rates at the time at least 200 basis points higher than those in the euro area – was that convergence to ECB-determined interest rates would stoke domestic inflation through the housing market, with disastrous consequences for UK competitiveness, and that thereafter, month-in, month-out, UK voters would await the decision of a foreign and secretive entity, the ECB, to know their disposable income and even the anticipated value of their homes! These problems were not seen in 1997 as insuperable, but they required time for their resolution, and various types of fiscal and labour-market intervention, before the UK was ready for euro-area membership. But as time passed and the weaknesses of the eurozone as a common currency area became more evident, they also stoked a lingering suspicion among an increasingly self-confident national economic and administrative elite in the UK that convergence also meant adjustments in the eurozone itself: that the euro was not ready for the UK too.

Thus began the long saga of New Labour’s dilemma on euro membership. The day after the general election victory of 1997 the new Europe Minister, Mr Doug Henderson, attended the incoming government’s first Council of Ministers meeting, and continental colleagues declared a new dawn of reasonableness. New Labour was widely admired across the EU, especially by the many social-democratic governments then in office. Nearly a decade later, the party looks to be on the verge of its third election victory, but if the euro is the main test, it is no nearer the heart of Europe than in 1997. Indeed, during the 2005 election campaign Tony Blair has come close to ruling out a referendum on UK membership of the euro during the life of the forthcoming Parliament. 2010 could therefore now be the earliest date at which the UK joins the euro area.

Why decide to join the euro?

It is not the purpose of this paper to judge whether this long self-exclusion represents a victory or a defeat for Labour’s European policy. Though almost all statements about euro membership emanating from the Labour Party and the Labour government are couched in conditional terms, it is clear that in its early years in power, New Labour projected the strong impression that it wanted the UK to join in monetary union. The precise ways in which UK influence would be diminished politically if it failed to do so were never spelled out, and it is difficult for commentators to generalise on their nature in a way that is remotely predictable or measurable. “Influence” applies to many different areas: institutional-building and decision-procedures; internal-market policies; external trade; macro-economic models and competitiveness policies; and external and security policy in its various dimensions. With the exception of decisions regarding the management of the currency itself, and the body of decisions surrounding it, self-exclusion from monetary union does not in principle exclude an EU member-state, especially a large and militarily important one, from any decision area. So the influence leakage is not easy to measure. It depends on subtle habits of psychological identification and trust between member-states, on national reputation, and on bi-lateral bargains that cross several bargaining-tables. New Labour has often implied influence is valuable, but it has never put a value on it.

The same may be said for the other side of that coin, which is a member-state’s capacity to persuade national public opinion to accept policies that it may not like, in return for some broader European, but also eventually national, benefit. Certainly, there looks to be an association between a belief in the benevolence of European integration, and willingness to accede to autonomy-limiting decisional procedures, such as majoritarian-based rather than unanimity-based voting, a common legal framework, common regulatory institutions, and monetary union. Member-states whose governments regularly articulate and reaffirm a belief in the historical link between economic welfare, political stability, and peace, on the one side, and progress towards European integration on the other, seem to find it easier, when they wish so to do, to accede to such procedures than those which find such an association less persuasive or significant. While the capacity of public opinion to see European policies as benevolent is not today to be assumed in any member-state, the long-term absence of that capacity has been claimed to be a particular blight on the UK’s capacity to act on the EU stage. It is of course far from clear that adoption of the euro – whatever credibility it might buy among EU partners – would necessarily lock British citizens themselves in to more benign attitudes towards the EU, but that too seems to be a possible good that would come of it in the minds of many of its supporters.

But for a British government it was always going to be difficult to engineer a fundamental shift in public attitudes towards European integration. The UK is not a country where governments have historically been attracted to any benign interpretive myth of the general benefits of integration, for reasons that are not difficult to identify. There is a pragmatic rather than an ideological political tradition. The political executive is for deep-rooted historical reasons strong, and relatively unbounded by formal checks and balances, or notions of power-sharing, and government is founded on the idea that the executive should have the power to control the country’s destiny. For reasons of history and geography it has been possible to sustain a myth of national independence more easily than in most countries of continental Europe. In European terms, for two centuries, the UK has been a large power not a small one. It emerged as a victor from two world wars. It was a nuclear power whose voters proved willing to sustain relatively high levels of defence spending after World War II, and thus a country which could believe in the possibility of “punching above its weight”. And, again for fortuitous historical reasons, its economic and cultural ties were on a genuinely global scale, very different from those of most of its continental partners.

All these factors seem to help explain why the United Kingdom has developed a distinctive position in the five decades of European integration. At first a non-player. Then (as a late joiner) an allegedly difficult partner. And in the era of at least partly variable-geometry Europe, again a non-player in some areas (monetary union, social Europe), and a reluctant one in others. And most recently in the contemporary era of serious institutional doubt about the original institutional model of Commission leadership, majority voting, and binding procedures, the UK has again been a proponent of voluntarism and inter-governmentalism (the Open Method of Coordination, a weaker Commission, maximum enlargement, stronger Council leadership). This is not to say an entirely different myth might not have been fostered in an earlier era – especially in the 1950s – had there been strong bi-partisan agreement that the United Kingdom’s moral and military strength enabled it to play a lead in European affairs through rapid integration. But it is difficult to believe in this counter-factual, even though it was often advanced in the 1970s and 1980s by domestic critics of the alleged timidity of UK governments’ European policies. The UK never had the same reasons for believing in the benevolence of integration or common institutions that Germany and Italy had, or even that France could persuade itself of. Nor, until the 1970s, did Europe appear to be a big enough or powerful enough pole of attraction to substitute for the UK’s global connections. Even when this attraction did become powerful, the many differences between the UK social model, its market system, and its natural interests, left a legacy of hesitation. The explanation of the UK’s European stance as a pure failure of imagination and political leadership is thus hard to sustain.

This background gives at least one set of reasons why it might not be reasonable to expect New Labour, when it came to power in 1997, to have generated a revolution, let alone a lasting one, in British thinking about European integration, either at mass or at elite level. The constraints were powerful. It is true that the outgoing government, through the bad luck of a small and fractious parliamentary majority, a single piece of economic misfortunate in the timing and the exchange rate at which it joined the ERM, and genuine uncertainty about how to handle the renewed drive towards integration that followed the end of the Cold War and German unification, was torn apart by the European question. Indeed it was torn apart at elite level. It tore itself apart. It was not repudiated by an electorate which did not share its views, nor by the threat of competition from a deeply eurosceptic Labour opposition. But what this lesson seems to have taught New Labour was less that it should strike out boldly in a new direction of European enthusiasm, or that it could ride on a tide of public support for European integration, than that it should manage the European question with extreme caution. It should if at all possible avoid head-on clashes with its European partners. It should talk in general terms about being “at the heart of Europe”, but it should reserve its position wherever possible (and especially on the vexed question of EMU), to avoid getting out of line with public opinion, giving a hostage to the opposition, or sowing dissension in its own ranks.

The good fortune inherent in a huge parliamentary majority, a weak and divided opposition, and an economy that was to perform with exceptional strength over an unprecedently sustained period, was obviously not a given in 1997. All three major postwar Labour governments had given the party no more than one significant parliamentary term. The caution which this induced – particularly in the medium-term economic strategy of the 1997-2001 Parliament, and the conservatism of welfare and social spending – was not unexpected. Hence too New Labour’s caution over European policy and especially EMU. And all these were considerations of an essentially political nature. They arose even before the very first argument over the economic case for euro membership was considered. Some of those arguments are considered below, but the point

And how to avoid a decision

So rather than interpret the outcome (to date) as success or failure, what we should do here is try to provide an explanation of what happened and why. Here, we need to do two things. Consider what the drivers have been to date of the decision not to proceed to a referendum, a return to the ERM, and eventual full entry into the euro area, and secondly compare what happened to other decisions concerning major EU issues in the UK (the long saga of initial entry; budget contributions; battles over constitutional reform etc.) and identify why, given the potential divisiveness of the issue, New Labour has in fact escaped remarkably lightly.

We start with a chronology. Government thinking, and intra-departmental relationships, have evolved through four stages since 1997:

• the establishment of the five key economic tests in December 1997, which effectively continued the Conservative government’s wait-and-see policy, and postponed a referendum decision on entry until after a second general election, and hence until 2002;
• the sharp appreciation of the pound against the euro in 1999/2000 that made entry at any acceptable exchange rate increasingly difficult, making the 2002 date improbable and focusing attention on an additional dilemma of the entry decision: whether a referendum held in advance of knowing the exchange rate was feasible. This crystalized out divisions between “economists” and “politicians”, the latter dismayed that if economic conditions were made the sole entry criteria, the moment would be postponed indefinitely. By October 2000 Tony Blair was forced, in the wake of the Danish rejection of the euro in a referendum on 29 September, to re-position the government’s stance tacitly recognising that conditions would probably not be ripe for a referendum in 2002;
• the long preparation for assessment of the five economic tests following the general election of 2001, and the deterioration in relations between Prime Minister and Chancellor, culminating in the complex political compromise between the Treasury and Downing St in the spring of 2003, that effectively declared that neither the euro area, nor the UK economy, was ready for UK entry, that the exchange rate was inappropriate, and that the five economic tests had not been met in full;
• the aftermath: an uncomfortable two-year stand-off between Treasury and Downing St, with a politically-weakened Prime Minister unable to move a Chancellor resistant to any change in policy, the latter firmly supported by public opinion, a shift in union attitudes, and a growing margin of comfort that the UK economy could remain outside the eurozone for a sustained period without suffering serious adverse consequences.

In retrospect, the five tests proved critical determinants of the subsequent process, especially as the Chancellor reviewed the trajectory of the pound-euro exchange rate against his own concern that lessons had to be learned from the 1992 expulsion of the pound from the ERM, itself widely attributed to entry at the wrong rate. In simple terms the five tests were: