Free Lunch (23 page)

The euro also creates price transparency. For years it has been an observable fact that prices across a range of products are higher in Britain than in other countries, including those in the rest of the EU. In some cases price differentials have narrowed, for example in cars, as result of action by the European Commission and the domestic competition authorities. But in many cases significant differences persist, and ‘rip-off Britain’ remains a reality. When everything is priced in euros, it is argued, such differentials will not only become more transparent than they are now but they will also be difficult to sustain. The euro, after the changeover period, will deliver lower prices for consumers (when the twelve members of euroland switched to notes and coins in early 2002 there were many examples of prices being rounded higher).

Some of these advantages can be questioned. Yes, the euro would remove currency instability within Europe, which is where nearly 60 percent of Britain’s visible exports (goods) go, but under 50 percent of total trade. It would, however, do nothing about instability with regard, say, to the dollar. The single market, as noted, needs a lot more than a single currency to complete it. Transaction costs are small, and arguably getting smaller in an era of electronic money. The interest rate gains are not significant any more. As for price transparency, as long as there are tax differences between EU members, and as long as product differences persist (something manufacturers are keen to preserve), it may not happen.

There is a bigger argument against the euro, however, and it has to do with what is sometimes called, in shorthand, the ‘one size fits all’ problem. Countries in the euro have to adopt the same exchange rate. A single currency means just that. No longer can France alter its exchange rate vis-à-vis Germany, or any of the other euro member countries. A euro is a euro, the currency shared by people from Berlin to Barcelona, Lisbon to Leipzig. They also, however, have to live with the same interest rate, set by the European Central Bank. Each country, admittedly, has a voting representative on the ECB’s rate-setting council but each, too, is implicitly accepting that they can live with the interest rate set by others. The easiest kind of monetary union would be between two identical countries, each with similar industries and similar vulnerability to economic shocks. If oil prices go up, or the price of cotton goes down, they are affected in the same way. Sharing a currency and an interest rate poses no dangers, as long as they started with roughly the same economic performance. There would clearly be trouble if, at the outset, one country had zero inflation, the other a 100 percent rate. This was why, when the decision was taken to proceed with the euro at Maastricht in 1991, conditions, or criteria, were set down, requiring countries wishing to take part to have broadly similar inflation, long-term interest rates, budget deficits and debt. The criteria, it should be said, were not always observed to the letter, particularly in the case of budget deficits and debt. Suppose, though, that, unlike our two similar countries, euro participants are very different, which comes closer to reflecting reality. The members of the EU differ in size, in industrial structure, in dependence on oil, in the proportion of GDP they export to non-EU countries. As individual countries with their own central banks, they could compensate when such differences began to tell by adjusting interest rates. In euroland that is not possible. Thus a standard piece of economics is the theory of optimal currency areas, most associated with Robert Mundell, the Canadian-born Nobel Prize-winning economist.

An optimal currency area requires either all participants to be not only closely interlinked through trade, but also broadly similar in structure. A single currency area that consisted of two economies, one whose sole product was wheat, the other cars, would be unlikely to work. A slump in world wheat prices would hurt one badly while leaving the other unaffected. Looked at another way, countries have to have the ability to respond to economic shocks, an example of which might be a sharp rise in world oil prices. There are three conditions for an optimal currency area. The first is ‘geographical mobility’ of labour. If people are made unemployed in one part of the euro area, they have to be willing to move to where the jobs are. The second requirement, either in tandem with or instead of geographical mobility, is wage flexibility. Suppose there is a shock that is threatening big job losses in one region. They have to be prepared to accept a cut in wages to persuade the employer not to pull out. The third requirement is a large enough central budget, so that fiscal policy can be used to provide help where monetary policy – which is set for the whole area – cannot. In America’s single currency (dollar) area, the federal budget works in precisely this way. When there is a downturn in, say, California, Washington can provide direct help, not least through larger assistance payments. At the same time a phenomenon known by economists as the ‘automatic stabilizers’ operates. California, during its downturn, pays fewer taxes into the federal budget, helping the state get through its difficulty. Is Europe an optimal currency area? Prior to the launch of the euro some economists believed that a small group of countries at the heart of Europe – France, Germany, Belgium, Luxembourg and the Netherlands – fitted that description. Few believed that it was true for the eleven who made it to the starting-gate (Austria, Finland, Ireland, Italy, Portugal and Spain joined too), or the twelve (Greece quickly became a member) euroland consists of at the time of writing. Even the smallest of these groups, lacking sufficient geographical mobility of labour and wage flexibility, did not satisfy pure optimal currency area requirements. The EU as a whole, with a tiny central budget of just 1.27 percent of GDP, is well below the 25 percent of GDP level generally reckoned to be needed to provide a proper offset to monetary policy.

The story does not end there. Mundell, curiously, became an advocate of the euro because, equally curiously, he decided that there were never any optimal currency areas in real life, but that it was worth pressing ahead with monetary unions anyway. He argued, in fact, for a global single currency backed by gold. There is also a line of argument that, whether the starting-point is optimal or not, once inside a single currency countries will adjust and make it work. Whether that adjustment is at the cost of high unemployment, which is the natural consequence of forcing countries into an inappropriate monetary union, is the big worry.

For Britain, there is another consideration. Previous monetary arrangements between Britain and Europe have ended in disaster. In 1972 sterling stayed in the ‘snake’, a forerunner of the European Monetary System (EMS), for just six weeks. Between 1990 and 1992 Britain spent twenty-three agonizing months inside the exchange rate mechanism of the EMS, before the humiliating exit on 16 September 1992. In the past, Britain approached Europe in the position of supplicant, usually to obtain some much-needed support for the beleaguered pound or to acquire by association some of Germany’s anti-inflation credibility. With the Bank of England independent, under arrangements that many consider superior to those of the ECB, and with Britain’s recent economic performance having been better than the rest of the EU (in inflation, unemployment and growth), the balance has shifted. That does not mean everything in the garden is rosy. Productivity is significantly higher in France and Germany than in the UK, 40 and 20 percent respectively, despite the government’s efforts to close the gap. Europeans also look askance at the poor quality of Britain’s transport infrastructure and public services. Improved UK economic performance, at the time of writing, does not mean that Britain should never join the euro but it does mean that the risks of losing something are greater. If the motto was ‘if it ain’t broke don’t fix it’, most economists would currently argue against membership. Whether that will be true for the longer term remains to be seen. Economists should also have a little humility in this debate. While they were given the role of assessing the Chancellor of the Exchequer’s five economic tests for UK euro entry – whether the economy is sufficiently converged with Europe and also flexible, and whether entry would be good for jobs, investment and the City – nobody pretends economics has all the answers, particularly on the politics of the euro.

Does economics make you happy?

This may seem like an odd question, particularly when the subject has been known on and off since the nineteenth century as the dismal science, and when you do not have to look too hard to find some pretty gloomy economists. The economics of happiness is, however, one of the subject’s growth areas. ‘The extent to which people are happy or unhappy is an essential quality of the economy and society,’ write Bruno Frey and Alois Stutzer in their book
Happiness and Economics
. ‘The state of the economy strongly affects people’s happiness.’ How do you measure something as subjective as happiness? Mainly through surveys that ask people how satisfied they are with life, or with their job. One difficulty, of course, is that people’s expectations change. Consumers come to expect product improvements, employees better working conditions. It is hard to compare two very different situations, to transform an individual’s condition. A Victorian factory worker teleported to a modern industrial plant would think he had arrived in heaven. So would a Model T driver handed the keys of a modern car. However, most improvements are incremental. Whether people are happy or not depends on whether those improvements exceed, keep pace with, or fall behind the rise in expectations. This also applies to areas of public service delivery such as the National Health Service, as successive British governments have discovered.

So what do we know about happiness? Andrew Oswald and Jonathan Gardner of Warwick University are among the economists who have researched extensively in this field. Their work on job satisfaction suggests that it declined during the 1990s, particularly among women and public sector workers. Of more interest, perhaps, is that the happiest workers in Britain are those with no educational qualifications (and lower job expectations), while the least satisfied are those with a degree. This may suggest that many people are over-qualified for their jobs, particularly those with degrees. People with postgraduate degrees, interestingly, are happier at work than graduates. Women tend to be happier at work than men. People in non-profit organizations have the most job satisfaction, probably because they feel they are doing good, followed by public sector workers, then those in the private sector. By age, the happiest workers are those in their sixties, with retirement just around the corner, the least happy are in their twenties. Oswald, along with David Blanchflower of Dartmouth College in America, also compared job satisfaction across nations. They found, in a survey of twenty-seven countries, Britain came seventeenth in terms of workers being satisfied with their lot at work. Denmark topped the rankings, while Cyprus, Israel, the Netherlands, the Philippines, Spain, Switzerland, the United States and even Russia had higher levels of job satisfaction than Britain.

Does money buy you happiness? Oswald and Gardner tested this by looking at the psychological health and happiness of a randomly chosen sample of 9,000 people. Some of those in the sample had been lucky enough to receive financial windfalls, such as lottery or football pools wins, or unexpected inheritances. On the basis of this information they were able to calculate the impact of money on happiness. A windfall of £50,000, or around $75,000, was sufficient to give people a significant lift in terms of happiness. But how much did it need to make a really miserable person happy? According to the study, a windfall of £1 million (about $1.5 million) was required to do this, to ‘move someone from close to the bottom of a happiness frequency distribution to close to the top’. Does happiness bought by extra money last? Probably not. Further study is needed but intuitively it seems that windfall effects wear off over time. In addition, the effect of money can be relative. The same amount of wealth could make you feel as rich as Croesus in most parts of the world but a relative pauper in Monte Carlo or the Bahamas. Three Swedish economists, Olof Johansson-Stenman, Fredrik Carlsson and Dinky Daruvala, found in 2002 that people’s happiness depended not just on absolute income, but also on their relative position in the income ladder. Not only that, but when a sample of people was surveyed using a series of scenario-based questions – they were asked to choose between two imaginary future societies – most expressed a preference for a more equitable distribution of income, largely because of the fear that they would end up at the bottom of the heap in an unequal society. Lots of conflicting factors come into the equation. People are competitive, driven by a desire to ‘keep up with the Joneses’, and their tastes and desires are conditioned by what others are doing. As Marx put it: ‘A house may be large or small; as long as the neighbouring houses are likewise small, it satisfies all the social requirements for a residence. But let there arise next to the little house a palace, and the little house shrinks to a hut.’