Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 29 June 2017

Economists and the Euro: for the record

Almost every time I write something about Brexit, I get at least one comment along the lines of ‘you economists got it wrong on the Euro, so why should we take any notice of you on Brexit’. This is beginning to annoy me, because in reality the opposite is true: it was because of economics and economists that we didn’t join the Euro in 2003. So the next time someone says the same to you, send them this blog post.

As far as I can see, the source of this ‘you got it wrong’ line is a poll that the Economist magazine did of academic economists on whether the UK should join the Euro in 1999. In that poll 65% said yes, and 35% said no. It was a good piece of journalism and a sensible survey, and it roughly corresponds with how I viewed academic opinions at the time. Claims by Andrea Leadsom that the Bank and IMF also recommended joining are simply wrong.

This poll has zero relevance to the Brexit issue for the following reasons:

  1. Academic economists split 2 to 1 in favour of joining in 1999. In the case of Brexit, for every one economist that thought leaving was a good idea, there were 22 that said the opposite. So while a majority of economists favoured joining the Euro, the overwhelming consensus was that Brexit would involve economic costs.

  2. Ask any academic about the Euro, and they will tell you that there are pros and cons, and it is largely a matter of judgement whether the pros or cons win. A key issue which I did some work on (with Rebecca Driver) was whether countercyclical fiscal policy could deal with asymmetric shocks. Our work suggested they could to a significant extent, but that made the proposed Stability and Growth Pact a concern. Others, looking at other types of risk, might come to a different conclusion.

    The contrast with Brexit is total. There are no major economic pros that need to be compared with the cons. Instead there are just economic costs, and the debate is about how large these will be.

  3. Euro membership involved macroeconomics. Membership of the EU is mostly about trade. These are different branches of economics with little in common. Brexit involves the impact of geography on trade (gravity equations) and the impact of trade on productivity, while Euro membership involves the macroeconomic response to asymmetric shocks. It is a bit like refusing to have your hip replaced because your flu jab didn’t stop you getting flu.

The poll was in 1999. The UK did not decide to make a decision whether to join the Euro or not until 2003, and thankfully it did more than take a poll of economists on the issue. The Treasury was given plenty of time to analyse the pros and cons of entry, and it did so by undertaking a large number of studies. This is how policy advice should work in the absence of delegation: you do not ask the expert what the decision should be, but instead ask what the issues are and let the politician make the decision. I have discussed the so called 5 tests process, overseen by Dave Ramsden, in detail here. Most of the studies were done ‘in house’ by Treasury economists, but advice was sought from a large number of leading academics in the field. Peter Westaway was brought in from the Bank to write a couple, and I wrote a study on the optimal entry rate, extending and developing work I had begun back in the days before we entered the ERM.

The analysis was at the highest level, and I could detect no overt bias one way or the other. Some studies found significant benefits from joining, and others found significant costs or concerns. Although it is easy to be cynical, I have talked to some of the actors involved and it does seem as if the economics, encapsulated in these various studies, was critical in first convincing Gordon Brown and then Tony Blair that now was not the right time to join.

So the reality is that studies that summarised state of the art academic economic analysis stopped the UK joining the Euro. Without that, the decision on UK entry would have been down to politics, much like the formation of the Euro itself, and who knows how that would have gone. The economic analysis anticipated some of the problems behind the Euro crisis but not all. Economics is far from perfect, but that is no reason to ignore it when it says things you do not like to hear.


  1. "The contrast with Brexit is total. There are no major economic pros that need to be compared with the cons. Instead there are just economic costs, and the debate is about how large these will be."

    Your model. Why do you think you can't be wrong here?

  2. Gordon Brown & assorted economists didn't keep us out of the euro because there was never any prospect of our joining. Tony Blair wouldn't have dared take us in without a referendum, which would have been lost.

  3. Interesting post. You are right to say that the arguments are different and differently weighted. The main problem I have with the "economists concensus"on Brexit is that it assumes a WTO end deal or similar. There is a high likelihood of a no-tariff deal for goods (around 80% of our exports) and some equivalence style for financial services (American banks will lobby for this). In this scenario the 2% loss of GDP will be seen as very pessimistic. And for decades they will say: you were wrong on Brexit. You should shout now what your assumptions are.
    Furthermore, given that 90% of world growth is coming from outside the EU, any reduction in tariffs with 60% (and growing) of our market should have a positive benefit. I never saw this quantified properly. In the long-term Asia, Africa and South America will be much more significant than the EU.

  4. Simon
    where you an economist at the time - did you get asked your opinion for the Economist survey?

  5. At the time, I got the impression that the Swedish referendum on the Euro was all about British politics. My guess is that Britain would have held a referendum had Sweden voted yes.

  6. Amalgamating Europe into one uniform system of administration reduces impediments to trade. Amalgamating the entire global economy into one uniform system of administration would do that even more. Having just one company with a global monopoly for all goods and services would also eliminate many trade frictions. But there are also costs from becoming too large and unwieldy. Being smaller often allows an organisation to react more effectively to new challanges. Having several parallel organisations working alongside each other allows different ways of doing things to be tried out. That is why larger countries and larger companies are not always better.

  7. I am not an economist, professional or otherwise, however my understanding is that membership of the EU does limit how the government can create money. That it has to do so by buying bonds. Have I misunderstood?

    1. derrida derider5 July 2017 at 03:58

      All governments print money by buying bonds. After all banknotes are themselves just another government bond with particular conditions (negotiable, infinite term, redeemable at call, paying zero percent interest).


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