Banking on Sterling: Britain's Independence from the Euro Zone 0739144103, 9780739144107

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Banking on Sterling

Banking on Sterling Britain's Independence from the Euro Zone Ophelia Eglene

LEXINGTON BOOKS A division of ROWMAN 8 LITTLEFIELD PUBLISHERS, INC. Lanham Boulder New York Toronto Plymouth, UK

Published by Lexington Books A division of Rowman & Littlefield Publishers, Inc. A wholly owned subsidiary of The Rowman & Littlefield Publishing Group, Inc. 450 1 Forbes Boulevard, Suite 200, Lanham, Maryland 20706 http://www.lexingtonbooks.com Estover Road, Plymouth PL6 7PY, United Kingdom Copyright 63 201 1 by Lexington Books A11 rigl~tsreserved. No part of this book may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without written permission from the publisher, except by a reviewer who may quote passages in a review.

British Library Cataloguing in Publication Information Available Library of Congress Cataloging-in-Publication Data Eglene, Ophelia. Banking on sterling : Britain's independence from the euro zone I Ophelia Eglene. p. cm. Includes bibliographical references. ISBN 978-0-7391-4410-7 (cloth : alk. paper) I. Monetary unions-Great Britain. 2. Euro-Great Britain. 3. Monetary policyGreat Britain. 4. Euro area. 5. Europe-Economic integration. 1. Title. HG939.5.E45 201 1 332.4'941-dc22 2010033280 The paper used in this publication meets the minimum requirements of American National Standard for Information Sciences-Permanence of Paper for Printed Library Materials. ANSUNISO 239.48- 1992. Printed in the United States of America

To my mother, Marie-Lka Vial

Contents Figures Tables Abbreviations Ackiiowledgments Chapter 1

Britain and the Euro: The Policy of Non-Decision

Chapter 2

Economic Actors and Monetary Policy

Chapter 3

The Structure of the British Economy

Chapter 4

The Coiiservative Party and EMU

Chapter 5

The Blair Years and the Euro

Chapter 6

Business and the Euro

Chapter 7

The City and the Euro

Chapter 8

Conclusion

Appendix Bibliography Index

ix xi

...

Xlll

xv

Figures Figure 2.1. Figure 2.2. Figure 5.1. Figure 6.1. Figure 6.2. Figure 6.3.

Frieden's Model Henning's Model Theoretical British Timetable for Joining the Euro Compared to First Wave Countries FDI in the UK, France, and Italy (1992-2005) Euro-Sterling Exchange Rate ( I 999-2007) Euro-Sterling Exchange Rate (2003- 10)

20 22 76 104 106 108

Tables Table 2. I . Table 2.2. Table 3.1. Table 3.2. Table 3.3. Table 6. I . Table 7.1. Table 7.2. Table 7.3. Table 8. I .

Predictions Based on Frieden's Model Predictions Based on Henning's Model Comparative Market Shares of the World's Financial Centers Leading City Investment Banks Comparative Taxes and Social Security Costs in Europe Initial Position of Business Interests on the Euro Opinion of City Executives on the Euro 01'C Derivatives Market Shares Growth in International Financial Markets in the UK Minimum Reserve Requirements on Transaction Deposits

25 25 35 38 41 88 126 127 128 141

Abbreviations AIM Al TC AMUE BBA BEC BES BExA BR BI BIE CBI CD CSFl CMUE COLCOM DM DTI ECB ECOFIN ECU EEC EMF EM1 EMS EMU ERM ESCB EU FBI FDI FSB GDP HlCP ICC IGC IMA IMF I PE I PO IUA

Alternative Investment Market Association of Investment Trust Companies Association for the Monetary Union of Europe British Bankers Association British Employers' Confederation British Election Studies British Exporters Association Business for Sterling British lnvisibles Britain in Europe Confederation of British Industry Certificate of Deposit Centre for the Study of Financial Innovations Committee for the Monetary Union of Europe City of London Concern over Maastricht Deutschmark Department of Trade and lndustry European Central Bank Economic and Financial Committee European Currency Unit European Economic Community European Monetary Fund European Monetary Institute European Monetary System Economic and Monetary Union Exchange Rate Mechanism European System of Central Banks European Union Federation of British Industries Foreign Direct Investment Federation of Sniall Businesses Gross Domestic Product Harmonized Index of Consumer Prices lnternational Criminal Court Intergovernmental Conference Investment Management Association lnternational Monetary Fund lnternational Political Economy Initial Public Offering lnternational Underwriting Association . .. Xlll

IoD IR IS LlBA LlBOR LSE M&A MMD MNC MP MPC NABM OM OTC Pu RPlX SEA SG P SME TARGET TE U TUC UK

Institute of Directors International Relations International System London Investment Banking Association London Interbank Offer Rate London Stock Exchange Merger and Acquisition Money Market Deposit Multinational Corporation Member of Parliament Monetary Policy Committee National Association of British Manufacturers Ostmark Over the Counter Political Union Retail Price Index excluding mortgage interests payments Single European Act Stability and Growth Pact Small and Medium Enterprise Trans-European Automated Real-Time Gross-Settlement Express Transfer Treaty on European Union Trade Union Congress United Kingdom

Acknowledgments This book could not have been possible without the support of several institutions that granted me the financial or logistical support needed to conduct my research and to complete my analysis. I thank Middlebury College for providing me with faculty research funds that financed my main research trip to Britain. I am grateful to the British Politics Group of the American Political Science Association for awarding me the Donald E. Stroke Dissertation Research Fellowship that allowed me to fund my third research trip to London. I am thankful to the lnstitut Fran~aisde Washington for granting me the Gilbert Chinard Research Fellowship that permitted me to travel to France to consult the archives of the Association for the Monetary Union of Europe located in the Archives Nationales in Paris. I thank the Benevolent Association of the University at Albany for its award that also contributed to advancing my data collection. Finally, I am indebted to the Minda de Gunzburg Center for European Studies at Harvard University for granting a postdoctoral fellowship. I was able to use the vast resources of Harvard University and work on refining my work in the most intellectually stimulating environment. Several individuals were critical to my intellectual journey towards completion of this book. First, I would like to thank Joseph Zimmerman, Gregory Nowell, and Thomas Walker at the University at Albany who encouraged me to initiate this project and helped me define it. At Harvard University, 1 had the opportunity to talk about my research and receive helpful comments from participants in the Center for European Studies New Research on Europe Seminar Series run by Arthur Goldhammer. I was also invited to present my work at the Government Department Research Workshop in Political Economy. I thank participants in the workshop for their invaluable feedback, particularly Jeffry Frieden, Jim Alt, Michael Hiscox, Daniel Ziblatt, Stefanie Walter, and Darnian Raess. I am grateful to the members of the Political Science department at Middlebury College, especially Kateri Karmola, Nadia Horning, Matt Dickinson, Mark Williams, Michael Kraus, and Erik Bleich, for encouragements and suggestions offered to me during my presentation at the Faculty Research Group. I received helpful comments on papers based on my research from Vivian Schmidt at Boston College-who also met with me to discuss my book concept-and Daniel Kinderman at Cornell University. I am also thankful to two economists for reading drafts and providing me with their perspective: Thierry Warin at Middlebury College and Kirsten Wandschneider at Occidental College. I thank Carol Rifelj for proofreading my manuscript. Finally, I owe the most to my wonderful husband, Jim, who always encouraged me and provided me with the intellectual support and constant love necessary to forge ahead. X \'

Chapter 1

Britain and the Euro: The Policy of Non-Decision The euro turned ten on January 1, 2009, a celebratory date for the sixteen member states of the European Union (EU) in which the single currency is currently legal tender. On the other side of the Channel, the date marked ten years of independence from the euro zone for the United Kingdom (UK). Since having been granted an opt-out option from the Economic and Monetary Union (EMU) during the Maastricht Treaty negotiations of the early 1990s, the British government has followed a policy of "non-decision" on euro membership under both the Tories and New Labour. The government has never committed to adopting the euro one day but it has never ruled out this possibility either. Under the Conservative government of John Major, the British policy on EMU was called "wait and see" whereas it became "prepare and decide" when Tony Blair came to power. While it sounded a little more determined, the position of the Labour government on the euro remained the same from 1997 to 2007, namely that it was in favor of adopting the euro "in principle" but that the case for joining would have to be clear and una~llbiguousbased on five economic tests devised by Gordon Brown when he was Chancellor of the Exchequer. A referendum would only be held in the UK if the government decided it was in the national interest to join. Even though many thought that Blair would hold a referendum on the euro during his premiership, he stepped down to leave his seat to Brown in 2007 without ever having put the question to the British people. This book addresses the question of why the United Kingdom, a member state whose share of trade with the EU is significant, has not adopted the European single currency-even under the euro-enthusiast Blair-and has stayed outside of the euro zone for over a decade now. Britain's peculiar policy towards the European monetary union has not been the subject of many serious empirical analyses. The British case-an outlier in the literature on European monetary integration-tends too often to be elucidated with state-centric or public opinion-based ideological arguments. It is often assumed that the UK is simply more ideologically concerned about its sovereignty than other EU member states. The main weakness of this type of analysis is that it treats the state as a unitary

2

Chapter 1

actor with an overriding goal while dismissing pluralist interests within society. British policy is always explained as stemming from a reluctance to relinquish too much sovereignty to the EU. However, the British government has not approached questions of European integration simply from an ideological perspective. Econoinic interests have always been in the equation, as applications for membership of the European Economic Community (EEC) in the late '60s and early '70s, under both Conservative and Labour governments, illustrated. As David Howarth contended, "Albeit very popular as an explanation of Conservative and Labour government policies on the Euro, relying on this traditional 'reluctance' and 'awkwardness' leaves many questions unanswered about the details of British policy."' A commonly accepted argument for the failure of the British government to adopt the euro is that public opinion in the UK was too opposed to giving up the pound. The euroskepticis~nof the Murdoch press and of the public at large is often cited as the culprit that led Tony Blair to shy away from holding a referendum on the euro when he seemed so intent to do so. As I demonstrate later in this chapter, the public opinion argument has been over-exaggerated as a factor driving the actions of the British government. Analysis of public opinion polls revealed that the majority of respondents were open to persuasion, as they have a limited understanding of the economics of monetary union. Studies have shown that there were several windows of opportunity during which the government could have won a referendum by making a strong economic case that adopting the euro was in the national interest. A referendum on the euro could have been won when Blair's popularity was high early in his first term and in his second term immediately after 911 1. As the 1975 referendum on whether the UK should stay in the EEC demonstrated, a well-run government campaign can turn around hostile public opinion. Another popular explanation for why Tony Blair did not take Britain into the euro is based on the interpersonal relationship between the Prime Minister and his Chancellor of the Exchequer. This explanation rests on the deep rivalry between Tony Blair and Gordon Brown that originated when Blair became party leader instead of his former officemate, once the favorite for the position. Blair was intent on taking Britain into the euro but Brown would not "let him." In May 2003, rumors even emerged that Blair had told Brown that he would step down and leave him the seat of Prime Minister-as he was supposed to do as part of the legendary deal between the two politicians-but only if Brown let him take Britain into the euro.* Supposedly, Brown resolutely refused and waited patiently until June 2007 when Blair finally stepped down with no conditions attached. The timing of the rumor, however, does not make sense, for in May 2003 Blair's popularity was at a low 30 percent due to the War in Iraq. Why would Blair have begged his chancellor to allow him to hold a referendum at a time when the chances of winning it were very low? It is quite possible that Brown, as Chancellor of the Exchequer, guarded the interests of the financial sector but it is unlikely that his negative assessment of the five tests a month later, in June 2003, was simply driven by a desire to undercut Blair's ambitions.

Britain and the Euro: The Policy ofNon-Decision

3

A better explanatory framework is needed to understand British policy on the

euro. I approach the question from a political economy perspective that takes into consideration the conflicting preferences of the business and financial sectors in explaining the government policy of non-decision on the euro.

Economic Actors and Monetary Policy This study, which highlights the influence of economic actors on monetary policy, contributes to restoring an imbalance in International Political Economy (IPE). Most of the research in this field focuses on the preferences and influence of economic actors on trade policy rather than monetary policy. The reason for the overabundance of studies in one area and scarcity in the other stems from the fact that scholars in political economy believe that economic actors are unable to exert pressure on monetary policy. The arguments advanced are that economic actors either do not understand how monetary policy can impact their interests or that they face collective action problems precluding them from influencing the government in this policy area. Stephen Krasner, John Odell, and Kathryn McNamara maintained that monetary policy is too complex to allow private actors to have clear preferences and to try to influence the government.' For example, Odell observed that, regarding United States international monetary policy, interest groups often acted contrary to what their interests would have dictated, which he attributed to the "esoteric nature of the subject of international monetary policy."4 In contrast, Joanne Gowa dismissed the idea that there exists an "intellectual barrier" preventing economic actors from grasping the consequences of monetary policy.5 She asserted, "International monetary policy should be no more intellectually inaccessible to the groups it affects than other issues, which are hopelessly obscure only to those without a clear stake in them."6 However, Gowa argued that although economic actors have clear preferences, the inherent "non-excludable" nature of exchange rates is a deterrent to collective action.' Because of the strongly held view of the inability of economic actors to hold and act on a clear preference when it comes to monetary policy, the advent of monetary union in Europe has not been extensively studied from a political economy perspective. As Bany Eichengreen and Jeffry Frieden regretted, "serious analysis of the distributional consequences of EMU is scarce."' Likewise, Stefan Collignon and Daniela Schwarzer noted that even though there is now a large literature on EMU, "[flew studies . . . have looked at the role of the private sector, especially the business and banking community."9 The reason for the lacuna in the literature on EMU is that political scientists have tended to explain the advent of European monetary integration from a realist perspective. They have presented the project of monetary union as a solution to contain the power of Germany within the EU or as a means to balance against the United States in the International System (IS). A main argument developed by Michael Baun, Robert Art, and Karl Kaltenthaler is that the reunification of Germany brought

to the forefront the "German question" again and that EU member states used EMU to ensure the commitment of Germany to European integration.'' Another argument based on concerns with relative power, advanced by David Andrews as well as economists Martin Feldstein and Charles Wyplosz, is that member states wanted to create a monetary system where all would have equal weight to replace the European Monetary System (EMS) that had become dominated by ~ e r m a n ~ Creating ." a rival to the US dollar and thus a counterbalance to American power is yet another realist explanation for EMU proposed by Kenneth Dyson and Kevin Featherstone, David Howarth, and George ~ o s s . ' ~ Only a few scholars have studied EMU from the perspective of domestic economic actors and have attempted to determine their position and role on the issue of monetary integration. Jeffry Frieden was the first to argue that "Europe's leading financial and multinational firms have been the stronghold of support for breaking down remaining barriers to EC financial and monetary integration."I3 Frieden, however, only presented what he himself described as "scanty evidence" in his 1991 article. This evidence was a study of the sectors likely to benefit from entry of Britain in the Exchange Rate Mechanism (ERM) and the fact that British membership of the pan-European Association for the Monetary Union of Europe (AMUE) consisted of internationally-oriented firms. Frieden contended, "[lln the absence of systematic empirical work, few serious assessments can be made, but the patterns are ~ u ~ g e s t i v e . "In' ~ a subsequent article, Frieden used proxy variables to determine the preference of economic actors on EMU." His conclusion was that "exporters of sophisticated manufactures and cross-border investors seem to support stable exchange rates."I6 Andrew Moravcsik also took into consideration the preferences and role of domestic econon~icactors in his book The Choice for Europe: Social Purpose and State Power from Messincr to Maastrrchl, where he tested two competing hypotheses to account for EMU and other European integration milestones: a geostrategic explanation and a political economy one. He rejected the main geopolitical arguments for EMU and found evidence supporting a political economy explanation. However, the influence of economic interests in his case study of EMU was also inconclusive, for he wrote: Although the evidence permits some tentative conclusions, in particular the rejection of ob.jective geopolitical factors in motivating the move to EMU, a more precise and reliable determination of the relative weights of economic interest and European ideology in each country must await the availability of more prirnary sources. In each country records of the preferences and tactics of business groups and the deliberation of national executives remain incomplete. Contrary to Moravcsik who tended to support Frieden, Kathryn McNamara directly contradicted the argument that the private sector was in favor of the development of EMU in her 1998 study of European monetary integration. She contended that economic actors are unable to assess the distributional consequences of different types of monetary regimes. She also argued that "microecocasts doubt on the view that the economic benefits of monen o ~ i ~ uncertainty ic

Britain and the Euro: The Policy ofNon-Decision

5

tary cooperation are compelling enough to stimulate strong and highly differentiated interest group pressures of the type proposed by Frieden, because the groups have trouble formulating and thus acting on a fixed and compelling preference."" She empirically tested Frieden's assertion that leading financial and multinational firms strongly supported European monetary union by conducting interviews with EU officials and business members of the AMUE. However, she found no evidence to support this claim. For example, she determined that the financial sector was not necessarily in favor of EMU, but divided. A single currency would cause some banking activities such as hedging and currency trading to suffer from a loss of business. Many banks, therefore, had reservations about monetary union. She also reported the inability of some multinational firms to determine their preference towards monetary union. Finally, she argued that membership of the AMUE was not an indication of actors' preferences. She asserted that many bankers joined the AMUE to be informed about EMU, not to lobby for it. British banks, for example, would be affected by the creation of a single currency on the Continent even if the UK was not in the euro zone. Banks joined precisely for this reason and not out of a desire to push for British membership. McNamara ultimately demonstrated that the AMUE is a problematic case study of actors' preferences and intentions because it originated as a political organization that sought the support of businesses and not the other way around. She characterized the organization as reactive to political decisions rather than proactive to trigger change. The association originated with the creation of the Committee for the Monetary Union of Europe (CMUE), a political initiative headed by former French President Valery Giscard d'Estaing and former German Chancellor Helmut Schmidt. In addition, the European Commission heavily funded the AMUE, another indication that it was mainly a political organization. From its creation in 1987 to 2001, the association received €2.7 million from the European omm mission.'^ McNamara looked for another explanation for EMU, as she found no evidence to support interest group theories. She argued, "To explain the evolution of European monetary integration, one must turn to government leaders and their beliefs about macroeconomic strategy."20 Her study, therefore, contributed to the literature on EMU based on the role of ideas in a constructivist tradition. In this type of analysis, the emphasis is still on the preferences of states, independent of pressures from domestic actors. The assumption is that states are influenced by each other through their increasing interactions and communications in the International System leading them to share macroeconomic beliefs. The European monetary union has been explained as the result of shifts in the economic policy preferences of major EU member states, mainly influenced by Germany. Francesco Giavazzi and Marco Pagano, David Andrews and Thomas Willet, Wayne Sandholtz, and Paul Pierson contended that EMU was favored by statesmen as a way to implement domestic austerity policies while strengthening credibility and avoiding political blame.*' Stefan Collignon and Daniela Schwarzer, in Private Sector Involvement in the Euro: The Power of Ideas, tried to address the disagreement between Frie-

den and McNamara regarding the preference and role of interest groups in the construction of monetary union. They asserted that "the business and banking community have indeed proactively pushed for EMU."'' They argued, however, that the distributional effect of EMU was an important motive accounting for these economic actors' advocacy for monetary union, but not a sufficient condition. Collignon and Schwarzer claimed that AMUE members were motivated by additional benefits to monetary union rather than just by material gains, such as political stability in Europe. Therefore, these actors were not simply pursuing rent seeking lobbying activities but rather contributing to a common good. Because the AMUE pursued an objective that could benefit many actors and established a wide network of relationships, the organization, according to Collignon and Schwarzer, served as "an epidemic community, allowing new ideas and evidence for the creation of EMU, and also as a forum for deliberation and as a point of crystallization for consensus on policy preferences."23 Collignon and Schwarzer concluded that business interests had an influence on the development of the monetary union as actors motivated by grand motives that happened to coincide broadly with the strategic interests of their firms.24 James Walsh in European Monefar)*Inregration and Domestic Politics took a different approach from other scholars in his comparative study that addresses the preferences of banking and industry on European monetary integration in three countries: Britain, France, and ltaly.*j Rather than relying on the involvement of firms in the AMUE, he surveyed the preference and lobbying of banks and business interests in each country from 1973 to 1998, i.e., from the negotiations on the European Monetary System to the negotiations on the Economic and Monetary Union. Walsh found support for the proposition that industry has a preference for exchange rate stability. His findings were also consistent with the hypothesis that the preference of banks over the stability of the exchange rate is determined by their ties with industry, which vary from country to country. In contrast, Mark Duckenfield in his study of trade associations in Germany and the United Kingdoni found that the position of business groups on EMU did not reflect the economic interests of their members but rather the official position of the g~vernrnent.'~Duckenfield argued that business associations are more likely to be influenced by the government than to exert influence in government policy choices. He stated, "[Tlhe direction of information and influence is often the reverse of what is conventionally posited."27 Political scientists who took into consideration business and banking interests when studying European monetary unification have not reached a consensus on their preferences and role in the project. A main reason for the lack of agreement on the issue is that the empirical data these scholars used were limited both in scope and time. They either only relied on the problematic case study of the AMUE or they only surveyed the opinion of trade associations and not of business firms directly. In addition, these studies, even the comparative ones by Walsh and Duckenfield, only focused on the period before the launch of the euro on January 1, 1999, although some member states, such as the United Kingdom, continued to have a national debate on the issue. The height of the debate on the

Britain and the Euro: The Policy ofNon-Decision

7

euro in the United Kingdom took place in the first term of Tony Blair, between 1997 and 2001. As many thought Blair intended to take Britain into the euro and would hold a referendum, the issue was highly debated and two national campaigns for and against the euro formed. These campaigns sought the support of business and financial interests. The expression of preferences and positioning of economic actors on the question of monetary integration were therefore very prevalent and easy to observe in the UK during this period.

Research Design This book takes at its point of departure IPE theories of economic actors' preferences on the level and stability of the exchange rate put forward by Jeffry Frieden and C. Randall Henning. Frieden posited that the business community will be divided on the issue of membership of a monetary union, with two specific groups of actors in favor and two groups opposed based on their inherent preference in the trade-off between exchange rate stability and monetary policy aut o n ~ mHenning ~ . ~ ~ added to Frieden's theory by contrasting the preferences of industry with those of banking and by paying specific attention to the ties between the two sectors.29Henning asserted that in credit-based systems, where industry relies on bank loans to finance its activities, banking will tend to support the position of its industrial clients on monetary policy. On the other hand, in capital market-based systems, where industry relies on equity financing rather than bank loans, industrial firms will lack the support of banking which will make it much more difficult for them to influence government policy. I use these theoretical models to derive and test hypotheses pertaining to the preferences and positioning of business and financial actors on British membership of the euro. The timeline of this study is December 1990 when the Maastricht Treaty negotiations opened to June 2007 when Blair stepped down from power after ten years in office. I document and analyze the evolution of economic actors' preferences over time, the lobbying activities that took place, and the way the Conservative government of John Major and then the Labour government of Tony Blair responded to the pressure of different interest groups. I use both secondary sources, such as the coverage of the euro debate in the business press, and primary sources in the form of business reports and position papers as well as original interviews with representatives from the business and financial sectors, former leaders and participants in the pro- and anti-euro campaigns backed by business interests, and representatives from the Bank of England. By undertaking a comprehensive longitudinal study of the preferences on the euro of economic actors in the United Kingdom, my research clarifies two highly debated issues in political economy: (1) whether economic actors are able to assess the distributional consequences of monetary integration on their welfare; and (2) whether they try to influence economic policy in a way that maximizes their interests.

8

Chapter I

The empirical data allow answering the two questions posed in the positive, but they reveal a more complex picture than anticipated in terms both of the preferences of economic actors and of {heir influence on government policy. I demonstrate that business and financial actors are perfectly able to determine how monetary policy changes are likely to affect their interests. As political economy theories predict, the business sector will be highly divided on the choice of monetary regime considered by the government according to the type of activity in which firms engage (production of tradable vs. nontradabie goods or services) and the market they serve (domestic or international). While the business sector will be quick to determine its preference on exchange rate regime, the financial sector will need more complete information to make a clear determination. Both sectors will try to press their views on the government although the lobbying activities of the business sector will be much more direct and visible than that of the financial sector. 1 demonstrate that the British government's precautionary policy of non-decision was a way to accommodate the need for more time required by the financial sector to clearly determine its interests while addressing the impatience of export-oriented firms to see the UK adopt the euro by providing alternative solutions to their concerns.

British Public Opinion As mentioned earlier, the impact of public opinion on government policy tends to be emphasized in many scholarly and journalistic writings pertaining to Britain and the euro. It is therefore necessary to explain why it is dismissed as a main explanatory variable in this analysis. Many argue that a referendum on the euro could not have been won because the British public is too reluctant to give up the pound sterling. Yet, studies have shown that although the majority of British people surveyed on the euro tend to be against it, public opinion on this issue is rather "soft," i.e., irresolute and open to persuasion.30 For example, in panel surveys conducted annually by the British Election Studies (BES) with the same respondents from 1999-2001, one third periodically changed their opinion on whether they favored the e ~ r o .In ~ 'addition, the polling institute MORl conducted public opinion surveys several times a year (fro111 1996 to 2004) that were more subtle than the traditional euro surveys asking a dichotomous supportloppose question and were very revealing. The MORI surveys asked respondents whether they: (A) strongly supported British participation; (B) were generally in favor but could be persuaded against if they thought it would be bad for the British economy; (C) were generally against but could be persuaded for if they thought it would be good for the British economy; or D) strongly opposed British participation. These surveys revealed that almost half of the British people regularly surveyed on the euro did not have a set opinion on the question but declared they were open to persuasion one way or the other.32MORI investigated the reasons for this lack of resolute opinion on the euro. The main reason identified was the fact that the public does not know enough about the

Britain and the E11ro: The Policy ofNon-Decision

9

issue.33The second most cited reason by respondents was that they do not understand economics." The conclusion of the MORl institute was that Blair could easily win a referendum on the euro if he made a strong economic case for it. Roger Mortimore and Simon Atkinson, the authors of a major report on British public opinion and the euro published by the Foreign Policy Centre, used the term "euro waverers" to describe the undecided respondents of the MORl Mortimore and Atkinson also polls who were potential voters in a referend~m.~' concluded that the large percentage of euro waverers made it possible for the government to win a referendum on the euro with an adequate campaign. They pointed out, "If all those opposed to the euro but prepared to change their mind are added to all those already in favour, they make up 61% of the public, so in theory the referendum is certainly winnable."36 In Who Are the Euro Waverers? Mortimore and Atkinson looked closely at the socio-demographic characteristics of the euro waverers, which were instructive in showing how the government could persuade the undecided group to vote in favor of the euro. For example, they argued that many of them have mortgages and would be sensitive to an interest rate argument. The report also estimated the number of people likely to go to the polls in each category (in favor, opposed, undecided), based on their answer to a question asking them whether they would vote, might vote, or would be unlikely to vote in a referendum. A relatively high turnout-about 70 percent, which is not untypical of referenda-would be determinant because the waverers, which would be the section of the public the government would need to target in a pro-euro campaign, were more numerous among those declaring they might vote in a referendum. The report concluded that a well-run government campaign, able to appeal to those generally in favor of the euro and convince about half of those generally opposed but open to persuasion, would result in a positive outcome. A poll conducted by MORl in September 1999 indicated how euro waverers would form their opinion on the euro in the event of a referendum. The survey asked respondents what source of information they would most trust on the question of whether the UK should join the euro. Surprisingly, that source was not the press: only 9 percent selected "the newspaper I read" as a trustworthy source of opinion on the euro. This finding disproved another popular argument that Blair did not hold a referendum on the single currency because he was terrified of the Murdoch press which was very hostile to British participation in EMU and could influence public opinion. The British people, although they are quite fond of the Murdoch press-as one can observe when riding the tube in the morning where almost all passengers are reading one of the famous tabloidsare well aware that this press is biased and they would not simply base their vote on the opinion expressed in these papers. Interestingly, rnajor banks and representatives of large businesses were among the top choices of sources whose opinions respondents would most trust on the euro.." However, it was revealed that the public does not value the opinion of representatives of small businesses (which formed the bulk of the anti-euro coalition) to the same extent, as only 1 percent selected this category.38Accordingly, if Tony Blair had had behind him

10

Chapter I

a coalition for the euro comprising big businesses, he would have been likely to tilake a successful case for adopting the single currency. Surprisingly, such a coalition was in place in 1999, ready to support Blair in forging ahead with the euro. Even more surprising, Blair also had the support of the trade unions so that both major employers and employees' representatives were behind the project of the euro in Britain. Longitudinal public opinion polls also show that there were several windows of opportunity or critical times when it would have been easier to make a strong case for British membership of the single currency and win a referendum, which the British government did not take advantage of. The British public, for example, was most open to being convinced of adopting the euro during the first term of Tony Blair. At that time, a large percentage of respondents declared that they were generally against the euro but could be persuaded if the government made a strong economic case for it.39In addition, Blair's popularity was very high in the first part of his first term, standing at about 60 percent in 1999.~' While the popularity of the Prime Minister subsequently declined, it rose again in the aftermath of the 911 1 attacks on America due to his command during the international crisis." In late 2001, Blair's popularity was close to 70 percent, which provided him with another opportunity to make a strong convincing case for the e ~ r oThe . ~ MORl ~ polls also show that during this period, the number of people stating their strong opposition to the euro had d i m i n i ~ h e d . ~ ~ Finally, the last referendum on Europe, the 1975 referendum on whether the United Kingdom should remain in the European Economic Community, has shown how public opinion can change when a strong campaign is launched by the British government with the support of the business community.44 While polls conducted prior to the referendum indicated that public opinion was strongly opposed to remaining in the EEC, the majority of people voted in favor when they went to the voting booth. The turnaround was attributed to the successful campaign by the government-with the support of business-in favor of continued membership in the EEC. The Foreign Policy Centre, in two reports on the lessons from the 1975 referendum, showed how the government could apply the same techniques to win a referendum on the e ~ r o . ~ ' Scholars who have looked in depth at the question of British public opinion on the euro have also reached the same conclusion as the think tanks and polling institutes cited above. David Howarth examined the relevance of leading explanations for the government policy on the euro and found that those based on public opinion can be more easily disproved than those based on pluralist intere s t ~~.o~w~a r t hpointed out that the strategy of the Conservatives of running on an anti-euro platform failed to win them many votes in the 2001 general election, proving that the public was not highly concerned about the euro. As a matter of fact, European integration is never on the top of the list of issues that British citizens cite as important to them in the run-up to the general election. They are more concerned about education or health care. In addition, Howarth noted that when polled, a very large majority of respondents (74 percent) declared it very or fairly likely that Britain would adopt the euro in the next five years, contra-

Britain and the Euro: The Policy of Non-Decision

II

dicting the strong opposition often assumed and revealing the "softness" of public opinion on this issue. Howarth also rejected the claim of the "unique features of British democracy and policy making as somehow more responsive to public opinion."" He contended that this has not been the tradition of British democracy and argued that the commitment of both parties to holding a public referendum on the euro had little to do with their concern about popular sovereignty but more with party politics.4s The political resources necessary to win a referendum on the euro could have been mustered but were never put in place. Matthew Gabel and Simon Hix also acknowledged that British public opinion on the euro was malleable and that party leaders and the business community could have turned around public opposition to the e ~ r oIn. their ~ ~ analysis of Eurobarometer and BES surveys, they found that perceptions of the EU and level of information on the euro of respondents affected their position on British membership of EMU. Gabel and Hix explained that information decreases the uncertainty of opinion about euro membership. Gabel and Hix contended, "If someone has low information about the single currency they are likely to be less certain in their opinions. Their attitudes are relatively unstructured by systematic causes and are therefore more variable."50 Therefore, information on the euro provided by the government and trusted sources such as large businesses as well as a positive portrayal of the EU would have been crucial in a referendum, which is what was in place with the "Britain in Europe" campaign. Neither public opinion nor the Murdoch press kept the British government from holding a referendum on the single currency. Public opinion polls conducted regularly in the UK and the experience of the 1975 referendum reveal that the British public could have been convinced of the necessity of forgoing the pound. The British government had big businesses, labour unions, and, with a little work, the public behind it to take Britain into the euro zone. However, there was one sector missing from the euro-enthusiastic coalition that led the government to be indecisive rather than to embrace the European single currency: the financial sector. Contrary to the internationally-oriented business community, which had a clear and unambiguous preference for the euro, the financial sector called for the government to adopt a cautious attitude.

Summary and Overview In the chapters that follow, I demonstrate that the policy of non-decision on the euro can be explained through an analysis of the conflicting preferences of the business and financial sectors which the government tried to address. The book is divided in three parts. The first part consists of a presentation of the theoretical framework that guided the study and of a description of the structure of the British economy, which are both necessary to understand the chapters that follow. Chapter 2, "Economic Actors and Monetary Policy," introduces theories of interest groups preferences towards the level and stability of the exchange rate developed by Jeffry Frieden and C. Randall Henning. These theories allow us to

derive hypotheses about the initial preference of economic actors on the question of British membership of the euro zone. 1 contend, however, that economic actors will alter their stated preference over time. Only a longitudinal study, therefore, can allow us to differentiate between strategic positioning and findamental preferences. Chapter 3, "The Structure of the British Economy," provides a brief historical overview of the economic landscape in Britain which features a thriving financial sector, the City, contrasted with a manufacturing sector that declined and became increasingly foreign-owned. This chapter also contains a description of the main trade associations in the business and financial sectors. The second part of the book focuses on the government policy on EMU from 1990 to 2007. Chapter 4, "The Conservative Party and EMU," surveys and analyses the Conservative government's position on EMU from December 1990, when the negotiations for the Maastricht treaty opened, to the May 1997 general election, when the Conservatives lost to New Labour. In order to understand the context in which John Major had to negotiate with his EU counterparts over the controversial issue of EMU, the policy of the Thatcher government is also included as a background. Chapter 5, "The Blair Years and the Euro," covers the policy of the Blair government on the euro from the election of Tony Blair as Prime Minister in May 1997 to June 3007 when he stepped down after having served three terms in office. I demonstrate that the policies on the euro of the Conservative and Labour governments were very similar, contrary to what has been claimed. They aimed at addressing the conflicting demands of the business and financial sectors at home while minimizing adverse developments and commitments at the EU level. The third part presents detailed empirical findings regarding economic actors' preferences on the euro and evidence of their influence on government policy. Chapter 6, "Business and the Euro," presents data on the division on EMU within the business community (defined as non-financial corporations). First, the chapter addresses the position on EMU of the three main British trade associations-the Confederation of British Industry, the Institute of Directors, and the Federation of Small Businesses-during the time period under study. The second part of the chapter provides an historical account of the pro- and antieuro campaigns supported by business interests while a third part traces the lobbying activities by large multinationals acting in their individual capacity. This chapter highlights the way the government responded to the demands of these economic actors. Chapter 7, "The City and the Euro," focuses on the preferences and positioning of the London financial sector (a.k.a. the City) on British membership of the euro. The chapter documents the initial concerns about EMU among financial institutions, which were quickly resolved and followed by the realization that it would be more advantageous to the City if Britain stayed outside of the euro zone. This chapter demonstrates the City's attempts at influencing the government policy on EMU both through direct and indirect pressure. Chapter 8, "Conclusion," highlights the empirical findings and their theoretical implications. This book clarifies an important point often disputed in

Britain and the Euro: The Policy ofNon-Decision

13

the literature on special interests and monetary policy: the empirical data demonstrate that economic actors are able to assess how monetary union would affect them, i.e., they have clear preferences, and they lobby accordingly. The data demonstrate, however, that when business actors that could benefit from a monetary union are not supported by the banking sector, they have difficulty being highly influential on government policy. This finding supports Henning's thesis that in capital market-based systems, the preference of banks and not o f industry is determinant in monetary policy. It also accounts for the difference o f government policy towards monetary union in the UK and in other EU member states. When bank-industry ties are measured across Europe, Britain stands out as remarkably different from its counterparts on the Continent, where industry relies on bank lending. The fact that, in Britain, the preference o f finance trumped that of export-oriented business interests on the issue of monetary union can be explained by the structure of the British economy. The careful analysis o f the policy of non-decision on the euro provided in these pages reveals the traditional unequal influence on the British economy of business and finance.

Notes 1. David Mowarth, "The Domestic Politics of British Policy on the Euro," Journal of European Integration 29, no. I (March 2007): 47-68.

2. Andrew Grice, "Blair Offered to Stand Down if Brown Supported Euro Referendum," The Independent, May 22, 2003, www.independent.co.uWne~~sluk/politics/ blairo f f e r e d - t o - s t a n d - d o w n - i f - b r o w n - s u p p o r t e r e n d u m - 5 3 8 8 6 6 . h t m (accessed May 20.2009). 3. Stephen Krasner, "United States Commercial and Monetary Policy: Unravelling the Paradox of External Strength and Internal Weakness," in Between Power and Plenty: Foreign Econotnic Policies of Advanced Industrialized States, ed. Peter Katzenstein (Madison, Wis.: University of Wisconsin Press, 1978); John Odeil, U S . International Monetary Policy: Markets, Power, and Ideas or Sources of Change (Princeton, N.J.: Princeton University Press, 1982); and Kathryn McNamara, The Currency of'fdeas: ~\,loneraryPolitics In the European Union (Ithaca, N.Y.: Cornell University Press, 1998). 4. Odell, U,S,International hlonetaty Policy. 5. Joanne Gowa, "Public Goods and Political Institutions: Trade and Monetary Policy Processes in the United States," in The State and American Foreign Policy, ed. John Ikenberry, David Lake, and Michael Mastanduno (Ithaca, N.Y.: Cornell University Press, 1988). 15-32. 6. Gowa, "Public Goods and Political Institutions," 19. 7. Gowa, "Public Goods and Political Institutions," 27. 8. Barry Eichengreen and Jeffry Frieden, eds., The Political Economy ofEuropean hlonetary Unification (Boulder, Colo.: Westview Press, 2001), 10. 9. Stefan Collignon and Daniela Schwarzer, Private Sector Involvement in the Euro: The Power ofldeas (New York: Routledge, 2003), I . 10. Michael Baun, "The Maastricht Treaty as High Politics: Germany, France, and 1;uropean integration," Political Science Quarterly 110, no. 4 (Winter 1995-96): 605-24;

14

Chapter I

Robert Art, "Why Western Europe Needs the United States and NATO," Political Science Qriarterly l l I, no. 1 (Spring 1996): 1-39; and Karl Kaltenthaler, Germany and the Politics ofEurope's hloney (London: Duke liniversity Press, 1998). 11. David Andrews, "Germany, Maastricht and EMU: The Limits of Integration 'Thcory" (Paper presented at the annual convention of the International Studies Association, Atlanta, Ga., April 1-4, 1992); Martin Feldstein, "The Political Economy of the European Monetary Union: Political Sources of an Economic Liability," Journal of Economic Perspectives I I, no. 4 (Fall 1997): 23-42; and Charles Wyplosz, "European Monetary Union: Why and How it Might Happen," Journal ofEconomic Perspectives 11, no. 4 (Fall 1997): 3-22. 12. Kenneth Dyson and Kevin Featherstone, The Road to Maastricht: Negotiating Econonzic atrd Monetary Union (Oxford: Oxford University Press, 1999); David Howarth, The French Road to European Alonetary [Jniori (1,ondon: Palgrave, 2001); and George Ross. "Monetary Integration and the French Model," in Euro and Europeans: European !\.lo~ietarj~Integration and the European Model of Society, ed. Andrew Martin and (jeorge Ross (Cambridge, Mass.: Canlbridge University Press, 2004), 76-102. 13. Jeffrp Frieden, "lnvested Interests: The Politics of National Economic Policies in a World of Global Finance," International 01-gunization45, no. 4 (Autumn 1991), 441. 14. Frieden, "Invested Interests," 448. 15. Jeffry Frieden, "Real Sources of European Currency Policy: Sectoral Interests and European Monetary Integration," Internatrotial Organization 56, no. 4 (Autumn 2002): 83 1-60. 16. Frieden, "Real Sources of European Currency Policy," 856. 17. Andrew Moravcsik, The Choice jbr Europe: Social Purpose and State Power fi-om iltessina to btaastricht (Ithaca, N.Y.: Cornell University Press, 1998), 428. 18. McNamara, The Ctirrency of'ldeas, 37. 19. AUME, 2001 ilnntial General Aleeting ,\Iinutes, Archives Nationales, Paris. 20. McNamara, The Currency ofldeas, 4 1. 2 1 . 1:rancesco Giavazzi and Marco Pagano, "The Advantages of Tying One's Hands: EhIS Discipline and Central Bank Credibility," European Monetary Review 32, no. 5 (Sune 1988): 1055-075; Wayne Sandholtz, "Choosing Union: Monetary Politics and Maastricht," ltrternational Organization 47, no. I (Winter 1993): 1-39; Paul Picrson, "'l'he Path to European Integration: A Historical Institutionalist Analysis," Comparative Political St~rdies29, no. 2 (April 1996): 123-63; and David Andrews and Thomas Willett, "Financial Interdependence and the State: International Monetary Relations at Century's End," International Organization 5 1, no. 3 (Summer 1997): 479-5 1 1. 22. Collignon and Schwarzer, Private Involvement in the Etrro, 7. 23. Collignon and Schwarzer, Private Ir~volvenret~t in the Euro, 21. 24. It is important to note that Collignon and Schwarzer's study was commissioned and funded by the AMUE, according to the archives of the association located in the National Archives in Paris, France. In addition, the authors are former staff members of the association: Collignon is the former Director for Research and Communication while Schwarzer is the former Head of the Information Department of the AMUE. 25. James Walsh, Europeatl A,lonetary Integration and Domestic Politics: Britain, France, andltaly (Boulder, Colo.: Lynne Rienner, 2000. 26. Mark Duckenfield, Business and the Euro: B~rsinessGroups and the Politics of EAfU in Gertnany and the United Kingdom (New York: Palgrave, 2006). 27. Duckenfield, Business and the Etlro, 16. 28. Friedcn, "lnvested Interests."

Chapter 2

Economic Actors and Monetary Policy Studying the preferences of business and finance on a policy issue dealing with their concerns about the level and stability of the exchange rate is not an easy task. The researcher is likely to encounter hurdles pertaining to the difficulty of capturing the fundamental preference of economic actors rather than their strategic positioning. The first step should therefore consist in using economic theory to deduce preferences. This will guide the researcher with "some prior way of establishing which firms are expected to hold which preferences."' The fundamental preferences of economic actors are likely to be revealed earlier in the policy debate when all options seem open. Recent scholarship has demonstrated that after some time, the preference of economic actors on a particular policy issue may change.2 For example, Jonathan Crystal argues that economic actors wishing for a particular outcome may eventually realize that the "expected utility" of continuing to press for their favored solution has greatly diminished and may therefore stop fighting for it.3 Other scholars, such as David Steinberg or Cornelia Woll, contend that economic actors may change their stated preference after a response of the government to their concerns in the form of direct compensation or implementation of policy alternatives that fulfill the same fundamental preference.4 It is also likely that economic actors who obtained their preferred outcome alter their stated preference, veering to neutrality, so as not to advertise any influence they might have had on the government, especially if the policy in question was controversial. Because the stated preference of economic actors will evolve over time, the only way to clearly differentiate their fundamental preference from their strategic positioning is to undertake a longitudinal study. When trying to identify the preferences of business and financial interests on a particular issue, it is very important not to rely solely on the position of trade associations but also to survey individual firms directly. Mark Duckenfield recently demonstrated that trade associations are political entities that sometimes have their own strategic goals and are not mere "transmission belts of firm prefe r e n c e ~ . "Therefore, ~ there is an inherent problem in trying to explain business preferences by focusing solely on trade associations' positions, as they may provide a distorted view. The position of trade associations on a policy issue must 17

18

Chapter 2

be complemented by additional data revealing of the opinion of their members. In this study, therefore, 1 survey the position on British membership of the euro of the main trade associations in Britain but also of individual firms through their involvement in the euro campaigns and through direct lobbying activities. A comprehensive overview of business opinion will allow for a better understanding of firms' fundamental preferences and strategies. Another important principle is that the researcher must employ a variety of sources in order to accurately trace the fundamental preference and strategic positioning of economic actors. Sources will have to be different for the business and financial sector. For the business sector, the researcher can investigate donations to political organizations, involvement in campaigns, threats and complaints through petitions and press releases, and position papers, in addition to conducting interviews. The lobbying activity of industry will be easier to observe than that of the financial sector which is not as open. Financial institutions are less likely to make open statements, engage in public threats, or make donations to not-for-profit organizations. Banks will often make their preferences known to the government through expert advice, as they have a more direct access to the ministries concerned. C. Randall Henning argued that there is an intrinsic difficulty in studying the preferences of banking: The communication between private banks and governments on sensitive financial matters such as foreign exchange is generally highly confidential and closely guarded. As a result, access to direct evidence of the influence of banks over governments in this secretive policy domain is restricted. There is nonetheless a significant body of accumulated evidence that suggest that bankindustry relations, bank preferences, and bank influence have affected policy outconies Therefore, gaining access to reports intended for circulation within the ministries dealing with monetary policy will be critical as will interviews with representatives from the financial sector.

Political Economy Theory: Economic Actors and the Exchange Rate Contrary to many scholars who argue that economic actors are unable to have a clear preference and determining influence on monetary policy, Jeffry Frieden asserted that firms have clear preferences when it comes to the level and stability of the exchange rate and that they will pressure the government to implement their most preferred policy.7 In his famous 1991 International Organization article "Invested Interests: The Politics of National Economic Policies in a World of Global Finance," Frieden reflected on the monetary policy choices that states face in a world where capital increasingly flows freely. According to the well-

Economic Actors and Monetary Policy

19

known Mundell-Fleming model, governments cannot achieve exchange rate stability, capital mobility, and monetary policy autonomy all at the same time.' Only two of these goals can be met and one must be sacrificed. However, when there is high capital mobility across borders as in today's world economy, the choice left to states is between exchange rate stability and monetary policy autonomy. Frieden argued that some economic actors would privilege the first goal while others would be keener on seeing the state achieve the latter. Frieden asserted that two groups of economic actors would favor exchange rate stability over national monetary policy autonomy: international traders and investors, and producers of export-oriented tradable goods.9 Exchange rate volatility is most detrimental to companies dealing with international trade or payments, as it involves additional risk and potential costs. Hedging as a protection against uncertainty still carries a cost and companies prefer a fixed exchange rate so as not to worry about currency fluctuations. Another reason why internationally-oriented companies value a fixed exchange rate over monetary policy autonomy is that they are not as sensitive to domestic economic conditions since their main markets are abroad. The state's ability to increase or depress domestic demand through national monetary policy is therefore not a crucial concern. Frieden also identified two groups that would have opposite preferences regarding the choices between a fixed exchange rate and government monetary policy autonomy. One group is producers of import-competing tradable goods for the domestic market that are mainly concerned with local demand and not adversely affected by exchange rate volatility. Frieden noted that this group might even benefit from exchange rate volatility as it makes importing riskier and therefore limits foreign competition. In addition, producers of nontradable goods and services, i.e., goods and services that are neither traded intemationally nor affected by foreign prices, will also care more about national monetary policy autonomy than exchange rate stability.'' In addition to the preference of socio-economic actors towards the stability of the exchange rate, Frieden included another dimension in his model: their preference regarding the level of the exchange rate or the value of the national currency. A depreciated currency is the optimal choice for producers of tradable goods because depreciation makes their products cheaper relative to foreign ones. Exports will therefore be more competitive. For the same reason, importcompeting tradable producers will also favor a depreciated currency. The price of imports will be higher than the price of goods produced locally, raising the attractiveness of national products. On the other hand, international investors will prefer an appreciated currency that lowers the price of foreign assets they want to acquire. Nontradable producers will also prefer an appreciated currency because, as Frieden explained, "From a differential distributional standpoint, the lower (more depreciated) the exchange rate, the higher is the price of tradable goods relative to nontradable goods. This of course, tends to help producers of tradable goods-whose output prices rise more than the prices of the nontradable inputs they use-and to hurt producers of nontradable goods."'1

Chapter 2

20

In a subsequent article, Frieden qualified his model by arguing that for exporters, there is inherently a trade-off between "stability and a predictable currency value, on the one hand, and the flexibility to alter currency values to facilitate competition with foreigners, on the other."" This trade-off would affect exporters differently depending on the type of goods that they export. One particular type of exporters-specialized product-differentiated manufactured goods producers-would be strongly in favor of exchange rate stability because they are "exporters of goods with limited pass-through, that is, goods whose prices to consumers do not fully reflect exchange rate movements, usually due to substantial product differentiation."I3 These exporters are more reluctant to vary their prices to reflect exchange rate changes and therefore bear the brunt of the cost of exchange rate volatility. Frieden gave the example of the automobile industry, which tends to price its products according to local market conditions, i.e., a Japanese car exporter will maintain the same prices in the United States even if the yen appreciates against the dollar for fear of losing market share. In contrast, standardized product manufacturers have a high pass-through, that is, their prices immediately reflect exchange rate changes. They can therefore greatly benefit from depreciation. These exporters, Frieden hypothesized, would be opposed to fixing the exchange rate.14 Figure 2.1. Frieden's Model

I Appreciated c;;rency

/

Flexible Exchange Rate

) Producers of nontradable

I

goods and services

I Fixed Exchange Rate I International traders and

I

investors

I

Import-competing producExport-oriented producers ers of tradable goods for the of tradable goods* domestic market Source: Jeffry Frieden, "Invested Interests: The Politics of National Economic Policies in a World of Global Finance," lnternational Orgut~izution45, no. 4 (Autumn 1991), 445. Depreciated Currency

*

/ti 2002 Frreden argued ihai only prodrrcers of highly specralrzed goods would favor a fired exchutrge rate m !lie trude-oflbehoren ~ i u b i l r yund the possrbrlry ofdeprecrairon

Even though Frieden proposed a very comprehensive theory of special interests and the exchange rate, he did not consider the preferences of the financial sector in his model. We have to turn to another scholar, C. Randall Henning, for insight on this sector. Henning contrasted the preference of industry with banking on the level and stability of the exchange rate.'' He posited that the extent to which banks would favor participating in a fixed exchange rate regime would depend on the performance of the national central bank in keeping inflation down. Banks prefer low inflation because a higher rate will affect the spread between the prices of their liabilities and the returns on their assets. If national

Economic Actors and Monetary Policy

21

policy makers pursue a loose monetary policy, banks will favor participation in a monetary regime that decreases inflationary tendencies. If the domestic monetary policy is satisfactory, banks will prefer that the state maintain domestic monetary policy autonomy, as they are not highly concerned with stability of the exchange rate. Henning asserted that banks, contrary to producers of tradable goods, can protect themselves more easily from exposure and can even profit from currency volatility. Indeed, some international activities, such as foreign exchange or futures and options trading, directly benefit from volatility. Nonetheless, Henning argued that the extent to which this aspect affects banks' aversion for fixed exchange rates should not be exaggerated because currency unions still leave room for volatility and the use of hedging. However, in a monetary union where exchange rate risk is completely eliminated and hedging rendered obsolete, the loss of business from volatility may be a more important concern to banks. As far as the level of the exchange rate is concerned, Henning inferred that banks generally tend to favor an appreciated currency. Banks engaged in international activities or with a substantial foreign assets portfolio will see additional actual and perceived benefits in currency appreciation. International bankers, for example, will be concerned with the international use of the domestic currency, both for the benefit of their institution as well as for the status of the financial sector in which they operate. An appreciated currency is more likely to be used internationally than a depreciated currency and should therefore be favored. The preference of banks towards the level and stability of the exchange rate, however, is likely not to be very strong, according to Henning. Banks with limited international exposure often will be more preoccupied with other pressing problems, such as domestic economic conditions or financial regulation, than with the level of the exchange rate. Even for large banks engaged in international activities, the preference for a strong currency might not be overriding because the exchange rate level might not affect all bank activities equally. Henning argued that "bank preferences in general are variable, highly situationally dependent, and typically not held with high intensity" especially regarding exchange rate flexibility, but also as far as the exchange rate level is concerned. l6 Henning argued that contrary to banking, industry has an "unambiguous and high intensity preference" towards the level and flexibility of the exchange rate. Concurring with Frieden, Henning contended that manufacturing would be concerned with the level of the exchange rate and prefer a depreciated currency. Multinationals would be a little different in that they would prefer an appreciated currency when they are in the process of acquiring assets abroad and a depreciated currency once they have made the investment. An appreciated currency would make purchase of assets cheaper while a depreciated currency would increase the income raised from these assets. As far as the flexibility of the exchange rate is concerned, Henning also agreed with Frieden that most producers would prefer a stable exchange rate.'' Henning argued that the principal

Chapter 2

22

means of escaping a fluctuating exchange rate, hedging, is costly and not always available to cover some types of exposure. Shifting production to avoid an unfavorable exchange rate is also costly and problematic because "exchange rate fluctuations and realignments often occur more quickly than productive facilities can be shifted abroad."" However, moving production to a monetary union where exchange rate risk is completely eliminated might be more desirable and realizable. Henning, contrary to Frieden, only took into consideration the preferences towards the exchange rate of industrial manufacturers rather than the tradable sector in general. He justified this conscious choice by stating that industrial manufacturing represents the largest share of total trade in advanced countries and is therefore one of the most important sectors of the economy. Henning did not take into consideration the nontradable sector, whose preferences on exchange rates will be opposite to that of the tradable sector. He argued that the nontradable sector has diffused interests towards the exchange rate because it is too large and will therefore not get organized to lobby for its preferences, contrary to the tradable sector. Henning chose to concentrate on banking and the manufacturing industry because these two sectors "when unified, constitute the most powerful institutional nexus in the political economy of advanced countries. Thus there is diminishing value in mapping the preferences of additional sectors."19 Henning, therefore, provided a simplified model of bank and industry preferences towards the exchange rate in which banks typically occupy the appreciated currencyiflexible exchange rate quadrant while industry generally occupies the opposite depreciated currency/fixed exchange rate quadrant. Hence, the preferences of banks and industry are diametrically opposed.20However, Henning introduced a difference in preference intensity of the two sectors: banks' preferences for the level and flexibility of the exchange rate are mild and ambiguous, while industry preferences are strong and unambiguous. Figure 2.2. Henning's Model

.

A P P ~ ~

.

I Flexible Exchange Rate

Depreciated Currency

I

Fixed Exchange Rate

I

I

Export-oriented Industry (Slrong and Unambiguous)

* Preference mtrtwiiy indrcated in I/alic Source: C. Randall tlenning, Currencies and Politics in the United States, Germany, and Japan (Washington, D.C.: Institute for International Economics, 1994).

Ecotzomic Actors and Monetary Policy

23

While Frieden asserted that the preferences of export-oriented industry would explain a move towards a fixed exchange rate by the government, Henning argued that the extent to which industry manages to have its preferences taken into consideration by national policy makers would depend on the interest that banks take in industry's success or, more simply put, on whether there are strong ties between industry and the banking sector. In credit-based systems, where industry relies on bank lending over equity financing, banks, which have a mild preference opposite to that of industry, will shift their preference to support the conditions most beneficial to industry. Indeed, the reliance on bank loans by industry creates a situation of mutual dependence. As banks are likely to be affected by the ability of businesses to repay their loans, they will lobby for an exchange rate scheme favorable to industry because their prosperity is directly tied to the performance of their industrial clients. A congruence of interests, therefore, takes place as banks' preferences move into the fixed exchange rateldepreciated currency quadrant. The support of banking broadens the private sector coalition and "facilitates the coherent articulation of those preferences to responsible officials in the government."2' It also allows industry's voice to be heard by providing the appropriate channels of access to policy makers. Indeed, Henning posited that finance ministries and central banks would be particularly sensitive to the demands of the banking sector over that of other sectors of the economy: The banking community is the natural client of finance ministries and central banks. In turn, ministries and central banks rely on banking institutions in numerous ways: as the channel through which monetary policy affects the real economy, as financiers and distributors of government debt, and as a bureaucratic raison d'&trefor regulation and supervision. Finance ministries and central banks, for all these reasons, must be sensitive to the health and needs of banking institution^.^^ In capital market-based systems, where industry raises revenue on the capital market rather than by borrowing from banks, banks will not be sympathetic to industry's preferences. In addition, in a capital market-based system, banks will tend to engage in international activities. Henning asserted that "[blanks that have been desintermediated from corporate finance have looked to the international arena as an alternative source of income."23 Therefore, banks in a capital market-based system will be more concerned about the international use of the national currency than banks in credit-based systems and more strongly opposed to the fixed exchange rateldepreciated currency preference of industry. As a result, industry and banking preferences will be found in their respective opposite quadrants. Without the support of banking, "the private sector will speak with many voices and will therefore be less coordinated and less effective."*"n that case, Henning argued that private sector lobbying will experience collective action problems because the benefits of a fixed exchange rate are nonexcludable and nonappropriable. In addition, industry's access to the govern-

24

Chapter 2

ment will be limited to ministries such as trade that are not directly involved in monetary policy.

Economic Actors and British Membership of the Euro Frieden's and Henning's models account for the preference of economic actors between a fixed exchange rate system and a flexible exchange rate system. However, we can apply them to the choice a state faces between joining a monetary union and conserving its national currency, which will divide economic actors according to the same preference: stability of the exchange rate vs. national monetary policy autonomy. From these models, therefore, we can predict the initial preference of business and finance on the issue of British membership of the euro. The hypotheses generated from the models can then be checked against the empirical data. With EMU, the choice of economic actors is between monetary policy autonomy and elimination of exchange rate risk with one major trade bloc, the European Union. Therefore, producers of highly specialized productdifferentiated goods that export mainly to Europe should be strongly in favor of EMU. Producers of standardized goods that export mainly to the Continent should be against joining the single currency. However, producers of standardized goods that export mainly to the United States and dollar-linked economies, the second largest market of the UK, should favor EMU because the euro is usually less appreciated against the dollar than sterling. Both import-competing producers of tradable goods for the domestic market should be against EMU even though the pound is appreciated against the single currency because of their overriding concern with national monetary policy autonomy. Actors that benefit from an overvalued pound should be against EMU as well. Nontradable producers of goods and services that benefit from the differential between the prices of tradable and nontradable goods should be opposed to the single currency. Table 2.1. summarizes expectations based on Frieden's model. I added another category that benefits from an overvalued pound which was not included in Frieden's model, retailers, who can import cheap products from the euro zone to be sold on the domestic market. As we will see in the following chapter, the United Kingdom is a capital market-based system where industry relies on equity financing rather than bank loans to finance its activities. Therefore, the financial sector should have defined its preference on the issue of euro membership independently of its effect on industry. It should have effectuated a careful cost-benefit analysis geared toward its interests; that is, the pursuit of low inflation, and should have favored a wait and see approach to assess whether the policies of the European Central Bank (ECB) led to lower inflation rates in the euro zone than at home. Incidentally, the UK has fared better than the euro zone in terms of its inflation performance." Since the Bank of England (BoE) was granted operational independence

Economic Actors and Monetary Policy

25

in 1997, it has been highly successful in keeping inflation under its 2.5 percent inflation target as measured by the Retail Price Index (RPIX).'~As the BoE thrived in keeping inflation down compared to the ECB, the banking sector should have become increasingly opposed to EMU. In addition, banks should have evaluated the opportunity costs of joining such as the loss of the international use of the pound sterling or loss of revenue from hedging. As the UK is home to many international banks dealing in foreign exchange and derivatives trading, we would expect the opportunity costs of joining to be high. Table 2.1. Predictions based on Frieden's 1991 Model (with 2002 addendum) For Membership of the Euro

Against Membership of the Euro

Producers of specialized productdifferentiated goods exporting mainly to the euro zone

Import-competing producers of tradable goods Producers of non-tradable goods and services

Producers of standardized goods exporting mainly to dollar-linked areas

Producers of standardized goods exporting mainly to the euro zone

(

Retailers

Table 2.2. Predictions Based on Henning's 1994 Model For Membership of the Euro

Against Membership of the Euro

Export-oriented Industry (Strong preference)

Banking (Mildpreference becoming stronger after evaluation of ECB inflationary performance)

The empirical chapters that follow will show that the business sector was divided on the issue of the single currency exactly as Frieden's model predicted. Export-oriented business firms expressed a clear preference for adoption of the euro in Britain while the nontradable sector and import-competing producers of tradable goods were opposed to it. Two campaigns backed by business interests, a pro-euro campaign "Britain in Europe" and an anti-euro campaign "Business for Sterling," reflected this division. In addition, trade associations initially took different positions according to the composition of their membership while large foreign-owned multinationals pursued lobbying activities on their own. As for the financial sector, it took a while to determine where its interests lay, in or out

26

Chapter 2

of the euro zone. Although the future inflationary performance of the ECB was a concern to the financial sector, its main worries had more to do with the monetary policy tools that would be used by the new central bank, as we will see. The financial sector was at first very cautious on the question of the euro. After all the features of the ECB were determined, however, it became clear to financial institutions that they would benefit more if the U K retained its national monetary policy. I will demonstrate how the policy of non-decision of the British government served to reassure the export-oriented industry in favor of the euro while buying time to allow finance to clearly determine its preference. The Labour government, which was keen on being trusted on the economy, had to take into consideration the City's concerns but was also fretful of massive disinvestment by multinational corporations, which would lead to a rise of unemployment in Britain's industrial regions. The strategy of the government confronted with conflicting demands-the impatience of export-oriented industry to see the UK in the euro zone and the request from the financial sector that no rushed decision be taken-was to adopt an ambiguous policy. The government strategy of "buying time" allowed for changes to occur that ultimately lessened the demands of export-oriented firms. Some of these changes were exogenous, such as compensations provided by the government in the form of subsidies and implementation of a monetary policy that is more advantageous to international trade. Other changes were endogenous to exportoriented firms, such as adaptation to doing business outside of the euro zone through new accounting practices. The result of these changes is that while the export-oriented business sector was very adamant about the need for Britain to adopt the euro in the late 1990s, its revealed preference shifted. By the third term of Tony Blair, the division on the euro within the business community had faded. Export-oriented firms stopped worrying about British membership of the European single currency and declared satisfaction with the status quo. Frieden's classification of economic actors' preferences towards the exchange rate thus would not apply anymore in this time period. A researcher surveying the position of business actors on the euro today would therefore conclude that they have no clear preference and that they do not attempt to influence government policy. This clearly demonstrates the need for a longitudinal study that takes into consideration a variety of actors over a long period of time using mainly primary sources.

On Preferences and lnfluence Determining the fundamental preferences of economic actors is challenging. However, by using political economy theories that tell us what preferences actors should hold and by undertaking a longitudinal study that allows us to differentiate between the initial positioning of economic actors and subsequent strate-

Economic Actors and Monetary Policy

27

gic positioning, we can be confident about our conclusions. Establishing the extent of the influence of economic actors on government policy is a greater challenge, however. We need to be particularly attentive to the discourse of the government with opposite coalitions. If the discourse is contradictory, it will indicate a concern of the government to respond to both sides in one way or another. In this study, the empirical data indicate that export-oriented business interests had sotne influence on the government in that it had to respond to their discontentment with the UK being outside of the euro zone with subsidies and a monetary policy that minimizes volatility of sterling with the euro. The influence, nonetheless, was limited. Export-oriented business interests did not lead the British government to commit to European monetary union and to hold a referendum on the euro. According to several studies, though, a well-run campaign backed by business interests and conducted at the time when Blair's popularity was high would have led to a positive o u t ~ o m e . ~ ' In contrast, the position of the financial sector, which cautioned against a rushed decision and eventually became opposed to membership of the euro, was highly influential on the government. Primary sources in the form of reports and interviews shed light on the concerns of the financial sector and the solidification of its views on the euro. Evidence of its influence on government policy is provided by paying specific attention to the timing and substance of government declarations in light of the advice emanating from the financial sector. I demonstrate throughout the following chapters that the British government was concerned about the impact of membership of the euro on the London financial sector. It is precisely this concern that determined the British policy on EMU from the early Maastricht Treaty negotiations under John Major to Gordon Brown's negative assessment of the five tests. The empirical data support Henning's assertion that weak bank-industry relations in a capital market-based system, such as the United States or Britain, lead to the prevalence of the financial sector in the determination of monetary AS we will see in chapter 3, the British policy of non-decision on the euro, which aimed at accommodating the financial sector, fits into the historical pattern of the greater influence of the financial sector than industry on economic policy in Britain. Scholars have documented that British banks have not traditionally supported industry in their demands for a more depreciated or stable currency.29The impact of monetary policy on the .~~ competitiveness of industry has not often been taken into c o n ~ i d e r a t i o nThe policy on the euro is yet another example of the importance of the financial sector in monetary policy decisions in Britain.

Notes 1. Jeffry Frieden, "Actors and Preferences in International Relations," in Strategic Choice and lnternational Relations, ed. David Lake and Robert Powell (Princeton, N.J.: Princeton University Press, 1999), 49. 2. See for example, Jonathan Crystal, "What Do Producers Want? On the Origins of Societal Policy Preferences," European Journal of lnternational Relations 9, no. 3 (September 2003): 407-39; David Steinberg, "Currencies, Compensations, and Coalitions: The Politics of Exchange Rate Valuation in Argentina, 1963-2007" (paper presented at the annual meeting of the lnternational Political 1:conomy Society, Philadelphia, Pa., November 14-15, 2008); and Cornelia Woll, Firm Interests: flow Governments Shape Bzrsirless Lobbying on Global Trade (Ithaca, N.Y.: C'ornell University Press, 2008). 3. Crystal, "What Do Producers Want?" 4. Woll, Firm Inlerests; and Steinberg, "Currencies, Compensations, and Coalitions." 5. Mark Duckenfield, Business and the Euro. Business Groups and the Politics of EhlU in Germany and the United Kingdom (New York: Palgrave, 2006), 194. 6. C. Randall Henning, Currencies and Politics in the United States, Germany, and Japan (Washington, D.C.: Institute for International Economics, 1994), 330. 7. Jeffry Frieden, "Invested Interests: 'She Politics of National Economic Policies in a World of Global Finance," Internatiot~ctlOrgan~zation45, no. 4 (Autumn 1991): 425451. 8. For a full explanation of the Mundell-Fleming model, see Benjamin Cohen, "The Triad and the Unholy Trinity: Problems of lnternational Monetary Cooperation" in International Political Economy: Perspectives on Globc~lPower and Wealth, ed. Jeffry Frieden and David Lake (Belmont, Calif.: Wadsworth, 2000), 245-57. 9. See also Ronald McKinnon, "Optimum Currency Areas," American Economic Review 53 (September 1963): 717-24. 10. The nontradable sector includes, for example, construction, transportation, public services, some financial services, and retail firms. l I. Frieden, "Invested Interests," 446. 12. Jeffry Frieden, "Real Sources of European Currency Policy: Sectoral Interests and European Monetary Integration, lnternationrll Organization 56, no. 4 (Autumn 2002): 840. 13. t:rieden, "Real Sources of European Currency Policy," 839. 14. Frieden, "Real Sources of European Currency Policy," 840. 15. Henning, Currencies and Politics. 16. Henning, Currencies and Politics, 26. 17. Henning, however, did not make a distinction between export-oriented producers and import-competing producers for the domestic market. 18. Henning, Currency and Politics, 26. 19. Henning, Currency and Politics, 34. 20. The conclusion assumes that domcstic nlunetary policy is anti-inflationary. 2 I . Henning, Currency and Politics, 30. 22. Henning, Currency and Politics, 3 1. 23. Henning, Currency and Politics, 29. 24. Henning, Currency and Politics, 30. 25. Steve Schifferes, "Five Years On: Rating the MPC," BBC News Online, June 6 ,

Economic Actors and Monetary Policy

29

2002. http://news.bbc.co.uk/2/hi/business/2002471.stm(accessed June 25,2009). 26. Willem Buiter and Anne Sibert, "How Good is the Bank of England's Inflation Targeting Record?" Mimeo, Birkbeck College, December 2004, www.nber.org/ -wbuiter/ BoE.pdf (accessed May 15, 2009). 27. See MORI, "Government Shift on Euro Would Slash Euroskeptic Lead: Blair Holds Key to Referendum Success," September 23, 1999, http://www.ipsosmori.com/polls/ 1999lgmb-euro.shtml (accessed June 9, 2006); Robert Worcester, How to Win the Euro Referendum: Lessons from 1975 (London: The Foreign Policy Centre, 2000); Mark Leonard and Tom Arbuthnott, eds. Winning the Euro Referendum: A Guide to Public Opinion and the Issues that Affect It (London: The Foreign Policy Centre, 2001): Roger Mortimore and Simon Atkinson, Who are the Euro Waverers? (London: Foreign Policy Centre, 2003): Matthew Gabel and Simon Hix, "Understanding Public Support for British Membership of the Single Currency," Political Studies 53, no. 1 (March 2005): 65-81; and David Howarth, "The Domestic Politics of British Policy on the Euro," Journal of European Integration 29, no. 1 (March 2007): 47-68. 28. tlenning, Currency and Politics. 29. See for example Franck Longstreth, "The City, Industry, and the State" in State and Economy in Contemporary Capitalism, ed. Colin Crouch (New York: St Martin's Press, 1979) 157-190; Bernard Elbaum and William Lazonick, "An Industrial Perspective on British Decline" in The Llecline of the British Economy, ed. Bernard Elbaum and William Lazonick (Oxford: Oxford University Press, 1986), 1-17; Peter Hall, Governing the Economy: The Politics of State Intervention in Britain and France (Oxford: Oxford University Press, 1986); and Henning, Currency and Politics. 30. Flenning, Currency and Politics, 33 I.

Chapter 3

The Structure of the British Economy This chapter provides an overview of the structure of the British economy by presenting key characteristics of its financial sector and of its business sector (defined as nonfinancial corporations providing goods and services). The weak relationship between banking and industry, in comparison with continental countries, is explained through a brief account of Britain's historical development and institutional features. While continental countries classify as creditbased systems according to Henning's typology, Britain is clearly a capital market-based system.

Characteristics of the British Economy The peculiarities of the British economy were determined by its unique historical development as an early industrializer.' Britain's industrialization began in textiles where start-up costs were relatively low. The main sources of investment of entering firms were retained earnings or contributions from family and friends, leading to the joint-stock form of corporate organization and the rise of the stock market.2 Countries on the Continent, in contrast, industrialized later around iron and steel, which bore higher starting costs. In this industrial landscape, firms needed long-term loans from large investment banks to start a new business."ndustry, therefore, came to rely heavily on banks, which acquired a keen interest in the prosperity of their clients. This practice and the subsequent strong ties that developed between industry and banking came to characterize countries such as France, Germany, or 1taly.' Firms in Britain, on the contrary, continued to rely on equity financing rather than on bank loans to finance their activities6 Additional factors to the low starting costs of industry led to the development of a capital market-based system in Britain as opposed to the credit-based system in place in continental European countries. In the nineteenth century, British regional banks had developed where industries were concentrated. How31

32

Chapter 3

ever, the lack of industrial diversification in banks' portfolios contributed to a . ~ a result, banks became very reluctant to lend very high rate of bank f a i ~ u r eAs to industry over the long term8 This aversion was reinforced when several banks that had advanced substantial overdraft facilities to industrial firms in the afiernlath of World War 1 were severely affected by the decline of the cotton and steel industry.9 These early experiences led to the custom of banks granting only short-term loans to industry for occasional liquidity problems rather than providing long-term financing. Effectively, in the mid-1930s in Britain, "banks sought to sever any long-term commitment to industry."'0 This situation also meant that no large equity share or involvement in the management of firms by banks was undertaken in Britain. Relatively weak ties between banking and industry, therefore, became the staple of the British economy. Today, the U K continues to stand out as remarkably different from European countries on the Continent when it comes to indicators of bank-industry ties. In terms of the liabilities of industrial firms, the percentage represented by borrowed funds is on average ten to twenty percent higher in continental countries than in Britain." Industrial firms in Britain continue to mainly rely on equity financing, which represented 47.2 percent of liabilities between 1981 and 1992, as compared to 3 1.9 percent in France and 23.9 percent in 1taly.I2As a result, the stock market capitalization in Britain between 1982 and 1990 represented 74.9 percent of GDP versus 19.7 percent in France and 12.9 percent in ~ t a l ~In. 2008, ' ~ of the largest countries in the world, Britain still had the greatest share of equity market capitalization in relation to G D P . ' ~And the custom of using retained earnings for investment and bank loans only for short-term liquidity continues.15 As a result of the lack of strong ties with industry, the financial sector in Britain developed the habit of focusing on its own interests. The preferences of the financial sector on macroeconomic policy, therefore, came to clash with those of industry. According to Peter Hall, the financial sector became "a powerful lobby against devaluation (which was widely expected to weaken international confidence in British financial markets), and a proponent of deflation in the face of balance of payment crises."I6 Not only has the financial sector expressed macroeconomic policy preferences in direct opposition to those of industry, but it has also been highly influential.I7 Bernard Elbaum and William Lazonick explained the influence of the financial sector in the determination of economic policy as the result of the concentration of financial activity in the ancient City of London which gave rise to "a relatively cohesive class of finance capitalists with much more concerted and coherent influence over national policy than industrial capitalists, who were divided along enterprise, industry, and regional lines."" Alan Hallsworth also insisted on the importance of the strong ties that exist between the London financial sector (the City), the Bank of England, and the Treasury, which form a sort of "tri~mvirate."'~ The Bank of England has always protected the interests of the City, even after the 1946 bank nationalization act as the bank still preserved its autonomy.20 Franck Longstreth asserted that, contrary to industry, banking has therefore al-

The Structure of the British Economy

33

ways benefited from "the privileged position of having its 'discriminating advocate' at the heart of the state apparatus where economic policy is formu~ated."~' The Bank of England's close relationship with the Treasury has ensured that its views, which always bear in mind the welfare of the internationally-oriented . ~ ~representative financial community, are taken into serious c o n ~ i d e r a t i o n A from the Bank of England, for example, is included in every economic committee in the ~ r e a s u rAs ~ . Anthony ~~ Hilton noted, "The Bank has an understandable desire to ensure the prosperity of its City constituency, and a key part of its role is to persuade governments to adopt policies which help the The influence of the financial sector on economic policy has led to the historical tradition of having an overvalued pound.25Hall observed that at several critical times in history, representatives of the financial sector pressured the government to maintain a high exchange rate and "in each instance, their views prevailed."26 Winston Churchill's decision to fix sterling to the same parity as before World War I or the entry of the pound in the Exchange Rate Mechanism at an overvalued rate under Margaret Thatcher are cases in point.27The traditional maintenance of an overvalued pound has led to the criticism that the British government consistently puts the interests of finance ahead of industry. The effects of an overvalued domestic currency on industry were largely ignored and contributed, according to many political economists, to the demise of industry in Britain in the twentieth century.28From 1950 to 1970, Britain's share of world trade in manufactures dropped dramatically, from 25 to 10 percent. In contrast, in Germany, where banks supported policies favorable to industry because of the strong ties between the two sectors, the share of world trade in manufacture increased significantly, from 7 to 20 percent, over the same time period.29Andrew Gamble and Gavin Kelly contended that even under Labour governments, "the voices of industry and trade unionism have always been subordinate to the interests of the banking and financial community and those who argued that devaluating the pound sterling was tantamount to betraying Britain's international obligation~."~~ While Britain's manufacturing sector increasingly lost market shares to the benefit of other industrialized nations, more and more capital flowed to London. The strength of the City as an international financial sector, therefore, grew exponentially at the same time as industry became weaker and insignificant. In 1980, interest rates were hiked up to further attract capital to on don.^' In 1986, financial deregulation, known as the Big Bang, further increased the City's activities. The importance of the financial sector in the British economy, which became stronger with deregulation, further reinforced its influence on government policy.3' Although the financial sector employs only a small part of the population in Britain, it contributes disproportionately to the national economy. In 2007, 1.06 million people worked in financial services, which accounted for 8.3 percent of ~~ services also represent significant tax revenues for the the UK G D P . Financial British government. Corporate tax paid by the financial sector amounted to £12.4 billion in 2007, which represented 27.1 percent of the total of UK corpo-

rate tax receipk3' Income tax paid by employees in the financial services amounted to £14.8 billion in 2006, which represented 13 percent of total income tax." The financial sector is also one of the largest contributors to the UK balance of The financial services trade surplus generally helps offset the deficit of trade in goods (manufactures, raw materials, and food stuff) which has steadily declined since 2003 while financial services have continued to strengthen.37In 2007, trade in financial services generated a surplus of £36.9 billion whereas trade in goods recorded a £89 billion deficiL3' The UK had the largest trade surplus in financial services in the world; it was three times the surpluses recorded in Switzerland and ~ u x e m b u r ~ . ~ '

The International Status of the City Although the City originally referred to a place, the ancient City of London, also known as the "square mile," the term has become widely used to designate one of the world's most important financial centers.40Today, the City is the international financial center with "the most banks, the largest stock exchange, and the greatest number of listings."" Although both retail services (mainly for individuals and small businesses) and wholesale services (for corporations, governments, and other financial institutions) are found in the City, its strength and renown lie in the wholesale sector.42London ranks ahead of Paris, Frankfurt, and other major cities in wholesale markets, making the City the leading European financial center. In 2003, its international wholesale financial services output was larger than the rest of the EU financial centers combined.43Since 2005, London has consistently been ranked number one world financial center by the Global Financial Centers lndex." London holds the largest market share in many international markets as Table 3.1. shows. The City is home to the largest comn~ercialand investment banks in the world. In March 2008, the number of authorized banks in the UK totaled 325.45 Out of these, 249 were foreign banks.46The City hosts more foreign banks than .~~ compared to ten years ago, there are New York, Paris, or ~ r a n k f u r t However, fewer banks in the U K today: in 1995, they numbered 48 1.48 This fact is explained by the consolidation in the banking industry that occurred after the launch of the euro in 1999. Banks decreased in number but increased in size and " City financial strength after a wave of mergers and acquisitions in ~ u r o ~ e .The has benefited from this trend as many banks have chosen to consolidate their activities in London. Even though the number of banks located in London has decreased, the banking sector's assets have increased dramatically. In 2008, banking assets in the U K reached £7,917 billion, which was three times more than in 1999.~'Foreign banks, mostly from Europe, owned over one-half of the asset^.^' In August 2009, although U K banking assets were down 7 percent due to the financial crisis, they still amounted to f 7,4 17 billion.52

The Strtrcture ofthe British Economy

Table 3.1. Comparative Market Shares of the World's Financial Centers Market Activity

% Market Share-World

London

NY 9

Financial Centers

Tokyo

19 8 Cross Border Hank Lending Foreign Equities 19 69 ... Turnover Foreign Exchange 36 14 7 Turnover Derivatives Turnover - Exchange Traded 6 39 2 - Over the Counter 43 24 4 International Bonds - Primary Market 60 ... ... - Secondary Market 70 ... ... Source: International Financial Services London, International UK (London: IFSL, November 2009), 3.

Paris

Frankfurt

8

11

...

7

...

...

1 7

12 4

... ... ... ... Financial Markets in the

The international financial activities of the City are varied and complex. A consideration of what the City does and who its principal players are is critical to understanding its position and main concerns on British membership of the euro, which are discussed in detail in the following chapters. The sections that follow, therefore, briefly present the City's main markets and services.

The City's Wholesale Markets The wholesale financial sector encompasses the capital, money, foreign exchange, and derivatives markets. The Capital Markets The capital markets comprise the trading of long-term debt (bonds) and equities (stocks). Either corporations or government entities can issue bonds, whereas equities are issued only by corporate entities. Equities and bonds can be domestic or international and are traded in the London Stock Exchange (LSE), the largest stock exchange in Europe. They are traded either on the primary market (where the borrower directly raises capital) or the secondary market (where investors trade financial instruments after they have been issued by the borrower). Companies may list on several stock exchanges to raise capital. Smaller growing companies that cannot list on the main market may list on the LSE's second-tier market for shares, the Alternative Investment Market (AIM), created in 1995. Bonds listed on the LSE comprise UK government bonds (called gilt-edged securities), foreign bonds (issued by a foreign borrower and denominated in ster-

ling), and Eurobonds (issued by a foreign borrower and denominated in the currency of another country). The City acquired a leading market share in international bonds (foreign bonds and Eurobonds) because of fortunate historical circumstances. The opening of the Eurobond market in 1963 coincided with President John F. Kennedy's policy of imposing a tax on foreign b o r r o ~ i n gto reduce the United States' balance of payment deficit. As Richard Roberts explained, "This was a stroke of fortune for the fledging market and the City, ensuring that a substantial volume of international capital market activity shifted from New York to ond don."^^ Even after the US eased regulations, the bulk of the international bond market stayed in London. The Money Markets The money markets are involved with highly liquid short-term debts and comprise the interbank market, money-market instruments, and the rep0 market. The interbank market involves lending and borrowing between banks for short periods of time (between one day and ninety days). It allows banks to manage their short-term shortages and surpluses. For example, if a bank has a cash surplus, it will lend it to another bank with interest rather than let the surplus sit idle. The interest rate for interbank market loans is known as the London Interbank Offer Rate (LIBOR) and corresponds to the rate of interest paid by the largest London banks. The interbank market is not restricted to banks, and corporations may use it if they need short-term capital.5JA variety of instruments denominated in sterling or foreign currencies are available: Money-Market Deposits (MMDs), which are interbank deposits of £500,000 or more; Certificates of Deposits (CDs) denominated in sterling or dollar; securities issued by government entities, such as Treasury bills or local authority bills; and securities in sterling or foreign currencies issued by commercial entities or banks, like bankers' acceptances and commercial papers. Repos are contracts whereby one party sells a security to another and agrees to repurchase it at a future date and agreed price, thereby allowing the party that sells the security temporarily to raise short-term cash. The Bank of England, which buys and resells securities, is the ultimate provider of liquidity to the market. Since it was granted operational independence by the Labour government in 1997, the Bank of England decides on the short-term interest rate, which is known as the rep0 rate.55 The City's money markets are well developed and competitive because London attracted a significant amount of Eurocurrencies in the 1950s and '60s. Eurocurrencies refer to currencies, such as the US dollar, which are held on deposits in banks outside of their country of origin. A Eurodollar refers to any dollar held on deposit in a non-US bank or a branch of a US bank located abroad. In the 1950s, an offshore dollar market developed in Europe as a result of US regulations that put restrictions on the way banks could operate.56 In particular, US Federal Reserve Regulation D set a minimum reserve requirement on bank deposits. 57 Reserve requirements represent a cost for banking institutions, as they translate into a portion of deposits that they are not allowed to lend and have to

The Structtrre of the British Economy

37

keep either in a bank vault or at a federal reserve bank. This regulation is also a monetary policy tool to control money supply and inflation. Another US Federal Reserve regulation, Regulation Q, contributed to the rise of the Eurodollar market in London as it prohibits banks from earning interest on reserve requirement deposits.58London was able to draw euro deposits by providing a more marketoriented environment where no reserve requirements are imposed.59As a result, the City became one of the world's largest money markets both in sterling and ~urocurrencies.~~ The Foreign Exchange Market London has the largest foreign exchange market in the world. There are four types of participants in the foreign exchange market: the major international banks that act as dealers and make a profit from the difference between bid and offer prices and from speculation on the direction of the exchange rates; specialist firms that act as brokers between buyers and sellers of currency; customers such as large businesses; and the Bank of England that supervises the market and may intervene to influence exchange rates. The Derivatives Market The derivatives market contains three types of instruments used to hedge currency risk that are traded on exchanges and over the counter: futures, options, and swaps. Futures are contracts whereby an agreement is made to buy or sell a financial instrument (bond, equity, commodity, or currency) at a hture date at a predetermined price. Options are contracts whereby the holder has the right to buy or sell a financial instrument within a specific time at a predetermined price. Swaps are transactions whereby two parties exchange cash flow instruments. Over-The-Counter (OTC) derivatives are directly available in banks. The UK is the most important OTC market place with a 43 percent share of world turnover in 2007.~'Exchange-traded derivatives are bought and sold in a London financial exchange. There are four derivatives exchanges operating in the UK: NYSE Liffe, London Metal Exchange, ICE Futures Europe, and EDX London.

City Services: Institutions and Trade Associations The City services involved in the financial markets reviewed above can be divided into the supply side and the buy side. Investment and commercial banks are on the supply side and institutional investors are on the buy side. Increasingly large institutions, such as Citigroup, are involved in both investment and conlmercial banking, although they are required to maintain a clear separation between the two activities. Each service sector is represented by one or several trade associations. In this section, I briefly present the different types of City services and the main trade associations that represent them.

38

Chapter 3

lnvestment Banking Investment banks engage mainly in corporate banking; that is, raising capital for their corporate clients by selling on the capital market the equities or bonds they issue for a fee. Other activities of investment banks include advising corporations on issues of mergers and acquisitions (I\/l&A), and derivatives trading. The London investment banking industry is dominated by foreign banks, mainly from the United States. Table 3.2. Leading City Investment Banks Size

Bank Name

Large lnvestment Banks

Goldman Sachs Lehlnan Brothers Merrill Lynch Morgan Stanley Citigroup J.P. Morgan Chase Credit Suisse First Boston (CSFB) Deutsche Bank UBS

Medium-size Investment Banks

Barclays Royal Bank of Scotland HSBC ING ABN Amro Dresdner Bank Societe GenCrale Paribas

Nationality United States United States United States United States United States United States Switzerland Germany Switzerland

United Kingdom United Kingdom United Kingdom Netherlands Netherlands Germany France France Source: Richard Roberts, The City: A Guide to Lorldo~l'sGlobal Financial Center (London: The Economist, 2004), 99.

The London lnvestment Banking Association (LIBA) is the main British association representing firms involved in investment banking and the securities industry. Its membership is rather limited but prestigious, consisting of about sixty of the largest investment banking and securities firms in the world that have an office in on don.^^ LIBA promotes the views of its members to the Brit. ~ ~ association's main ish government and to the European Union a u t h o r i t i e ~The goal is to ensure that London retains its dominant position as a location for investment banking.64

The Structure of the British Economy

39

Commercial Banking Commercial banks are intermediaries between savers who make deposits and borrowers who take on loans. Domestic commercial banking consists of services mostly in sterling to individuals and small businesses. International commercial banking consists of lending to foreign borrowers in sterling or in Eurocurrencies. As explained earlier, London attracted Eurocurrencies and gained preeminence in this market as it has favorable regulations. Commercial banks, as well as investment banks, are also active in the Eurobond market and in foreign exchange and derivatives trading. Commercial banking is undertaken by British banks and by branches or subsidiaries of foreign banks authorized to take deposit in the UK. The main British banks are Barclays, HSBC, Lloyds TSB, National Westminster, and Standard Chartered. The City has the largest number of foreign banks, as opening a branch in London has become a sign of international status.65The presence of these banks is one of the strength of the City as they provide depth and liquidity to the markets, improve financial innovation, and attract the most talented workforce from all over the The fact that foreign banks dominate the City has led to the expression "wimbledonization of the City," meaning that, in financial services as in the world of tennis, London is the host of the best international contingent of competitors. The British Bankers Association (BBA) was created in 1919 to represent British commercial banks. In 1972, BBA extended its membership to foreign banks and British merchant banks.67 Since then, it has become the main trade association for domestic and foreign banks operating in the UK. Today, the majority of its members (75 percent) are foreign, and BBA represents sixty countries. BBA strives to foster an environment in which its members can prosper by "building relationships with decision makers, promoting and protecting the UK's leading position in the global financial services industry, [and] providing information and guidance."68 BBA has 218 members that together "hold 90% of the UK banking sector's assets and represent 95% of all banking employment in the U K . " ~ ~ Fund Management While conlmercial and investment banks are on the supply side of financial markets, institutional investors who engage in fund or asset management are on the buy side. The City is one of the most important fund management centers in the ~ o r l d . The ' ~ main institutional investors are insurance companies, pension funds, unit trusts, and investment trusts. They invest the money flowing from pensions, contributions, and insurance premiums into financial assets. In doing so, they strive to minimize risk and maximize return^.^' The insurance industry is one of the most important institutional investors in the UK. Insurance companies invest in domestic and foreign equities and corporate bonds that account for two-thirds of their assets.72Other assets purchased by insurance companies are government securities and real property. Pension funds, which developed in the UK in the 1960s and today account for 40 percent of Britons' retirement income,

40

Chnpter 3

also invest mainly in domestic and international corporate ~ecurities.'~ The other main institutional investors, unit trusts and investment trusts, are professionallymanaged collective investment institutions. They allow investors to earn higher returns by investing their collective contributions in a diverse portfolio of shares. The lnvestment Management Association (IMA) and the Association of lnvestment Trust Companies (AITC) represent unit trusts and investment trusts, respectively. The International Underwriting Association of London (IUA) represents international and wholesale insurance and reinsurance companies located in the City.

The Business Sector Most of the very large nonfinancial corporations in Britain are foreign-owned multinational corporations (MNCs) although a few British multinational corporations remain. In 2002, there were 3,132 British MNCs (parent corporations) . ~ ~ sharp contrast in the and 13,828 affiliates of foreign MNCs ( s ~ b s i d i a r i e s )The ratio of British versus foreign-owned manufactures has led to the criticism that Britain has become "an assembly base for foreign-owned manufacturers seeking access to markets in the European Foreign-owned MNCs play an important role in the British economy. In 2005, foreign affiliates in Britain accounted for 35 percent of the turnover in manufacturing, the second highest rate in the G7 economies after ~ a n a d a . ' ~ European multinational corporations such as Siemens, Philips, and Nestle were among the first to set up subsidiaries in Britain at the beginning of the twentieth century. Foreign Direct Investment (FDI) from the United States, however, came to dominate the post-WWI1 era." Britain was an attractive place for the subsidiaries of American MNCs because of the English language as well as the increasing presence of American banks and business services." In the 1970s, FDI came from a new corner of the earth, Japan. Sony and Toshiba were among the first Japanese subsidiaries in Britain; but the biggest investment came from Nissan whose Sunderland plant provided enlployment for over four thousand ~ r i t o n sHonda . ~ ~ and Toyota came in the 1980s along with German manufacturers of motor vehicle components. In the 1990s, the motor vehicles industry was the largest employer among foreign-owned manufacturing enterprises located in ~ritain." When BMW acquired the British group Rover in 1994, Britain became "the first member of the G7 industrial nations to have had a thriving mass automobile industry and to lose it entirely to foreign contro~."~' Successive British governments have provided incentives to continue to attract or retain foreign-owned MNCs by providing an environment with advantageous fiscal and labor regulation^.^^ The UK market is particularly attractive to MNCs, in comparison with other European states, because Britain has more flexible labor laws and provides important tax concessions, resulting in important cost savings as Table 3.3. demonstrates.

The Structtlre of the British Economy

Table 3.3. Comparative Taxes and Social Security Costs in Europe

UK

France

Germany

Italy

20% 40% 20% 45% 41% 42% 29% 34% 33% Source: "Why EMU Would Sell Britain Short," News of the World, July 1998, 8. Social Security Costs Corporate Tax Income Tax

10% 3 1% 23%

When the UK became part of the European Economic Community in 1973, it provided further encouragement for foreign-owned multinational corporations to invest in Britain. By locating their factories in Britain, now a member of the EEC, MNCs could take advantage of the open trade to continental Europe, which dramatically reduced their costs. With completion of the Single Market in 1992, the UK became the location of choice for foreign-owned MNCs because of its beneficial tax and labor regulations combined with access to the European Community markets. An additional step that the British government could have taken to further increase the attractiveness of the UK as a preferred investment location would have been to adopt the euro. If the UK had adopted the euro, not only would affiliates of foreign MNCs benefit from open trade with continental Europe but they would also no longer have to deal with currency conversions, which would translate into further cost reductions. In the following chapters, I survey the actions that foreign-owned and British MNCs have taken on the question of the euro. While corporations, even foreign-owned corporations, often lobby on their own, they may also rely on the actions of the trade associations to which they belong. I therefore also look at the position and actions of the major trade associations in Britain, which are described in the following section.

British Business Trade Associations In many European countries, such as France and Germany, one major employer association usually represents a variety of businesses, from small-size enterprises to large exporters. In contrast, in the United Kingdom, there are three leading business lobby groups representing different interests. The Confederation of British Industry (CBI) is considered to be the voice of large internationally-oriented corporations, the Institute of Directors (IoD) represents mediumsize companies mainly in the services industry, and the Federation of Small Businesses (FSB) is the leading lobby group for small businesses and selfemployed individuals.

The Confederation of British Industry The CBI was born in 1965 out of the merger of three employers' associations: the Federation of British Industries (FBI), the National Association of British Manufacturers (NABM), and the British Employers' Confederation (BEC).'~ These organizations, which emerged at the beginning of the twentieth century with the first attempts at creating a system of industrial representation in the UK, soon started to compete against each other in the type of service and representation they provided.84The FBI and the BEC represented large employers with the only distinction being that the BEC dealt niainly with labor issues. However, as the BEC moved away from solely concentrating on labor issues, with the expansion of the role of the Trade Union Congress in these matters, the BEC started to encroach on the FBI's territory. The NABM, although it represented mainly small-to-medium-sized industries, also came to be viewed as duplicating the FBl's services.85The presidents of the FBI, NABM, and BEC agreed, in the early 1960s, that the three organizations should merge in order to increase effectiveness. The Labour government encouraged the merger, stating its preference for dealing with one organization instead of three.86The FBI, the largest of the three organizations, served as the basis for the creation of the CBI, which adopted a similar organizational structure as its predecessor.87 NABM's members were the most suspicious of the merger and worried that the interests of smaller industries would not be represented adequately in the CBI. They also feared that the government would control the new organization and were against including nationalized industries in its membership. A significant number of NABM members, therefore, decided to form their own organization, the Society of Independent Manufacturers, which became the Smaller Business Association, known today as the Federation of Small ~ u s i n e s s e s . ~ ~ The CBI has over 10,000 direct members, i.e., individual corporations holding a membership, and about 250,000 indirect members, which are represented by the membership of approximately two hundred specialized trade associat i o n ~ . ~ % e m b e r s h iin~ the CBI is open to all companies operating in the UK. As a result, some of the largest affiliates of foreign-owned MNCs are active members of the CBI. The bulk of the revenues of the CBI is generated by members listed in the Times' top 500 list of leading companies, which ensures the domiWyn Grant and David Marsh, in their nant position of the trade a~sociation.'~ comprehensive study of the CBI, found that large companies value the CBI for its perceived influence on the government, even though they often have direct contacts with government departments thenlselves. They also believe that their combined membership strengthens the CBl's position. "It is the presence of big firms like us that makes the CBI influential" commented the director of a large firm." The CBI has been criticized for being an oligarchy, as the largest corporations tend to dominate its decision-making structure. The CBI has sixteen standing committees supporting specific policy areas where the CBI position is debatedSg2For example, EMU was debated in the Economic Affairs Committee and the Europe Committee. The directors of large national or multinational cor-

The Structure of [he British Economy

43

porations usually chair the committees. Imperial Tobacco CEOs, for example, ~ ~ CBI also has twelve have been actively involved in this role at the C B I . The regional councils. Chairmen of the regional councils and of the standing committees form the Chairmen's Committee, which is responsible for determining the CBl's position on all policy matters and proposes candidates for president and deputy president of the C B I . The ~ ~ candidate for the presidency of the CBI is usually chosen from among the largest corporations in the as~ociation.~' The president of the CBI has a high profile; he initiates positions on major issues and represents the trade association's views.96However, the president holds office for only two years, and no one has ever held two consecutive mandates." The relatively short tenure of the president of the CBI has often prevented the organization from holding a firm position on major policy issues.98The president of the CBI, with the approval of the chairmen's committee, appoints the director general, whose position is more administrative than political.99 As the CBI is considered the most important business lobby in the UK, its policy statements enjoy significant media coverage. However, the CBI is usually very cautious in its pronouncements because it does not wish to alienate some of its large and most influential members. The CBI sometimes has difficulty presenting a unified voice, as it represents both public and private interests.loOThe CBI also has close ties and contacts with ministers and civil servants, which creates both opportunities and limitations: "The price of this relationship is the necessity to avoid public campaigning. To some sections of business opinion this produces a moderation in attitude and behaviour amounting to collaboraGrant and Marsh discerned a concern by some members that t i ~ n . " ' ~Indeed, ' the CBI was being used by the government rather than having real influence on it.''' There is an inherent tension among the members of the CBI between those who favor a more outspoken and independent stance on policy issues and those who favor cooperation with the government in exchange for industry-specific conce~sions.~~~ In terms of membership, the CBI does not include financial institutions. As Graham Wilson explained, "The City is not really part of the CBI. This gap in the comprehensiveness of the CBl's membership would cause concern ips0 facto; the absence of the financial institutions is all the more worrying for the CBI because of the importance of financial institutions in Britain."lo4 Relationships between industry and financial institutions have been difficult in Britain. The CBI attempted to open a dialogue with the City, as industrial members expressed the belief that financial institutions were not sympathetic to their problems and that their relationships were uneasy. In 1986, the CBI established a Cityllndustry task force composed of representatives of both sectors to meet and discuss opportunities and challenges.'05However, the problem is that the City has its own direct contact with the government and does not feel that it needs the CBI to represent its interests. The CBI channels of access to government are very limited compared to "the channels of access to the government which [City interests] have developed for themselves over the decades."Io6 Grant and Marsh asserted that "these links are reinforced by the effective possession by the City

of a range of sanctions, movement of capital, influence on sterling, for instance, for which industry has no real counterpart."lo7 Another sector that was reluctant to participate in the CBI for a long time is retail. For many years, the British Retail Consortium claimed that the CBI coultf not represent the interests of both manufacturing and retail, which are often at odds, and it discouraged its members from joining the ~ ~ 1 . l ~ ' The lnstitute of Directors The Institute of Directors (IoD), founded by royal charter in 1906, is located on Pall Mall, in the former home of George IV The loD represents individuals in their capacities as directors, which differentiates the association from the CBI that represents corporations.lo9Three-quartcrs of the IoD members are in the services sector and the rest are manufacturer^."^ The loD currently has 53,000 members in the UK, 75 percent of which are small- and medium-size companies, a fact often overlooked."' James Walsh, Head of the Regulatory and European Affairs at the loD, stated "there is a common misconception that the IoD members are captains of industries running the largest companies on the land, which is not true. Most of our members are in the middle bracket. We do have members who are directors of the Fortune 500 but they are the exception to the rule."'" The IoD offers prestigious services to its members, one being the ability to use the various rooms of its beautiful headquarters conveniently located near Trafalgar Square. For this reason, the 1oD hds been described as more of a social . l ' ~ is open to individuals responsible for the diclub than the ~ ~ 1 Membership rection of an "entity" in the public or private sector that has a minimum turnover or budget of £250,000."~ The IoD has an annual subscription income of about f 10 b i ~ l i o n . " ~ The loD has a policy team that conducts research and produces position papers on specific issues of interest to its members. For example, the IoD issued a series of briefing papers on EMU that were widely distributed to its members. The IoD also regularly conducts surveys of its members on important policies. The IoD council, composed of the loD's chairman and elected members, decides on the positions taken by the trade a~sociation."~ Resolutions are also sometimes passed after consultation of the members followed by a vote at the annual general meeting of the loD. For example, the IoD adopted its position on EMU after such a vote. In addition to the chairman or non-executive director, the IoD also has a director-general, who is responsible for the management of the trade association and has a three-year term. The Federation of Small Businesses The Federation of Small Businesses (FSB), founded in 1974, is the largest organization of direct members, i.e., individual companies can be members without having to be part of a specialized trade association. The FSB has 215,000 members who are owners of small firms (up to two hundred employees) or selfemployed."' Eight-out-of-ten FSB members operate solely in the United King-

The Structure ofthe British Econonzy

45

d ~ m . "The ~ FSB has two lobbying branches, the Westminster Press and the Parliamentary office, which represent the views o f its members to the government and the media."' The FSB claims to represent real British business interests as opposed to the CBI, which is viewed as being dominated by a few multinational corporat i o n ~ . ' ~As ' a matter o f fact, the largest number o f businesses in Britain (69 percent) consists of self-employed individuals with no employees but themselves. In contrast, large businesses employing more than 250 people are few, representing 0.2 percent o f businesses in ~ r i t a i n . ' ~However, ' the contribution to the British economy o f these two types of businesses is significantly different. Businesses o f one employee accounted for 12.8 percent o f employment and 7.2 percent of turnover in 2001 while large businesses accounted for 44.6 percent of employment and 48.6 percent of t ~ r n o v e r . ' ~ '

Notes 1. See for example, Stephen Blank, "Britain" in Between Power and Plenty: Foreign Econonlic Policies of Advanced lndustrial States, ed. Peter Katzenstein (Madison, Wisc.: University of Wisconsin Press, 1978), 89-138; Franck Longstreth, "The City, Industry, and the State," in State and Econonly in Contemporary Capitalism, ed. Colin Crouch (New York: St Martin's Press, 1979), 157-190; Peter Hall, Governing the Economy: The Politics of State Intervention in Britain and France (Oxford: Oxford University Press, 1986); and Bernard Elbaum and William Lazonick, The Decline of the British Economy (Oxford: Oxford University Press, 1986). 2. Hall. Governing the Economy, 38; Michael Best and Jane Humphries, "The City and Industrial Decline' in The Decline ofthe British Economy, ed. Bernard Elbaum and William Lazonick (Oxford: Oxford University Press, 1986), 224. 3. Hall, Governing the Economy, 39. 4. Hall, Governing the Economy, 39. 5 . For the case of Germany, see C. Randall Henning, Currencies and Politics in the United States, Gertnany, and Japan (Washington, D.C.: Institute for Internationa! Economics). 1994. For the case of France and Italy, see James Walsh, European Monetary Integration and Dontestic Politics: Britain, France, and Italy (Boulder, Colo.: Lynne Itienner. 2000). 6. Henning, Currencies and Politics, 337. 7. Best and Humphries, "The City and lndustrial Decline," 227. 8. Best and Humphries, "The City and Industrial Decline," 228. 9. Best and Humphries, "The City and Industrial Decline," 229. 10. Best and Humphries, "The City and Industrial Decline," 230. 1 1 . Walsh, European Monetary Integration, 9. 12. Walsh, European Monetary Integration, 10. 13. Walsh. European Monetary Integration, 10. 14. International Financial Services London, International Financial Markets in the UK (London: IFSL, November 2009), 9. 15. Walsh, European Monetary Integration, I I . 16. Hall. Governing the Economy, 59.

17. Longstreth, "The City, Industry, and the State." 18. Bernard Elbaum and William Lazonick, "An Industrial Perspective on British Decline" in The Decline of the British Ecotionty, ed. Bernard Elbaum and William Lazonick (Oxford: Oxford University Press, 1986), 5. 19. Alan Hallsworth, "Short-Termism and Economic Restructuring in Britain," Econotliic Geography 72, no. 1 (January 1996), 24. 20. Hall. Governing the Econonv, 60; and Longstreth, "The City, Industry, and the State," 185. 21. Longstreth, "The City, Industry, and the State," 185. 22. Longstreth. "The City, Industry, and the State," 161; and Henning, Currencies rrnd Pol~tics,337. 23. Longstreth, "The City, Industry, and the State," 186. 24. Anthony Milton, Ciw within a State: A Portrait of Britain's Financial World (London: I. B. Tauris, 1987), 106. 25. 1-Ienning, Ctirrencies and Politics, 337-338; Hall, Governing the Economy, 49; and Andrew Gamble and Gavin Kelly, "The British Labour Party and Monetary Union," West Eiiropean Politics 23, no. 1 (January 2000), 1-25. 26. Hall, Governing the Econon?y. 251. 27. Henning. Czirrencies and I'olitics, 337-38. 28. David Rose, Carolyn Vogler, Gordon Marshall, and Howard Newby, "Economic Restructuring: The British Experience," Annals of the American ilcadeniy ofPolitica1 and Socicil Science 475 (September 1984): 137-57; Hall, (;overning the Economy; Hallsworth, "Short-'l'ermism;" and Longstreth, "The City, Industry, and the State." 29. Rose et al., "Economic Restructuring," 140. 30. Gamble and Kelly, "The British Labour Party," 9. 3 1. Hallsworth, "Short-Termism," 33. 32. Longstreth, "The City, Industry, and the State," 161; and Hallsworth, "ShortTermism," 24. 33. lnternational Financial Services London, Economic Contribution of UK Financial Services (London: IFSL, December 2009), 1 34. I FS L, Econon~icContribtition, 4. 35. IFS1,. Ecotiomic Contribution, 4. 36. International Financial Services London, Itzternational Financial Markets in the Uk'(London: IFSL, November 2008), 2. 37. IFSL, Interna~ionalFinuricial Markets, 2008, 2. 38. IFSL, Econonzic Cotltribiition, 2. 39. International Financial Services London, UA' Financial Sector Net Exports 2009 (London: IFSL, August 2009), I. 40. Richard Roberts, The City: A Guide to L,ontlon's Global Financial Centre (London: The Economist. 2004), 2. 41. Ruediger von Rosen, "The View from Frankfurt," in Sizing Up the Ciry - Lon(Ion's Ranking as a Financial Centre, ed. Centre for the Study of Financial Innovation (London: Corporation of London, June 2003), 34. 42. Von Rosen, "The Vie~vfrom Frankfurt," 1. 43. Von Rosen, "The View from Frankfurt," 2. 44. IFSL, Infernational Financial htarkets, 2009, 3. 45. IFSL, lnternational Financial Markets, 2008, 5 . 46. IFSL, lnternational Financial Markets, 2008, 5. 47. International Financial Services London, lnternational Financial Markets in the L'h' (London: IFSL, April 2006), 6.

The Strzrctzrre of the British Econon~y

48. IFSL, International Financial h4arkets, 2008, 5. 49. I FS L, Internatioizal Financial Markets, 2006,6. 50. IFSL, International Financial Markets, 2008, 5. 5 1 . IFSL, International Financial Markets, 2008, 5. 52. IFSL, International Financial Markets, 2009, 2. 53. Roberts, The City, 38. 54. Roberts, The Cify, 87. 55. Roberts, The City, 88. 56. Roberts, The City, 37. 57. Federal Reserve Bank of New York, Fed Point: Reserve Requirements, http:/l w w ~ r newyorkfed.org/about . the fed/fedpoint/fed45.html (accessed August 14, 2006). 58, The Federal Reserve Board, Regulations, Regulation Q, http:llwww. federalreserve.gov/ Regulations/#d (accessed August 26, 2006). 59. EMU City Working Group, Preparingfor EMU: The Implications of European i24onetnry C'nion for the Banking and Financial itlarkets in the United Kingdom (London: EMU City Workgroup, September 1996), 10. 60. Eugene Brigham and Joel Houston, Fzrndatnentals of Financial ~Managenzent (New York: The Dryden Press, 1998), l l I. 61. IFSL. bzternational Financial h4arkets in the UK, 2009, 14. 62. Mark Duckenfield, Business and the Euro: Business Groups and the Politics of EA4U in Gernlany and the United Kingdom (New York: Palgrave, 2006), 151. 63. London Investment Banking Association, 2004 Annual Report (London: LIBA, 2005). I . 64. London Investment Banking Association, www.liba.org.u!d (accessed March 29, 2006). 65. Roberts, The City, 156. 66. Roberts, 7%e City, 156-57. 67. British Bankers Association, Iiistory of the BBA, www.bba.org.u!d bba/jsp /polopoly,.jsp?d = 103&a=5676( accessed March 17, 2006). 68. British Bankers Association, Histoty oftlze BBA. 69. British Bankers Association, About BBA, www.bba.org.uk/ bba/jsplpolopo ly,jsp'?d= 103 & a=1559 (accessed March 17, 2006). 70. Levin, No Overtakit~g,16. 7 1. Roberts, The City, 1 12. 72. Roberts, The City, 1 18. 73. Roberts, The City, 120. 74. Malcolm Sawyer, The UK Econoiny (Oxford: Oxford University Press, 2005), 161. 75. tlallsworth, "Short Termism," 34. 76. Organisation for Econo~nicCo-operation and Development, "United Kingdom," OECD Econonzic Surveys, Volume 2007117, September 2007, 38. 77. Anthony Ferner, "Foreign Multinationals and Industrial Relations Innovation in Britain" in Industrial Relations: Theory and Practice, ed. Paul Edwards (Malden, Mass.: Blackwell, 2003), 82. 78. Ferner, "Foreign Multinationals," 82. 79. Ferner, "Foreign Multinationals," 82. 80. Ferner, "Foreign Multinationals," 84. 8 1 . Hallsworth, "Short Termism." 33. 82. Hallsworth, "Short Termism," 34. 83. Alan Crookman, Michael Wilcox, Christine Woodland, and Richard Storey, The

48

Chapter 3

C'oNfederation of British Industry and Predecessor Archives (Coventry: University of War~vick1,ibrary. 1997), 3 1. 84. Wyn Granl and David Marsh, The Confederation of British Industry (New York: Holmes & Meier, 1977), 19. 85. Grant and Marsh, The Cotzfederutiotz of British Indzistry, 20. 86. Grant and Marsh, The Coifederation ofBrltish Industry, 25. 87. Crookman et al. The Cotfederation o f B r i t ~ ~Industry, h 37. 88. Grant and Marsh, 7he Cotfederatiort oj'Brrtish Indtrstry, 26. 89. Duckenfield, Btrsiness and the Euro, 145. 90. Grant and Marsh, The Confederation ofBr~tishIndustry, 37. 9 1. Grant and Marsh, The Confederation of British Industry, 49. 92. Confederation of British Industry. CBI Governance. Background and Committee Overview, www.cbi.org.uklndbs/content.nsf/802737aed3e3420580256706005390 ael 63aOc3fc22c7478e80257026004eOba4?0penDoc~mnt(accessed October 27,2005). 93. Grant and Marsh, The Cotzfederatiot~ofBritrsh Industry, 86. 94. Confederation of British Industry, CBI Govetxance. 95. Grant and Marsh, The Cotfederntion of Brirlsh It~dtrstty,86. 96. Duckenfield, Business and the Et~ro,146. 97. Iluckenfield, Business and the Euro, 146. 98. Duckenfield, B~rsinessand the Euro, 146. 99. Confederation of British Industry, CBI Governance. 100. Graham Wilson, Busitzess and Politics: A Conzparative lntrodliction (Chatham, N.J.: Chatham House Publishers, 1985), 62. 10 1 . Wilson, Blrsirless and Politics, 63. 102. Grant and Marsh, The Cotfederation ofBritish Industry, 91. 103. Grant and Marsh, The Conjederation ofBritish Indlrstty, 104. 104. Wilson, Business and Politics. 63. 105. Confederation of British Industry, .4t1ntr~iIReport for the Year Ending 31 Decetitber 1987 (London: CBI, 1988), 17. 106. Grant and Marsh, The Coifederation of British Industry, 34. 107. Grant and Marsh, The Conjkderation of British Industry, 71. 108. Grant and Marsh, The Confederation of British Industry, 33. 109. Personal interview with James Walsh, Forrner Head of European and Regulatory Affairs, Institute of Directors (IoD), London, November 30, 2005. 110. Walsh interview. I I I . Walsh interview. 112. Walsh interview. 1 13. Duckenfield, B~rsinessand the Euro, I5 I . 114. Institute of Directors, "Joining the IoD," www.iod.com (accessed January 12, 20 10). I 15. Duckenfield, Business and the Ezrro, 15 1. 1 16. Duckenfield, Business and the Etrro, 15 1 ; and IoD website. 117. FSU website, "About the FSB," www.t'~b.org.uk/about(accessed March 3, 2010). 118. Interview of Brian Prime, FSH Policy lJnit Chairman cited in "Small Businesses Unprepared for the Single Currency," il,12 Presswire, April 20, 1998. 119. FSB website. 120. Duckenfield, Business and the Euro, 150. 12 1. Sawyer, The UK Ecorton~y,156. 122. Sa~+yer, The C'K Econonly, 156.

Chapter 4

The Conservative Party and EMU This chapter presents the position of the Conservative government on the Economic and Monetary Union from the Maastricht Treaty negotiations in 1990 to the elections of 1997 when the Conservative Party lost to New Labour. The focus of the chapter is on the government of John Major, who came to power a few weeks before the start of the European negotiations on EMU. The legacy of his predecessor, Margaret Thatcher, on this question is also presented as it affected the maneuvers of his government. 1 demonstrate that the government of John Major played a two-level game in Maastricht where it paid close attention to the conflicting demands of domestic actors while attempting to maximize its bargaining power with its European partners. On the domestic level, the interests of the financial sector loomed large in the position taken by the British government during the negotiations. After signature and ratification of the Maastricht Treaty, the Conservative government started the practice, which would be taken up by the New Labour government, of having a policy on EMU ambiguous enough to appeal to both pro- and anti-euro coalitions while continuing to protect the interests of the financial sector. However, deviation from this strategy in order to differentiate itself from the opposing party in the run-up to the general election would contribute to the Conservative Party's defeat.

Negotiations on EMU (1990-1991) The negotiations for the Maastricht Treaty (Treaty on European Union) started in December 1990, with the opening of the Intergovernmental Conference (IGC) on Economic and Monetary Union and on Political Union, and ended in December 1991, with the Maastricht European Council where member states negotiated and agreed on the final text of the treaty. The decision to convene an IGC on EMU was made at the Strasbourg European Council in December 1989, while the idea of running a parallel conference on political union originated in an April 1990 joint letter to the Irish Presidency by then President of France Franqois Mitterrand and Chancellor of Germany Helmut Kohl.

50

Chupter 4

Anthony Forster characterized the Maastricht negotiations as a failure for the UK, which could not halt progress towards full monetary union by the other member states and was ''left to negotiate the terms of its own self-exclusion."l This account of the Maastricht negotiations differs from the perception held in the UK of a negotiating success summarized by Prime Minister John Major as "Game, Set and ~ a t c h . " ' 1 argue that the British government achieved exactly what it needed at Maastricht to both satisfy powerful domestic actors and continue to be influential in the design of EMU. The position of the British government throughout the negotiations can be conceptualized as a two-level game. Robert Putnam coined the term "two-level game" in an attempt to provide a better framework to analyze international negotiations. Putnam argued that intemational negotiators face constraints at both the international and the domestic levels. Therefore, they will strive to "satisfy domestic pressures, while minimizing . " ~ is exactly what the the adverse consequences of foreign d e v e ~ o ~ m e n t s This UK tried to do during the Maastricht negotiations. Domestically, the British government had to respond to the conflicting preferences of economic interests on EMU. A balanced position that appealed to both coalitions was therefore necessary. At the European level, the British government had to ensure that it continued to be influential in the negotiations on EMU, as its development would affect the UK whether it joined or not. Therefore, it was crucial not to appear completely closed to the idea of ever joining the monetary union. Margaret Thatcher's refusal to fully "play" the two-level game caused friction with her ministers and eventually contributed to her fall, leaving the delicate task of negotiating EMU to John Major.

Maastricht: A Backward-Looking Treaty It is important to place the negotiations of the Maastricht Treaty in historical context, as the early 1990s were characterized by sweeping changes brought about by the end of the Cold War. In 1989, East Germany's borders opened, allowing the free circulation of citizens on both sides of what had been known for almost half a century as "the wall." On October 3, 1990, Germany's reunification took place. The impact of this milestone affected the desire for closer European integration of France and Germany. The two member states called for such a move at an emergency European Parliament debate in Strasbourg, France, on November 22, 1989, and reiterated this aspiration in the April 1990 KohlMitterrand joint letter. A plethora of European integration studies argued that the end of the Cold War had a tremendous effect on the outcomes of the Maastricht Treaty, especially regarding the agreement on EMU. Monetary union has been explained as a desire by France to tie Germany closer to Europe and avoid any resurgence of nationalism stemming from reunification. As for Germany's agreement to EMU, crucial for the negotiations to move forward, two realist explanations have been provided. Karl Kaltenthaler argued that the lack of opposition to monetary union by Germany was the result of a bargain negotiated

The Conservative Party arid EMU

51

with France in order to secure its support for re~nification.~ Michael Baun and Robert Art, in contrast, contended that the decision to support EMU was made by Germany in order to convince and reassure its partners of its commitment to However, the claim that geostrategic motives related to the end of the Cold War were a driving force in the agreement on EMU has been disputed. David Andrews, Andrew Moravcsik, and Anthony Forster rejected explanations of the outcome of the Maastricht Treaty based on geostrategic argurnenk6 Forster stated: I t is true that the coincidence of a series of remarkable international events centered on the collapse of Communism shaped the immediate context and parallel nature of the lGCs on EMU and political union. But these events did not directly affect the content of the IGCs which were concerned with an existing West European agenda and took little direct account of the implications of changes in Central and Eastern Europe. In this sense Maastricht was a back\card-looking treaty.'

By calling the Treaty on European Union a backward-looking treaty, Forster insisted on the notion that the negotiations were about long-sought goals of the European partners. Indeed, the goal of monetary union had been on the agenda of member states since the beginnings of European integration. The goal of monetary union was implicit as early as 1959 in the Jean Monnet Action Committee for a United States of ~ u r o ~ eIn. ' 1962, the European Commission proposed "the fixing of exchange rates between European currencies and the creation of a European reserve currency in preparation for the third phase, monetary union.""he 1969 Barre Plan for monetary cooperation led to development of the Werner Plan in October 1970, calling for the progressive achievement of economic and monetary union, which was adopted by member states in two resolutions passed in 1971 and 1972." The Werner plan had the ambitious goal of creating a European single currency by 1980. Even though the plan failed because of the economic crisis of the time, steps to move in this direction were taken by having close exchange rates in the Snake first and in the European Monetary System (EMS) later on." The goal of monetary union was reiterated in the Single European Act (SEA) in 1987. Soon after the SEA, the Delors Monetary Committee was convened to consider the possibility of establishing an economic and monetary union to complete the single market. At the Madrid European Council of June 1989, a recomnlendation for a three-stage approach to EMU was issued despite strong opposition by Prime Minister Margaret Thatcher. In considering external factors influencing the position and strategy of newly elected Prime Minister John Major during the Maastricht negotiations, this long-time ambition present in Europe since its first days is important in itself, as is the way the prime minister he succeeded had dealt with it.

52

Chapter 4

Margaret Thatcher's Intransigence on EMU John Major's predecessor, Margaret Thatcher, had been strongly opposed to the idea of moving towards a European single currency. Her stubbornness on this issue would lead to her isolation in the Cabinet and eventually contribute to her downfall.'* Thatcher found herself in a difficult situation, for her European counterparts were truly committed to the long-desired goal of monetary union. In addition, when the U K became a member of the EEC in January 1973 under Conservative Prime Minister Edward Heath, the British government had agreed to the goal of monetary union. According to the recently opened archives of the Foreign Oftice, this aspect of EEC membership was not fully revealed to the public, and a decision was made not to hold any debate on its implications.'3 The strategy of the British government, which already had suffered two vetoes from France, was to ensure that no domestic backlash regarding application to the EEC would occur and that EEC partners with a potential veto could not use British unease with an important aspect of the European project to reject UK membership. Luckily for the British, the Werner plan that envisioned the establishment of a single currency by 1980, only seven years after Britain joined, became officially defunct in 1974 after the oil crisis and subsequent recession made its goal impossible to achieve. The early commitment of the UK to the goal of monetary union when it joined the EEC, nonetheless, prevented the member state from opposing a move towards this goal in the late 1980s. Margaret Thatcher recognized the institutional constraint of having agreed to the Werner plan in the 1970s. She was frustrated by not being able to prevent discussion and planning for a single currency among her European peers: 1 was fighting with one hand tied behind my back for another reason. As a 'future ntzmber' of the EEC, the UK had agreed to a communique in Paris following a conference of heads of government in October 1972. This reaffirmed 'the resolve of the member states of the enlarged Community to move irrevocably [towards] Economic and Monetary Union, by confirming all the details of the acts passed b) the Council and by the member states' representatives on 22 March 1971 and 21 March 1972.14

Thatcher had already been confronted with this constraint when she negotiated the Single European Act. Jacques Delors, President of the European Commission, had insisted that the goal of EMU be included in the text of the treaty. As a compromise, Thatcher had given her approval to its inclusion in the preamble.'5 In the final text of the SEA, the preamble reiterated the goal agreed by the heads of state and government of the EEC at the Conference in Paris on October 1972, namely commitment to "the objective of the progressive realization of economic and monetary union."16 French Finance Minister Edouard Balladur reintroduced the idea of monetary union in January 1988 at a time when economic circumstances were propitious and dissatisfaction with the European Monetary System was high. The

The Cotzservative Party and EMU

53

EMS was created in 1979 to achieve monetary cooperation between member states. At its core was the Exchange Rate Mechanism that imposed a limitation on the bilateral exchange rates variation among member states' currencies to a narrow band of 2.25 percent around a central parity. A wider band of 6 percent was later added to accommodate Italy. Central rates were expressed in the EMS internal accounting unit, the European Currency Unit (ECU), which represented a basket of all the European currencies. However, the EMS had become dominated by the monetary policy of Germany, the country with the strongest economy and currency, which created dissatisfaction among members. Balladur's efforts to revive the project of monetary union were followed by a memorandum from Hans-Dietrich Genscher, the German Foreign Minister calling for "a European Currency Area and a European Central ~ a n k . " At ' ~ the 1988 Hannover European Council summit, France and Germany argued that a single currency was necessary to complete the single market and a decision was made to delegate the task of preparing a report on the feasibility of monetary union to a committee of member states' central bank governors and financial experts under the leadership of the Commission's president, Jacques Delors. The report, which became known as the Delors report, would then be examined at the June 1989 Madrid European Council. Thatcher insisted on the inclusion of central bank governors in the committee, instead of relying only on independent experts, because she thought they would rapidly come to the conclusion that EMU was unrealizable. l 8 The Delors report did not contain a costlbenefit analysis of EMU and did not confirm or disprove the claim that the single market could only function optimally with the help of a single currency.'9 Instead, the report outlined the way to achieve monetary union in a three-stage approach. Even though both Governor of the Bundesbank Karl Otto Pohl and Governor of the Bank of England Robin Leigh-Pemberton were not certain it could be achieved, they signed the report, to the dismay of hatcher.^' Leigh-Pemberton later confided that everyone signed the Delors report with not much faith in its realization, but rather thinking that it would have the same fate as the Werner plan.21Nevertheless, the three-stage plan for monetary union, which would be revised later and included in the Maastricht Treaty, had been devised. The plan included a first stage consisting of closer monetary and macroeconomic cooperation between member states with all currencies being part of the ERM; a second stage when a European System of Central Banks (ESCB) would be created to monitor and coordinate national monetary policy and when margins of fluctuation within the ERM would be narrowed; and a final stage 111 that would mark irrevocably fixed exchange rate parities, adoption of a single currency, and delegation of full authority for monetary policy to European institutions. In Britain, as in all other European countries, publication of the Delors report was well received by the export-oriented business community because it promised achievement of a single currency that would completely eliminate exchange rate risks. The Confederation of British Industry urged the government to seriously consider the EMU project during the upcoming international nego-

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Chapter 4

tiations." Ignoring the enthusiasm of the CBI for the Delors report, Thatcher's Cabinet busied itself with devising a strategy to prevent the other member states from accepting the plan at the Madrid summit. The idea was to propose altematives to full monetary union as envisioned in the Delors report in order to slow down the drive towards a European single currency. The Treasury, however, advanced that the UK should maximize its bargaining power at the summit by agreeing to participate in Stage I of the Delors plan, which involved joining the ERM, in order to have more sway on alternatives regarding the following stages.23In a document entitled "The Madrid memorandum," the Treasury argued that vetoing the whole project was simply not possible and that hence "[tlhe choice was between engagement in the debate and banishment to the sideline~."~' The memorandum stated that not being involved in the development of EMU could be highly damaging to the prosperity of the City of on don.'^ It was important for the UK not to appear too opposed to the idea of monetary union while proposing less radical solutions. At the Madrid European summit of June 26-27, 1989, therefore, Thatcher stated that the UK agreed with Stage I of EMU and declared: "I can reaffirm today the United Kingdom's intention to join the ERM-but the British government must be free to decide the timing."26 She also made clear the British government's disapproval with Stage 11 and 111 and announced that the UK would propose alternative plans.27The conclusions reached by all member states at the Madrid summit were to set the beginning date of Stage I of EMU for July 1990, and to convene an Intergovernmental Conference to discuss the remaining stages of the Delors report.28The date for the IGCEMU would later be scheduled for December 1990. Alternative Plans to EMU In preparation for the IGC-EMU, the British government set about developing its alternative proposals. Chancellor of the Exchequer Nigel Lawson devised the first plan, the "competing currencies plan," in November 1989 at the request of Prime Minister Thatcher. The competing currencies plan aimed at granting legal-tender status to all the currencies of the EU. In this market-driven system, the strong currencies would become the preferred ones to use. In a Darwinian way, the weak currencies would be driven out of the system. However, the plan did not trigger much interest in Europe. At the informal meeting of finance ministers in Antibes, where Lawson tested the waters, the competing currencies plan ~ v e nwithin the LJK, the plan attracted little support. was not well re~eived.~' The Treasury was not very enthusiastic about Lawson's proposal, and City bankers were mostly opposed to it.30The Bank of England also expressed skepticism." Legal tender of all European currencies would create competition for the use of sterling in international payments. The system risked becoming domi. ~ ~a result, sterling would likely depreciate, an nated by the ~ e u t s c h m a r k As outcome not favored by banks. Large business firms, for their part, stated their preference for a single currency because the competing currencies plan would not ensure exchange rate stability.33

The Conservative Party and EMU

55

In early 1990, a better proposal came out of the City. Paul Richards, Director of Public Finance at the commercial bank Samuel Montagu, approached Sir Nigel Wicks, Second Permanent Secretary and Director of International Finance at HM Treasury, with a proposal called the hard E C U . AS ~ ~ Wicks expressed enthusiasm for the project, Richards refined the plan with the help of Sir Michael Butler, Director of Hambros Bank and Chairman of the European Committee of the British Invisible Exports ~ o u n c i lThe . ~ ~idea behind the hard ECU plan was to use the already existing unit of account of the EMS, the ECU, as a common currency, running in parallel to national currencies. Monetary policy and foreign exchange reserves would therefore continue to be the responsibility of national central banks. A new institution, the European Monetary Fund (EMF), which would be owned and operated by the central banks of EU member states, would be created to manage the hard E C U . The ~ ~ EMF would issue hard ECU financial instruments in exchange for national currencies. The hard ECU would be traded on foreign exchanges and would no longer be just a basket of European currencies. Paul Richards and Michael Butler asserted, "The ECU would thus become a real European currency alongside each of the national currencies and be at least as strong as the Deutschmark. The preferences of users would determine whether or not it gradually came to predominate in crossborder transactions and thus be a candidate for the EC's main or, one day, single currency."37 The hard ECU proposal was therefore a cautionary and evolutionary approach to monetary union that might lead to a single currency.38 The hard ECU offered many advantages. First and foremost, it would be a strong currency that could not be devalued. National currencies would appreciate and depreciate against the hard ECU within the bands of the ERM. However, if a realignment of central parities was needed, the hard ECU could not be devalued against any national ~urrency.'~ The UK proposal would also allow convergence on low inflation in the EU, another preference of banks in the City. Paul Richards explained the mechanism envisioned that would prevent domestic inflation: "So as to prevent the validation in hard ECU of excessive liquidity creation at national level, national central banks will accept an obligation in Stage 2 to repurchase their national currencies at the request of the EMF in exchange for hard ECU or foreign curren~ies."'~ Both the Treasury and the Bank of England seriously studied the hard ECU plan and contributed significantly to improving it and putting it f ~ r w a r d . The ~' hard ECU plan had the support of commercial and investment banks in the city." The governor of the Bank of England, Robin Leigh-Pemberton, gave its full support to the hard ECU proposal.43The attractiveness of the hard ECU proposal was that it was a community approach and not a two-tier approach, i.e., it involved all members of the EEC and would not result in one bloc being fully integrated while another bloc would move at a different speed. Richards warned against a two-tier approach as proposed in the Delors report. In a two-tier scheme, Germany would likely carry a lot of power in the integrated tier whose operational center would probably be located in Frankfurt. A great concern in

the City was the threat of competition to London's status of international financial center. In July 1990, the EEC Committee of Central Bank Governors agreed to consider the hard ECU proposal endorsed by the new Chancellor of the Exchequer John Major at the special meeting scheduled in September in preparation for the IGC-EMU.'" In August, Commission President Jacques Delors stated that the British proposal would be carefully considered if it were intended, as it appeared, as a genuine way to achieve monetary union and not as a scheme to derail it." In order to convince their European counterparts, Governor of the Bank of England Leigh-Pemberton, Chancellor of the Exchequer John Major, and Foreign Secretary Douglas Hurd declared that the UK was not ruling out the potential develo ment of the hard ECU into a single currency as envisioned in the Delors plan! The consensus had been reached that the only way for the hard ECU proposal to make headway during the IGC-EMU was for the UK to agree to the goal of a single currency.47 Entry of the Pound Sterling into the ERM On October 5, 1990, the pound sterling finally entered the ERM at the rate of DM 2.95 per sterling. The rate of entry was criticized for being overvalued, by about 10 percent according to the National Institute for Economic and Social Research and several economist^.^^ Entry into the ERM, as we have seen, was motivated by the possibility of increasing the UK's bargaining power at the Maastricht Treaty negotiations. in addition, City representatives had warned the governtilent that British membership of the EKM would be necessary for the hard ECU to be given serious consideration during the upcoming IGC- EMU.^' The timing for entry was excellent, as it was just before the first Rome European summit aimed at preparing for the IGC-EMU. Another perceived benefit of entry was the reduction of inflation that would ensue, which was emphasized in official s t a t e ~ n e n t sThe . ~ ~ monetary policy authorities in Britain were looking for an alternative to the monetary targets used to achieve inflationary discipline, which had led to a disappointing performance." The aspiration of the financial sector for low inflation, therefore, loomed large in the decision to enter the ERM. The rate of entry also corresponded to the preference of the financial sector for an overvalued currency. The announcement of the entry of sterling in the ERM at DM 2.95 led to a "euphoric reaction" in the In the business sector, reaction to entry into the ERM was dichotomous. The Confederation of British Industry praised the decision by the Thatcher government. 53 Even though export-oriented business interests would have preferred entry at a lower rate, the exchange rate stability that membership of the ERM would bring was greatly appreciated." The Federation of Small Businesses supported ERM entry for a different reason than the CBI. As small family businesses rely on mortgages, the cut of the interest rate by 1 percent that accompanied entry and the future inipact of ERM membership on interest rates were perceived as b e n e f i c i a ~ In . ~ ~contrast, the Institute of Directors expressed its shock and dismay at the ERM d e c i s i o ~ i . ~ ~

The Conservative Par& and EMU

57

As anticipated, entry of sterling into the ERM led to a fall in inflation. As measured with the RPIX, the Retail Price Index excluding mortgage interest payments, inflation fell from 9 percent before entry to 4.2 percent in 1992.~' Interest rates cuts amounted to 3.5 percent in 1 9 9 1 . However, ~~ GDP growth fell to minus 1.5 percent in 1991 and unemploynient rose from 5.5 percent in 1990 to 10.2 percent in 1992.59

The Fall of Thatcher Thatcher's acquiescence to the entry of sterling into the ERM tipped the balance positively towards making the UK appear as a conciliatory partner in the eyes of other member states. Nevertheless, her attitude during the European summit and her subsequent declarations at the House of Commons undermined any chance for the alternative plan to EMU, the hard ECU, to be taken into serious consideration. Having disagreed with all her European counterparts over the timing of Stage I1 of EMU, she stated during the European summit that she would refuse the imposition of a single currency.60This comment was not crucially damaging to the UK's bargaining position, as the proposed hard ECU plan was an evolutionary approach towards the eventual goal of single currency. However, in her comments in the House of Commons, the Prime Minister made her views clearer and matters worse. She stated her belief that "the hard ECU would not become widely used throughout the Community," thereby undermining the credibility of the hard ECU plan her Cabinet had worked so hard for.6' Two days later, Deputy Prime Minister Geoffrey Howe resigned with the following words: "We must be at the centre of the European partnershipplaying the sort of leading and constructive role which commands respect. We need to be able to persuade friends as well as challenge opponents, and to win arguments before positions become entrenched. The risks of being left behind on EMU are eve re."^' Howe's resignation added to the already existing call for a challenge to the leadership of the Conservative Party. Thatcher, who failed to defeat Michael Heseltine in the first ballot, did not wait for the second round and resigned on November 22, 1990.

The IGC-EMU John Major was elected new leader of the Conservative Party and became Prime Minister shortly before the IGC-EMU was due to start. He faced a tough negotiating position, as Thatcher's stubbornness on the subject of EMU had led to diplomatic isolation in the EEC. Major was intent on repairing the damage caused by his predecessor. The negotiating team that was due to go the IGCEMU agreed they needed "to be positive in the IGC negotiations if they were to be successful, to seek areas of agreement where possible and to nurture support froni other Member States in order to avoid unpalatable Treaty clauses."63 John Major's strategy at the opening of the IGC was to keep the hard ECU plan on

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Chapter 4

the table even though, by that time, the Prime Minister had realized that the British proposal had very little chance of being accepted by the other member states6' However, promoting the hard ECU had another purpose: it satisfied the goal of appeasing both euroskeptics and europhiles at home. As Forster noted, the hard ECU "could be presented to euroskeptics on the one hand as a means to frustrate the EMU project without appearing anti-European, and to euroenthusiasts on the other hand as a step on the way to Britain herself joining a single currency."65 Paul Richards recognized the appeal of his plan to the UK government for these specific domestic purposes: It was a stage 11 proposal rather than a stage 111 proposal and a stage I1 proposal that could lead to stage 111 but did not necessarily lead to stage 111. And in that sclise it was important because it [net the requirements of both sides of the political debate. It was a way forward, it was a colnniunity way forward, but both the proponents of EMU and the opponents of EMU could support it. And that was i~nportantpolitically.66

By continuing to advocate the British proposal during the IGC, the British government also hoped to be in a position to influence other aspects of EMU.^^ AS EEC member states expressed strong reservations about the hard ECU, Major began advocating another solution, a generalized opt-out whereby all member states would have to seek national ratification before joining Stage 111 of EMU. This feature had the potential to make cotnpletion of EMU very difficult. The generalized opt-out was discussed during a meeting of finance ministers in Luxemburg on May 11, 1991. Jacques Delors proposed that the UK, which was so ' opt-out adamant about this option, obtain a unilateral ~ ~ t - o u tA. ~unilateral would pertnit the UK not to move to Stage 111 unless the House of Commons approved it. However, the British government, desiring not to be singled out, continued to press for a generalized opt-out, which was included in the Dutch draft Treaty, but ultinlately rejected. The UK eventually resolved to accept a unilateral opt-out one week before the Maastricht European Council was about to start.69Even though the British Government would have preferred a generalized to a unilateral opt-out, this position, as Forster noted, "served many of the same domestic functions as the hard ECU policy had done."70 It satisfied both pro- and anti-euro domestic interest groups. The other issues discussed during the IGC and resolved on time for the Maastricht European Council concerned the substance of Stage I1 and the transition to Stage I11 of EMU. In September, an agreement was reached on the creation of a European Monetary Institute (EMI), ensuring coordination of monetary policy in Stage 11, which would start on January 1, 1994. A European Central ~ UK was satisfied by this arBank would only be initiated in Stage 1 1 1 . ~The rangement, as it left responsibility for monetary policy to national central banks until the introduction of the single currency.72The transition process to Stage 111 would be based on adherence to convergence criteria. The Council of Finance Ministers would assess by 1997 which countries met the criteria. At least six

The Conservative Parry and EIZ~U

59

countries would have to meet the criteria for a single currency to be adopted. This additional obstacle to reach Stage 111 was also pleasing to the U K . ~ ~ The last unresolved details on the three stages and a timetable were finalized during the Maastricht European Council. Regarding the transition from Stage I1 to Stage Ill, member states agreed that a single currency would be adopted in 1997 if enough countries met the convergence criteria. Otherwise, Stage 111 would automatically start on January 1, 1999, making the move to a single currency irreversible. However, a protocol recognizing that "the United Kingdom shall not be obliged or committed to move to the third stage of economic and monetary union without a separate decision to do so by its govemtilent and Parliament" was included in the rea at^.^^ The convergence criteria to be met by member states to qualitjl for Stage 111 were established as follows: Price stability: an average inflation rate not exceeding by more than 1.5 percent that of the three most performing member states; Budgetary discipline: a budget deficit of less than 3 percent of GDP and a public debt ratio not exceeding 60 percent of GDP; Currency stability: respect for normal fluctuation margins (2.5 percent) of the ERM 'without severe tensions' for at least two years with no devaluations; Interest rate convergence: an average nominal long-term interest rate not exceeding by more than 2 percent that of the three best performing member states."

Ratification of the Maastricht Treaty (1992-1993) Upon his return from the Maastricht summit, John Major received praises in Parliament for having skillfully negotiated a sound treaty.76Shortly thereafter, the Prime Minister secured a second term for the Conservative Party at the 1992 general election. However, the entry of sterling into the ERM, which was designed to strengthen Britain's bargaining position during the negotiations for the Maastricht Treaty, soon would come to haunt the Conservative Party and contribute to its eventual defeat.

Black Wednesday (September 16,1992) International events unfolded that damaged the credibility of the British government to keep the pound sterling in the ERM. After John Major's election victory of April 9, 1992, the ratification process of the Maastricht Treaty started but it soon encountered difficulties on the Continent. On June 2, Danish voters rejected the Treaty, shattering investors' confidence in the project of EMU and in consequence creating speculation on the ability of sterling and other currencies to maintain their parities. In mid-July, the Bundesbank raised its interest rate in order to deal with inflationary pressures caused by Germany's reunifica-

tion, which led other currencies in the ERM to depreciate and added to the speculative pressure.77In addition, concerns started to be raised about the success of the upcoming French referendum that President Franqois Mitterrand pledged to hold in late September. Speculative attacks against the pound sterling and other currencies continued while Germany refused to lower its interest rate and suggested that other currencies should devalue. The British monetary authorities made it clear that they opposed devaluation and insisted on maintaining the DM 2.95 parity at which sterling had entered the ERM.~'John Major declared on September 10, 1992: "The soft option, the devaluer's option, the inflationary option would be betrayal of our future; and it is not the government's The Bank of England used about one-half of its reserves on September 16 to intervene in the foreign markets and maintain the parity.80The Bank then proceeded to raise the interest rate, which had been climbing since the beginning of the crisis, to 12 and then 15 percent, which failed to make a difference. As it could not raise the interest rate further or buy tilore sterling on the foreign exchange market, the British government resigned itself to suspending its participation in the ERM and allowing its currency to float. The sterling crisis created an unprecedented recession in the UK. Doubledigit interest rates undercut consumer spending. As a result, thousands of businesses had to file for bankruptcy. The sectors that were the most hardly hit were nontradable producers of goods and services. The cotnmercial property market, for instance, suffered tremendously. Con~paniessuch as Olympia & York that had invested billions in developments projects in Canary Wharf and elsewhere were devastated." Banks such as Barclays that had funds tied to property loans also encountered tremendous losses as their clients could not service their debts." The crisis did not hurt everyone, however. Currency speculators made tremendous profits from the crisis; one of its most famous beneficiaries was George Soros who is known to have made a billion dollars out of it.83The crisis also benefited exporters as sterling depreciated by about 20 percent against the DM after its exit from the ~ ~ ~ . ~ " o m ~ a with n i e major s sales overseas welconied the competitiveness brought by the devalued sterling. A few internationally oriented firms recorded an all time increase in their overseas sales.s5 The devaluation of the pound led the shares of companies with major overseas earnings such as Glaxo and Reuters to climb.86The FTSE index recorded a 10 percent increase a week after the devaluation of the pound.87 The ERM experience left a lasting impression on many and affected the ratification of the Maastricht Treaty in Parliament. The exit of sterling from the ERM triggered euroskepticism from the very members of Parliament (MPs) who had congratulated John Major for obtaining a satisfactory agreement at Maastricht." The currency crisis made it very difficult for the government to foresee an easy ratification of the Treaty; ratification would take over a year and a half. Thatcher added to the difficulties by urging Conservative backbenchers to vote against ratifi~ation.'~The no-vote in Denmark had already led some one hundred MPs to sign a House of Commons motion to reject the treaty." However, John Major was set on seeing the treaty approved because non-ratification

The Conservative Party and Eh4U

61

would have been a serious blow to his authority and would also have severely ' with increasing divisions within damaged the UK's position in the E U . ~Faced his party, Major finally decided to hold a vote of confidence "to take the process of ratification to the level of brinkmanship," a strategy that proved s u c ~ e s s f u l . ~ ~ The UK officially ratified the Treaty of Maastricht on August 2, 1993.

Wait and See (1994-1996) In the aftermaths of the ERM debacle and the difficult ratification of the Maastricht Treaty, the government of John Major adopted the policy of "wait and see" on EMU. This policy had the advantage of satisfying both the anti- and proeuro elements of the split Cabinet and of uniting the party. The new Chancellor of the Exchequer, Kenneth Clarke, had urged the Prime Minister not to completely rule out membership of EMU because of the potentially highly damaging economic and political consequences of doing so." Clarke was looking out for the interests of the City, which at that time was not sure how it would be affected by the advent of the euro. As we will see in detail in chapter 7, it was important that the UK stay involved in the development of EMU because some of its features had not yet been decided and could have an impact on the London financial sector, even if the UK stayed out. Therefore, the official position of the government was one of non-decision, which left all options open, as expressed by Chancellor Clarke at a European Movement Gala Dinner on February 9, 1995: The combination of a lack of convergence and a lack of clarity about the detail convinces me that the exercise of our choice of whether or not to move to a single currency is unlikely to face us as a decision for this country for some time to come. But it would be folly for us to decide now one way or the other simply in response to the short-tenn political pressures of today.94 While the Conservative government of John Major stayed on its guard, the other member states of the European Union were forging ahead with their goal of achieving EMU by the end of the century. At the Madrid European Summit of December 1995, the member states agreed on the name of the single currency, the euro, and set the details for the start of the third stage on January 1, 1999, despite the wariness of the UK. The British government warned against interpreting the Maastricht convergence criteria too loosely and showed no interest in participating in the multi-million euro campaign to be launched by the European om mission.^^ The position of the British government at the Madrid summit reflected feelings within some ranks of the Conservative Party that the issue of membership of the euro zone would be important in the approaching general election." Participation in a public information campaign on the euro financed by the European Comnlission was therefore out of the question.

62

Chuptrr 3

The Referendum Party, formed by financier billionaire Sir James Goldsmith in 1996, complicated the issue of the euro for the Conservative Party. Goldsmith created a single-issue party campaigning for the goal of holding a referendum on the entirety of Britain's relationship with the European Union. As the Maastricht Treaty had been a highly divisive issue within their party, the Tories were concerned about losing votes to the Referendum Party. This fear led John Major to announce on April 3, 1996, that a Conservative government would allow the British people to vote in a referendum, not on the entirety of Britain's relationship to the EU, but on whether the country should adopt the single currency. The Labour Party felt it had to make the same promise in order to position itself competitively in the general election. Shadow Chancellor of the Exchequer Gordon Brown declared on November 17, 1996, that a Labour government would also poll the British people in a referendum before joining the European monetary union. Meanwhile, in December 1996, the European Union reached an agreement on the legal framework for the use of the euro and on the principles of the Stability and Growth Pact (SGP) at the Dublin European Council. The SGP was designed to ensure fiscal discipline by requiring members of the euro zone to maintain government deficits and debt below 3 percent and 60 percent of GDP, respectively. Exceeding these limits would result in an excessive deficit procedure requiring the delinquent illember state to take corrective action. The euroarea countries could also be subject to financial penalties as a last resort. As rnember states on the Continent furthcr demonstrated their commitment to achieve EMU, the Conservative Party became increasingly divided on the European single currency. As the elections approached, several ministers of John Major's Cabinet declared their opposition to EMU and refused to follow the government policy of "wait and see" in their election declarations; instead, they staunchly stated their opposition to ever replacing the pound.97 On April 16, 1997, in a plea for party unity, the Prime Minister reiterated his policy: "My policy has been, on an issue of such importance that we have never seen its like in the political lifetime of anyone alive today, that we would negotiate until we knew what was involved, and then we would decide.''98 The continuation of the wait and see policy responded to the concerns of the City expressed in a major report entitled Preparing for EMU: The Itnplications o f Ezcropean Monefury Union for the Banking and Financial Markets in the United Kingdom, issued in November 1996. This authoritative study, undertaken by the main financial trade associations, the London Investment Banking Association, the British Bankers Associations, and the Association for Payment and Clearing Services together with the major British banks, restated the importance for the U K to stay involved in the design of EMU because some of its undecided features could have an adverse impact on the London financial sector.99 The report implied that it would be unwise for the government to make a decision on the euro because the impact on the financial sector of the two possible optionsBritish membership and non-membership-was still unclear at that time.

The Conseivative Party and EMU

63

As EMU increasingly became a prominent issue in the forthcoming general election, the Labour Party tried to position itself differently from the Tories. The strategy chosen by the Labour Party was to appear more open-minded and united than the Tories on the issue of the single currency but not overtly europhile so as to avoid allegations that the Labour Party was ready to "sell" Britain to Europe. Indeed, while the Labour Party portrayed the Tories as extremely divided on the EU, the Tories depicted their opponents as excessively proEurope. A famous Tory campaign poster, for example, featured Tony Blair as a ventriloquist puppet in the hands of German Chancellor Helmut Kohl. Struggling to define the policy of the Labour Party on the euro in a non-damaging way, Shadow Chancellor Gordon Brown and his economic advisor Ed Balls came up with the idea of the famous "five tests." Before a Labour government would decide to join the euro zone, an assessment would have to be made regarding the following five criteria: =

Whether European countries are at different stages of the economic cycle; Whether there is sufficient flexibility in the operation of the new currency's stability pact and in Labour markets to respond to economic shocks; The impact on employment; The impact on investment by British companies in Britain and elsewhere in Europe and on inward investment in Britain; The impact on the UK financial services industry.'00

Brown and Balls, en route to the office of United States Treasury Secretary Robert Rubin, where they were to explain the Labour Party's position on the euro drafted the five tests on the back of an envelope in a New York taxi."' Balls called Robert Peston, political editor at The Financial Times, to brief him on "the British economic tests," as they were first referred to before being simply called "the five tests."Io2 Peston, outlining New Labour's policy in a February 20 Financial Times article, argued that the tests brought Labour's policy closer to that of the government, which was at that time perceived to be more and more hostile to EMU."^ This was not the perception Brown and Balls hoped to convey, which might explain why the five tests were not included in the Labour Party manifesto published in April 1997 and only resuscitated after Labour's election victory. Labour continued to position itself as slightly more open on the euro than the opposing party. The Conservative Party manifesto argued for trying to delay the onset of the third stage of EMU: "If it cannot proceed safely, we believe it would be better for Europe to delay any introduction of a single currency rather than rush ahead to meet an artificial timetable. We will argue this case in the negotiations that lie ahead.'"'' Rather than contending that the UK could dissuade its European partners to launch the euro in 1999, the Labour Party manifesto took the more realistic position of stating that there would be "formidable obstacles in the way of Britain being in the first wave of membership."'05 How-

64

Chapter 1

ever, the Labour Party manifesto explicitly ruled out a permanent opt-out of EMU in order to keep influencing its developn~ent:"to exclude British membership of EMU forever would be to destroy any influence we have over a process which will affect us whether we are in or out. We must therefore play a full part in the debate to influence it in Britain's interest^."'^^ This statement echoed positively in the City, which had expressed its concerns that the U K stay fully involved in the development of EMU. On May 2, 1997, Tony Blair won the general election with 43 percent of the votes and 418 seats, bringing Labour back to power after being in the shadow for eighteen years.'07 The Tories received 30 percent of the vote and a mere 165 seats.Iu8The landslide victory of Labour was attributed to the party unity that it presented as well as the promise of economic competence.'09 The Conservatives, on the other hand, had suffered gravely from the ERM crisis, which was attributed by many to poor decisions regarding both the timing and rate of entry into the system. In addition, Labour's EMU policy appealed to the widest electorate. Executives of large businesses, who would generally tend to vote for the Conservatives, preferred the approach of Labour regarding the single currency, as it promised eventual membership. Those working in the City were concerned about how EMU would develop and also favored a more positive approach to ensure British influence in the final details of the European monetary union. New Labour's policy was also ambiguous enough to satisfy those in the larger public who were more in favor, undecided, or slightly opposed to losing the pound. The Labour government would continue a convenient policy of nondecision on the euro throughout its term. In the next general election, the Conservative Party would campaign on saving the pound, which would not bring it back to power.

Notes I . Anthony Forster, Britain and the Manstricht ,Vegotiations (New York: St Martin's I'ress, 1999). 160. 2. John Major cited in Sarah tlogg and Jonathan liill. Too Close to Call: Power and Politics-John hlcljor- it1 h'o. 10 (London: Little, Brown and Company, 1995), 157. 3. Kobert Putnam, "Diplomacy and Domestic Politics: the Logic of Two-level Ga~nes."Itite~.t~ational Organization 42, no. 3 (Sumnicr 1998): 434. 4. Karl Kaltenthaler, Gernlany and the Politics oJ'Eur-ope's 12.loney (Durham, NC: Lluke University Press, 1998). 5. Michael Baun, "The Maastricht Treaty as High Politics: Germany, France, and European Integration," Politicul Science Qtt(~rlerly110, no. 4 (Winter 1995-96): 605-24; and Robert Art, "Why Western Europe Needs the United States and NATO," Political Science Quarterly I I I, no. 1 (Spring 1996): 1-39. 6. Andrew Moravcsik, The Choice for- Europe. Social Purpose and State Power front .2lessina to hlaastr.icht (Ithaca, N.Y.: Cornell University Press, 1998); Anthony Forster, Britarn c~ndthe ~~laastriclit Negotiations, 2 ; and David Andrews, "The Global Origins of the Maastricht l'rraty on EMU: Closing the Window of Opportunity" in Alan

The Conservative Government and EMU

65

Cafruny and Glenda Rosenthal, eds. The State of the European Community (Boulder, Colo.: Lynne Rienner, 1993), vol. 2, 107-42. 7. Forster, Britain and the Maastricht Negotiations, 2. 8. Forster, Britain and the Maastricht Negotiations, 47; and Jean Victor Louis, From E.tlS to i\lonetary Union (Luxembourg: Office for Official Publications of the European Comniunities, 1990), 7. 9. Louis, From EMS to Monetary Union, 7. 10. Louis, From EMS to hlonetary Union, 7. 1 1 . The Snake in the Tunnel was an attempt at having a joint float of European currencies against the dollar after the failure of the Bretton Woods system. For a detailed explanation of the functioning of the snake, see David Wood and Birol Ye~ilada,The Enzerging European Union, 4th ed. (New York: Pearson, 2007), 127. 12. Philip Stephens, Politics and the Pound: The Conservatives' Struggle with Sterling (London: Macmillan, 1996). 13. Foreign and Commonwealth Office, Implications of Membership of the EEC: ~VlonetaryUnion, London: 1970, National Archives: Kew, UK. 14. Margaret Thatcher, The Downing Street Years (New York: Harper Collins, 1993). 74 I . 15. Stephens, Politics and the Pound, 1 I 1. 16. Single European Act, Preamble. Oflcial Journal L 169, 29. 6. 1987. 17. Alasdair Blair, Dealing with Europe: Britain and the Negotiations of the Maastricht Treaty (Brookfield, Vt.: Ashgate Publishing, 1999), 149. 18. Blair, Dealing with Europe, 153; and Stephens, Politics and the Pound, 1 1 1. 19. Destnond Dinan, Ever Closer Union, 2nd ed. (Boulder, Colo.: Lynne Rienner I'ublishers, 1999), 456. 20. Stephens, Politics and the Pound, 1 l 1 - 12. 2 1 . Blair, Dealing with Europe, 15 1. 22. Confederation of British Industry, European Monetary Union: A Business Perspective (London: CBI, 1989); and Confederation of British Industry, Annual Reportfor the Year Ending 31 December 1989 (London: CBI, 1990), 20. 23. Stephens, Politics and the Pound, 1 15. 24. Stephens, Politics and the Pound, 1 16. 25. Stephens, Politics and the Pound, 1 1 6. 26. Stephens, Politics arid the Pound, 1 18- 19. 27. Stephens, Politics and the Pound, 1 19. 28. Baun, "The Maastricht Treaty as High Politics," 609. 29. David Buchan, "Lawson Currency Plan Receives Cool Reception," The Financial Tinles, September l I, 1989, 1. 30. Stephens, Politics and the Pound, 161; and Leila Talani-Simona, Betting For cind Against EMU: Who I.Vins and Who Loses in Italy and in the U K f i o t ~ the i Process of Elrropean Ilonetaiy Integration (Brookfield, Vt.: Ashgate. 2000), 154. 3 1 . Buchan, "Lawson Currency Plan." 32. lvor Owen and Ralph Atkins, "Competing Currencies Plan Draws Fire from Labour," The Financial fimes, November 3, 1989, 14. 33. Alex Brummer, "An Idea Whose Time has Come ...and Gone," The Guardian, Suly 19. 1990, Notebook. 34. Personal interview with Paul Richards, Former Director of Public Finance, Samuel Montagu, London, July 17, 2006. 35. Stephens, Politics and the Pound, 161; Michael Butler and Paul Richards, "Europe's urgent need for hard ECU," The Independent, May 18, 1990, 23; Peter Nor-

66

Chapter 4

man, "Business Takes an Interest in ECU," The Financial Times, May 29, 1990, 27; and Richards interview. 36. Paul Richards, "The Hard Ecu and Alternative Paths to European Monetary Union: The Case for an Evolutionary Stage 2," 1,ondon School of Economics Financial Markets Group, Special Paper Series, Special Paper No 29, July 3 1, 1990,4. 37. Butler and Richards, "Europe's Urgent Need for Hard ECU." 38. Richards interview. 39. Richards, "The Hard Ecu," 4. 40. Richards, "The Hard Ecu," 5. 4 1. Richards interview. 42. Personal interview with Sir Adam Ridley, Director, London Investment Banking Association. London, November 30, 2005. 43. Rodney Lord, "Hard Ecu has Full Support of Governor," The Tirnes, June 22, 1990, 5 . 44. "Economic And Monetary Union: Governors' Committee Agrees to Examine British Proposals On Hard Ecu," European Report, July 14, 1990, 2. 45. Michael Binyon, "Delors Welcomes 'Positive' British Plan for Hard Ecu," The Times. August 22, 1990, I; and Tim Dickson, "Delors Gives Hard Ecu Proposals a Second Look," 771e Financial Times, August 22, 1990, 4. 46. "Economic and Monetary Union," European Report. 47. Stephens, Politics and the Pottnd, 180. 48. David Cobham, The Alakitig of hlonetnry Policy in the United Kingdom, 19752000 (Hoboken, N.J.: John Wiley & Sons, 2002), 75. 49. "The Late Arrival at the EMU Ball," The /.'inancia1 Tin~es,June 22, 1990, 22; and Talani-Simona, Betting For and Against EMU, 152. 50. Cobham, The &faking ofiCtonetary Policy it1 the United Kingdom, 74. 5 1 . Cobhani, The hlaking ofhlonetary Policy irr the United Kingdom, 77. 52. David Lascelles, "Britain and the EMS: Spot of Light amid Gloom," The Financial Tiines. October 8, 1999, 17. 53. For the position of the CBI on the ERM, see Confederation of British Industry, E~rropeanAlonetary Union: A Bllsirless Perspective, 20; Confederation of British Industry, .lnn~ial Report for the Year Ending 31 Decen1bt.r 1990 (London: CBI, 1991 ), 19; and Confederation of British Industry, Annual Report jLr the Year Ending 31 December 1988 (London: CBI, 1989), 6. For the reaction of the CB1 to entry of sterling into the ERM, see Confederation of British Industry, Agenda for Europe: Con~pletingthe Single Market (London: CBI. 1990), 13. 54. "ERM Entry is Gook for Industry," Press Association, October 5, 1990. 55. Mark Duckenfield, B~tsinessand the Euro: Blrsiness Groups and the Politics of EMU in Gerntarzy and the United Kingdom (Neu York: Palgrave, 2006), 158. 56. Dan Atkinson and Simon Beavis, "?'he ERM Decision: Mixed Response from Business," 7he Guardian, October 6 , 1990. 57. Cobham, The Making ofh'lonetary PolrL:,'in the Urlited Kingdom. 77. 58. Cobham, The Making of iLlonetaty Po1rc:v in the Utzited Kingdom, 77. 59. Cobham, The Making of ildonefary PollL in the United Kingdonl. 77. 60. Stephens, Politics and the Pound, 18 1. 61. House of Commons, Hansar.d Debates, Volume 178, Column 878, October 30, 1990. 62. Geoffrey Howe Letter of Resignation, November 1, 1990 cited in Stephens, Politics and the Potrnd, 182-83. 63. Stephens, Politics and the Pound, 34.

The Conservative Government and EMU

67

64. Forster, Britain and the Maastricht Negotiations, 54; and Blair, Dealing with Europe, 176. 65. Forster, Britain and the htaastricht Negotiations, 55. 66. Richards interview. 67. Blair, Dealing with Europe, 177; and Forster, Britain and the h4aastricht Negotiations, 60. 68. Blair, Dealing with Europe, 178. 69. Blair, Dealing with Europe, 18 1. 70. Forster, Britain and the Maastricht Negotiations, 63. 7 1 . Blair, Dealing with Europe, 1 84; and Forster, Britain and the Maastricht Negotiations, 63. 72. Forster, Britain and the Maastricht Negotiations, 64. 73. Forster, Britain and the Maastricht Negotiations, 68. 74. Treaty on European Union, Protocol on Certain Provisions Relating to the United Kingdom of Great Britain and Northern Ireland. February 7, 1992. http://europa.eulenlrecord/mt/protocol.html (accessed May 3, 2006). 75. Desmond Dinan, Ever Closer Union (Boulder, Colo.: Lynne Rienner Publishers, 1994), 427. 76. Alasdair Blair, Saving the Pound? Britain's Road to Monetary Union (London: Prentice Hall, 2002), 160. 77. Reunification of Germany involved converting dstmarks (OM) into Deutschmarks (DM), which was done at a rate of one to one. As the DM was approximately equivalent to seven OMS previously, this fueled inflation in reunified Germany. 78. Cobharn, The Making ofhtonetaty Policy in the IJnited Kingdom, 78. 79. John Ma,jor cited in Philip Stephens and Emma Tucker, "Major Stresses Solid Opposition to Devaluation: Pound's Realignment Would Be 'Betrayal,"' The Financial Tinzes, September l I. 1992, I. 80. Walsh. European Monetary Integration and Domestic Politics, 122. 81. liichard Thomson. "A Year Best Forgotten," The Independent, December 27, 1992, 3. 82. Thomson, "A Year Best Forgotten." 83. Stephens, Politics and the Pound, 226. 84. Wayne Asher, "Happy Hour for Britain's Exporters!" Daily Mail, September 21, 1992, 35. 85. Ken Smith, "Exports Taking off, Says Airline Chief," The Herald, October 30, 1992. 3. 86. "Enhancing European Equities," The Econotrrist, September 26, 1992, 91. 87. "Enhancing European Equities," The Economist. 88. Blair, Saving the Pound, 1 84. 89. Blair, Saving the Pound, 193. 90. Blair, Saving the Pound, 194. 9 1 . Blair, Saving the Pound, 195. 92. Blair, Saving the Pound, 196. 93. Blair, Saving the Pound, 201. 94. Chancellor's Speech to the European Movement Gala Dinner (London: HM 'Treasury, February 9, 1995) cited in Blair, Saving the Pound, 202. 95. John Palmer and Michael White, "Euro Tide Engulfs Major," Manchester Guardian IVeekly, December 24, 1995, 4. 96. Blair. Saving the Pound, 203.

68

Chapter 1

97. Robert Pestoil and John Kampfner, "Tory Crisis over Euroskeptic Rebels Ministers Breach Official Line to Declare their Opposition to Monetary Union," The Financial Enzes, April 16, 1997, 28. 98. .lohn Major cited in John Gapper, "PM Regs His Party Not to 'Bind My Hands' o n EU," 7he Financial Tinzes, April 17, 1997, 10. 99. EMU City Working Group, Preparingfor 1-1.2lU: The It~iplicationsof European Afonetary Unionfor the Banking and Financial hlarkets in the United Kingdoni (London: EMU City Working Group, 1996). 100. Robert Peston and Gerard Baker, "Opposition Ailns to Set EMU Tests: Senior US Treasury Ofticials Will Hear of Labour Party's New Position," The Financial Times, U S A Edition. February 20, 1997, 8. 101. Robert Peston, Brown's Britain (London: Short Books, 2005), 193; and Anthony Hilton. "Have We Passed the Five Tests?" The Everling Standard, May 16, 2002, 4. 102. Pzston, Brown 's Britain, 193. 103. Peston and Baker, "Opposition Aims to Set EMU tests." 104. Conservative Party, Consetvutive Party General Election Manifesto: You Can Only Be Sure with the Conservatives, 1997. www.conservativemanifesto.corn/ 199711997-conservative-n1aiiifesto.shtmI (accessed April 23,2006). 105. Labour Party, New Laboll/-: Beca~lseBrilcriri Deserves Better, 1997. www. labour-party.org.uk/manifestos/l997/1997-labour-inai1ifesto.shtml (accessed April 23, 2006). 106. Labour Party, New Labour. 107. BBC News Online. 1997 Election Battle Results, http://news.bbc.co.uk/hi/ english lstaticlvote2001 /in-depth/election_battles/I997-resu1ts.stm (accessed April 24, 2006). 108. BBC News Online. 1997 Election Battle Results. 109. Blair, Suvitzg the Po~lnd,2 13.

Chapter 5

The Blair Years and the Euro Even though Tony Blair seemed to be a committed European ready to take Britain into the euro, the policy on EMU implemented by the Labour government reflected the same two-level game strategy of the preceding government. New Labour's policy aimed at making the UK appear as a serious partner to other EU member states, one that was considering joining the full European endeavor. This projected image on the Continent was necessary to ensure continuous influence of Britain in the final details of EMU, which could considerably affect its prized financial services industry. In addition, the policy would be ambiguous enough to quench the impatience of the pro-euro business coalition to be in the euro zone while allowing enough time for the financial sector to determine its preference.

Blair's First Term (1997-2001) In the context of preparing for EMU, the Labour government of Tony Blair adopted major reforms that were directly beneficial to the interest of the London financial sector. The first such reform consisted in granting operational independence to the Bank of England, a move long awaited by City interests. The Labour government then implemented its "prepare and decide" policy on EMU, which granted the time necessary for the financial sector to assess its interests.

Independence of the Bank of England Granting operational independence to the Bank of England was one of the very first actions the newly elected Labour government took in the spring of 1997. Only a few days after the election results, Chancellor Gordon Brown announced the stunning decision.' After raising the interest rate by 0.25 percent, the Chancellor declared it would be the last time he would be making the decision over borrowing costs. The Bank of England would now be responsible for setting the interest rate. The Chancellor announced that the structure of the bank would be

70

Chapter j

changed with the establishment of a Monetary Policy Committee (MPC) which would meet monthly to decide on interest rates. The MPC would consist of the governor of the Bank of England, and two deputy governors, respectively responsible for monetary policy and financial stability. The government would appoint the governor and deputy governors. In addition, the MPC would include two executive directors, appointed by the BoE after consultation with the Chancellor, and four external experts, appointed by the chancellor.' Decisions would be made on the basis of one-person, one-vote with the Governor of the Bank having overriding power in case a majority could not be r e a ~ h e d . ~ The news pleased the City, where the foreign exchange and stock market reached new highs4 The decision to grant operational independence to the central bank was also welcomed by the Institute of Directors and the Confederation of British Industry for different reasons.' The IoD had recommended granting independence to the Bank of England in the early 1990s as an anti-inflationary policy and an alternative to joining the ERM, to which it was opposed. The CBI, for its part, viewed independence as a move towards qualifying for entry into the third stage of EMU. According to Article 108 of the Maastricht Treaty, each inember state had to initiate the process leading to the independence of its central bank during the second stage of EMU, which started in 1 9 9 4 . The ~ CBI had indicated to Ed Balls, Economic Advisor to Shadow Chancellor of the Exchequer Gordon Brown, that decisions concerning the Bank of England would be viewed by the association as "the most important test of whether Labour is seriously comlnitted to European integration."' Balls had subsequently presented Brown with a report entitled The Macroecotzonzic Frartlework that advocated granting independence to the Bank should the Labour Party win the elections. In the report, Balls argued that "the willingness of a Labour government to act in accordance with the Maastricht Treaty [would] be viewed with increasing importance both domestically and within ~ u r o ~ e . " ~ The independence granted to the Bank of England by the Labour government, however, is only operational and not sufficient to meet the criterion for participation in the third stage of EMU. Article 107 of the Maastricht Treaty stipulates that "neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any government of a Member State or fiom any other body."9 Article 108 requests that each member state ensure compatibility of its central bank's status with the specified requirement.'' National central banks had to become completely independent from governments at the latest at the date of the establishment of the European System of Central ~ a n k s . " Under the Bank of England Act of 1997, the Chancellor of the Exchequer continues to set the inflation target that the Bank of England strives to meet by setting an appropriate interest rate. Therefore, the Bank is not completely independent and follows instruction from the government. The British government also retains responsibility for determining the exchange rate regime. Therefore, it is difficult to argue that the independence of the Bank of England showed a commitment of the new government to join EMU as, when one looks at it

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71

closely, it does not quite meet the Maastricht Treaty requirements. Nevertheless, operational independence created the perception that the government was willing to join, both domestically and in the EU, as advocated in 1995 by Ed Balls. The principal motivation to grant independence to the Bank of England had very little to do with the Maastricht Treaty requirements in a direct sense. The Bank of England was made independent in order to move to a more successful counter-inflationary policy. l 2 However, as Christopher Taylor, former Chief Economic Advisor in the European Division at the Bank of England, stated, ''It was convenient that the British government could tick that box."13 Operational independence increased the credibility of the British government's antiinflationary policy, which had not been highly successful. After Black Wednesday, a new monetary policy had been put in place to replace the exchange rate target of the ERM. The Conservative government had decided to use inflation targets, which had to be in the range of I to 4 percent, with the goal of achieving a rate below 2.5 percent by the Spring of 1997." Inflation during the early to mid 1990s was in the wider range and fell in the narrower target only momentarily in April and May 1997.15Therefore, the new monetary policy introduced after the ERM crisis represented an improvement in controlling inflation but was limited and inconsistent.16 One of the main attractions of EMU is that having the interest rate set by an independent European central bank removes political blame from governments and provides credibility to maintain low inflation. With operational independence of the Bank of England, however, the Labour government achieved the same result early in its first term. Granting operational independence to the Bank of England was an alternative to joining EMU in order to achieve low inflation." Paul Richards, who was at the time special advisor to the Governor at the Bank of England, stated: 71'he independence of the Bank of England was connected solely to the objec-

tive of trying to achieve low inflation. . . . There was a feeling that if the Bank of England was given independence in achieving an inflation target and if there uas a monetary policy committee to decide on that month by month, then it would be a better way to achieve low inflation in the U K than the other way, that is joining EMU. That was the reason why the Bank of England was made independent."

Under operational independence, inflation (which had been brought down before the government decision) has remained low and near target. This success has been attributed to the explicit inflation target, to the transparency of the Monetary Policy Committee, which has to publish the minutes of its meetings and quarterly forecasts, and to the fact that the governors and staff of the bank as well as the independent members of the MPC are concerned about their reputation.I9 The primacy given to domestic inflation as the basis for interest rate decisions and the reduction in political control over policy led sterling to appreciate substantially from late 1998. This hurt the tradable sectors of the economy, par-

72

Chapter 5

*'

titularly export-oriented manufacturing industry. However, sustaining the conipetitiveness of British industry, which had been a key object of policy at times in the past, was no longer accepted as an objective in itself. It only mattered in so far as it affected the prospect for inflation. Despite the concerns of industry, therefore, policy was not weakened to drive down the exchange rateand indeed it remained high for a further decade. The competitiveness of industry, a former member of the MPC confided, was never considered a reason on its own for changing interest rates; it came into debate only insofar as it affected the outlook for the output gap and future inflation.*'

The Prepare and Decide Policy The second endeavor of the newly elected Labour government was to initiate its "prepare and decide" policy on EMU, which included introducing and conducting a preliminary assessment of the five tests and establishing a national changeover plan. Even though these are steps that seemed to point towards membership of EMU, I will demonstrate that they did not constitute a true commitment to adopting the single currency. l~ltroductionof the Five Tests According to the UK Protocol of the Maastricht Treaty, the British government had to notify the European Council by January 1, 1998-before determination of which member states fulfilled the convergence criteria-whether the UK intended to move to the third stage of EMU.^^ On October 27, 1997, in a statement at the House of Commons, the Chancellor announced the government policy on EMU. The Chancellor declared that the UK was in favor of joining the euro, in principle, provided it was successful: "[llf, in the end, a single currency is successful, and the economic case is clear and unambiguous, then the government believes Britain should be part of it."23 The assessment of whether the case is "clear and unan~biguous"would be based on the five economic tests that had been drafted by Gordon Brown and Ed Balls in preparation for the general election, only slightly modified. The five tests were stated as follows: I.

2. 3. 4. 5

Whether there can be sustainable convergence between Britain and the economies of a single currency; Whether there is sufficient flexibility to cope with economic change; The elTect on investment: The impact on our financial services industry; Whether it is good for employment.2"

The decision to include as one of the tests the effect of euro membership on the financial services industry led to outrage from the manufacturing sector. The overwhelming feeling was that the government was once again privileging the financial sector. Manufacturing interests argued that the fourth test or "City test," as it came to be known, was a clear example of how the government fa-

The Blair Years atld the Euro

73

vors the financial sector in its economic policy decisions. The remark of Richard Laming, head of campaigns at the European Movement and subsequently elected member of its Executive Committee, is illustrative of the way manufacturers felt about the fourth test: "Why would one of the tests be is EMU good for the City? Why not is it good for the car industry? Why is the City privileged?"25 Similarly, Martin Weale, Director of the National Institute of Economic and Social Research, asserted that the effect of membership of the euro on the City should not be one of the five tests: "Why should one product group, like financial services, be considered more important than any other, such as manufacturing?"'6 He was joined by other economists who contended that the fourth test amounted to nothing else than the government "pandering" to the City. Managing Director of Capital Economics Roger Bootie also said: "It is bizarre why no other industry has a say."27Balls and Brown, who had quickly drafted the tests in early 1997 in order to present the Labour Party's position on EMU at a meeting with US Treasury Secretary Robert Rubin, had not foreseen such a negative reaction to the fourth test. The government announced that a brief preliminary assessment of the five tests had led to the conclusion that adoption of the euro in 1999 with the first wave of countries to qualify would be too soon to allow the conditions for success to be met: "British membership of a single currency in 1999 could not meet the tests and therefore is not in the country's economic interests. . . . We will therefore be notifying our European partners, in accordance with the Maastricht Treaty, that we will not seek membership of the single currency on 1 January 1999."28The Chancellor further stated, in an effort to limit the speculations on entry, that it would be unrealistic to expect the government to join during the life of the current Parliament. However, entry early during the next parliament could be possible and required the UK to prepare now. Chancellor Brown listed the necessary preparation: Commence work on the detailed transition arrangements for the possible introduction o f the Euro in Britain, including the introduction o f notes and coins, should we wish to enter; step-up the work on what business should do now to prepare for the introduction o f the Euro in 1999, whether we are in or out; work with business on what government must do to prepare for E M U , should we decide to join it in the next parliament.29

The Chancellor of the Exchequer invited Bank of England Governor Sir Edward George and President of the Confederation of British Industry Sir Colin Marshall to join him in setting up a Standing Committee on Preparations for EMU.^' The Chancellor's statement initiated Labour's "prepare and decide" policy on the euro, differentiating itself slightly from the previous government "wait and see" policy by appearing more proactive and willing to join, at least rhetorically.

74

Chapter 5

The Inquiry of the House of Commons on Government Policy Following the Chancellor of the Exchequer's statement, the House of Commons Select Committee on Treasury conducted an investigation of the Chancellor's policy on EMU. The Committee's mission was to evaluate "the validity of the Chancellor's five economic tests and how performance against them will be assessed and the decision on UK participation in Stage Three taken." 3 1 Interestingly, the report of the Select Committee noted that even though the government established these tests, "the Chancellor did not give any specific commitment that policy would be steered to meeting the tests."32 Therefore, these tests were reflective of a Labour policy very similar to the previous government's "wait and see" policy where no attempt would be made to meet the conditions required to join EMU. However, if the right circumstances came to be, the UK could envision joining. Mark Littlewood, former Head of Campaigns at the European Movement, aptly described the "prepare and decide" policy as one that was not proactive. He echoed the concerns of those who wanted to see true progress towards membership of Stage I l l of EMU: The British government behaved as if it was an observer looking at an objective external economic series of events which was wholly out of its control. It would just observe, note, and analyze rather than show any will or power to affect Britain's position and capacity to enter. This was true both on the comrnunicatiotl side to persuade public opinioit and in terms of actually making the economic conditions right.'' The Select Committee report further noted that the Chancellor's five tests were very subjective to interpretation, as they did not include any measures or indicators allowing a determination of whether a test had been met.34Similarly, the Chancellor's statement indicated that the UK would only join a "successful" l d assessed.35 EMU but never defined how this success w o ~ ~ be The House Committee pointed out another problem with the government policy on EMU. Although the government expressed its willingness to join, there was an uncertainty as to whether the UK would meet all of the convergence criteria and no effort was being made to clarify or address this issue. Although the UK would certainly meet the inflation, public debt, deficit, and long-term interest rate convergence criteria, it was unclear whether it would meet the exchange rate criterion. Indeed, the exchange rate criterion requires that "a Member State has respected the normal fluctuation margins provided for by the Exchange Rate Mechanism of the European Monetary System without severe tensions for at least the last two years before the e ~ a m i n a t i o n . "The ~ ~ wording of the Maastricht Treaty does not indicate whether it requires a member state to have been in the ERM for two years or simply to have maintained its currency tluctuations within the bands of the ERM without necessarily being a member. However, the possibility of a member joining Stage I11 of EMU (adoption of the single currency) without having joined Stage I (entry into the ERM) was never envisioned. The Select Committee on Treasury noted in its fifth report:

The Blair Years and the Euro

75

"Opinions now differ on how the criterion should be interpreted, with many commentators arguing that actual membership of the ERM is needed to satisfy the criterion." The report also indicated that the government had said in a testimony to the House: "We have no intention of rejoining the ERM but we have as our goal exchange rate stability."" The Select Committee investigated the question of whether the UK would have to rejoin the ERM to satisfy the exchange rate convergence criterion or whether, as the government argued, it would be sufficient to show that sterling had stayed within the margins of the ERM without actually being in it. For this purpose, the committee met with EU representatives. However, the answer the committee obtained from these meetings was inconclusive: We heard differing views as to whether the UK would be expected to join the ERM before participating in the single currency. In one of our meetings on the continent we were told candidly that the political desire for the UK to join would enable its understandable reservations about the ERM to be accomrnodated. However, others were adamant that stability in relation to a rate defined after the event (ex post stability) was not a substitute for participation in the ERM and the discipline of holding a currency within range of a rate defined in advance (ex ante ~tability).~' The Select Committee, therefore, urged the government to clear any misunderstanding with European finance ministers and central bank governors regarding this issue.39In its response to the Select Committee report, however, the government failed to directly answer this point. The government stated that its position on the ERM was clear; it had no intention of rejoining. Recognizing that exchange rate stability was an important aspect of preparing for EMU, the government expressed its belief that the best way to achieve it was through the monetary and fiscal framework it had put in place.40Christopher Taylor, former Chief Economic Advisor in the European Division at the Bank of England, indicated that the answer to the question of whether the UK would have to rejoin the ERM to enter the third stage of EMU was different at home and on the ~ o n t i n e n t .The ~ ' feeling at the top of the Bank of England at that time was that if the U K indicated a willingness to join, it would not be required to pass that test in the sense that was set out in the Treaty. But the other major central banks in Europe saw it very differently. Taylor indicated that it might have been quite a difficult and awkward issue to resolve.42The fact that the British government did not try to solve a practical issue regarding whether or not the UK would meet the Maastricht Treaty requirements for entering the third stage of EMU is indicative of a loose rather than proactive prepare and decide policy. As Charles Goodhart, former member of the Monetary Policy Committee at the Bank of England, noted, the government never considered it important to deal with this matter: "How we would be treated if we wanted to enter the euro, whether we would have to be in the ERM for a transitional period, it's never been an effective issue because in the end, Gordon Brown's five tests were failed."43

The National Changeover Plan A national changeover plan, published in February 1999, was the result of the preparation work on eventual entry announced by Chancellor Brown in 1997. The changeover plan was a theoreticul exercise presenting what would happen should the government make a decision to join the single currency. It did not include any dates or commitment to join at a certain time. As figure 5.1. shows, the national changeover plan anticipated that joining the euro would take less time than it had for the first wave of countries because the UK would already have been "exposed" to the euro. Indeed, the national changeover plan stated that many businesses in the UK would already be using the euro, the City would be dealing in euros, and the public sector would be offering services in euros by the time a decision was taken.44The comparative timetable shows that it took about fifty months from the 1995 Madrid summit to the launch of the euro whereas it would take only forty months from a decision to join the single currency by the British government to circulation of euro notes and coins in the UK.

rqr

Figure 5.1. Theoretical British Tinletable for Joining the Euro Compared to First Wave Countries

TFl

Countries joinir~gin 1999

30 ~llor~ths

8 months

36 months

6 months

IIK Joining (illustrative only) Kefe~endum

4 lnor~ths

6 months

Source: Her Majesty's Treasury, Ozitline iVnfiotza1Clzirngeover Plan (London: H M 'freasury. February 1999), 2 1.

The National Changeover Plan reiterated that before any decision could be made, the five tests would have to be met, which was deemed unlikely during the current Parliament. However, the government had to prepare, in case things changed in the next Parliament: "[P]reparations should be made in this Parlia-

The Blair Years and tile Euro

77

ment so that, should the economic tests be met, a decision to join a successful single currency can be made early in the next Parliament. Without preparation, it is not a practical option. The British people should be in a position to exercise genuine ~ h o i c e . " ~The ' national changeover plan outlined all the steps that would be required for the UK to join the euro. The changeover plan also noted that verification by the EU Economic and Financial Committee (ECOFIN) that the UK met the convergence criteria would be required. But the changeover plan did not go over specifics of the convergence criteria and failed to mention the uncertainty related to the ERM criterion emphasized by the House of Commons report. The national changeover plan outlined the practical implications for the UK of the launch of the euro on January 1 , 1999, and of the circulation of euro notes and coins on January 1, 2002, in the euro zone. The document, therefore, served another, more realistic, purpose: to assess how the UK remaining outside of the euro zone would be affected. There was great uncertainty as to how much the euro would be used in the UK by businesses and public authorities starting in 1999. The changeover plan stated, "Many firms will want to use euro as a second currency while the UK remains out if that helps them to retain existing customers or attract new ones."46 Similarly, the Business Advisory Group, a consultative body, indicated, "It is difficult to estimate how widely the euro will be used for business within the UK from 1 January 1999, but it is expected to be more widely used than other currencies are today. If so, a wider range of businesses in the UK will need to adapt to using the euro, despite the UK remaining outside EMU."^' The City also insisted that adequate preparations had to be in place for the launch of the euro and abolition of national currencies whether the UK was in or out." The wholesale financial sector had to be prepared even if the UK did not join. Paul Richards, former Director of Public Finance at the investment bank Samuel Montagu, explained, "It was very important that the City be well prepared, particularly for the City's own good but also for the success of the project across Europe as a whole because of the large role that the City had in wholesale financial markets, including in the legacy currencies, Deutschmark, French franc, and so on."" There was also anticipation that once the euro notes and coins would be in circulation in the euro zone, they would be used in the tourism industry in the U K . ~ Depending ' on the interest the euro triggered, its use could be extended to other industries. The House Select Committee report on EMU had noted, "if for some reason the euro did become widely used throughout the economy, it could impact on the operation of monetary policy."51 However, the report had indicated that neither the Bank of England nor the government could predict precisely the extent of the use of the euro in the U K . ~ ~ The national changeover plan was therefore as much a plan to prepare for British adoption of the single currency as it was a plan to prepare for staying outside of the euro zone. In both scenarios, the UK would be greatly impacted by the launch of the euro in 1999, and preparations were needed. Hence, the fact that the British government put time into a national changeover plan does not

78

Chapter 5

necessarily indicate an intention to join. It constituted an exercise that allowed anticipating the impact of monetary union on the UK in or out of the euro zone. It was particularly important for the wholesale financial services industry. As a matter of fact, the success of the City can be partly attributed to the time that was put into preparations for the launch of the euro by the government, no matter what its ultimate decision would be.53

Blair's First Term: Conciliatory EMU Policy The policy on EMU planned and eventually implemented by the Blair government after the general election was one of conciliation of domestic and European interests that wanted to see the UK eventually join the single currency. Regarding relations with the EU, it was critical that the UK appear as a willing partner in the monetary union project. The preceding Conservative government had used the same two-level game during the Maastricht negotiations. As we will see in detail in chapter 7, this strategy, continued by the Labour government, would allow the UK, and particularly the City, to avoid discrimination as the final details of EMU were determined. Pursuing at the same time its strategy of not appearing too europhile to avoid domestic attacks by euroskeptics, the Labour government gave different messages to the EU and to different interest groups at home throughout its first term. Prime Minister Blair, as we will see, would successfully manage to control the pro-euro campaign run by business interests, "Britain in Europe," by constantly reassuring businesses that the government intended to join the euro zone after the 2001 general e~ection.~"owever, Blair was also careful not to alarm financial interests. For example, before his Chancellor of the Exchequer delivered a speech at the 2001 annual Bankers and Merchants dinner at the Mansion House, Blair, worrying that it sounded too pro-euro, had several of the pro-euro elements of the speech removed." At about the same time, Blair was assuring his European counterparts that the British government was still considering early entry during the next ~arliament.'~

Blair's Second Term (2001-2005) Whereas it was difficult, in the run-up to the 1997 general election, to distinguish between the Labour and Conservative policies on the euro, things got easier in the 2001 election campaign, as the Conservatives became outwardly hostile to joining. The new leader of the Conservative Party, William Hague, established a very euroskeptic shadow cabinet and adopted the policy line of opposition to the euro for the next ten years.57The Tory leader organized a "save the pound truck campaign" whereby he toured cities, towns, and villages to deliver a message against membership of the single currency.58 In 2001, the Conservative Party manifesto si111pIy stated: "The next Conservative government

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79

will keep the pound."59 For its part, the Labour manifesto restated that the government was "in principle, in favor ofjoining" and that an assessment of the five tests would be done "early in the next ~ a r l i a m e n t . "The ~ ~ Labour manifesto directly attacked the Conservatives' EMU policy by saying: "So the choice is between a Conservative Party which will deny the people of Britain the chance to join, even if it is in our national interest to do so-and the Labour Party which says that, if it is in our national economic interest, the decision should be made Despite a low voter turnout (59 percent by the British people in a referend~m."~' versus 71 percent in the previous election), Labour once again won a large victory with 40 percent of the vote and 413 seats.62 Immediately after the Labour victory, Blair reshuffled his Cabinet to mitigate its strongly pro-euro elements. Robin Cook was demoted to Leader of the House of Commons while the more euroskeptic Jack Straw was appointed to the post of Foreign Secretary in his place, and Stephen Byers was moved from Sect . ~ ~the government retary of State and Industry to Secretary of ~ r a n s ~ o rWhile policy on EMU had not changed, the reshuffling showed that Blair was not inclined to make membership of the euro the priority of his second mandate. However, the Labour government would have to do a thorough assessment of the five tests as it had committed to during its first term. Indeed, in 1997, the government had declared that an assessment of the five tests would be conducted early in the next Parliament. When asked in an inquiry at the House of Commons what early in the next Parliament meant, Gordon Brown had stated "within two years of the new Parliament."

2003 Assessment of the five tests In 2003, therefore, as promised, the government undertook a thorough analysis of the five tests. Considerable time and resources were devoted to the assessment, which in the end consisted of eighteen background papers of about one hundred pages each.64However, this activity did not necessarily demonstrate a serious consideration ofjoining the single currency, but can be viewed the other way. As Robert Peston said, the assessment by the Treasury "would be worth it, if all uncertainty and argument about monetary union could be silenced by its sheer enormity."65 The assessment, undertaken at Her Majesty's Treasury, was to be presented at 10 Downing Street in January 2003. However, the presentation was postponed several times as, at that time, the Prime Minister was preoccupied by the buildup to the war in ~ r a ~When . ' ~ Blair finally heard the conclusion of the Treasury regarding the tests, he insisted that the assessment should not be so categorically negative but rather give an impression of "not quite yet, we don't quite yet meet the test^."^' So the initial assessment of the tests had to be redrafted to match the Prime Minister's desire.68Catchphrases such as "since 1997 the UK has made real progress towards meeting the five economic tests" were included in the docu~nent.~~

80

Chapter 5

Originally, the assessment was to be included in the budget speech to be delivered by Chancellor of the Exchequer Brown on April 9, 2003. Some changes to be introduced in the budget, such as the adoption by the Bank of England of the measure of inflation used in the euro zone, the consumer price index, could be presented as a way to get closer to meeting the tests in an indeterminate future." However, Blair changed his mind at the last minute regarding the timing of the announcement of the negative assessment of the five tests. When the draft of the budget, including the revised assessment of the tests, was delivered to the Prime Minister's office from the Treasury, the draft was sent back with a request to remove the assessment of the five tests. The rationale of the Prime Minister was that the government should not appear as trying to take advantage of problems in Iraq to "sneak out its euro de~ision."'~ The assessment of the five tests was finally introduced at the House of Co~nmonsa couple of months later, on June 9, 2003, by Chancellor Brown. As the Prime Minister requested, the assessment gave "an impression of strong progress towards meeting the tests at some indeterminate point."72 Only one test had passed, the most controversial one: the City test, which had the advantage of removing allegations that the financial sector's interests were determinant of governnient economic policy. Although the test was said to have passed, the assessment in the Treasury report was more about why the London financial sector would not be negatively affected by the UK staying outside of the euro zone than about why it would be positively affected by the UK joining in. For example, the report indicated that entry could strengthen London's position of leading financial center if there was any reluctance to locate wholesale financial activities in a financial center outside of the euro area. However, the Treasury recognized that this had not been the case since the euro was launched and that it was unlikely to be the case in the future: services activity might be To the extent that the location of wholesale ti~~ancial based on membership of the single currency, then a decision not to join the single currency might imply an adverse perception for future location decisions. flowever, the first four years of the euro have not produced any evidence of such concerns affecting location decisions. Wholesale financial firms such as those tiom the US are likely to continue to place greatest weight on the locational advantages of London already highl~ghted,including its critical mass of financial expertise and a skilled labour force." Another paragraph indicated that the aging EU population, new marketbased instruments by firms and investors in the euro zone, and enlargement of the E U would be sources of new business for the London financial services industry. However, it was also noticed that the City would be able to take advantage of these developments whether the UK was inside or outside of the euro zone.7JThe conclusion of the Treasury report on the City test was very general and sirnply indicated: "Inside or outside EMU, the competitive strength of the City should mean that the UK continues to attract a significant level of

The Blair Years and the Etrro

81

wholesale financial services activity."75 While the assessment of the fourth test found in the Treasury report was not straightforward, the conclusion on euro membership in the City was clear: the London financial sector had benefited from its position outside of the euro zone and remaining out was the most favorable option.76As the four other tests were failed, no one in the City minded the positive assessment of the City test because there was no risk that the UK would join, and it took the attention away from the financial services sector.77 The assessment of the five tests also allowed the government to introduce needed domestic economic reforms. For example, greater labour market flexibility measures were justified as necessary to allow the U K to move closer to meeting the employment test. The Chancellor announced that progress on these reforins would be evaluated during the next budget and, based on this evaluation, a decision would be made as to whether to conduct another assessment of the five tests.78This subsequent assessment of the five tests would not take place as, at that time, the attention turned to the drafting of the EU Constitution and whether the U K would hold a referendum on it.

Blair's Third and Last Term (2005-2007) In preparation for the 2005 election, the Labour Party maintained its policy of postponement of membership of the euro without ever ruling it out, based on the five tests. The Labour Party manifesto stated: On the euro, we maintain our common-sense policy. The determining factor underpinning any government decision is the national economic interest and whether the case for joining is clear and unambiguous. The five economic tests must be met before any decision to join can be made. If the government were to recolnniend joining, it would be put to a vote in Parliament and a referendum of the British people.79

Meanwhile, the Conservative Party continued to position itself as opposing further European integration, not only rejecting euro membership but also the EU Constitution. The 2005 Conservative Party manifesto stated: "We oppose the EU Constitution and would give the British people the chance to reject its provisions in a referendum within six months of the General Election. We also oppose giving up the valuable freedom which control of our own currency gives us. We will not join the ~ u r o . " ' ~ The Labour government of Tony Blair won a third term, even with the debacle in Iraq. Blair's popularity had suffered from the decision to assist the United States in the war on Iraq and his party received only 36 percent of the votes which was nonetheless sufficient to ensure victory and secure 356 seats.8' In his third term, Blair did not make any headway on euro membership, which no interest group continued to advocate. As the following chapter will demonstrate, whereas there was an important mobilization of internationally-

oriented business actors for euro membership during the first tern1 of Blair and early in his second term, the pressure eventually faded away as the government responded to these actors' concerns with alternative solutions. Meanwhile, the City. which had had plenty of time to assess its situation outside of the euro zone, was enjoying a tremendous growth from the advent of the euro, the past six years having proven its instinct right that it could become a most successful offshore euro center. Within two years of his third term, on June 27, 2007, Tony Blair stepped down to give his much-awaited seat to his Chancellor of the Exchequer Gordon ~ r o w n . ~This ' transfer of power to the one figure in Blair's government who had always had in mind the well-being of the City definitely closed the debate on the euro, or what was remaining of it by that time. In 2008, as the subprime crisis reached Europe, rumors emerged that the UK was considering joining the single currency. The rumor spread after President of the European Commission Jose Manuel Barroso said in an interview with French radio RTL that in light of the economic crisis, Britain was closer than ever before to adopting the e ~ r o . 'The ~ spokesman for Prime Minister Gordon Brown, Michael Ellam, immediately issued a statement that the UK had no intention of joining the euro zone.84Apologies from the European Commission for the erroneous claim followed shortly thereafter. The spokesman for Barroso, Johannes Laitenberger, qualified the European Commission president's statement by saying that he simply implied that there was a reflection in countries outside of the euro zone about reconsidering their positions.85 While the rumor that the British government was thinking of adopting the euro was short lived, analyses by economists increasingly demonstrated that the United Kingdom had made the right choice by staying out. Paul Mortimer-Lee, head of market economics at BNP Paribas, for example, argued that the crisis would have hit the U K harder had it been in the euro zone." A panel on the future of the euro at tlarvard University, which gathered leading economists, came to the same conclusion and advanced that the United Kingdom would weather the crisis better than other EU member states thanks to .~' the 2010 Greek debt crisis, which threatits exchange rate f l e x i b i ~ i t ~Finally, ened the euro zone viability and led the euro to plunge to a four-year low against the dollar, was further confirmation that the UK had not missed anything by staying out.

Conclusion During both the Conservative and Labour governments, no attempt was made to meet the conditions necessary for entry in the third stage of EMU, reflecting a passive policy rather than a proactive policy of a government intent on joining. Even though the Labour policy involved "preparations," these preparations were necessary for the UK to be ready for the launch of the euro if it stayed out. They were not indicative of the government's readiness to join. Other policy changes

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83

implemented by the Labour government that could be interpreted as showing a willingness to be ready for entry into the euro zone, such as the independence of the Bank of England, were motivated instead by the desire to find an alternative to joining. The British government did not even find it necessary to clarify whether it would meet one of the most important conditions for membership stipulated in the Maastricht Treaty: the exchange rate criterion. Finally, the five tests designed by the Labour government to help the UK decide whether it should adopt the euro were highly subjective and open to interpretation, as they did not offer any criterion that would indicate whether a test had been met. The tests were a convenient tactic delaying any decision on a policy that created a deep schism among the main sectors of British society, as w e will see in the next two chapters. The City test, which had been the subject of criticism, was conveniently passed although its assessment was more indicative o f the fact that the City was not affected by non-membership of the euro zone. Adequate planning would allow the City to be fully prepared to take advantage of new business steinniing from completion of monetary union on the Continent and to become a successful offshore euro center.

Notes 1. Larry Elliott and Michael White, "The Bold Chancellor: Brown Gives Bank Independence to Set Interest Rates," 7'he Guardian, May 7, 1997, I . 2. David Cobham, The Making of Monetar,~Policy in the United Kingdom, 19752000 (I-loboken, N.J.: John Wiley & Sons, 2002), 107-08. 3. Alasdair Blair, Saving the Pound? Britain's Road to Monetav Union (London: I'rentice I-lall,2002), 220. 1.Diane Coyle and Nic Cicutti, "At Last, Independence for the Bank; Chancellor's Move Heralds Cheaper Long-Term Money," The Indeper~dent,May 7, 1997, 20. 5. For the reaction of the CB1 to independence of the Bank of England, see Jill Sherman and Alasdair Murray, "Independence for Bank of England," The Times, May 7, 1997. I . 6. Mzastricht Treaty, Provisions Amending the Treaty Establishing the European Economic Community with a View to Establishing the European Community, February 7, 1992. 21. 7. Robert Peston, Brown's Britain (London: Short Books, 2005), 187. 8. Ed Balls cited in Peston, Brown's Britain, 187. 9. Maastricht 'Treaty, Provisions Amending the Treaty Establishing the European Economic Cotnmunity with a View to Establishing the European Community, Maastricht, 1:ebruary 7, 1992, 17. 10. Maastricht Treaty, Article 108, 17. l I . Maastricht Treaty, Article 108. 17. 12. I'ersonal interview with Christopher Taylor, Former Chief Advisor, European Division, Bank of England, London, August 2, 2006. 13. Taylor interview. 14. Cobham, The Making of Monetary Policy in the United Kingdom, 93. 15. Cobham. The ~tiukingoj'i24onetarjl Policy in the United Kingdom, 106.

16. Cobham, The Making ofhlonetaty Policy in the United Kingdom, 106. 17. Peston, Brown's Brilain, 187. 18. Personal interview with Paul Richards, Forrner Director of Public Finance, Samuel klontagti; Former Special Advisor to the Go~zrnor,Bank of England, London, July 17,2006. 19. Cobhain, 711eMaking of Motietaty Policy in the United Kingdom, 1 13. 20. Cobham, The i24aking of Monetaty Policy in the United Kingdom, 113. 2 1 . Personal interview with Sir John Gieve, Former Deputy Governor at the Bank of England, Cambridge, MA, May 15, 2009. 22. The Maastricht Treaty, Treaty on European Union and the Treaties Establishing the European Communities, Protocols, Protocol on Certain Provisions Relating to the United Kingdom of Great Britain and Northern Ireland (Maastricht, February 7, 1992), 33. 23. Gordon Brown. "Statement on Economic and Monetary Union." H.M. Treasury, October 27. 1997, ~ww.h~ii-treasury.go~.ukinewsroom~and~speeches/speeches lstatcnientlspeech- statement 271097.cfin (accessed February 22, 2006). 24. Brown, "Statement on Economic and Monctary Union." 25, Personal interview with Richard Laming, Former [lead of Campaigns, currently tlonorary Secretary, the European Movement and Media Director, British Soft Drinks Association, London, December 8, 2005. 26. Karl West, "Brown Pandering to the City on Euro Tests, Say Economists," The Hercild, January 29, 2003, 24. 27. Miest, "Brown Pandering to the City." 28. West, "Brown Pandering to the City." 29. West. "Brown Pandering to the City." 30. West, "Brown Pandering to the City." 3 1 . t-louse oCCommons, The UK and f'reparciiions for Stage Three of Economic and .Idot~eiaq~ Lrnion. Treasury Select Committee, Fifth Report, April 1998, Paragraph 4, w~v~v.publications. parliament.uk~pa~cm199798/cn~select/cmtreasy/503v/ts0503.htm (accessed March 19, 2006). 32. tlouse of Cornmons, The UK and Preparutions for Stage Three, Paragraph 22. 33. Personal interview with Mark Littlewood, Former Head of Campaigns, the European Movenient, London, December 2, 2005. 34. House of Commons, The UK and Preparutiot?sfor Stage Three, Paragraph 23. 3 5 I-louse of Commons, The UK and Preparutions for Stage Three, Paragraph 26. 36. Maastricht Treaty, Protocol or] the Conljt.rgence Criteria Referred to in Article 109 J of [he Treaty Estciblishing the E~~rvpecit7Cotnt~~zinity, Article 3 , http://europa. eu.intlen/recordlnitiprotocol.ht~nl (accessed September 26, 2006). 37. House of Commons, The UK and Preparutions for Stage Three, Paragraph 82. 38. tlouse of Commons, The UK and Prepa~.ationsfor Stage Three, Paragraph 83. 39. House of Commons, The UK and Prepat.ations for Stage Three, Paragraph 89. 40. House of Commons, T%e UK and Preplirationsfor Stage Three ofEconomic and i2tonetary IJnion: The government 's Response to ihe Committee's Fifrh Report ofsession 1997-98, Treasury Select Committee, Sixth Special Report, w~vw.publications.parliament.ukipalcm 199798/c1nselectlcmtreasy/905/90503.htm(accessed July 18, 2006). 4 1 . Taylor interview. 42. 'l'aylor interview. 43. Personal interview with Charles Goodhart, Former Member of the Monetary I'olicy Committee at the Bank of England, London, August 2, 2006.

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85

44. Her Majesty's Treasury, Outline ~VationalChangeover Plan (London: H.M. Treasury. Fcbruary 1999), 14. 45, tler Majesty's Treasury, Outline National Changeover Plan, 7. 46. Her Ma,jesty' s Treasury, Outline National Changeover Plan, 23. 47. Business Advisory Group Report cited in House of Commons, The UK and Preparations for Stage Three, Paragraph 53. 48. Richards interview. 49. Richards interview. 50. Business Advisory Group Report cited in Ilouse of Commons, The UK and Preparationsfor Stage Three, Paragraph 59. 5 I . I-louse of Commons, The UK and Preparcltions for Stage Three, Paragraph 61. 52. House of Commons, The UK and Preparationsfor Stage Three, Paragraph 62. 53. Richards interview. 54. Chapter 6 provides a full empirical account of the Britain in Europe campaign. 55. Peston, Brown's Britain, 225. 56. Derek Scott, OSf Ch'hitehall (London: IB Tauris, 2004). 57. Stephen Castle, "Hague Picks Right-Wingers, " The Independent, June 22, 1997,

-

L.

58. Martin Hickman, "Hague Launches 'Save the Pound' Truck Tour," Bath Chronicle. October 15, 1999, 7. 59. Conservative Party, 2001 Conservative Party General Election Manifesto: Time for Con~tnon Sense, www.conservativemanifesto.com~2001/2001-conservativeriianifcsto.shtml (accessed April 24, 2006). 60. Labour Party. 2001 Labour Party General Election Manifesto: Ambitions for Britain. www.Iabour-party.org.ukinianifestos/2001/2001-labour-manifesto.shtml (accessed April 24, 2006). 6 1 . Labour Party. 2001 Labour Party General Election Manfesto. 62. "Election Results Through Time: 1945 to 2001," BBC News Online, http://news. bbc.co.uW lisharedl vote2005/past~elections/htmlidefault.stm (accessed April 25, 2006). 63. Karnal Ahmed, "Blair Axed Cook Over Euro Row: PM Feared Cabinet Split on Currency," The Observer, June 10, 2001, 1 . 64. Peston, Brown's Britain, 234. 65. Peston, Brown's Britain, 233. 66. Peston, Brown's Britain, 235. 67. Peston, Brown's Britain, 233. 68. Peston, Brown's Britain, 239. 6 9 . ller Majesty's Treasury, UK Membership of the Single Currency: An Assessment ofthe Five Econonzic Tests (London: I1.M. Treasury, June 2003), 6. 70. Peston, Brown's Brituin, 235. 7 1 . Peston, Brown 's Britain, 239. 72. Peston, Brown's Britain, 243. 73. Her Majesty's Treasury, UK Menzbership ofthe Single Currency: An Assessmetlt of the Five Tests, Chapter 4: Financial Services, www.hm-treasury.gov.uk/documents/ i1iternational~issues/the~euro/assessmet/report/euroassess03repchap4cfm(accessed September 28, 2006). 74. Her Majesty's Treasury, UK Membership of the Single Currency. 75. Her Majesty's Treasury, UK Membership of the Single Currency. 76. Chapter 7 explains in detail the evol~rtionof the City's view on British membership of the euro.

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77. Personal interview with Sir Brian Pitman, Former Chief Executive Oficer and Chairman of Lloyds TSB, Former President, British Bankers Association, currently Senior Advisor. Morgan Stanley, London, July 17. 2006. 78. Gordon Brown, Statenzent by the Chancellor of the fichequer on UK At.~nbership of the Single Currency, June 9, 2003, www.hm-treasury.gov.uk/ docu11~ents/international~issursithe~euro/assessnient/euro~assessO3~speech.cfm (accessed July 3.2006). 79. Labour Party, Britain For~oard,Not Back (London: Labour Party, 2005), 84. 80. Conservative Party, Are You Thinking CC'hat We 're Thinking? It's Time for Action (London: Conservative Central Office, 2005). 26. 81. "Blair Secures Historic Third Term," BBC News Online, May 6, 2005, http://nrws. bbc.co.uk lllhi/ukgoliticsivote-200jlfrontpagel4519863.stm (accessed July 7. 2006). 82. "Blair to Step Down as Britain Begins Brown Era," Agence France Press, June 27, 2007. 83. "UK Closer to Joining Euro, EU Comniission President Says," The Guardian, Dece~iiber 1 , 2008, www.guardian.co.~1kipolitics/2008/deci0I/euro-barroso (accessed March 3, 2009). 84. George Parker, "Brown Quashes Barroso's Euro Claims," The Financial Times, December 2,2008,4. 85. "UK Says It's Not Thinking about Adopting the Euro," Associated Press, December 1,2008. 86. Pat11Mortimer-Lee cited in David Smith. "Wrong 'Sime for Brown to Reach for Ih~roI,ifeli~ic," The Sunday Times, December 14, 2008, 4. 87. "The Future of the Euro," Study Group on the Future of the EU, Center for European Stt~dies,I-larvard University, May 6, 2009.

Chapter 6

Business and the Euro As the policy of the British government on EMU was ambiguous and seemed to leave all options open, business interests proceeded to determine their preference and to lobby accordingly. The business sector--defined as "corporations whose principal activity is the production of market goods or non-financial servicesn-was highly divided on British membership of the euro zone. In order to gain a full understanding of the domestic cleavages regarding EMU in the business community, it is necessary to document the position and lobbying activity of the leading trade associations, to trace actions taken by large multinationals acting in their individual capacity, and to examine the involvement of businesses in the major campaigns for and against the euro. Scholars have too often used limited empirical data, usually simply relying on the stated position of trade associations at one point, to determine the preferences of business interests on membership of the European monetary union. A comprehensive longitudinal overview of lobbying activities in Britain can provide us with a clearer picture of business preferences. This chapter demonstrates that at the beginning of the debate on the euro, business interests positioned thelnselves exactly as political economy theories predicted. The hypotheses derived fioni Jeffry Frieden's model of economic actors' preferences towards the exchange rate were that large exporters would favor and lobby for adoption of the euro while companies selling their goods mainly on the domestic market and non-tradable producers (i.e., services, construction, or transportation) would be against switching to a single currency. This division was reflected in the position of the trade associations, in the polarization of business owners in the two campaigns on the euro-"Britain in Europe" and "Business for SterlingH-and finally, in the lobbying activity of foreign-owned multinational corporations. Table 6.1. summarizes the initial position of business interests on the euro. However, the division between exportoriented and import-competing producers eventually faded as lobbying from the pro-euro side vanished. The response of the government to concerns of the proeuro coalition was critical to this evolution, which represents a variation of stated preferences rather than a reversal of fundamental preferences.

Chupter 6

88

Table 6.1. Initial Position of Business Interests on the Euro PRO-EURO Trade Associations

Confederation of British Industry (CBI)

Membership: Large exportoriented companies in the manufacturing sector

ANTI-EURO Institute of Directors (IoD)

Membership: Medium-size companies mostly in the service sector Federation of Small Businesses (FSB) Membership: small firms

and self-employed individuals operating mainly on the domestic market Campaigns

Direct 1,obbying (threats)

Britain in Europe (BiE)

Business for Sterling (BE)

Chair: Colin Marshall,

Chair: Nick Herbert, Direc-

Chairman of British Airways, President of the CBI

tor of British Field Sports Society

Selected Donors: IJnile~er, British American Tobacco, B.A.E. Systenls

Selected Donors: Sainsbury, Dixons, Hansons

Foreign-owned MNCs

N/A

Trade Associations and EMU While the position of the trade associations was briefly mentioned in the chapters on the Conservative and Labour governments, the following paragraphs provide a detailed chronological account of their preferences and lobbying activities, starting with the early discussion on monetary union among EEC members. When the project of monetary union became serious with publication o f the Delors report, the two major trade associations, the Confederation o f British Industry and the lnstitute o f Directors, positioned themselves quite differently on the issue. Sir John Hoskyns, head of the lnstitute of Directors, accused the Delors report of displaying the same "muddled thinking" that he thought was characteristic o f proposals by the European om mission.^ The l o D questioned the need for a European monetary union when the benefits would be s o sniall.' The CBI responded to the project of monetary union in a less visceral approach

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by holding a major conference on the topic and by commissioning a working group to study the Delors report. The product of the working group's study, European Monetary Union: A Business Perspective, was very enthusiastic about the idea of a single currency for the advantages it would bring to many of its members.' The CBI, therefore, advocated that the government seriously consider the project of monetary union. The CBI and the IoD were also at odds with each other on the prospect of British membership of the Exchange Rate Mechanism. The CBI had been putting pressure on the government to enter the ERM since 1 9 8 5 . ~When the pound sterling finally entered the ERM in October 1990, the CBI praised the longawaited move by the Thatcher !government." The CBI declared: "This will bring stability for the pound against other European currencies and much greater predictability for UK businesses in quoting for export orders."' The IoD, contrary to the CBI, was very wary of British entry into the ERM. In November 1989, Director of the loD Peter Morgan warned those who called for early entry into the ERM of the danger of "hurtling into a half-baked system with an uncertain f u t ~ r e . "The ~ IoD argued that the price stability many sought by advocating entering the ERM could be achieved as well by giving operational independence to the Bank of ~ngland."When the pound sterling entered the ERM, the IoD expressed its surprise that the government had decided to give up interest rate fi.eedom." The Federation of Small Businesses, for its part, supported membership in the ERM as long as it meant lower interest rates. '' Because small family businesses rely on mortgages, interest rates are of great concern to many members of the FSB. Before the start of the Intergovernmental Conference on EMU scheduled for December 1990, the CBI was eager to see the government take a positive position on the project of single currency. In July 1990, in a position paper entitled European Monetary Union: The Next Steps, the CBI called on the government to play its full part in achieving the single currency.I3The CBI was also very excited about the completion of the Single Market and launched the "Agenda for Europe" campaign in December 1990 in support of this goal.'' The CBI viewed EMU as complementary to the Single Market. In the report published for the campaign, the CBI strongly and unambiguously endorsed the goal of monetary union: "A single European currency continues to be a major objective of CBI policy."'5 The CBI was even supportive of the UK joining in with the first wave of countries rather than at a later date, as was implied in a CBI News editorial by the organization's Director General Sir Brian Corby where he said: "[Tlhe next task will be moving towards EMU. Over time, step by step, in unison, one race, not two, sprints and marathons don't mix, so no two speed ~ u r o ~ e . " ' ~ The CBI, understandingly, cooled down its support for EMU for a while after Black Wednesday and was never again as blunt in advocating the adoption of a single currency in Europe. Whereas the CBI had been adamant about the need for the European Economic Community to complete the Single Market with a monetary union, CBI Director of Economic Affairs Andrew Sentence stated in 1993: "tiigh unemployment and a declining share of world trade suggest

Europe's economy is inflexible. It would be dangerous for EC members to relinquish totally the ability to adjust exchange rates."" sentence, one of the Chancellor of the Exchequer's "seven wise men," explained that only when there would be genuine economic convergence between the member states could monetary union be successful, and that this convergence would take longer than envisioned in the Maastricht Treaty. He therefore recommended "proceeding cautiously towards monetary union."18 This Inore vigilant stance implied that the CBI no longer favored early entry as it had prior to Black Wednesday. The IoD, for its part, criticized the government for an ill-advised policy decision to enter the ERM in 1990, which the trade association had warned against.lg Later, the loD argued that "it was time for the ERM to go" and that it would welcome the cornplete collapse of the ERM.~'Instead, the loD called for thinking about alternatives to moving towards a single currency as designed in the Maastricht Treaty by reviving the hard ECU proposal, which the loD had always supported." The Confederation of British Industry did not make any other official statement on EMU until 1995, less than two years before the UK government had to make a decision on whether to be part of the first wave of countries that would adopt the euro in 1999. Director General of the CBI Adair Turner deplored the state of the debate on EMU in the UK at the time, which he judged too political, and set out to provide a sound econolnic debate on the issue. The CBI took two initiatives for this purpose: (1) a poll of nearly two thousand businesses on the question of the single currency in cooperation with the Chambers of Commerce, and (2) the production of a report on the key arguments in the EMU debate. The results of the CBI poll showed ambivalent support for the single currency: 19 percent of businesses argued that the UK should adopt the euro in 1999 with the first wave of countries and 36 percent believed that the government should not enter EMU yet but leave the option of joining open, while 12 percent wanted the government to immediately reject EMU membership.'2 As for the official position of the trade association, Director General Turner declared in the association's newsletter of December 1995: "At this stage, it is deliberately neutral."23 However, the CBI stated its strong opposition to the U K being part of an ERM I1 should it not adopt the euro in 1999.~" In March 1996, the CBI became even more wary about the European monetary union and called for the government to be clearer as to how the decision on whether to join would be made. The CBI asked whether the government would take into consideration additional specific econolnic criteria such as convergence of the balance of payments or cyclical and/or structural unemployment.25 Doug Godden, Head of the Economic Policy Group at the time, explained that the CBI felt certain criteria for joining were necessary: "We took the view that there were conditions the UK Government should be looking for in terms of the right convergence of the economy and similar interest rates needs. We also wanted to make sure the conditions in the euro zone itself proved positive."26 A year later, in October 1997, the government announced a set of tests, in addition to the convergence criteria, that the UK would have to pass before it could join

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EMU, the famous five tests, originally drafted in February of the same year by Gordon Brown and Ed Balls. The CBI's concerns would therefore be addressed. The Institute of Directors, which had been proven right when warning against the dangers of entering the "half-baked" ERM too soon, maintained its strong stance against EMU. In 1995, IoD Head of Policy Ann Robinson went so far as to argue that EMU was "the most risky policy since the dawn of democracy."" The IoD officer described EMU as a trap from which Britain would not be able to escape until markets blew it apart, as happened with the ERM.'~The Executive Director of the loD, Tim Melvin-Ross, further insisted on the significance of the EMU debate for Britain by stating: "Other than going to war, no decision could be more important than one to enter EMU and abandon our national currency."29 In June 1995, the IoD published a report entitled A Single Europenn Currency: Itnplications for the UK Economy that made two important points. First, the IoD reiterated its earlier argument that joining the monetary union was not the only way to achieve price stability; it could be achieved as efficiently by adopting sensible domestic monetary policies. Second, the IoD warned that the City of London's role as a world financial center would be threatened by EMU membership if the European project progressed to fiscal and political union, leading to a more restrictive regulatory regin~e.~' The Federation of Small Businesses shared the feeling of the IoD concen~ingthe European monetary union but in an even more extreme way. During the 1995 annual conference of the FSB, the majority of its members voted for complete withdrawal from the European ~ n i o n . ~ ' The loD dedicated its 1996 annual conference to the question of British nlembership of EMU. After a debate on EMU that featured speakers debating the pros and cons, the loD polled its membership on the issue. The result showed that membership of the loD was divided, although the great majority was against joining. Nearly 70 percent of members present at the conference agreed with the motion adopted at the end of the debate, which stated that the disadvantages of being a meniber of EMU would outweigh its potential benefits, while 28.3 percent rejected the motion and 2.6 percent abstained from the vote.32 The vote led the association to adopt its official position on the euro, which was that the U K should not join in the foreseeable future.33In the following months, the loD continued to be involved in the euro debate by attacking the pro-euro organization "The European Movement" in its efforts to provide a positive assessment of membership of the euro. The European Movement published a pamphlet The Other Side of the Coin that demonstrated the benefits of EMU membership. In response, the IoD published a briefing note The Dark Side of the Euro that dismissed all of the European Movement's argument^.^' At the New Year's message to the IoD members at the end of 1996, Director General Tim Melvin Ross, alluding to the coming election, stated: "A new Government must ensure the UK does not join up to a single European currency."35 As EU member states prepared for the 1996 IGC conference where unresolved issues of the Maastricht Treaty, including monetary union, would be discussed, the CBI took the initiative of publishing numerous reports and articles

presenting both sides of the argument. Because politicians were reluctant to talk openly about the issue in economic terms in the run-up to the general election, CBI President Sir Colin Marshall argued that business had to lead the debate and that the CBI intended to take on the task.36Therefore, in the spring of 1996, the CBI launched the "Business in Euro e" campaign in order to trigger "a balanced and unemotional debate on EMU."^ The Business in Europe campaign involved public debates at the local, regional, and national levels as well as a series of policy briefs that presented the issues surrounding membership of the euro zone in an objective manner. The late 1996 issue of CBI News was dedicated to EMU and featured on the cover a one euro coin with the effigy of Queen Elisabeth 11. Equal space was granted to two guest articles on the euro, one strongly in favor and the other strongly opposed. However, the CBI did not take an official position at that time. In the introduction to the special issue on the euro, CBI Director General Adair Turner briefly presented both sides of the arguments, and noted: "Different business people make different judgments about how these pros and cons balance out. The CBI is not yet taking a definitive position either way.7138 The CBI conducted a second opinion poll of its members. The results were very similar to the first one although they showed slightly more enthusiasm for EMU: 28 percent of businesses were in favor of the UK joining the euro in 1999, compared to 19 percent the year before, and only 7 percent argued the government should reject EMU immediately as an option, compared to 12 percent before.39 On July 22, 1997, after the general election, the CBI finally announced its official position on EMU: "We support UK membership of a successful EMU, but should join only when the conditions for success are in place."40 The policy was reached through the usual process that involves consultation with the CBI niembers and debates in the President's Committee (which includes the largest companies) as well as in other relevant committees, which were the Economic Affairs Committee and the Europe Committee in this case. The conditions for success that the CBI referred to were those it kept emphasizing during the previous year: convergence of inflation rates, one of the Maastricht criteria, but also an appropriate sterling exchange rate at entry of the UK into EMU, sound public tinances of the member states, and labor market flexibility.41According to the CBI, these conditions for success were unlikely to be met by 1999, which justified its conditional yes to EMU: "The likelihood is that EMU will go ahead in 1999, but in less than ideal circumstances. This is the context against which the UK nust decide its policy. That policy should seek a successful EMU, arguing for the conditions required for success and aiming for British entry when-and only when-those conditions are met."42 The CBI official policy sounded very similar to the official government policy on EMU that would be announced by Chancellor of the Exchequer Gordon Brown three months later. On October 27, 1997, Chancellor Brown announced that the UK was in favor of joining the euro, in principle, provided it was successfirl and the econoniic case for it was clear and unambiguous based on the five economic tests.43Brown declared that the UK would not join with the first

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wave of countries to adopt the euro in 1999, as the five tests could not yet be met.'?he emphasis on joining a successful monetary union put forward by the CBI was used in the description of the "prepare and decide" policy on EMU. The five tests of the Labour party had also been inspired by the trade association, which as early as 1996 had called for the inclusion of additional economic criteria before joining EMU. Officials of the CBI have a certain pride in feeling that the trade association influenced the government policy on EMU.^' Recent accounts of the CBI have described it as an association reactive to government policy that tends to follow the position of the government.46 The fact that the CBI's position was reached before the government's position, however, is viewed as proof that the government followed the CBl's stance and not the other way a r ~ u n d . ~ ' There are important nuances, however, between the CBl's and the government's positions. The CBI concluded that if things looked favorable on the balutice of probability, then the UK should join, whereas the government's view was that the UK should only join if the economic benefits were u n a r n b i g u o ~ s . ~ ~ Similarly, the five tests differ from the conditions that the CBI viewed as critical before the UK could join EMU. For one thing, the City test was not one that the CBI considered important. The inclusion of this test was perceived as a blow to manufacturing, as mentioned earlier. In its recommendation of additional criteria, the CBI focused more on external conditions of success concerning the euro zone such as, for example, whether the currency zone established was based on sound economic principles. However, one of these concerns, whether sufficient flexibility in the euro zone was present, became part of the government's five tests (the second test). This criterion is essential for a successful monetary union according to the influential theory of Optimum Currency Areas developed by Robert ~ u n d e l l . "The CBI was very adamant about this criterion arguing that without labor flexibility, EMU could be more detrimental than useful.jOAs the UK was preparing to hold the presidency of the European Council on January 1, 1998, Director General of the CBI Adair Turner reiterated the importance of ensuring EMU was a success by pushing the member states to adopt more flexibility in their labor market.jl The CBI continued to debate the economic case of EMU and to poll its members regularly in the years that followed. In July 1999, the CBI undertook a three-month consultation with its members and another even larger poll. After this input from its members, the CBI adopted a similar position as in 1997, stating that "membership has the potential to deliver significant benefits to the UK economy, but that progress is still needed within the euro-zone to ensure the economic success of the EMU project and to minimise the risks invo~ved."~' Therefore, the CBI, contrary to accusations from euroskeptic groups and the British press, was not excessively pro-euro but adopted a cautious position very close to the government's policy of ensuring that the conditions were right for the UK before it decided to enter EMU.'^ However, the media, especially the anti-euro Murdoch press, was quick to portray the CBI as staunchly pro-euro. The CBI came to make the headlines very often and was accused of putting the

interests of downsizing multinationals first by being unequivocally in favor of a policy that divided the nation. Headlines about the CBI unwaveringly supporting the adoption of the euro multiplied as the question of British membership of the euro zone became increasingly debated.53The trade association started to attract too much attention and to acquire a bad reputation. When Adair Turner left the CBI to be replaced by the more moderate Digby Jones, the CBI announced it would stop its involvement in the euro debate and declared neutrality on the question. The CBI also withdrew from the pro-euro campaign "Britain in Europe" of which it was an official supporter in order to be completely neutral. The new CBI Director (ieneral explained the decision in these words: "There are so many issues where business can make a difference, and which go to the core of creating wealth and creating jobs, but business can only make that difference if it is unified. . . . You don't have to be a rocket scientist to know that the euro is a divisive subject. 1 didn't change our policy but what I did was to say let us concentrate on the things that unite The division of opinion within the business conimunity that the director referred to was not only between the CBI and the othel business organizations such as the loD and the FSB, but also within the CBI itself. Doug Godden, Head of the Economic Analysis Unit, aptly summarized the division within the CBL membership: "As a general rule, the larger the company, the tiiore likely they were to be in favor of the euro. Also, manufactures were much more in favor than services. In particular, the opposition was very focused in those companies such as distribution and construction that basically had to tdrget the domestic market, whereas exporters seemed to be much more in favor."56The new leadership felt that the bad press portraying the CBI as staunchly pro-euro was detrimental to the association, whose fundamental goal is to maintam its membership. The Institute of Directors, for its part, became increasingly more temperate in its stance against the euro under Director General George Cox, appointed in July 1999, than under his predecessor, Tim Melvin-Ross. The latter tended to make bolder public statements against joining "in the forseeable future" than Cox, who kept a low profile. As the euro became highly divisive in the nation, the loD was careful to emphasize that although it was against the UK joining EMU based on economic grounds, it had no stance on the political aspects of the project.57Therefore, the turning point for the IoD in its involvement in the euro debate came when the No campaign, of which the loD was an official supporter, released a contentious political advertisement to be shown in cinemas across Britain. The anti-euro ad featured British comedian Rik Mayall dressed as Hitler lifting his arm in a Nazi salute and saying "Ein Volk, Ein Reich, Ein E ~ r o . " ~ * The direct reference to the Nazi slogan "Ein Volk. Ein Reich, Ein Fuhrer" aimed at reminding people that the Nazis had envisioned the creation of a European single currency. The distasteful clip was not well received in the country, as it was deemed totally inappropriate and insulting to the memories of the Holocaust victims. The loD did not want to be associated with a lobby group that had become too radical in its opposition to the EU, fearing it could lead some members to leave the trade association. Shortly after the advertisement was shown, the

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Institute of Directors asked that its name be withdrawn from the list of official supporters of the No campaign.59 Subsequently, the loD declared neutrality on the euro debate.

The Euro Campaigns As in preparation for the 1975 referendum on whether the U K should stay in the European Econoniic Community, two highly organized campaigns, for and against British membership of the euro, were set up in the late 1990s. The Yes campaign was led by the cross-party organization Britain in Europe (BiE), an alliance of politicians and business executives in favor of the single currency. The No campaign was a coalition of groups opposing membership of the euro, which included the very vocal Business for Sterling (BR), an association of business interests staunchly against EMU. Both campaigns were heavily funded and backed by business interests.

The Yes Campaign: Britain in Europe Tony Blair and the Labour party came to power in 1997 with a landslide victory and a pro-European stance. Leaders of very large companies with a significant portion of their trade in the European Union were very enthusiastic about the idea of Britain joining the euro, and a majority of them believed Blair would deliver on this policy objective. These business leaders, therefore, started to get together and prepare an initiative that would allow the Prime Minister to turn to the business sector for support when he felt ready to take Britain into the e ~ r o . ~ " At the same time, The European Movement, one of the oldest and most influential pro-European organizations in Britain, also felt preparations to join the euro should begin. The European Movement emerged out of the Hague Congress following Winston Churchill's 1946 Zurich speech for a United States of Europe. The European Movement has always strived to insure Britain's constructive engagement in Europe. Business leaders approached The European Movement to launch a common initiati~e.~' However, the leadership of The European Movement was concerned with the political baggage of the organization that had come to be associated with federalist goals. The leaders believed that what was needed to press the issue of the euro was a campaign distinct from the well-known ~ r g a n i z a t i o n . ~ ~ The campaign they envisioned would encompass a broad range of mainstream opinion from the business community, ordinary people, and all the major political parties. They decided to call the campaign "Britain in Europe," resuscitating in this way the pressure group that had campaigned for British membership of the EEC in the 1960s and for a yes vote on the 1975 referendum on whether to stay in the EEC. It is important to recall that the 1975 Britain in Europe campaign had been highly successful at turning public opinion from wanting to

leave the EEC to agreeing it was in the national interest to remain a member. When the time came to go to the polls, more than 60 percent of Britons voted to stay in the EEC, as the yes campaign had advanced very convincing economic arguments. Perhaps by keeping the sarne name, the pro-euro campaign would achieve a similar success. Britain in Europe's mission was defined as "raising funds, collecting donations and spending funds collected in order to campaign in favor of UK membership of the single currency."63 This campaign strongly appealed to Liberal Democrats politicians, some Conservative politicians, and a few Scottish and Welsh Nationalist politicians, to the alarm of the new Labour government that felt it was losing control of a campaign for British membership of EMU before it was interested in it.6kolin Marshall, Chairman of British Airways and President of the Confederation of British Industry, became Chair of Britain in Europe. The campaign was mainly funded by business donations. Some of Britain's largest businesses contributed significant sums of money to BiE. For example, Unilever, the multinational corporation producing the internationally popular Dove soap and Lipton tea, donated £270,000 to Britain in Europe from 1999 to 2001 ." Among the multinationals that supported the organization with generous donations were British American Tobacco, which supplied £25,000 in 2001 and 2002 to help the cause and B.A.E. Systems, the British MNC specialized in defense equipment, which contributed £50,000 in 2 0 0 2 . ~ Another ~ significant contributor was British Petroleum, which helped set up the Scottish branch of B ~ E . ~ ' Britain in Europe accepted no funds from the British government, the European Union, or political parties. Although The European Movement used to accept grants from the European Commission, Britain in Europe refused any funding from the EU to avoid criticism of being "an agent of ~ r u s s e l s . " ~ ~ Britain in Europe started its activities in March 1999 with an information campaign on the benefits of joining the euro that would take its organizers to one hundred fifty towns and cities across the UK. The first information campaign was held in Birmingham, targeted because of its strong manufacturing base in the West idl lands.^^ The strongest argument of Britain in Europe was that not joining the euro could be damaging to British jobs and inward investment, as multinational companies such as Unilever that employ over five thousand people in the UK could decide to relocate in the euro zone. The campaign, which aspired to be cross-party and sought to put pressure However, by on the government, wanted to get the Prime Minister invo~ved.'~ October 1997, the Blair government had only declared its conditional support for the single currency, subject to assessment of the five tests, and not absolute support. The government, therefore, could not support a campaign which was designed to get Britain to join the euro because it would mean supporting a campaign that was designed to change government policy. Britain in Europe, which the government could not support in its existing form, started to seriously worry Nunlber 10. Simon Buckby, a friend of Tony Blair who had run the 1997 Labour Party advertising campaign, was asked to take over Britain in Europe and change it in a way that would be acceptable for the government: "I was ap-

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proached by 10 Downing Street to see if I was interested in heading up a coalition that was already forming at the time and that they thought was not forming in a way they wanted it to. They were looking for someone whom they could trust politically and competently to create the coalition in a way that they wanted it done."7' Buckby reconfigured the campaign in order to allow the Prime Minister to support it: "I changed the purposes of the campaign, and that then allowed Brown and Blair to launch it."72 The main condition for the support of the Prime Minister was that BiE reduce its emphasis on joining the euro and campaign on a broader pro-EU stance.73The revamped campaign would aim at addressing and deconstructing common anti-Europe arguments, such as, for example, that the EU is nothing but a costly and inefficient bureaucracy and that being tied to the EU jeopardizes the UK special relationship with the United States and threatens Britain's identity." The argument made to participants of Britain in Europe was that such a focus would prepare the ground for later campaigning for joining the euro. Chancellor of the Exchequer Gordon Brown had explained to members of BiE that they needed to campaign first on the pro-European issue. Then, at a later date, he assured them, "we will move onto the specifics for the Euro, once my five economic tests have been metM7'Richard Laming, head of campaigns at the European Movement at the time, explained: "It all hinged on these five tests, so what the government told us was that once the tests were met, they wanted us to say 'let's join the euro,' but that until they were met, we had to be indecisive about the euro. So we weren't allowed to speak up the need or the urgency to join the e ~ r o . Therefore, "~~ by the time of the official launch of the BiE campaign, the original pro-euro stance of the organization had been significantly toned down. The aims of Britain in Europe changed from "campaigning for a Yes vote in a euro referendum to campaigning to stay in the EU and keeping open an option to join the eu1-0."~~ The official launch of Britain in Europe, in October 1999, gathered iniportant figures in the world of politics. Former Chancellor of the Exchequer Kenneth Clarke, former Conservative Deputy Prime Minister Michael Heseltine, and leader of the Liberal Democrats Charles Kennedy joined Prime Minister Tony Blair, Chancellor of the Exchequer Gordon Brown, and Foreign Secretary Robin Cook in backing BiE. The message was about the benefits of being in the European Union in general. Tony Blair delivered a speech that started with these inspirational words: "Once in each generation, the case for Britain in Europe needs to be remade, from first principles. The time for this generation is now."78 After making the case that being part of the EU was in the British national interest, Blair reiterated the ambiguous policy of his government on the euro: "In principle, if the single currency succeeds and it is in Britain's economic interest, we should join. In practice, the economic conditions must be met. Meanwhile we prepare so we can de~ide."'~ However, as many observers noted at the time, all the speakers were careful not to mention the original aim of the campaign, which was to take Britain into the euro.

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From the time Simon Buckby took over BiE to the general election of 2001, businesses understood the position of the government and what the new director of BiE was doing and why he was doing it. Even though the public stance had been changed, businesses still believed the aims of the campaign were the same and that the government would deliver on the e u r ~ . ~ O T hmessage e businesses heard from 10 Downing Street was simple: the government would not join EMU in this Parliament because of other pressing priorities, but might join in a second term. Therefore, the Prime Minister needed to have a ready campaign in case the government was going to hold a referendum on the euro. However, there was a very clear signal given to participants in BiE that the Prime Minister intended to have a referendum on the euro." Participants in Britain in Europe, therefore, agreed to delay heavy campaigning for the euro until after the general election to take place in May 200 1 . At that time, the Britain in Europe group would be direly needed to allow the Prime Minister to make the case for the euro, assess the five econo~nictests early in the honeymoon period of the government, and hold a referendum, probably about 18 months later.82 After the general election of 200 1, things changed in Britain in Europe. Until then, businesses had been patient when told by the government that basically no serious move would be taken towards ~netiibershipof EMU in the current Parliament. However, after the general election, businesses started to get anxious and to seriously ask when the adoption of the euro was going to happen.83 BiE had fi~ltilledits agreement to delay heavy campaigning for the euro until after the general election, when Chancellor Gordon Brown would assess his five econornic tests. At that time, therefore, businesses began to put much more pressure on the government to take Britain into the euro. Simon Buckby explained: After 2001, the position of the campaign was still what I reconfigured it to be, nhich was being pro European and support the euro when the conditions are right. tiowever, in practice, our approach became much more aggressive and we now started to press the government a lot more. . . . The business leaders and I \yere of the same view that we should join when the conditions are right but we now wanted to encourage the government to make the conditions right.84

In Blair's second term, however, it became clear that his main priority had shifted away from the issue of the euro with the reshuffle of his cabinet. Businesses engaged in Britain in Europe started to doubt the intentions of the government to fulfill its part of the agreement. They now resorted to issuing threats to disinvest if the government continued to be undecided on the euro. Chairman of Unilever Niall FitzGerald, for example, told the press: "Everything on which we have based judgment up to now has assumed that by 2002-sometime in the second half of 2002-there will be a referendurn which will probably be won."85 FitzGerald added that a confirmation that "the ground rules have changed" might prompt Unilever and other big corporations to rethink whether the UK is

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the right place to locate its manufacturing facilities, which employ thousands of ~ritons.~~ The threats to disinvest by British multinational corporations, however, did not materialize when Gordon Brown finally gave his assessment of the five tests, in June 2003, and declared that only one of the tests had passed. Whereas from 1998 to 2001, internationally-oriented businesses had intensely lobbied the government to join the euro, by 2003, many had lost interest in the issue. Britain in Europe had started experiencing great financial difficulty in raising enough money to reach its targeted budget because donors had become scarcer." Public records of BiE's finances reveal that in 2002, "the group's cash reserves collapsed by 9 8 . ~ % . "Large ~ ~ donations from businesses became a thin of the past. In 2002, only nine companies gave more than £5000 to the cause.F9 Many of the large donors initially involved in the campaign stopped supporting Britain in Europe and went on to worry about other issues.90The negative assessment of the five tests in June 2003, therefore, did not lead to a huge uproar in the exportoriented business community. The real disillusioned actors were not heads of international corporations but the administrators of the campaign. Director of Britain in Europe Simon Buckby resigned his position shortly after the assessment of the five tests. 9' Upon leaving, he declared that he had realized early in the second term of the Labour government that the army originally set up to fight for the euro was never going to take arms: "The first signs that we might never fight at all came in the early days of the second term. We had assumed that then was the moment, but we were publicly told to 'cool it' until ministers were ready. The problem was, they never were ready."92 After the departure of Buckby and the loss of business support, Britain in Europe moved its focus to campaigning on a different issue: the EU constitution. Britain in Europe officially ceased to exist in August 2005 after the no votes on the EU Constitution in France and the etherl lands.^^ BiE failed to achieve its original goal. In the end, many, such as Mark Littlewood, former Head of Campaigns at the European Movement, criticized the organization for having been taken over by the government to "parrot Labour's equivocal policy, to embarrass the Tory party, and to do nothing to advance the cause of the e ~ r o . " ~ ~ Individuals who had put time into the organization were angered at its lack of influence on the government's policy, characterized by non-decision throughout the life of the organization.

Business for Sterling and the No Campaign Business for Sterling (BR), a pressure group opposed to British membership of the single currency, was launched in 1998 to challenge the idea propagated by the niedia that British business was in favor of the euro. The Confederation of British Industry, as we have seen, was highly involved in the euro debate and conducted two very large surveys of its membership on the issue: the first one, in 1995, showed business support for the euro in principle, the second one, a

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year later, reported growing enthusiasm for euro membership. These surveys were distortedly revealed in the press as an indication of strong support for the euro by British business although they represented only a part of business in the UK, mainly the industrial export-oriented sector. Business for Sterling sought to demonstrate that the position of the CBI members on the euro only represented a very specific portion of British business and that the business community as a whole was far from being united on the question of membership of the single currency. The chair of Business for Sterling was Nick Herbert, former director of the British Field Sports Association, a domestic hunters club. Sixteen thousand businesses were members of B R . Not surprisingly, BfS also benefited from the support of the Federation of Small Businesses and the Institute of Directors, the latter having provided help in setting up the o r g a n i ~ a t i o n The . ~ ~ bulk of the membership of BfS consisted of small- and ~nediuni-sizedenterprises that mainly operate in the domestic market and have very little trade with Europe. For example, prominent members were the leading British food retailer Sainsbury, which dominates the British supermarket industry; Dixons, the UK retailer of electronics; and Hanson, the UK leading supplier of heavy building material. The strategy adopted by Business for Sterling was that for every business leader who went on television or talked to the press in favor of the euro, the organization put up another business leader to speak against adoption of the single currency." Sin~ilarly,B R tried to embarrass the CBI by accusing it of representing large multinationals engaged in downsizing and by citing polls that totally contradicted those of the employers' association. Early in its campaign, B R focused on making an economic case against the euro rather than a political one. Indeed, the leaders of the organization thought an economic case would be more successful in convincing the general public not to support the idea of abandoning the pound sterling. One of the economic arguments of B R was to say that the companies that really matter for the British economy are the small- and medium-sized companies and not the large multinationals. B R also questioned the official figure representing the share of trade of the UK with the EU, which is approximately 50 percent. The famous argument among euroskeptics of the "Rotterdam effect" was used extensively by BfS to demonstrate that the portion of trade with Europe was actually much less significant than it appeared." B R further posited that most British companies export mainly to the United States and Asia and use the dollar rather than the euro for international payments. As volatility between the euro and the dollar is greater than between the pound sterling and the dollar, it would be damaging for British businesses to adopt the euro. While the validity of the economic arguments of the No campaign is debatable, the idea behind BfS strategy was to prevent the pro-euro side from making a convincing economic case for the euro. In 2000, B R joined New Europe-an anti-euro cross-party organizationto launch the multi-million pound No campaign whose motto was "Europe yes, ~ ~ Europe had been careful, like Business for Sterling, to be porEuro 1 1 0 . " New trayed as anti-euro but pro-Europe. As Britain is home to a host of radical anti-

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EU organizations, one more hostile than the other to the euro, the euroskeptics had acquired a bad reputation in Britain as "a bunch of wild men with stripy shirts, staring eyes and distasteful views against foreigners."99 The Campaign for an Independent Britain, the UK Independence Party, and Global Britain, for example, argue not only for keeping the pound but also for Britain to withdraw from the EU. New Europe, funded by former Labour Foreign Secretary Lord Owen, strove to distance itself from these groups by affirming the commitment of its members to the EU but not to adopting the euro. The timing and purpose of the No campaign were clear. Members of the anti-euro group, like participants of Britain in Europe, thought that the government would soon hold a referendum on the euro: "We are stepping up now because we are convinced that the government intends, should it win the next election. to call an early referendum. If this happened we could have only twelve months to m o b i l i ~ e . " 'Whereas ~~ funding was a recurrent problem for Britain in Europe, which struggled to raise enough for its £1.5 million budget, it was not an issue for the No campaign, which was backed by extremely wealthy business leaders often contributing to the campaign in an individual ~ a p a c i t y . ' ~Paul ' Sykes, the self-made British millionaire, known to be worth £250 million and who owns a range of shopping centers and other business interests in Yorkshire, heavily funded the campaign.Io2James Goldsmith, founder of the Referendum Party that successfully pressured the Conservatives and consequently the Labour Party to promise a referendum on the euro, also gave a fortune to the cause. The No campaign hired the reputable firm M&C Saatchi, named agency of the year in 1998 by Campaign Magazine, to run a huge advertising campaign that included one million leaflet drops and newspaper inserts, and a direct mailing to one million businesses and twenty thousand selected members of the The No campaign also ran fund-raising events that attracted wealthy individuals opposed to British membership of the euro from an ideological or political perspective. These individuals tended to make significant contribution^.'^^ The No campaign, as a result, was much better funded that the Yes campaign. Mark Littlewood, who was Head of Campaigns at The European Movement, judiciously noted that "campaigns that oppose government action or likely government action tend to be more vigorous and better funded than campaigns that basically support the Prime ~inister.""' As Britain in Europe was taken over by the Labour government, many businesses thought it meant that the battle was already won: Blair was going to take Britain into the euro. According to Littlewood, the thought of many businesses was as follows: "Tony Blair is so powerful and so popular that he's bound to deliver. When he calls the referendum, we'll throw money at it but until he actually calls it, why should we part with substantial amounts of cash?"'06 The No campaign expanded its membership in 2002 when two additional groups joined the coalition against the single currency: Labour Against the Euro-backed by thirty-eight members of the Parliamentary Labour Party and more than one hundred Labour Councillors-and the Green Party, opposed to the euro for its centralized and undemocratic decision-making rules.'07

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In addition to using printed advertisements and leaflets, the No campaign also produced video commercials. In one of its broadcasted advertisement, however, the No campaign went too far in its opposition to the euro by diverting from the clever strategy adopted earlier by Business for Sterling of making an economic case against the euro instead of reverting to political arguments. In 2002, the No campaign released the "Ein Volk! Ein Reich! Ein Euro!" distasteful advertisement. The unfortunate three seconds portraying Hitler as welcoming the euro were highly damaging to the No campaign's image and credibility. Former Vice-President of the European Co~nmissionLord Brittan of Spennithorne argued that the tasteless advertisement showed "the underlying nastiness behind much of the No campaign as well as an element of desesperation." log The Hitler advertisement not only damaged the No campaign's image but it also cost it the support of one of its most visible contributors, the Institute of Directors, which asked that its name be withdrawn from the list of official supporters of the No campaign.'0g The No campaign stopped its activities in 2004 after Chancellor Gordon Brown, in his budget statement, did not recornmend a new assessment of the five tests."' The No campaign interpreted this statement as evidence that the British government would not seek membership of the single currency."' Individuals involved in the No campaign, despite the loss of credibility they suffered in 2002, credit thelnselves for having achieved two significant accomplishments: first, they believe they made the CBI stop campaigning for the euro; and second, they feel that they won the debate on the euro.'12 The self-gratification of the No campaign is problematic because, however well-funded and organized, the No campaign never had to convince the public to vote against the euro. As we have seen with the story of Britain in Europe, the British government, by taking over the pro-euro group, did not allow for a genuine debate on the euro to take place. The No campaign may have contributed to the decision by the Confederation of British Industry to stop campaigning for the euro, as the attacks by B R led to bad publicity for the trade association. However, former participants in the No campaign have a distorted view of their true influence on the government policy towards the euro, which, as I will demonstrate in the following chapters, was determined by other less visible factors.

Multinational Corporations' Direct Lobbying In addition to the pressure that British businesses involved in Britain in Europe tried to exert on the government, another group of corporations-foreign-owned lnultinational corporations-lobbied individually for the adoption of the euro. The Japanese multinational corporation Toyota was one of the first companies to pressure the government to adopt the single currency as soon as possible. In January 1997, Toyota started issuing threats to influence the government that was due, by the end of the year, to state its decision on whether the U K would

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take part in the first wave of countries to adopt the euro in 1 9 9 9 . " ~Hiroshi Okuda, Head of Toyota, announced that the company, which exports 75 percent of its production, would consider building new plants on the Continent if the UK did not join EMU. The government did not take Toyota's threat seriously. However, in December 1997, Toyota decided to build its second European plant in France rather than in Britain. Many perceived this decision as being motivated by the fact that France was in the euro zone while Britain was not.'I4 The threats to disinvest were also voiced by foreign-owned automobile manufacturers from Europe and the United States, such as Peugeot, BMW, and General Motors, which warned that the UK car industry might suffer adverse consequences if a positive decision on the euro was not taken."5 Soon MNCs in the motor vehicle industry were joined by multinational corporations in other industries urging the government to adopt the single currency. In November 1998, one hundred and fourteen industry leaders of British and foreign-owned multinational corporations in various fields signed a letter asking the government to join EMU."^ his letter was published in the Financial Times on November 23, 1998. The combined turnover of these companies was estimated at £200 billion, one-quarter of the wealth generated in the UK, and was the first time that a demand to the government to join the single currency was backed by so many leading businesses. l 7 The initial response of the government to multinational corporations' threats was to reassure them that the UK would soon join the euro zone using a similar discourse as the one that was used with British businesses involved in Britain in Europe. After Toyota announced its plan to build its second European plant in France instead of Britain, Tony Blair met with executives of Japan's Federation of Economic Organization (Keidanren) and assured them that as far as the euro was concerned, Britain would "definitely join early in the twenty-first cent ~ r ~ . "In" a~similar instance, in August 1999, the managing director of Nissan UK said that his bosses might be reluctant to continue investin in Britain if a decision war not made to enter the euro zone in the near future." In September, U K Foreign Secretary Robin Cook traveled to Tokyo where he reassured an audience of Japanese businesses that Britain did seriously intend to become part of the euro zone.'20 As threats to disinvest intensified, the government took measures to compensate for the loss some companies suffered from exchange rate fluctuations. Heavy subsidies to targeted companies most affected by the position of the UK outside of the euro zone were used to assuage their complaints. These subsidies effectively provided MNCs with incentives to continue to produce in the UK. In 2001, Nissan, which had threatened to move its production to the Continent, received an aid package of £40 million from the UK Department of Trade and Industry (DTI), which led the corporation to build its new model, the Micra, in its Sunderland plant.'2' The substantial aid package made the Japanese company ~ 2004, Nissan was once again the most heavily subsidized firm in ~ r i t a i n . "In encouraged to build its newest medium-size car model in Sunderland rather than ~ ~similar example is in France with a regional aid package from the D T I . ' A

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Black & Decker, which had initially considered moving all its production to continental Europe and closing down the UK plant located near Tony Blair's constituency. Black & Decker had warned the Prime Minister that whether or not the UK joined the single currently would play a significant role in the comI~~ a seven-figure government "package" led the US pany's d e c i ~ i 0 n .However, company to leave some activities in the UK. 125 MNCs that did not receive government subsidies, such as Motorola and Agco, which employed thousands of Britons, did disinvest, as well as several Japanese and Taiwanese electronics groups.'26 In 2002, the UK registered its first annual decrease of FDI in five years. Ernst & Young Inward Investment Consultant Mark Hughes said in 2002, "Five years ago the UK would have been top of the list for companies contemplating extending their activities. But of the European Union, the UK has seen its position fall the most."127In 2003, the European Commission revised its rules on state aid in the EU, which affected the ability of the British government to provide generous compensations to industries affected by the euro-sterling exchange rate. Under the new EU rule, funds channeled to corporations through state programs are only allowed in the value of 6 percent of the company's investment instead of previous figure of 20 percent, a significant change.'" Subsidies to multinational corporations complaining of the currency conversion costs they incurred because the UK remained outside of the euro zone were therefore substantially reduced after 2003. Despite the decrease in compensations, however, the decline of FDI in Britain was only temporary, as Figure 6.1 clearly demonstrates.

Figure 6.1. FDI in the UK, France, and Italy, 1992-2005 (millions of US $) 170000

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By 2004, the UK experienced a growth in FDI although it had become clearer that the UK would not join the euro zone. In 2005, FDI in the UK surpassed by far FDL in other EU member states such as France and Italy that are part of the euro zone. Companies such as Honda, Toyota, and Nissan, which had talked about scaling down their operations in the UK, increased the output of their British f a ~ t 0 r i e s . In I ~ 2005, ~ Nissan, which had been criticized for its previous stance on the euro and for blackmailing the government to adopt its favored policy, declared neutrality on the euro debate. In a press release issued on January 13, 2005, Nissan stated it was not demanding that the government join the euro zone anymore.'30

Significance of the Government's Response to Business Lobbying The preliminary negative assessment of the five tests in 1997 and decision not to join the euro with the first wave of EU countries had led to mobilization and major threats to disinvest to the euro zone by large exporters. The 2003 assessment of the economic tests and similar decision not to join in the immediate future, however, left the internationally-oriented business community much more indifferent. The government's response to the business lobby favoring the euro helps explain their loss of interest in continuing to push for the issue. The main strategy of the government, when confronted with a strong business lobby in favor of the euro, was to mitigate their impatience to join by buying time. This strategy can be seen in the way the government took control of the Britain in Europe campaign by momentarily changing its focus. The same strategy can be observed with the reassuring and then granting of subsidies to corporations affected by the exchange rate in order to convince them to retain production in Britain. This tactic of buying time was made possible by a government policy on the euro that seemed to let all doors open while retaining complete control of the timing of a decision. The Labour government made it clear at the outset that it would not rush its decision on the euro by making it determinant on the five economic tests to be assessed early in the next Parliament, i.e., in a second term. By pushing the date for a decision on the euro so far forward, the government could hope that the intensity of the internationally-oriented business community's preference for the euro would decrease as corporations would respond to compensation and adapt to their new environment. In fact, large businesses with significant markets on the Continent realized that life outside the euro zone could be managed. For many firms, it was a niatter of shifting the currency risk down the supply chain. Toyota and Nissan were among the first multinational corporations to start working around the currency problem that threatened their competitiveness by shifting the burden of fluctuating exchange rate risks to their suppliers.'3'The MNCs started a practice that requires suppliers to invoice them in euros. As long as the invoices in euros do

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not exceed the multinational corporations' euro revenues, they can avoid currency fliictuation costs. Many MNCs followed Toyota and Nissan's "currency neutral production strategy" to remain competitive in European markets. Another change that mitigated exporters' pressure to join the euro zone is that the exchange rate between sterling and the euro became more favorable both in terms of level and stability. As Figure 6.2. illustrates, the pound sterling not only substantially depreciated against the euro after 2003 but the exchange rate between the pair of currencies became much less volatile. From 1999 to 2003, volatility between sterling and the euro, as measured by the standard deviation, was almost 8 percent, whereas it fell to 2 percent between 2003 and 2007. Compared to other pairs of currencies, the euro-sterling exchange rate was very stable during this period, in which we could say that Britain had a de facto fixed exchange rate with the euro zone. Multinational companies such as Toyota and Honda had indicated that a stable exchange rate between sterling and the euro was the second most preferred solution (after adoption of the euro) to the problem of c ~ ~ r r e n cconversion y costs."* Figure 6.2. Euro-Sterling Exchange Rate (1999-2007)

Source: Bank of England

We may wonder whether the changes in the level and stability of the exchange rate were a direct response of the government to exporters' con~plaints. Did the Bank of England, upon instruction from the government, either: (1) closely follow the European Central Bank's monetary policy in order to reduce volatility between the two currencies? and/or (2) intervene on the foreign exchange market to influence the level of the euro-sterling exchange rate? Recent scholarship has claimed that European Union member states outside of the euro

zone tend to closely follow the European Central Bank monetary policy in order ' ~ ~ it is clear that counto protect the conipetitiveness of their i n d ~ s t r i e s .While tries that are part of ERM 11, such as Denmark, closely follow the European Central Bank monetary policy, it does not seem to be the case for ~ r i t a i n . ' ~ ' Interviews with former members of the Monetary Policy Committee of the Bank of England and minutes of the MPC meetings indicate that raising or lowering the exchange rate was never a direct reason behind decisions about interest rate changes.'35The MPC was focused on the overall inflation target set by the government and the path of the exchange rate was significant only as an influence on that objective. Former members of the MPC also confirmed that there was no intervention on the foreign exchange market to change the rate of exchange with the euro.'36 In 2003, however, Chancellor of the Exchequer Gordon Brown made two important announcements that had an impact on the exchange rate. First, he declared that the five tests had not passed and that therefore the UK would not join the euro zone. The negative assessment of the five tests eliminated the uncertainty that had prevailed over British membership of the euro zone and had caused part of the volatility. Second, Chancellor Brown stated that the Bank of England would adopt the same inflation measure used by the European Central Bank, the Harmonized lndex of Consumer Prices (HICP), instead of the RPlX (the Retail Price lndex less mortgage interests) traditionally used in the UK. The new target was set at 2 percent, the same as in the euro zone. As the HICP is usually much lower than the RPIX, targeting a 2 percent HICP instead of a 2.5 percent RPlX meant a significant loosening of monetary policy, affecting the level of the exchange rate. Therefore, even though there was no direct intervention by the Bank of England in the foreign exchange market or any effort by the Monetary Policy Committee to closely monitor and follow the European Central Bank monetary policy, the change in the level and stability of the exchange rate still retlected a deliberate move by the government to respond to exporters' concerns. Reducing the uncertainty surrounding the euro decision had a market effect on the exchange rate while the adoption of the same inflation target as the European Central Bank led to a monetary policy more closely aligned on the euro zone. The depreciation of sterling that preceded the increased stability between sterling and the euro was also welconied by export manufacturers, which, as Frieden indicated, prefer a more depreciated currency that increases the attractiveness of their goods abroad. Internationally-oriented companies had complained about the strength of sterling damaging their competitive position in William Pedder, head of inward investment at UK Trade euro zone ~narkets.'~' & Investment, a government agency that tries to attract foreign companies in the UK, indicated in 2005 that the criticism of Britain remaining outside of the euro zone was not as harsh after sterling's depreciation against the euro and the decrease in volatility.'38As the financial crisis hit Europe in 2008, sterling depreciated against the euro dramatically, as shown in Figure 6.3., which has been advantageous to corporations located in the UK and exporting to the euro zone

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because it provided them with an export boost. In September 2009, exporters from West Midland stated they were starting to see the benefits of the depreciation of sterling against the eu1-0.'~'As Figure 6.3. shows, sterling almost reached parity with the euro, making life easier for UK-based companies trading with the euro zone. Figure 6.3. Euro-Sterling Exchange Rate (2003-10)

Source: Bank of England

Recent events, such as the financial crisis of 2008 and the Greek debt crisis of 2010, have confirmed that the euro is now completely off the political agenda in Britain. However, the business community had reached this conclusion as early as 2005.'~'All the organizations sponsored by business interests to lobby for the euro had stopped their activities by then. The way the British Exporters Association (BExA)-a group whose fundamental preference should be for euro membership-responded to questioning on its position on the euro in 2005 was telling: "There is not strong pressure ftom our membership on this issue as the general view is that the UK is unlikely to join the euro in the foreseeable future. We, therefore, have little more to say at present."'41

Conclusion At the beginning of the debate on EMU, the business community in the UK was clearly divided between those likely to benefit from the European single currency-companies exporting to the EU represented by the Confederation of British Industry and members of Britain in Europe-and those more concerned about the ability of the government to conserve its monetary policy autonomy-

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small- and medium-sized enterprises and companies operating mainly in the domestic market represented by the Federation of Small Businesses and the Institute of Directors as well as by the pressure group Business for Sterling. Research findings, therefore, reveal that business actors are perfectly able to determine how a particular monetary regime will affect their interests. Business interests position themselves on a major monetary policy decision affecting the exchange rate-in this case, membership in a monetary union-exactly as Frieden's model posits. Frieden's 1991 model is therefore a good predictive tool of how businesses will initially position themselves on monetary policy. However, as we have seen, the stated preference of business interests was not sustained over time. The intense division in the business community eventually eroded, and neutrality on the question o f euro membership became the norm. The position of non-decision of the government, paired with compensations and a depreciation o f sterling followed by a less volatile exchange rate against the euro, were successful in diminishing the demand of British exporters to be part of the euro zone. This longitudinal study o f business preferences, therefore, has demonstrated that preferences are not constant but evolve according to changes in the strategic environment. While it is u s e h l to understand what affects the initial positioning of business interests, it is critical to understand what leads to a departure from the pareto optimal solution. The pro-euro business interests eventually gave up pressing for the euro, realizing the concessions they had obtained were the limit o f what they could hope for. It would be unfair to say that big businesses did not have any influence at all on the government, as it had to contain this sector's unhappiness with being outside of the euro zone with subsidies and a national monetary policy that minimizes exchange rate volatility with the euro. However, the influence was minimal compared to the original preference ofthis sector for membership of the euro zone.

Notes I . Organization for Economic Cooperation and Development, Glossary of Statistical Tertlls, 2007. 2. "Hoskyns Warns Delors: 'Stop the Double Talk,"' PR A'ewswire Europe, April 24, 1989. 3. "Hoskyns Warns Delors," PR Newswire Europe. 4.Conf'ederation of British Industry, European Monetary Union: A Business Perspective (London: CBI, 1989). 5.Confederation of British Industry, Annual Heportfor the }'ear Ending 31 December 1989 (London: CBI, 1990), 20. 6. Confederation of British Industry, European Monetary Union, 5; Confederation of British Industry. ,4nntral Report for the Year Ending 31 December 1990 (London: CBI, 1991), 19; and Confederation of British Industry, Annual Report for the Year Ending 31 Decen~bei-1988, (London: CBI, 1989), 6. 7. Confederation of British Industry, Agenda for Europe: Completing the Single Market (London: CB1, IYYO), 13.

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8. "ERM Entry is Good News for Industry," Press Associc~tion,October 5, 1990. 9. "loD Backs ldea of Independent Bank," 712e Tin~es,November 18, 1989. 10. "loD Backs ldea of Independent Bank." The Times. I I . Dan Atkinson and Simon Beavis, "The ERM Decision: Mixed Response from Business," 7'he Guardian, October 6, 1990. 12. Duckenfield, Mark, Business and the Ezcro: Business Groups and the Politics of EhlU in Cernlany and the L'nited Kingdonz (New York: Palgrave, 2006), 158. 13. Confederation of British Industry, Annllal Report for the Year Ending 31 December 1990, 19. 14. "CBI Launches Agenda for Europe," CBI A1ews,January 199 1, 5. 15. Confederation of British Industry, Agenda Jor Girope, 13. 16. Sir Brian Corby, "Creating the Right Europe," CBI News, December 1991lJanuary 1992. 4. 17. Andrew Sentence. "Monetary Union: What Now?" CBI hrews,September 1993, 2. 18. Sentence, "Monetary Union: What Now?" 19. Nicola Reeves, "Recovery Despite Treasury: Institute of Directors in Scathing Attack of Government's Economic Policy," The Iler-uld April 28, 1993, 15. 20. Chris Stone, "It is Time for Monetary System to Go, Says IoD," The Herald, July 31, 1993, 13. 21. Stone, "It is Time for Monetary System to Go"; and Colin Narbrough, "IoD Backs plan for 'hard ecu,"' 7'he Times, July 6, 1990. 22. "Stay in EU, but Spare us its Bureaucracy, UK Firms Tell Government," CBI News, NovemberiDecember 1995, 8. 23. Adair Turner, "Time for a Business-driven Approach to Europe," CBI News, November/I>ecember 1995, 3. 24. "Ready for the Single Life?" CBI News, NovemberiDecember 1995,21. 25. Confederation of British Industry, The Tran.siriotz to u Single European Currency: A Preliminary CBI View (London: CBI, March 1996). 2. 26. Personal interview with Doug Godden, tlcad of Economic Analysis Group, I~conornics and Enterprise Directorate, Confederation of British Industry, London, December 2, 2005. 27. Mike Cassell, "IoD's Policy Chief Warns against Monetary Union," The Firzancial Times, February 17, 1995, 10. 28. Cassell. "IoD's Policy Chief Warns." 29. "Open Debate on EMU Threat is Vital-loD," PH Newswire Europe, February 22, 1995. 30. Michael Cassel, "loD Says Single Currenc) Costs Outweigh Benefits," The Financial 7'ittzes, June 9, 1995, 8. 3 1 . Mike Betts\vortli, Federation of Snzull Busit~i~sses, 1974-1 999-25th Anniversary Conztnen~orc~tive History (Lytha~nSt Anns: National Federation of Self Employed and Small Businesses Ltd, 1999), 270. 32. Nick Ilerbert, "IoD Membership Backed Stance over Euro," The Financial Times, January 8, 1999, Letter to the Edi~or,14. 33. "loD Rejects a Single Currency," The Times. April 25, 1996, 25; Herbert, "IoD Membership Backed Stance." 34. Mark Milner, "loD Takes Tough Stance Against Monetary Union," The Gziardian, December 2, 1996, 17. 35. "loD Warns Against Single Currency," The Flerald, December 30, 1996, 16. 36. Sir Colin Marshall, "An Enemy of State Aids, Trade Barriers, and Overregulation," CBI News, May 1996, l I .

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37. Adair Turner, "It is up to us to Make Europe more Enterprising," CBI News, April 1996, 3. 38. Adair Turner, "Economics of Monetary Union," CBI News, NovemberIDecember 1996, 3. 39. "UK Businesses Reaffirm Commitment to Europe," CBI hlews, NovemberDecember 1996,6. 40. "A Conditional Yes to EMU," CBI News, September 1997,3. 41. "A Conditional Yes to EMU." 42. "A Conditional Yes to EMU." 43. Gordon Brown. "Statement on Economic and Monetary Union." HM Treasury, October 27. 1997. http:iiwww.hm-treasury.gov.uk/newsroom-and speeches/speeches/ statementispeech- statement- 271 097.cfm (accessed February 22, 2006). 44. Brown. "Statement on Economic and Monetary Union." 45. Godden interview. 46. Mark Duckenfield, Business and the Eziro. 47. Godden interview. 48. Godden interview. Emphasis added. 49. Robert A. Mundell, "A Theory of Optimum Currency Areas," American Econon~ic Review 5 1 (September 1961): 657-65. 50. '.A Conditional Yes to EMU." 5 I . Adair Turner, "In the Driving Seat," CBI News, NovemberiDecember 1997, 3. 52. Adair Turner, "CUI Still Wants to See Progress Towards EMU," The Financial Tinzes, October 20, 1999, Letter to the Editor, 26. 53. "A Conditional Yes to EMU," CBI News. 54. See for example, Mark Atkinson, "CBI to Plump for the Euro," The Guardian, July 20. 1999, 23; Robert Lindsay, "CBI Members Back Blair Over Joining Euro," Birmingham Post, July 21, 1999, 17; Rik Kendall, "CBI Comes Under Attack for its ProEuro Stance," The Journal, July 29, 1999, 29; and Olivier Morgan, "CBI Tips Towards Euro as Top Dogs Join Lobby Group," The Observer, November 28, 1999, 3. 55. Digby Jones interview cited in David Smith: "CBI Chief Makes Strides by Steering Away From Euro," Sunduy Tinies, July 30. 2000, 10. 56. Godden interview. 57. "UK's loD Sees No Euro Entry for Foreseeable Future," AFX' European Focus, December 7 , 2001. 58. The translation in English is "One people, One Realm, One Euro." 59. James Blitz and Cathy Newman, "IoD Refuses to Lend Name to No Campaign: Organization Insists on Staying Independent in Debate on UK Entry," The Financial Tinzes. July 5. 2002. 2. 60. I'ersonal interview with Simon Buckby, Former Director of Britain in Europe, London. December I . 2005. 6 1 . Duckby intervien. 62. Personal interview with Mark Littlewood, Former Head of Campaigns at The European Movement, London, December 2.2005. 63. Dominic Cummings. "Head to Head: The Euro," BBC News Online, October 14, 1999. http:ilne~vs.bbc.co.uki2ihi/uk~news/politicsi73705stm (accessed March 1, 2006). 64. Buckby interview. 65. Unilever plc. Annual Reports, 1999-2001. 66. British Anzericarz Tobacco, Annual Keports, 2001-2002; B.A.E. Systems, Annual Report. 2002.

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67. Robert Shrimsley, "Pro-euro Campaign Reveals Blue-chip Credentials," The Firzanciul Times, August 24, 2000, 2. 68. Buckby interview. 69. Robert Coppinger, Former Britain in Europe Acting Organizer for the West Midlands, Letter to the Editor, "Pro-European Campaign 'Poisoned,"' The Financial Times, August 28, 2000, 14. 70. Littlewood interview. 7 1. Buckby interview. 72. Duckby interview. 73. Nick Assinder. "Pro-Euro Group Wins Blair's Backing," BBC News Online, June 28, 1999. http:iinews.bbc.co.uU2ihi!uk-newslpolitics/380027.stm (accessed March 1, 2006). 74. Mark Tran, "Tory Heavyweights Join Blair for Launch of Britain in Europe Campaign," The Gtrardian, October 14, 1999, w\vw.guardian.co.uWbusiness/l999/ oct/l4/en1u.tlieeuro1 (accessed May 17, 2007). 75. Gordon Brown cited in the Press Association, Dec 15, 2000. 76. Personal interview with Richard Laming, Former Head of Campaigns, The European Movement, London, December 8.2005. 77. "Don't Mention the Euro," BBC News Online, October 14, 1999. http:iine~~s.bbc.co.uk/2/hiluk~newsipoliticsi474769.stm (accessed March I, 2006). 78. Tony Blair, Speech by Prinie Minister Tony Blair about Britain in Europe, October 14. 1999. Tony Blair Archives, Speeches, statements and Press Conferences, www.number1 O.gov.uk/output!PageI46 1 .asp (accessed March 15,2006). 79. Blair, Brituin in Europe. 80. Ruckby interview. 8 1. Buckby interview. Emphasis added. 82. Andrew Grice, "It's a Great Mistake to Try and Forget about the Euro until after the Election," The Independent, October 20,2000, 4. 83. Buckby interview. 84. Buckby interview. Emphasis added. 85. Kevin Brown, Ed Crooks, and Adam Jones, "Pressure from Companies that Want the lJK to Say Yes," The Financial Times, June 12, 2001, 4. 86. Bro\vn et al., "Pressure fro111Companies." 87. Littlewood interview. 88. Brian Brady and Allister Heath, "Sterling Crisis for Pro Euro Pressure," The B~rsiness,May 11, 2003, 2. 89. Brady and Heath, "Sterling Crisis." 90. Brady and Heath, "Sterling Crisis." 91. "Euro Campaign Chief Quits as Referendum Evaporates," The Guardian, Sept 10, 2003. 8. 92. Simon Buckby, "More in Sorrow than Anger," The New Statesman, June 27, 2005, w\~~.1iewstatesn1an.co11i/200506270012 (accessed June 25, 2006). 93. Britnit~in Ellrope, Press release, August 17, 2005. 94. Mark Littlewood, "Blair Bottles Out," 771e Spectator, December 9, 1999, http:lifindarticles.comlplarticlesinii~qa3724!isl99912lai-n8877940t (accessed June 27, 2006); and Andrew Pierce, "Euro Campaigners Defy Leader," The Times, December 10, 1999, 2. 95. Personal interview with Ruth Lea, Former Head of Policy Unit, Institute of Directors. London, November 30, 2005.

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96. Personal interview with Alex Hickman, Former Chief Executive of Business for Sterling and the No Campaign, London, December 3, 2005. 97. The argument is that the UK typically ships goods to Rotterdam as a transit point before they are shipped to other world markets. However, because the goods first go to Rotterdam, they count as a European export and distort the figure of UK exports to the euro zone. 98. Andrew Parker, "Anti-Euro Groups Unite for No Campaign," The Financial Times, September 4, 2000, 2. 99. "The Euro: Many Ways of Saying No," The Economist (US Edition), March 6, 1999, 55. 100. "BR and New Europe Combine to Form 'No' Campaign," No Campaign Press Release. September 4, 2000. 10 1 . Andrew Pierce, "Resignation Shakes Euro Group," The Tinres, November 4, 2000, 12; and Littlewood interview. 102. Steve Boggan, "The Euro Goes Live: Owen Joins Forces with the 'No' Campaigns," The Independent, January 4, 1999, 5; and Littlewood interview. 103. No Crrnzpaigrz Press Release, "BR and New Europe." 104. Personal interview with Mark Glendenning, Campaign Director, The Democracy Movement, London, January 27,2005. 105. 1,ittlewood interview. 106. Littlewood interview. 107. No Euro, tiistory of the Campaign, www.no-euro.com/whoweare/who.asp (accessed October 3,2005). 108. "Blair Dismisses Hitler's Spoof Ad," BBC News Online, July 3, 2002, http://news. bbc.co.uki2/hi/~k-news/politics/2090583~stm (accessed June 26, 2006) 109. James Blitz and Cathy Newman, "loD Refuses to Lend Name to No Campaign: Organization Insists on Staying Independent in Debate on UK Entry," The Financial Tinres. July 5. 2002. 2. 110. Gordon Brown, The Cl~ancellorof the Excheqrrer's Budget Statement to the Conzn~ons,March 17, 2004. 1 I I . Michael White, "Euro No Campaign Halted," The Guardian, March 24, 2004, 10. 112. Hickman interview; Lea interview; and Walsh interview. 113. Kevin Eason,"Toyota Urges Britain to Join the Euro" The Times, January 30, 1997, 1 . 1 14. Ben Macintyre and Polly Newton, "Britain Loses to France in Pounds 400 Million Fight for Car Sobs," The Times, December 10, 1997,7. 115. Robert Taylor. "Car Industry Warns of Bleak Future if UK Fails to Join the I,uro," The Financial Tinzes, October 26, 1998, I. 1 16. "Join Euro, Urge Business Leaders," The Northern Echo, November 24, 1998. 1 17. "Join Euro," The Northern Echo. 1 18. "Blair Assures Japan of Britain's Participation in Euro Currency," Agence France Press, January 10, 1998. 119. Christine Buckley, "Nissan Urges Early Entry in Euro," The Times, August 18, 1999. 25. 120. "Cook Warms to the Euro," BBC News Online, September 6, 1999. http://news.bbc. co.uk /2/hilbusiness/43947I .stm (accessed July 3, 2006). 121. Oliver Morgan, "Bid to Woo Nissan with Regional Aid Sweetener: Euro Threat Forces DTI to Consider Cash as Sunderland Incentive," The Observer, Business Pages, I I January 2004, 2.

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122. "Nissan's Latest Tone is 'Currency Neutral,"' The Journal, November 13, 2004, 78. 123. Morgan. "Bid to Woo Nissan." 124. Liz Lamb, "Black & Decker Workers' Alarm at Reports of Pull-Out Over Euro," The Northern Echo, July 12, 2002, I . 125. I'eter Marsh, "Jobs Squeezed by Strong Pound and Eastern Europe: Embracing the Euro Might Help Stem the Tide of Plant Closures," The Financial Tinzes, February 3, 2003. 5. 126. Lamb, "Black & Decker Workers' Alarm." 127. Lamb, "Black & Decker Workers' Alarm." 128. Morgan, "Bid to Woo Nissan." 129. Peter Marsh, "Japanese Investment in Full Bloom," The Financial Times, 19 August, 2005, 3. 130. "UK Need Not Join the Euro -Nissan," The Northern Echo, January 13, 2005. 13 1. "Nissan Drives a Wedge between the Euro Argument," The Guardian, February 2, 2005, City Pages, 2 1. 132. Nigel Tutt. "Toyota Europe CEO says Profits can Increase if EuroIStg Rate Stable," AF,Y .lsia, July 5 2001; Andrew English, "UK Will Never Join Euro," Daily Telegraph, 3 1 October 2002, 36. 133. Thomas Plii~npcrand Vera Troeger. "Monetary Policy Autonomy in European Non-Euro Countries, 1980-2005," European Union Politics 7, no. 2 (June 2006): 213234. 134. ERM 11 replaced the defunct EMS for countries that are not yet part of the euro zone. Its purpose is to maintain a stable exchange rate between the euro and the currencies of these member states. The UK did not join ERM 11. For more information on EIiM 11, see l~ttp://europa.eullegislation_summaries/ economic-and-monetary_affairs/ institutional-a1id_economi~-fra1nt:worMI250821i htm. 135. Goodhart interview, 2006; personal interview with John Gieve, former Deputy Governor of the Bank of England, Cambridge, Mass., May 15, 2009; Bank of England, Monetary Policy Committee minutes, 2002-2007, www.bankofengIand.co.uk/ publications/~ninuteslrnpciindcx.htm.(accessed January 22, 2010). 136. Goodhart interview, 2006; Gieve interview, 2009. 137. See f'or example, Jonathan Watts, "Toyota Threat to Quit UK over Euro," The Guardian, January, 18, 2000, 2; Tim Burt and Alexandra Harney, "Toyota May Rethink U K Investment," The Financial Tinzes, April, 6 , 2000; "Ford Motor Chief Urges UK to Sign Up for Euro," Evening News, Nove~iiber25, 2002, 3; and "We Need You in the Eurozone, Ford BOSSWarns Britain," The Birrninghanl Post, November 26, 2002, 17. 138. Marsh, "Japanese Investment in Full Blooni." 139. "Exporters Feel the Benefit as Falling Pound Nears Euro," The Binningharn Post, September 22, 2009, 6. 140. Walsh interview, Lea interview, Littlewood interview, and Godden interview. 141. I'ersonal correspondence with Hugh Bailey, Director, British Exporters Association (BExA), September 29, 2005.

Chapter 7

The City and the Euro Contrary to the internationally-oriented business community, which early on expressed a clear and unambiguous preference for British membership of the euro, the City-the London financial sector-was more ambivalent and engaged in careful in-depth studies in order to determine its preference. After the Treaty on European Union was signed with an opt-out option for Britain, the financial sector was concerned with how EMU would function, as the final details could have different effects on the City depending on whether it stayed out of the euro zone or not. As these issues were resolved, the preference of the financial sector became clearer. The consensus reached was that staying outside of the euro zone would be more advantageous to the City because it would become the most important offshore euro center. Indirect and direct pressure on the government, therefore, focused on this prediction, which would become reality after the launch ofthe euro in 1999.

City Preferences During the negotiations on the Maastricht treaty, the London financial sector expressed its preference for a common currency rather than a single currency as illustrated by its endorsement of the hard ECU plan. While everyone in the City would have preferred that the EU members not commit to the goal of a single currency, once determination had been made that Europe would have its own currency, whether to join or stay out was a different question. Answering it required having all the data concerning how EMU would operate.

Advocating a Common rather than a Single Currency As explained in chapter 4, the idea of the hard ECU originated in the City. The first proposal to EMU developed by Chancellor of the Exchequer Lawson did not trigger much interest from the other member states because it did not involve

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a treaty change. Paul Richards, Director of Public Finance at the investment bank Samuel Montagu, took advantage of the policy vacuum at the time to approach Sir Nigel Wicks, Second Permanent Secretary and Director of International Finance at Her Majesty's Treasury, with the idea of the hard ECU.' This proposal was an evolutionary approach to monetary union where member states would use a common currency, the ECU, which could eventually, but not necessarily, lead to a single currency. With approval horn Wicks, Richards, together with Sir Michael Butler, Director of Hambros Bank and Chair of the European Committee of the British Invisible Exports Council, refined the plan.2 This alternative, which was endorsed by Prime Minister John Major, was the most favored one in the City. The director of the London Investment Banking Association, Sir Adam Ridley, asserted: "We were commanding the hard ECU plan very vigorously. It attracted considerable interest in the The City found the hard ECU plan attractive because it had the advantage of preventing a two-speed European Union to which the City was opposed and it avoided moving irrevocably towards monetary union.4 However, City representatives warned that in order for the proposal to have any chance to be considered during the upcoming Intergovernmental Conference on EMU, the UK would have to join the ERM.' The City, therefore, supported entry of the pound sterling into the Exchange Rate Mechanism, which was also perceived as a way to lower high interest rates and to provide a much-needed boost to the markek6 As a matter of fact, the timing of the government's decision to enter the ERM in October 1990 was perfect for the City and provided a "euphoric reaction" in the square mile.' Financial affairs commentators argued, "ERM entry may just have come at the right time to forestall the impending sense of gloom among marketmakers and equity strategists."' Bankers such as Barclays Chairman Sir John Quinton welco~ned the UK membership of ERM for its predicted antiinflationary effect on the economy.g The euphoria over the ERM, however, was short lived, as Black Wednesday would demonstrate. In addition, British membership of the ERM did not provide more bargaining power to the UK in the Maastricht negotiations. The British government failed to impose its hard ECU proposal during the IGC-EMU. The results of the negotiations were a disappointment for some in the City, who formed the group City of London Concern over Maastricht (COLCOM). In 1993, the group published Maastricht: The Case Against Economic & Monetary Union, where the benefits of EMU were deconstr~cted.'~ It was written by investment banker Ian Milne, Executive Director and Head of Corporate Finance at Bank of America and Svenska Handelsbanken.

Initial Concerns of the City regarding EMU After the Maastricht Treaty was signed and ratified by all member states, the City had to face the reality that EMU would be established and lead to a European single currency by the end of the century at the latest. However, all the

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technical issues concerning how the single currency and the European Central Bank would work were still not determined and left room for uncertainty. These unsettled issues were of particular concern to the City, as they could affect its competitiveness.

Minimum Reserve Requirement of the European Central Bank The first issue of concern to the City was whether the monetary tools of the European Central Bank would include a minimum reserve requirement that would apply to banks inside the euro zone. Many Bank of England officers thought it was reasonable to assume that the Bundesbank would try to impose the instruments of monetary control that were features of the German banking system.'' As early as 1992, Germany argued that reserve requirements, used in West Germany since 1948, should be levied at the European level when EMU was completed.'2 The absence of a minimum reserve requirement on bank deposits in the United Kingdom, however, is one of the features that have attracted foreign banks to the City, as explained in chapter 3. The 1996 authoritative study undertaken by the EMU City Working Group--composed of the three main British financial trade associations, the British Bankers Association, the London Investment Banking Association, and the Association for Payment and Clearing Services, as well as representatives from Barclays Bank, Lloyds TBS Group, the Royal Bank of Scotland, Midland Bank, and National Westminster Group-warned of the damage that imposition of a minimum reserve requirement would cause to the City should the UK join EMU.'^ The EMU City Working Group report Preparingfor EMU: The Implications of European Monetary Union for the Banking and Financial Markefs in the United Kingdom emphasized the importance of the absence of minimum reserve requirements in the City as a unique feature that had to be preserved: "Deep, well developed, money markets are a key feature of the UK financial system. In addition to the sterling market, augmented at the beginning of 1996 by the introduction of the open gilt repo mechanism, liquid markets also exist in a variety of other currencies. A market oriented environment, notably the absence of minimum reserve requirements, is a particular strength."I4 The report implied that the City would lose a significant competitive advantage should the ECB impose minimum reserve requirements and should the UK decide to join the monetary union.'' The EMU Working Group report contended that if banks in the UK had to abide by ECB reserve requirements, even if the requirement was minimal, the appeal of the City for foreign banks would significantly decrease. As transaction deposits are on the order of very large figures, even a 2 percent reserve requirement as opposed to no reserve requirement represents a significant amount of money that banks would have to hold at the central bank and could not use to lend with interest on the money markets. It would directly affect the money multiplier and banks' profitability. l 6 ~ i s t o r i c a l lforeign ~, banks have been attracted to the City "to undertake money market activities in an offshore market that was free from reserve requirements and restrictive regulations."17 And, as Michael

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Blanden stated in an article published in The Banker in November 1996, the City's preeminence depends on "the UK capital's retaining its magnetic attraction for banks from abroad."" The monetary policy operation of the ECB was therefore identified in the EMU Working Group report as one of "a limited number of crucial issues of overarching significance in considering the possible effects of EMU on UK financial ~narkets."'~ The authors of the report recognized that were the ECB to establish a rninimunl reserve requirement applying to all banks within the euro zone, a "euro-euro" market would likely develop outside of the euro area: "High levels of reserve requirements would make the holding of Euro deposits unattractive and could impede the development of the money market, providing an incentive for banks to hold liquidity elsewhere perhaps spurring the development of an offshore Euro money market."20 Under this scenario, it was predicted that should the UK not join EMU, the City could become this offshore euro center: "Onerous reserve requirements in the EMU would increase the attraction of London as a location for Euro market activity."2' The City had good reasons to fear the imposition of minimum reserve requirements on banks in the euro zone. In August 1998, the ECB announced the introduction of compulsory minimum reserves on all banks located in member states that would adopt the euro in 1999, a decision that "upset bankers across ~ u r o ~ e . The " ~ ' ECB reserve requirement was set to be between 1.5 percent and 2.5 percent of liabilities on average over a month and to include punitive charges for banks failing to comply. The ECB tried to soften the blow to European banks by emphasizing that they would be able to earn some minimum interest on their deposits. However, continental banks responded to the announcement with anger because the ECB reserve requirement, in their view, provided an unfair competitive advantage to those banks located outside of the euro zone that may have a lower rate or no mandatory reserves at Access to TARGET, the Euro Wholesale Payment System The second issue of concern to the City was the status of EU member states that would choose to opt out or that would fail to meet the convergence criteria. Whereas the uncertainty regarding reserve requirements led the City to believe it would be better off outside of EMU (and rightfully so as it turned out), the unsettled issue of the status of non-EMU members led to worries of being disadvantaged by not joining. This concern is related to the previous issue. The City feared that as a way to prevent the development of an offshore euro market, the EU would discriminate against financial centers outside of the euro zone. The London financial sector was particularly worried that the Trans-European Automated Real-Time Gross-Settlement Express Transfer (TARGET) system, which was being devised to allow wholesale payments in euro, would not be available on the same basis to countries outside of the euro zone.24Aware of this concern of the London financial sector, former Bundesbank President Helmut Schlesinger, suggested using TARGET to convince the City to urge British

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membership of the e ~ r o . To ' ~ alleviate worries in the City and to respond to pressure from EU member states, the Bank of England took a confident view ~ ~ view was based on a that TARGET was not a crucial problem for the U K . This report from a study group con~posedof representatives from Citibank, Barclays, and Lloyds. These bank representatives argued that there were many alternatives to TARGET, such as the possibility of using the ECU Bankers Association Clearing System for euro payments, and that TARGET had potential drawbacks such as high costs and potential delay. In their report, they concluded that TARGET was not important enough an issue for the UK to be swayed to join EMU." After Chancellor of the Exchequer Gordon Brown announced in October 1997 that the UK would not join the euro with the first wave of countries and ruled out membership for the life of the current Parliament, ECB President Wim Duisenberg announced that access to TARGET would be available to non-EMU members on the same terms as EMU members.28This announcement removed an important worry in the City in the scenario where the UK would stay outside of the euro zone. The EU decision regarding TARGET was not surprising to Graham Bishop, European Financial Affairs Adviser at Salomon Brothers. He thought it would be very difficult for the EU to discriminate against the UK because the British government strategy at Maastricht had led other EU member states to always treat the UK as a "pre-in" member of EMU.^^

Competition from Frankfurt Initially, the City worried about the location of the European Central Bank no matter whether the UK was in or out of EMU. There were concerns that such a large and influential bank located outside of the UK would threaten the City's international financial center status. 30 For this reason, the City lobbied the government to support its bid for the ECB to be located in London. John Major personally backed the bid on May 13, 1992.~'In addition, Her Majesty's Treasury provided f 1.5 n~illionto the Corporation of London for its campaign.32Despite the UK's efforts, the seat of the ECB went to one of the other main financial centers in Europe, Frankfurt. After London lost the bid, the pro-euro business lobby exacerbated the City's fears of competition from this rival financial center. Pro-EMU voices commonly portrayed catastrophe scenarios where banks would flee the City en route for Frankfurt. However, after the decision on the ECB location was announced, London-based banks insisted that the City was still the best place to be. For example, Sumitomo Bank Managing Director, Shunichi Okuyama, asserted that Japanese banks would stay in the City because no other international financial center could compete with it in terms of the advantages it provided.33 Likewise, Deutsche Bank Director, Ulrich Cartellieri, said that "Frankfurt would continue to trail behind ond don."^^ The director of LIBA, Sir Adam Ridley, indicated that discussions of the association with Finanzplatz representatives shortly after the launch of the ECB revealed their disappointment from realizing that Frankfurt had not benefited very much from the presence of

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the central bank on its soil in terms of attractin more financial institutions or creating a large center for international banking.3 F After Gordon Brown announced that the UK would not adopt the euro in 1999 with the first wave of EU member states, allegations that there would be a movement of banks out of the City to countries committed to adopting the euro were renewed. However, the scareniongers were proved wrong once again. Financial institutions did not feel the need to leave the City. As a matter of fact, the number of EU financial institutions located in London increased from 238 to 350 between 1998 and 2001.36The reason for this paradox is that even though the City is not in the euro zone, it has other advantages that continue to attract foreign banks, notably the absence of a minimum reserve requirement. In addition, the City offers a favorable regulatory environment combined with more flexible labor laws and a more favorable tax regime for foreigners than any other financial center.37It also has a pool of extremely talented and competent people as well as the advantage of using the English language. Chairman of New Star Asset Management, John Duffield, stated confidently in 2001: "London has big advantages that will not be eroded by staying outside the ~ u r o . Director "~~ of the Center for the Study of Financial Innovations (CSFI), David Lascelles, asserted: "The idea that financial centers should be inside a currency zone, geographically close to big economies is irrelevant in an age of technology and free floating capital. What matters for a financial center is a hospitable environment, good regulations, and professional support."39According to Lascelles, London had competitive advantages over other financial centers, and the creation of the euro could not affect that position of strength as long as London had access to the euro markets. which it did.40

Direct and Indirect City Influence Attempts by the financial sector to influence the government decision on EMU were made through influential private studies emanating from City institutions, expert advice provided to the government, and direct lobbying through the involve~iientof City institutions in the pro-euro campaign.

Private Studies on EMU from the Financial Sector Although many institutions in the City were undecided until all the features of EMU were in place, a few important investment banks determined their preference on EMU earlier. Goldman Sachs was one of the first large investment banks that made an early determination as to whether the UK should join EMU. The July 1994 issue of the International Bonds and Foreign Exchange Bulletin published by Goldnian Sachs was entitled "Economic and Monetary UnionDinosaur or Phoenix?" This special issue concluded that the beast was more of a prehistoric nature that had proven unlikely to survive if we consider previous

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attempts at monetary ~ n i o n . The ~ ' case for monetary unification in Europe was therefore rejected. It is interesting to note that the Chief International Economist at Goldman Sachs, Garvyn Davies, participated in the Panel of Independent Forecasters that was set up after the ERM crisis of 1992 to advise the UK government on future economic policy. In May 1995, the panel produced a special report on EMU. In his submission to the Panel of Independent Forecasters, Davies recommended that the government stay involved in the planning process of EMU but avoid joining: "It is in our national interest to remain a full participant in the planning process for as long as possible, but at the end of the day it would be better to remain outside a flawed and premature move towards EMU than feel compelled to join."42 On January 1, 1997, Roger Bootle, the chief economic adviser of another large investment bank, HSBC, joined the six members of the Panel of Independent Forecasters, adding one more view from the City. HSBC had also published a report on EMU in May 1995 entitled The Econonlics of European Monetary Union, which argued that the UK not participate in EMU.^' The report contained, at the end, a disclaimer addressed to policytnakers that stated: "[Alny opinions expressed herein are given in good faith, but are subject to change without notice. No liability is accepted whatsoever for any direct or consequential loss arising froln the use of this document."44 The HSBC study took up the task of deconstructing the myth that the City could be hurt if the UK did not participate in EMU by stating: "Although this fear seems widespread, it appears to have little substantive foundation." The report presented the following argument to support the conclusion that the UK did not have to adopt the euro: ''In practice, London's advantages as a financial centre are so huge that were an inner core of countries to form a monetary union, it would be a fair bet that the biggest trading centre for its currency would be ond don."^^ The HSBC report, which preceded the comprehensive report done by the EMU Working Group, came to the conclusion that the City would be better off outside the euro area without even taking into consideration the possibility of a minimum reserve requirement imposed by the ECB. The HSBC report also addressed the issue of the effect of the UK staying outside of the euro zone on foreign direct investment: "Japanese companies who have invested or who might invest in Britain in real operation in order to be able to export to continental Europe from within the EU might conclude that such investments were now of precarious value. This is perhaps the most serious risk of all."J6 According to Christopher Taylor, former Chief Economic Adviser in the European Division at the Bank of England, all institutions in the City were aware of this risk.47However, the HSBC report contended that the risk of losing FDI to the euro zone had to be qualified and assessed properly: If policy-making in the inner core were 'a success,' and especially if British policy were badly managed and British economic performance lagged that of the inner core, then this would compound the effect of 'exclusion' in determining overall investment. But suppose the other set of preconditions applied . . .

why should Britain not remain a more attractive place for the Japanese to invest than continental ~ u r o ~ e ? ' ' ~ ~ The HSBC report concluded that the UK did not have to join EMU to retain its competitiveness but that what it needed to do was to ensure it had a sound monetary policy. Interestingly, it corresponds to the move by the government towards independence of the Bank of England in 1997 in an effort to improve its monetary policy credibility and performance. As mentioned in chapter 4, this move was solely motivated by this domestic policy goal and not by any desire to meet one of the Maastricht criteria. The study undertaken by the EMU City Working Group, Preparing for EMU: The It~zplicationsof Ezrropean Monetary Union for the Banking and Financial A4urkets in the United Kingdom, was still the most authoritative and comprehensive work on EMU because it envisioned the consequences of the two possible scenarios-British membership of EMU and non-participationand assessed the effect of the two scenarios on each of the City markets. Preparing for EMU predicted that whether the UK joined EMU or not would not make a huge difference for the capital markets, as the City already benefited from a large market share of Eurobonds trading. In their report, the banking and financial services trade associations stated that even in case of non-participation of the UK, "it is expected that there would be significant volumes of trading of EMU area bonds in on don."" The fact that the City would be outside of the euro zone would not affect its ability to attract Eurobonds to be traded on the London Stock Exchange. As a matter of fact, international bonds issued in the UK in 200 1 had an outstanding value of £436 billion-four-fifth of which were Eurobonds-making the City the leading center for ~ u r o b o n d s . ~ ~ Regarding equities, the EMU City Working Group report stated: "In the event the UK did not participate in EMU, then the UK equity markets would continue in sterling. However, it is possible that issuers from within the EMU area may wish to trade in euros. . . . The extent of this demand is uncertain but it is unlikely that it would present significant transitional problems."5' A 1997 study by Her Majesty's Treasury also predicted that should the UK stay outside of the euro zone, its capital markets would not suffer but would actually benefit from the emergence of a new bonds and equity market in euro. The report concluded: "With modern information technology and communication capacity, there is no reason why securities trading should be in the country where it originates. Rather it will go through the financial centre or exchange that offers the most efficient trade, measured by the cost, speed, and integrity of the transact i ~ n . " ~It' is interesting to note that the London Stock Exchange did not lose its attractiveness after the launch of the euro. The LSE is clearly the market of ~ ~ and AIM have choice for international Initial Public Offerings ( I P O S ) . LSE more foreign companies listed-as many as 629 in 2009-than any other exchange~.~~ As far as money markets are concerned, the EMU City Working Group predicted that the growth of the money market would be greatly hampered if there

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was a minimum reserve requirement imposed by the ECB and the UK joined the euro zone. However, if the UK did not participate, the City's competitiveness would be enhanced as banks would seek to hold euro deposits in the center that offered the greatest liquidity. Non-participation of the UK in EMU would therefore ensure that the City would become the principal Euroeuro market as it had become the main Eurodollar market. Similarly, the Bank of England asserted in 1997 in its series Pructical Issues Arising From the Euro that the London money ~narketswould continue to thrive if the UK remained out of the euro zone: The introduction of the euro represents an opportunity for London rather than a threat. There will be a vigorous 'Euro'-euro market in London, just as there is a vigorous market in Euro-DM, Euro-francs, Euro-$ and Euro-yen now. The location of financial activity does not depend on the local currency: it will continue to be carried on wherever it can most conveniently, efficiently and profitably be carried on.55 The EMU Working Group report highlighted that foreign exchange and derivatives would be the markets the most negatively affected should the UK participate in EMU. These findings were supported by a subsequent study, The Impact on the City of UK Eurozone Membership, published by the Corporation of on don.^^ First and foremost, if the UK adopted the euro, it would eliminate one more currency conversion. City institutions engaged in foreign exchange saw an advantage in continuing to swap sterling for euros and collect commission fees. The EMU Working Group report also predicted that the London Foreign Exchange would become a preferred location for euro trading even if the UK did not take part in EMU because of the City's reputation and lead in this market. Today, the euro/dollar is the most traded pair of currencies on the London exchange. London remained the largest center for foreign exchange activity, with a 36 percent lnarket share in 2009, a position unchanged since 2001.~' The assessment of the impact of British membership of the euro zone on the derivatives market was also negative. According to the financial trade associations' report, membership represented more threats than opportunities. In general, if the UK adopted the euro, companies exporting to the EU would no longer need to hedge currency risk, which would result in an important loss of business for the derivatives market. Already in 1990, when the UK joined the ERM, one concern in the City was that a more stable sterling would "reduce foreign exchange trading volume and cut demand for the hedging services that have become a substantial part of bank earnings."58 According to research by the Center for the Study of Financial Innovations, £490 million a year are spent on ~ therefore estimated currency hedging by companies located in the U K . It~ was to be to the advantage of banks trading derivatives to keep the pound. The overall conclusion of the EMU City Working Group study was that "in the event of non-participation, UK markets would still attract considerable euro business. If the EMU area were to be characterized by a high regulatory culture, the con~petitiveposition of the City would be strengthened f~rther."~' The Cor-

poration of London report also indicated that one of the main benefits of staying outside the euro zone was the fact that the UK could then become a major euro offshore center.61

Involvement of City Institutions in the Euro Campaigns The No campaign, formed in 1999, had in its membership a significant number of City representatives. For example, the Chairman of the London International Financial Futures and Options Exchange, Sir Brian Williamson, was a member. This fact is hardly surprising: as we have seen, British entry into the euro zone would negatively impact the derivatives market. Michael Spencer, Chief Executive Officer of the money broking company [CAP, was also a member. ICAP's donations to "Business for Sterling" were motivated by the way the financial firm would be affected by adoption of the euro as its former Chief Operating Officer, David Gelber, pointed out: "We decided that we wished to donate to the campaign for sterling for two reasons: not the political reasons but basically because we believe that one, the euro was a wrong and flawed concept, and two, we make a lot of money out of sterling so we did not want to see sterling disappear; so it was a fairly self-interested c ~ n t r i b u t i o n . "Representatives ~~ of some of the most influential investment banks were also involved in the No campaign. For example, the Director of JP Morgan, Campbell Gordon, and the Vice Chairman of Goldman Sachs, Lord Griffiths of Fforestfach, were active members. Commercial banking was also represented. British commercial banks such as Standard Chartered Bank, Hambros Bank, Clydesdale Bank, Yorkshire Bank, and Alliance & Leicester had representatives in the No campaign.63 Many City interests preferred that the UK stay outside of EMU to retain a certain independence from political pressure exercised by the EU on banks to use the euro and to take a generally positive attitude towards the single currency. David Lascelles of the Center for the Study of Financial Innovation explained: "We felt the political pressure was unhealthy. We felt markets could not flourish in that sort of politically pressured environment. We felt that if London was outside that political pressure, it could better supply independent markets."64 Lascelles asserted, "In the course of countless conversations with City figures of all types and at all levels over the last two years, I have found a fairly consistent pattern. When asked personally about their views on EMU, two-thirds of the respondents expressed skepticism."65 It was important for many that the City retain its reputation of having a light regulatory touch, which it would lose by being part of EMU. Even though the City might be subject to some regulations as a member of the EU, what mattered for many in the City was to preserve "an aura of independence."66 Therefore, City representatives deemed irrelevant the europhile argument that by joining EMU, the City could benefit by becoming the official financial capital of the euro zone. As David Lascelles explained in an interview in 2006, "The City is the financial capital of the euro zone. Why

The C i b and the Euro

125

would it want to become official? It would only defer on it bureaucratic and political pressures, which London would not welcome."67 To respond to the involvement of the City in the No campaign, Britain in Europe tried to recruit City people. It created a subgroup-the City in Europedesigned to encourage the financial sector to support the euro. The City in Europe was launched on June, 25, 2001, with fifty-three supporters to surpass the twenty-eight City members of the No campaign. However, three days later, the No campaign added twenty-four new supporters from the financial community to its cause, bringing its support from the City to equality with that of the proeuro group.68 The City in Europe published a report No Overtaking: To Stay in the Lead the City Needs the Euro which pointed out the need for a "wake-up call of the British financial sector." 69 However, in this report, the City in Europe had to acknowledge that not joining would not be highly damaging to the City: "[Nlo useful purpose is served, however, by exaggerating. The City would survive if we did not join, and joining might not lead immediately to spectacular benefits." The report also recognized that the City had unbeatable comparative advantages: "The City's greatest advantage is its critical mass. Nowhere else has the skills, talent and expertise all in one place."70 The conclusion of the report, nonetheless, argued that there was a risk that the City could lose business to the Continent if it did not join the euro zone.7' Britain in Europe managed to recruit members working for the City but these individuals had a personal agenda and did not really represent the City's interests. For example, one City in Europe member was Vice Chairman of Citigroup, Anthony Nelson, a strong europhile and former Tory minister who joined the Labour party in 1997, and had personal political ambitions in backing the campaign supported by Tony Blair. 72 Similarly, another member, Graham Bishop, worked as European Financial Affairs Adviser for Salomon Brothers for twenty years, and wanted to take advantage of the entry of the UK into EMU to create his own consulting company. Bishop had held a number of political appointments at the European Union and had acquired quite an expertise on the issue of EMU. Bishop had both a political and personal agenda, as he explained: "I campaigned for entry of the UK in the euro zone for political reasons; I was on the European Commission's Committee of Independent Experts who thought out how to make the conversion to the euro for the whole of Europe. I also wanted to use that expertise for British companies that would be thinking about making the t r a n ~ i t i o n . " ~ ~ Other City interests supporting the euro were subsidiaries of European banks. These banks were under considerable political pressure from the EU to speak favorably on the euro. As a result, the management of these banks took a pro-euro public position.74The same applied to institutional investors such as insurance companies. According to Former CEO of the International Underwriting Association, Marie-Louise Rossi, opinion on EMU differed depending on the nationality of the member organizations: "The Swiss had their own views because they are outside the euro zone. But the view from Paris, the view from Munich was very clear, they were very pro-euro."75

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This division of opinion based on the home-base of financial institutions was also illustrated by a 2000 MORl poll of senior executives in the City that asked respondents: "How strongly do you agree or disagree that it would be in the best interests of the City of London if Britain joined the euro?" As table 7.1. shows, the British banks were distinctly more opposed to EMU than banks whose headquarters were not in the UK, including banks from the euro zone.

Table 7.1. Opinion of City Executives on the Euro How strongly do you agree or disagree that it ~vouldbe in the best interests of the City of London if Britain joined the euro'?

I Bnse:

I UK based

I

Non-UK based

1

Percentages

Strongly agree Tend to agree Neither agree nor disagree Tend to disagree Strongly disagree Don't know AGREE DISAGREE Source: MORI. 2000

17 18 14 13 30 8

36 27 11 16

35 43

64 25

9 0

Benefiting from the Offshore Position of the City The launch of the euro in 1999 led to consolidation in the financial sector. Banks and financial institutions decided to consolidate their euro business in one financial center. Ironically and as predicted by many in the City, that consolidation happened in London rather than in Paris or Frankfurt. David Lascelles explained: "Because these banks already had their biggest operations here [in the City], they have brought, for example, Eurocurrency trading to London. They brought it out of Paris, out of Frankfurt. They brought bond trading denominated in euro in London. So London has actually grown as a result of it."76 The director of the Futures & Options Association, Anthony Belchambers, concurred with Lascelles that "the euro has done more damage to the smaller financial centers in the EU on the Continent while it has led to a big migration of business in terms of the euro in on don."" Contrary to fears spread by pro-euro business lobbies, the financial sector experienced a movement into London as a result of the euro. An illustrative example is the fact that the main three German banks located in Frankfurt-

The City and the Euro

127

Deutsche Bank, Dresdner Bank, and Commerz Bank-moved their securities, foreign exchange, and derivatives trading to the City in 1999.'~The German banks were more interested in locating in the most attractive financial center in terms of skills and government regulations than in promoting Frankfurt as an international financial enter.'^ Table 7.2 shows how OTC derivatives trading migrated to London to the detriment of other financial centers, particularly Frankfurt. Today, the UK still has a 42.5 percent market share, making it the leading OTC market place.80 Table 7.2. O T C Derivatives Market Shares Market Place UK France Germany Belgium

% Market Share 2004 1998 42.6 36.1 10.2 9.7 3.1 7.2 2.6 8.9

Source: International Financial Services London, Internation6 Financral Markets rn the UK (London: IFSL, April 2006), 14.

Another telling example is ICAP, one of the largest money brokers in the world, which was formed in 1999 from the merger of Garban plc and Intercapital plc. ICAP, which acts as an intermediary broker for commercial banks and investment banks, took the decision to operate from London rather than from continental Europe. David Gelber, one of the founders of the company, explained: "We took a bet that post the euro, business would move to one center and would move to the center where the most liquidity exists, and that by far and away is London and that is exactly what has happened rather than what people were fearing, that Frankfurt or Paris would take over."" In 2000, the House of Comlnons commissioned a Select Committee on Treasury to study the particular question of whether the City, which had not suffered from being outside of the euro zone, had actually benefited from this peculiar position. After receiving oral and written testimonies from City witnesses, the Select Committee noted that "many witnesses from the financial services sector were agreed that the City of London as a global financial centre has '~ Invisibles (BI), the benefited from the UK's position outside the E U ~ O . "British association promoting the international activities of the City, testified to the House of Commons: "There is no evidence since the euro was launched, either from available market data or BI's poll of its members, of any adverse impact on London's position as an international financial centre that might have originated from changes in strategy of UK-based financial in~titutions."~~ Financial sector representatives who testified all agreed with B1 that the status of the City as an international financial center had not been negatively affected by the UK being

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outside of the euro zone.84The select committee noted that the City of London "was warned that its business would fade away, but the reverse has happened."" Even financial institutions mainly involved in currency trading gained from the advent of the euro. The loss of business from the trading of legacy currencies was offset by the new business brought by the euro to London. David Gelber of ICAP stated: "Because so much of the business has migrated from Brussels and Madrid to London, we haven't lost any business even though we were dealing actively in Spanish peseta, Italian lira, Belgian franc, e t ~ . In " ~addition, ~ by staying outside of EMU, City financial institutions involved in currency trading and hedging retained the business brought by sterling, whose international use actually increased after the launch of the euro. In 1998, the pound sterling accounted for 18 percent of London's foreign exchange market turnover while in 2004 it accounted for 28 percent.87Gelber explained this phenomenon as a product of two factors: One, traders like something to bet on and you couldn't bet anymore about the guilder against the Deutschmark or the French franc against the Italian lira or the Italian lira against everything else which we were always betting on. Two, people want currency diversification and [here are basically only three and a half currencies left in the world-you have the dollar, you have the euro, you have sterling, and you have the yen. The reason I say the yen is half a currency is because its rate is highly manipulated by the Central Bank, it's not a truly free market zone. So yes, sterling use has increased because there are fewer places wherz people can go to speculate.88

In late 2001, the Bank for International Settlements published figures showing that the City retained its dominance as a global financial center after the introduction of the euro. Recent figures published by the International Financial Services in April 2006 showed that London has experienced growth in each of its principal markets over the past ten years, as table 7.3. illustrates. Table 7.3. Growth in International Financial Markets in the UK Main Markets Cross Border Lending ($ billion) Foreign Equities Turnover ($ million) Foreign Exchange Trading ($ billion) Derivatives Turnover - Exchange Traded (mil. of contracts) - Over-the-counter ($ billion)

1995 1,350 627 464

2005 4,122 2,488 789

Growth 205 % 296 % 70 %

201 74

639 643

218 % 769 %

Source: International Financial Services London, lttter~wlionalFinuncial Markets m the U K (London. IFSL, April 2006), 2 .

A 2002 survey of overseas banks with London operations by management consultants Radley & Associates argued that what kept attracting foreign banks to the City was "the large market, the tax and regulatory systems and the large

The City and the Euro

129

skill base." None of these features depended on any hture British membership of the euro. On the contrary, the tax and regulatory systems were viewed as best preserved by not being associated with the euro zone.89A 2003 study by the Centre for the Study of Financial Innovations demonstrated that the City still ranked ahead of Paris and Frankfurt as a preferred financial center. Based on questionnaires and interviews of City practitioners and observers, the CSFI report established that the crucial characteristics of a financial center are, in ranking order: skilled labor, competent regulations, a favorable personallcorporate tax regime, responsible government, a light regulatory touch, and an attractive living and working environment. Based on these criteria, London ranks well ahead of Paris and Frankfurt. The report concluded, "There is much evidence that the City has benefited from the new business generated by the euro, and little that it has lost any."90 This finding was based on assertions by City practitioners that "the lion's share of new euro-denominated business--eurobonds, foreign exchange and corporate deals-had been handled from London, suggestToday, the City is doing extremely well and ing that staying out was no 10~s."~' continues to rank number one on the Global Financial Centres ~ n d e x The .~~ London financial center keeps contributing to the strength of the UK economy. In 2007, the U K registered the largest trade surplus in financial services in the world, ahead of ~witzerland.'~

Neutrality after the Fact As we have seen, the fact that the City would benefit by staying outside of the euro area was predicted by a number of banks, financial institutions, and trade associations that expressed their opinion through position papers or direct involvement in the No campaign. After it became clear that the City had not suffered from being outside of the euro zone and would continue to benefit from its offshore position, City institutions adopted a position of neutrality on the euro. In 2002, the Sir John Cass Business School surveyed one hundred senior banking professionals in thirty-five major institutions in the retail and wholesale banking sector on membership of the euro for a study commissioned by the Corporation of London. The report highlighted that UK-based banks had "collectively adopted a neutral stance on entry" for political matters and because of concerns about their relations with customer^.'^ Most banks surveyed reported that they did not want to offend customers who might have had a strong view on the issue (such as internationally-oriented business interests), and also that they did not want to be perceived as influencing a decision that had to be decided by the people.95One UK bank quoted in the report seemed to summarize the overall feeling in the banking industry: "[The euro] is clearly a very sensitive issue and there is no appetite for spelling out [our] stance. There is no upside, there is only a downside in doing so."96

The financial trade associations also took a public position of neutrality after having participated in authoritative studies that strongly argued that the City would benefit from staying out of the euro zone. The British Bankers Association and the London Investment Banking Association, which were both part of the EMU City Working Group that published the 1996 study Preparing for the Ezrro: The Iiriplications of European Monerary Union for the Banking and Financial Markets in the United Kingdom, later expressed neutrality on the question of British membership of the euro zone. BBA's response to a request by the author for an interview with one of its representatives was: "As a trade association, our focus has been upon the technical and practical issues which would have to be addressed to affect the introduction of the euro should the decision be taken to do so by the UK government, parliament and the voting population in a referendum. We do not therefore believe it would be of benefit to your research for us to Behind this stance of neutrality in the City, however, was a consensus that British membership of EMU would not be favorable to the City and should be discouraged. For example, the late Lord Alexander, Chairman of National Westminster (NatWest) in the 1990s, the second largest bank in the UK, was a strong europhile and was in favor of EMU from a political point of view. He used to voice his personal views until his board asked him to stop doing so for it did not represent the bank's preference.98 David Lascelles of the Center for the Study of Financial Innovation-an organization that keeps very close to City opinion-contended that from 2000 to 2005, the City position shifted gradually c.~~ the towards opposition to EMU and became strongly e ~ r o s k e ~ t iSimilarly, director of LIBA, Sir Adam Ridley, indicated that although LIBA's membership had always been divided, it became increasingly critical of EMU."' When polled, members' opinion was not constant through time but evolved in a euroskeptic direction.I0'

Conclusion In order for the financial sector to clearly assess its best interest, it was critical that the British government adopt a position that left all options open. City interests had recommended the strategy adopted by the British government of always appearing as a willing member of the euro zone in order not to be discriminated against at the EU level. During the negotiations on EMU, the Conservative government always had the interests of the City in mind. The Labour government pursued the same approach: the "prepare and decide policy" based on the five tests was a delaying tactic that allowed the financial sector sufficient time to fully determine where its interests lay. Meanwhile, pro-euro business interests were skillfully kept at bay by the government. This chapter has clearly demonstrated that by 2001, when Blair commenced his second term, the City had started reaping the benefits from its position outside of the euro zone. Alan

The City and the Euro

13 1

Brown, Chairman of State Street Global Advisors, clearly stated the evidence in a June 2001 letter to The Financial Times: "Since the euro's launch, eurodenominated foreign exchange and Eurobond business has concentrated in London . . . and European Union financial institutions have increased rather than diminished their presence in the The dark scenarios of the pro-euro voice did not materialize. The City saw no movement of its banks and financial institutions to Frankfurt, as it continued to offer the best regulatory environment. The City remained the dominant financial center completely eclipsing rival European financial centers. City interests were therefore resolutely opposed to British membership of EMU, contrary to business interests that still hoped that Blair would hold and win a referendum on British membership of the single currency in his second term. The opportunity costs of joining the euro zone increased significantly for the London financial sector as time went by. Having become the main offshore euro center, London felt comfortable in this position that brought to the City all of the benefits of the euro while being free from EMU membership. The removal from critical positions of the most euro-enthusiastic members of the Prime Minister's cabinet, the increasing compensations to industry, the negative assessment of the five tests except for the controversial City test (which, as it is interesting to note, contradicts the most authoritative studies done by financial institutions) and the effort to minimize volatility with the euro are all indications that the Labour government was well aware of both the impossibility of continuing to consider membership of the euro zone and of the need to accommodate the internationally-oriented business community that had definitely lost the battle for the euro.

Notes 1. Personal interview with Paul Richards, Former Director of Public Finance, Samuel Montagu, London, July 17, 2006. 2. Philip Stevens, Politics and the Pound: The Conservatives' Struggle with Sterling (London: Macmillan, 1996), 161; Michael Butler and Paul Richards, "Europe's Urgent Need for Hard ECU," The Independent, May 18, 1990,23; Peter Norman, "Business Takes an Interest in ECU," The Financial Times, May 29, 1990, 27; and Richards interview. 3. Personal interview with Sir Adam Ridley, Director, London Investment Banking Association (LJBA), London, November 30, 2005. 4. Kichards interview. 5. "The Late Arrival at the EMU Ball," The Financial Times, June 22, 1990, 22; and Leila Talani-Simona, Betting For and Against EMU: Who Wins and Who Loses in Italy and it? the UKfron2 the Process ofEtlropean Monetary Integration. Brookfield, Vt.: Ashgate, 2000, 152. 6. David Lascelles, "Britain and the EMS: Spot of Light amid Gloom," The Financial Times, October 8, 1990, 17. 7. I,ascelles, "Britain and the EMS."

8. Andrew Hill, "Wake up to the Brave New World," The Financial Times, October 6, 1990, 2. 9. Lascelles, "Britain and the EMS." 10. Ian Milne, Maustricht: The Case Against Econotnic (e Monetary Union (Oxford: Nelson & Pollard in co-operation with City of London Concern Over Maastricht, 1993). I 1 . Personal interview with Christopher Taylor, Former Chief Advisor, European Affairs. Bank of England, London, August 2, 2006. 12. David Marsh, "No Place for Bank to Call Home," The Financial Times, January 14, 1992, 16. 13. EMU City Working Group, Preparingfor E,LtU: The Implications of European Monetary Unionfor the Banking and Financial Markets it1 the United Kingdom (London: EMU City Working Group, 1996), l I . 14. EMU City Working Group, Preparingfor EhtU, 10. 15. EMU City Working Group, Preparingfor E.ilU, 10. 16. On the money multiplier, see Lawrence Ritter, William Silber, and Gregory Udell, Principles of Money, Banking, and Financial Mrirkets (Upper Saddle River, N.J.: PcarsonIAddison-Wesley, 2004). 17. City Research Prqject, Final Report cited in EMU City Working Group, Prepar~ n for g EA'fli, 3. 18. Michael Blanden, "London Calling: Foreign Banks in London," The Banker 146, no. 849 (November 1, 1996): 34-38. 19. EMU City Working Group, Preparingfor E.\IU, 2. 20. EMU City Working Group, Preparingfor EhtU, 2 2 1. EMU City Working Group, Preparing for Ei\lU, 1 1. 22. "ECB Minimum Reserves Rule Causes Controversy," European Banker, August 1998. I . 23. "ECB Minimum Reserves Rule Causes Controversy," European Banker. 24. Blanden, "London Calling." 25. "No Price for Euroland: Pressures on the UK to Join the European Monetary Union" The Banker 147, no. 854 (April 1, 1997): 2 1. 26. ?'a> lor interview; and "No Price for Euroland," The Banker. 27. "No Price for Euroland," The Banker. 28. "ECB Minimum Reserves Rule Causes Controversy," European Banker. 29. Personal interview with Graham Bishop, Former European Financial Affairs Adviser. Salonion Brothers, London, December 1, 2005. 30. Andrew Marshall, "London Stakes its Claim for Europe's New Bank," The Indepenc.fenl. January 27, 1992, 23; and Taylor intervie\\. 31. Marsh, "No Place for Bank to Call llome." 32. Marsh, "No Place for Bank to Call IJome." 33. t3landen, "London Calling." 34. Blanden, "London Calling." 35. Ridley interview. 36. David Lascelles, The City atid the Euro (London: New Europe, 2001), 4. 37. "Banking in London Still a Capital Idea," Ellropean Batlker, March 24, 1997, 4. 38. John Duffield, "The Trouble with the Euro," The Financial Times, June 27, 2001, 21. 39. Personal interview with David Lascelles. Director, Center for the Study of Financial Innovation. London. December 6, 2005. 40. I,ascelles interview.

The City and the Euro

133

4 1. Goldman Sachs, "Economic and Monetary Union-Dinosaur or Phoenix?'Internationul Borids and Foreign Exchange Bulletin, Issue 137, July 12, 1994. 42. Garvyn Davies cited in Panel of Independent Forecasters, Special Report on EA'IU (London: Panel of Independent Forecasters, May 1995), 82. 43. Roger Bootle, The Econotnics of European Monetary Union (London: HSBC Markets Research, May 1995). 44. Bootle, The Economics ofEuropean Monetary Union, Inside back cover. 45. Bootle, The Economics of European Monetary Union, 17. 46. Bootle, The Econonzics ofEuropean Monetary Union, 16. 47. 'faylor interview. 48. Bootle, The Econon~icsofEuropean Monetary Union, 16. 49. EMU City Working Group, Preparingfor EMU, 12. 50. Richard Roberts, The City: A Guide to London S Global Financial Centre (London: l'he Economist, 2004), 82. 5 1. EMU City Working Group, Preparing,for EMU, Background Papers, 16. 52. David Currie, The Pros and Cons ofEMU (London: HM Treasury, July 1997), 17. 53. Rana Foroohar, "Goodbye Manhattan: London Has Turned Hot for International Banking." Nervsweek, March 20, 2006, E18. 54. International Financial Services London, International Financial Markets in the IJ'K (London: IFSL, November 2009), 8. 55. Bank of England, Practical Issues Arisingfrom the Introduction ofthe Euro, Issue 6. December 1997. 12. 56. Chrystal Alec, Alex Stqjanovic, and Peter Crossan, The Impact on the City of UK Enrozone Xfenzbership (London: Corporation of London, November 2002), 46-47. 57. Bank of England Quarterly Bulletin, Winter 2004, 471; and International Financial Services London, International Financial Markets in the UK, 15. 58. David Lascelles, "Britain and the EMS: A Source of Relief from Pain," The Fintrncial Times, October 6, 1990, 6. 59. David Lascelles, Currency Futtrres: How Modern Markets Overtook the Euro (London: No Campaign, 2004), 12. 60. EMU City Working Group, Preparingfor EMU, 26. 61. Alec et al., The lnzpact on the City ofUK Eurozone Membership, 53. 62. Personal interview with David Gelber, Former Chief Operating Officer, Current Non Executive Director, ICAP, London, July 18, 2006. 63. List of No Campaign members in Lascelles, Currency Futures, 17-23. 64. 1.ascellrs interview. 65. Lascelles. Cotdidence in the City outside the Euro, 25. 66. Lascelles interview. 67. Lascelles interview. 68. Kevin Brown, Brian Groom, and Peter Marsh, "City Will Do Fine Outside Euro, Claims Lobby Group, Financial Times, June 28,2001, 5. 69. Levin. h'o Overtaking, 4. 70. Levin, h'o Overtaking, 4. 7 1 . Levin. ,Yo Overtaking, 32. 72. "Ex-Minister Defects to Labour," BBC News Online, June 4,2001. http:il neus.bbc.co.uklvote2001/hilenglish/newsidl369000/1369364.stm (accessed March 3, 2006). 73. Personal interview with Graham Bishop, Former European Financial Affairs Adviser, Salolnon Brothers, London, Deceniber 1, 2005.

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74. Lascelles interview. 75. Personal interview with Marie 1,ouise Rossi, Former CEO, International Under\\riting Association (IUA), L,ondon, December 5, 2005. 76. Lascelles interview. 77. Personal interview with Anthony Belcharnbers, Director, Futures & Options Association, London, July 18, 2006. 78. Roberts, The City, 25 1 . 79. Roberts, The City, 252. 80. International Financial Services London, Intert~ationalFinancial Markets in the U K , 14 81. Gelber interview. 82. House of Commons, Econonlic and hlonetary Union, Treasury Select Committee. Eighth Report (London: The Stationary Oftice, July 2000), Proceedings to the Committee Relating to the Report, Draft report proposed by Mr. Michael Fallon, Mr. David Ruflley, and Sir Michael Spicer. Paragraph 13. 83. House of Commons, Econonzic and Alonetaty Union, Memorandum by British Invisibles, Appendix 10, Paragraph 4. 84. House of Commons, Ecotlonlic and A4oneta1y Union, Paragraph 42. 85. House of Commons, Econon~icand hlonetay Union, Proceedings to the Committee Relating to the Report, Paragraph 5. 86. Gelber interview. 87. Mario Jung and Agnes Oestrich, "Developments in Global Foreign Exchange" in Stephen Barber, The City in Europe and the World (London: European Research Forum, London Metropolitan University, 2005), 126. 88. Gelber interview. 89. Jarlies Mackintosh, "Foreign Banks Play Down Euro Importance to City," The l;rtztrncinl Titnes, February 6 , 2002, 5. 90. Center for the Study of Financial Inno\,ations, Sizing Up the City-London's Rankitzg CIS a Financial Cetztre (London: CSFI, 2003), 2. 91. Centre for the Study of Financial Innovation, Sizing up the City, 29. 92. International Financial Services London, International Financial Markets in the UK, 3. 93. International Financial Services London, UK Financial Sector Net Exports 2009 (London: IFSL, August 2009), I . 94. Alec et al., Tile Inzpact on the City ofUK Etlrozone hfembership, 6. 95. Alec et al., fie lnzpuct on the City of l/K Eurozone A4etnbership, 8. 96. Alcc ct al., The Itnpact on the City o f U K Eurozone hien~bership,25. 97. Personal correspondence, British Bankers Association, October 28,2005. 98. I~ascellesinterview. 99. Lascelles interview. 100. Kidley interview. 101. Kidley interview. 102. Alan Brown, "Being outside EMU has not lleld City Rack," The Financial Tirlzes, June 28, 2001, Letter to the Editor, 20.

Chapter 8

Conclusion As I finish writing these pages, the euro zone is dealing with the need to rescue one of its sick members, Greece-whose government debt to GDP reached close to 120 percent-while the newly elected government of David Cameron sighs with relief that Britain conserved the pound sterling. The bailout package to Greece by euro zone members and the International Monetary Fund (IMF) did not prevent the euro from tumbling and hitting a four-year low against the dollar in June of 2010. Questions are being asked about whether Greece will have to leave the European monetary union if the bailout fails to reverse current trends.' Some even wonder if the crisis in Greece could lead to the implosion of the euro zone, which has definitely proven not to be an optimum currency area.' A Spring 2010 survey of leading economists in the City revealed that nearly 50 percent believe that the euro zone will not have maintained its current form five years from now.' They predict that several weaker members will have had to return to their national currency while the euro zone will continue to exist only with a few members. The recent difficulties in the euro zone make it even more relevant to understand why Britain did not follow its counterparts in the risky gamble on European monetary union. The underlying argument of this book has been that both the Conservative government of John Major and the Labour government of Tony Blair had first and foremost the interests of the London financial sector in mind and followed the same strategy, which was to give sufficient time to the financial sector to determine where its interests lay, in or out of the euro zone. While there was a strong business lobby for membership of the euro, the government was able to lessen its demands with a strategy aimed at buying time and at providing alternative compensatory policies. The idea of joining the European monetary union, and thus of foregoing exchange rate risk, was as attractive to business corporations in Britain as it had been to those on the Continent. However, because the pro-euro business lobby did not benefit from the support of the City, it was unable to influence the government in the direction of a commitment to EMU.

The account I provided in these pages has significant implications for the way we understand the policy on the euro of the British government. The policy of non-decision was not determined by a typical unease of the state or public opinion with the European Union but by the structure of the British economy. The empirical findings illuminate the relationship between government and economic actors in a capital market-based system such as Britain. This study ultimately says a lot about economic actors' preferences and influence on monetary policy as well as the way we approach these questions. The first part of this concluding chapter summarizes the research findings and theoretical implications related to the preferences and influence of the business and financial sectors while the second part discusses the necessity to consider British policy on EMU as a two-level game.

Exchange Rate Policy: Preferences and Influence of Economic Actors Even though political economy theory models tell us what preference economic actors should have over the exchange rate, there is very little empirical research that shows whether economic actors niobilize around clear preferences and whether they have any influence on policy outcomes. Daniel Kinderman recently observed that "[wlhile there is a large and growing literature on exchange rates preferences and politics, the variation in firms' lobbying of political authorities and central banks and their underlying preferences remain largely unexplored.""his study provides clarification on both the preferences of economic actors on exchange rate policy and their influence on the government.

Preferences of Economic Actors One major difference between the preferences of the business and financial sectors on exchange rate policy revealed in this study is that the business sector is able to assess its interests very early on whereas the financial sector needs more time and complete information. The Business Sector The point of departure for studying the position of the business sector on euro ~ne~nbership was one of the most famous models of economic actors' preferences towards the exchange rate developed by Jeffry Frieden in 1991. Numerous articles have recently reiterated the value but also the inherent limitations of Frieden's classification of economic actors' preferences.5 1 have demonstrated that Frieden's model should be qualified as representing the fundamental preferences of business actors that can only be observed in a particular political environment in which the debate on a policy related to the level and stability of the exchange rate is at its earliest stage. A researcher trying to determine the prefer-

ences of business interests on the euro in Britain today would not find Frieden's model applicable because export-oriented producers express satisfaction with the status quo. While the fundamental preference of this group remains the same (i.e., the adoption of the euro in Britain is still the optimal solution for internationally-oriented producers), its stated preference has changed from the beginning of the euro debate. Moreover, the differentiation that Frieden made in 2002 between the preferences over the exchange rate of standardized goods exporters and of specialized goods exporters was not found to be relevant in this study.6 Frieden hypothesized that exporters in the former group would be opposed to a fixed exchange rate because they can greatly benefit from depreciation while those in the latter group would be strongly in favor because they have limited pass-through (i.e., the price of their products usually does not reflect variations in the exchange rate). As we have seen, however, both producers of standardized goods, such as commodities, and of highly specialized goods, such as automobiles, favored British membership of the euro zone. British Petroleum and British American Tobacco were early supporters of the adoption of the euro in Britain as were foreign-owned car manufacturers, such as Toyota or Nissan. In chapter 2, it was hypothesized that if Frieden's differentiation was correct, a preference for the UK joining the euro by standardized goods producers could be possible if their main market was the United States and not Europe, as the euro is usually less appreciated against the dollar than sterling. However, the United States is British American Tobacco's least important market while its main market is ~ u r o ~ eBritish .' Petroleum's Europe market is also the one generating the most sales.' Both MNCs, nonetheless, had a strong preference for British membership of the euro. Another important caveat revealed by this study is that trade associations behave very differently from the individual businesses they represent as far as revealed preferences are concerned. The two main trade associations in the UK, the Confederation of British Industry and the institute of Directors, became neutral on the issue of British membership of the euro much earlier than individual businesses. The Confederation of British Industry stopped campaigning on the euro in 2000, when the appreciation of sterling against the euro and highly volatile exchange rate worried export-oriented producers. The behavior of the trade association, therefore, was at odds with individual corporations in its membership that continued to lobby for the euro through the Britain in Europe campaign. The factors that led the trade associations to become neutral on the euro were very different from those that influenced individual corporations. The CBI, representing the UK's largest export-oriented businesses and dominated by a few internationalists in its administrative structure, was very enthusiastic about the European single currency project at the time of the IGC-EMU and the signing of the Maastricht Treaty. However, after British membership of the ERMwhich the CBI had encouraged-proved a catastrophe in the UK, the CBI toned down its pro-euro stance. The organization adopted a very cautious policy that came to be only a step ahead and slightly more pro-euro than the position of the government. However, because it had originally been adamantly in favor of the

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European project of monetary union and seemed to back a government policy of joining eventually, the organization was portrayed in the press as staunchly proeuro. When the issue of the European single currency became increasingly divisive in Britain, the CBI started to feel uncomfortable being dragged into the politics of EMU. As the CBI came to make the headlines of newspapers too often and was heavily criticized for its support of the euro, the trade association did not sustain its position on British membership of EMU. It is important to note that bad publicity also led the trade association with an opposite stance on the euro to withdraw from the debate. The Institute of Directors withdrew its support from the No campaign after the broadcasting of a politically incorrect advertisement that bothered many of the trade association's members. Therefore, the two main trade associations in Britain with clashing interests took strong stances on the euro but then quickly reverted to neutrality when attacked by the media or when acquiring bad publicity by being associated with controversial political arguments. This shows that trade associations are particularly concerned with their public image because pleasing and retaining members is critical to the survival of these associations. The difficulty of trade associations to hold a strong position on a controversial government policy in the face of public criticism is also compounded by the leaders' political ambitions. Both the Confederation of British Industry and the Institute of Directors started to tone down their stance on the euro after changes of leadership. Interestingly, the more moderate leaders of the CBI and the IoD both had the political ambition to move into government. After leaving the IoD, Cox went to work for Her Majesty's Treasury while Jones was appointed Minister of State in Brown's government. This illustrates another aspect of trade associations, the revolving door phenomenon. Mark Duckenfield noted that this trend often affects the ability of trade associations to oppose rather than follow government policy.9 As the position on EMU of the Labour government became more and more ambiguous and neutral, it became more difficult for Jones and Cox to lead an association with a strong position for or against the euro if they were at all concerned about their personal relationship with Downing Street. They very aware of the rewards-in addition to retaining members-that came in reverting to the political expediency of neutrality. The factors identified as accounting for the change of preferences of the trade associations are of epistemological importance. The empirical findings confirm that trade associations are most fundamentally political entities whose internal dynamics lead them to often take moderate stances on government policy. Trade associations are unlikely to sustain a strong position on a controversial policy issue due to their main goal-to retain members-and because of the personal ambitions of the associations' leaders not to fall out of favor with the government. Research in political economy needs to move away from the easy solution of simply surveying the position of trade associations when attempting to understand the preferences of business interests on a particular policy issue. As the case of Britain and the euro debate has demonstrated, the position of trade associations does not always reflect the position of their members. The

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Confederation of British Industry became neutral on the euro while the majority of its members continued to lobby for adoption of the single currency via the pro-euro campaign, Britain in Europe. And while the Institute of Directors declared neutrality, most of its members remained strongly opposed to Britain giving up the pound as reflected by this statement by Head of European and Regulatory Affairs James Walsh: "Our views now, f w e expressed them, are that we are not in favor of going in. We don't think the British economy is in the right shape; it's not convergent with the euro zone. There are severe differences."" The Financial Sector While the business community was able to determine its preference right away on a question affecting the level and stability of the exchange rate, the financial sector needed more time and data. The main reason for the difference between the two sectors is that technical issues about the functioning of EMU could affect the interests of the financial sector rather than simply the level and stability of the exchange rate, which are the only concerns of business. The financial sector, therefore, needed more complete information to make a clear determination. The preference of the financial sector at the onset, as we have seen, was that the government continue to stay involved in the negotiations on EMU to influence its development while not committing to anything. We can say that the difference in preference intensity of business and finance identified by C. Randall Henning was correct. The business sector had a "strong and unambiguous" preference on the issue of British membership of the euro while the financial sector had a more "mild and ambiguous" preference. However, Henning's labels could be more appropriately replaced by "determined" and "undetermined" preference to reflect the difference not so much in intensity but in the ability to make a clear determination, which would apply both to capital market-based systems and credit-based systems. In a credit based system, as Henning explained, the financial sector will take into consideration the interests of its industrial clients-which will be easily and quickly determined-and will therefore not remain undetermined for as long as in capital market-based systems. On the Continent, for example, the financial sector got on board with the export-oriented manufacturing sector very early on in supporting the goal of monetary union. The archives of the Association for the Monetary Union of Europe provide evidence of the differing attitude of the financial sector in Britain and on the Continent. While Kathryn McNamara pointed out that membership of the AUME is not necessarily an indication of a strong support for EMU, as it could simply signify an interest in being informed, financial contributions are a different matter. As early as 1988, before any political decision had been made on EMU, six French banks-Banque Nationale de Paris, Compagnie Bancaire, Credit Commercial, Credit Lyonnais, Credit National, and Paribas4ontributed €5 1,115 to the organization which complemented the €122,555 from the business sector (with the most important contributors being Total and ~h6ne-~oulenc)." The sparse British membership did not show such a collaboration of the industrial and financial sectors in

not show such a collaboration of the industrial and financial sectors in supporting the goal of monetary union. As we have seen, financial institutions in Britain undertook a careful costbenefit analysis geared to their own interests and that of London's status as an international financial center in general. That analysis led the City to eventually prefer the status quo, which contrasted with the position of major industrialists that wished the UK would eventually adopt the euro. The London financial sector was not sympathetic to the interests of the export-oriented industry that could benefit from a single currency. The Britain in Europe campaign was unable to recruit many supporters from the City. The only City interests found in the City in Europe were individuals with personal and/or political ambition as well as representatives from European-based banks under political pressure from the EU to speak favorably about the euro. It was much easier for the no side to recruit City representatives. Business for Sterling was able to match the City in Europe membership in a matter of a couple of days. In determining their preference on the issue of membership of the euro, City interests took into consideration more than just the inflation performance of the monetary union. One major issue of concern to the financial sector was how the new central bank would operate, especially what monetary policy tools would be put in place. As we have seen, whether the European Central Bank would impose minimum reserve requirements on banks inside the euro zone was a critical area of concern for the London financial sector. A mandatory reserve requirement is a monetary policy instrument that has not typically been employed in Britain while it has been used across continental Europe. One of the competitive advantages of the City over other financial centers takes the form of greater liquidity and lending capacity brought by a regulatory environment where banks do not have to hold a minimum reserve requirement with the central bank. Even though there has been a worldwide trend to reduce the minimum reserve on transaction deposits that credit institutions have to hold with their national central banks, Britain continues to distinguish itself from other financial centers as table 8.1. demonstrates. A change in the percentage of deposits to be held at the central bank brought by membership of the euro zone would have been highly damaging to the City. It would have led to a major contraction of liquidity and reduced economic activity in London. The imposition of a minimum reserve requirement would have damaged the attractiveness of the City for foreign banks looking for the greatest ability to earn returns on deposits. As a result, the City would not have been such an attractive center in which to consolidate euro activities. Consolidation after replacement of the twelve legacy currencies with the euro took place in London rather than in the euro zone financial centers specifically because London stayed free from ECB regulations and could continue to offer the greatest liquidity. Ironically, had the UK been in the euro zone, euro business activities might not have migrated to its financial center.

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Table 8.1. Minimum Reserve Requirements on Transaction Deposits

I

Euro zone L. (

2.0% 1.O%

5.1%

France

I

I

12.1%

Germany I

I

I

I

I

I

2.0%

(2)

l ) l ' h t I ' K clots not Iia\e a tni~iimutnrestr\t rt~~uire~ii~'tit. 1:ipur~'sindicate voIunt3r!

average reserve held by credit institutions. (2) All credits institutions located in the euro zone are now subject to ECB reserve requirement. Sources: Bank of England, Banque de France, Deutsche Bundesbank, European Central Bank.

Another concern of the financial sector was that it would not be discriminated against by members of the monetary union, i.e., that it would have equal access to the wholesale euro payment system TARGET. While a technical issue, it is an important one because not having access to it could have jeopardized the ability of London to become a successful offshore euro center. It was therefore critical for the City that the British government did not appear completely close to ever joining the monetary union.

Influence of Economic Actors on Policy Outcomes Both the business (export-oriented) and financial sectors had some influence on the government policy on EMU. The influence of the business sector, however, was qualified as minimal while that of the financial sector as determinant. Moreover, the channels to communicate their preferences to the government differed for the two sectors. The business sector resorted to threats and involvement in campaigns while the financial sector often communicated its concerns through position papers and expert advice because it had more direct access to the ministries concerned.

The Business Sector This study has demonstrated that all the actors in Frieden's four quadrants do not have equal bargaining power or the ability to affect government decisions regarding the exchange rate. The most powerful actors are those that favor a fixed exchange rate-export-oriented producers of tradable goods-because these actors are by their very nature mobile and can choose to relocate. Their main bargaining power is the possibility of disinvestment, i.e., leaving the country to operate from a more favorable environment. In contrast, the group favor-

ing a flexible exchange rate has relatively no bargaining power because of its immobility: producers of nontradable goods and services are by nature not movable as are import-competing producers of tradable goods for the domestic market. There is limited value in considering their preferences, as Henning noted.'* If the government decides to go against their preferences, there is little that these actors can do to sway the government to reconsider its position. On the other hand, if the government decides against the preferences of the internationallyoriented business actors, they can threaten to leave the country and to resettle elsewhere, which is exactly what happened in Britain. The government, therefore, cannot ignore their concerns and must at a minimum provide alternative solutions. The critical issue for the government is to prevent massive disinvestment from export-oriented firms in response to dissatisfaction with government economic policy. Conlpensation in the form of subsidies is the most immediate alternative that will provide an incentive for companies to maintain production in the country. Even though the solution can be viewed as a temporary one, its secondary effect is to lead manufacturers to slowly adapt to their new environment. Export-oriented companies will resort to "operational hedging" as a way to minimize costs, which in the case studied consisted in requiring suppliers to invoice them in euro.13 An additional step that the government can take to fbrther satisfy manufacturers is to align the national monetary policy on the monetary union so that the exchange rate becomes less volatile and there is, if not a de jure, a de facto fixed exchange rate with a significant geographical market. In Britain, there was a clear expression of a preference for membership of the euro zone by the export-oriented business conlmunity. As we have seen, the mobilization led the British government to first respond with subsidies. After the European Commission modified EU rules on government subsidies to industry, however, the British government resorted to another form of compensation, the ilnplernentation of a monetary policy more closely aligned on that of the euro zone leading to a less volatile exchange rate. The response of the government, in the forni of both direct and indirect compensation, lessened the interest group's demand. There was therefore a two-way intluence between business actors and the government, which has recently been observed by other scholars.'' Cornelia Woll, for example, has noted that "[flirms may influence policy outconies, but policies and politics in turn influence business demands."I5 This research has shown that export-oriented business actors will decrease their lobbying activities for a fixed exchange rate as: (1) the government provides more co~iiprehensivealternative solutions to their fundamental preference (exogenous factor) and (2) the learning curve of operating outside of a fixed exclia~igerate system increases (endogenous factor). Business actors that were once very concerned about being located outside of the monetary union when it was first created became disinterested in the issue and even stated their satisfaction with the status quo. These findings are consistent with recent scholarship on economic actors and the exchange rate. For example, David Steinberg has observed that "preferences and policies towards the value of the exchange rate are

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systematically influenced by the availability of compensatory measure^."'^ And Daniel Kinderman has argued that "we may be moving towards a world without pronounced or highly differentiated exchange rate preferences" because companies nowadays are more inclined to find ways to avoid currency conversion costs, such as operational hedgingi7 The Financial Sector While the British government responded to the concerns of the export-oriented industry in a way that lessened their demands by buying time and providing compensatory policies, the interests of the financial sector were always at the heart of the official policy on EMU both under the Conservative government of John Major and the Labour government of Tony Blair. During the negotiations on the Maastricht Treaty, the influence of the financial sector was significant. The commitment to Stage I of EMU made by entering the ERM was advocated by the City in order to be more influential in the negotiations and to benefit from its anti-inflationary effect. The overvalued rate of entry was also favorable to the City to the detriment of Industry. Siinilarly, the alternative to the Delors plan that the British government commanded and tried to impose on its European partners had been developed by City bankers with City interests in mind. Finally, both the "wait and see" policy of the Conservative government and the "prepare and decide" policy of the Labour government allowed the UK to be treated as a "pre-in" in the remaining negotiations on EMU after the treaty of Maastricht was signed. This strategy followed the concerns and advice of the London financial sector voiced in private reports and expert advice to the government. The Labour government's "prepare and decide" policy was more similar to the Conservative government policy than has been assumed. Its principal goal was to give sufficient time to the financial sector to assess its interests with complete information. As we have seen, two unresolved issues about how the monetary union would function of critical importance for the City were the minimum reserve requirements of the ECB and access to the euro wholesale payment system. Careful analysis of the Labour policy on EMU has revealed a delaying tactic rather than a proactive policy of a government intent on joining the euro. All the measures taken by the Blair government had the advantage of being ambiguous enough to reassure pro-euro business interests-at least for a while before resorting to compensations-while not compromising the future of the financial sector. Once it was clear that the City had become a successful offshore euro center and would likely maintain this privileged position, the policy on EMU of the Labour government became less tentative and more closed to eventual membership. At the same time, the controversial City test was removed from the set of five tests-so as to avoid allegations that the financial sector's interests were once again driving economic policy-while City banks and institutions conveniently adopted a position of neutrality on a question that had been set according to their interests.

British Policy on EMU: A Necessary Two-Level Game The European Union ultimately entangles its meliiber states in a complex web that tilakes responding to the demands of domestic interest groups even more challenging. This study of British policy on EMU demonstrated that a two-level game, as proposed by Robert Putnam, is most useful to understand the actions of the British government that had to consider both the pressure from domestic non-state actors and institutional entanglements at the EU level. To use Putnam's words, the British government had to "strive to satisfy domestic pressures, while minimizing the adverse consequences of [EU] developments."18 Indeed, the UK could not prevent other member states from making plans for moving towards monetary union because the UK had bound itself to this goal when beconling a member of the EEC, as Margaret Thatcher bitterly regretted. When the discussion on moving towards the adoption of a European currency started, the government of John Major could not impose the solution preferred by its London financial center, the hard ECU. Finally, as member states committed to the Delors plan and adoption of the single currency by the 21st century, the British government could not opt out permanently. Opting out permanently would have lead to two adverse consequences for Britain: (1) a disenchantment of its exportoriented industry that may have moved factories to the Continent and 2) a high risk for its financial industry that the British government be shut out of the remaining negotiations on the design of EMU and that discrin~inatorymeasures be taken against the reluctant member state. The strategy for a state of appearing willing to join an international agreement at a later date in order to influence its development has been observed in other contexts. For example, Bill Clinton was highly criticized for signing the Rome Statute establishing the International Criminal Court (ICC) just before the deadline.19 g ow ever, administration officials explained the signing at the eleventh hour as a "tactical move to keep the government involved in the negotiations on the treaty."20 Clinton knew that whether Congress ever ratified the statute or not, the United States would be affected by the establishment of the new court that could have jurisdiction on non-members. The United States had a better chance to argue against conserving this feature by being a willing signing member. The strategy of the British development regarding EMU was very similar and paid off. Ultimately, the strategy followed by the UK government of always appearing willing to enter EMU as soon as the conditions would be right impeded discrimination from the EU and allowed the City to become the main offshore euro market. The City can be described today as a most successful offshore euro center as it attracted the largest share of Eurobonds and securities trading to its financial hub. EU membership, however, contrived the British government in its response to the concerns of export-oriented business actors of being outside of the euro zone. While direct compensations in the form of subsidies are an efficient niean

to alter the demands of export-oriented actors for a fixed exchange rate, the European Commission's ruling of 2003 prevented the British government from resorting to subsidies at the same level as before. The European Commission's ruling can be viewed as a reaction of the EU to the British policy which allowed the member state to retain foreign-owned manufacturers without being in the euro zone. Therefore, the British government had to turn to an alternative that would respond to exporters' concerns with the status of the UK outside of the euro zone. The implementation of a monetary policy closer to the one of the European Central Bank through a change in the inflation target used, which ultimately implied a looser monetary policy, was the solution chosen. This study shed light on the British policy on the euro for the past twenty years, since the early negotiations on the Maastricht Treaty. The British government never committed to the European monetary union while not appearing completely closed to ever joining to respond to the conflicted interests of domestic coalitions at home and to always be treated as a pre-in at the EU level. As the financial subprime crisis of 2008 allowed the UK to recover more rapidly than the Continent for having conserved exchange rate flexibility and as the financial difficulties of Greece threaten the viability of the European monetary union, the new British government of David Cameron can openly congratulate its predecessors for having made the right choice. While it is easy to explain the policy of non-decision on the euro undertaken by the Major and Blair governments as simply revealing of the euroskepticism of the UK, the determining factor was the historical structure of the British economy. The UK developed over the years as an economy with a strong and influencing financial sector that is not tied to a declining and increasingly foreign-owned manufacturing sector. In this environment, export-oriented producers could only have a minimal influence on the government whose main concern-whether it was from the Conservative or the Labour party-was not to jeopardize the jewel of the British economy, its financial sector.

Notes I . "Greece's Debt Crisis Requires Tough Austerity Measures and a European Rescue," The Times, April 23, 2010, 2; Dan Robert, "Eurozone Turmoil: Why Greek Crisis AtTects us All," The Guardian, April 29, 2010, 7 . 2. Claire Gatinois, "Entretiens avec Nouriel Robini," Le Monde, June 8, 2010, www. ie~i~onde. frleconomieiarticlel20101061071nouriel-roubini-nous-sommes-dans-unezone-dangereuse-l368943-3234.html#ens-id12 16746 (accessed June 9,2010). 3. Edmund Conway, "Euro 'will be Dead in Five Years,"' The Daily Telegraph, June 5, 2010, www.telegraph.co.uklfinance/economics/78060641Euro-~vill-be-dead-inlive-years.html (accessed June 7 , 2010).

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4. Daniel Kinderman, "The Political Economy of Sectoral Exchange Rate Preferences and Lobbying: Germany from 1960-2008, and Beyond," Review of lnternational Political Economy 15, no. 5 (December 2008). 852. 5. For recent scholarship commenting on Friedcn's niodel see for example Jonathan Crystal. "What Do Producers Want: On the Origins of Societal Policy Preferences?" Eul.opean Jolirizal of lntert7ationi71 Relations 9. no. 3 (September 2003): 407-39; Mark Duckenfield and Mark Aspinwall, "Private Interests and Exchange Rate Policy: The Case of British Business" (Paper presented at the annual conference of the lnternational Studies Association, Chicago, February 28-March 4, 3,007); Stefanie Walter, "A New Approach for Determining Exchange-Rate 1,evel Prekrences," lnternational Organization 62. no. 3 (Summer 2008): 405-38; arid Kinderman, "The Political Economy of Sectoral Exchange Rate Preferences." 6. Jeffry Frieden, "Real Sources of European Currency Policy: Sectoral Interests and European Monetary Integration." 1nte1,national 0t.ganizntion 56, no. 4 (Autumn 2002), 83 1-60. 7. British American Tobacco, 2008 Annual Report (London: BAT, 2009), 37. 8. British Petroleum, 2009 Ann~ialReview (London: BP, 2010), 29. 9. Mark Duckenfield, B~tsinessand the Eiiro. Biisiness Croups and the Politics of EMU in Gernlony and the United Kingdotn (New York: Palgrave, 2006). 10. Personal interview with .lames Walsh, Former Head of European and Regulatory Affairs, Institute of Directors (IoD), London, November 30, 2005. Emphasis added. I I. Association for the Monetary Union of Europe, Status of Membership and Fees (Contributions) as of October 15. 1988, Archives Nationales, Paris, France. 12. C. Randall l-lenning, Currencies and Politics in the United States, Gerniany, and Japan (Washington, D.C.: Institute for Internationdl Economics, 1994), 26. 13. 1 am thankful to Daniel Kinderinan for suggesting that asking suppliers to invoice in euro is a type of"operational hedging." 14. See Cornelia Woll, Firnz Interests: How Governtnents Shape Business Lobbying on Global Trade (Ithaca, N.Y.: Cornell University Press, 2008); and Steinberg, "Currencies, Compensations, and Coalitions." 15. Woll, Firnt Interests, 4. 16. David Steinberg, "Currencies, Compensations, and Coalitions: The Politics of Exchange Kate Valuation in Argentina, 1963-2007" (Paper presented at the annual meeting of the International Political Economy Socicty. Philadelphia, Pa., November 14-15, 2008), 37. 17. Kinderman, "The Political Economy o i Sectoral Exchange Rate Preferences," 876. 18. Robert Putnam, "Diplon~acy and Dornestic Politics: the Logic of Two-level Games." lnternational Organization 42, no. 3 (Summer 1998), 434. 19. See for example, Lee Casey and David Rivkin, "Clinton's Worst Folly: Bush Administration Must Undo lnternational Court [)amage," The CVashington Times, January 9, 2001, A15. 20. Thomas Ricks, "US Signs Treaty on War Crimes Tribunal: Pentagon, I