On the Outside

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Sweden is booming. its economy is expected to grow almost 4% this year, nearly double the average growth rate in the European Union. In neighboring Denmark, unemployment has fallen from a depression-like level of 12.1% in 1993 to 5.7% today. Greece's stock exchange has soared 95% this year, the best performer in Europe. And trading by euro-zone companies in Britain's financial markets expanded by 59% in the first half of this year. Although economists have no shortage of theories to explain this rash of economic good news, it's hard to overlook the one thing all four economies have in common: they did not join the 11 other E.U. members who in January launched the common currency known as the euro. So it's fair to ask: Will success on the outside spoil the euro's chances to attract new members?

The answer must be a qualified no. The four countries are collectively referred to in Brussels as pre-ins, though that may reflect more bureaucratic wishful thinking than reality. Greece, the one E.U. member that wanted to join but failed to meet the rigorous economic and budgetary criteria, now seems certain to apply for membership next spring. It is almost equally certain that Athens will be accepted into the fold. Denmark's government is talking about setting a date for a referendum to approve the change. And Swedish Prime Minister Goran Persson last week said it was no longer possible for his country to say no to the euro; yes was only a matter of timing. Only Britain remains a question mark, with popular opposition to joining actually growing since the new currency's launch.

Although the booming economies in the four non-euro countries have raised doubts about the economic benefits of joining EMU, the loudest arguments against are political and even cultural. From London to Stockholm, euro-skeptics bewail the loss of national sovereignty implied in surrendering the pound or the krona in favor of a common currency.

Paradoxically, the reasons behind this fear of a loss of monetary control are polar opposites. It is the prospect that Brussels bureaucrats will attempt to force Britain to adopt costly bits of Europe's welfare state that puts off many British doubters, while opposition to the euro in Sweden and Denmark has coalesced around concerns that adoption of the currency will lead to lower taxes and a dismantling of the welfare state. The recent corruption scandals on the European Commission alarmed voters in Britain and the Nordic countries, where misfeasance by public figures is far less tolerated than in other countries. Support for the euro dropped dramatically in Sweden and Denmark when the scandal was at its height. "The political consequences of joining the euro are not really being discussed," says Holger K. Nielsen, leader of Denmark's Socialist People's Party.

Economists have also made it clear that the recent economic good times in the four holdout countries may be based to a large extent on an expectation that they will eventually join the euro. If they should actually decide against participation, the market reaction could be swiftly negative. "I think we'll see a big impact on levels of foreign direct investment should Britain decide never to join," says Eunice Lau, senior economist at the Confederation of British Industry (C.B.I.).

British voters have been notoriously skeptical of Europe's politicians for centuries. Britain's humiliation at being forced by wily speculators to retreat from the euro's predecessor, the Exchange Rate Mechanism, in September 1992 is still fresh in many people's minds. Britain is the only one of the four holdouts where business is not squarely behind joining the common currency. In fact, a Financial Times/MORI survey of 1,000 British companies showed only half were committed to joining, down from 63% a year ago.

Graeme Leach, chief economist at the Institute of Directors, an association of 60,000 executives, argues that Britain is significantly different from the rest of Europe. "Across a large range of economic variables--labor markets, housing markets, financial markets, the size of the public sector--the U.K. stands at the end of the spectrum," he says. Adds Paul Turnbull of U.S. investment bank Merrill Lynch, while Britain sells a majority of its manufacturing exports to Europe, "the U.K. economy has tended to be more closely correlated with the [business] cycle in the U.S., so there are a lot of conflicting considerations."

There's no question that being outside the euro, even two years before euro notes and coins go into circulation, has been painful to some companies. John Starbuck, managing director of London-based Twiflex Ltd., which exports nearly 60% of its industrial disk brakes to the E.U., estimates that the appreciation of the pound against the euro has cost his company $1.5 million, about 14% of annual sales. Surprisingly, the London financial zone known as the City has defied pundits by thriving despite being outside the euro zone. Lord Levene, the outgoing Lord Mayor of London, noted that the City was to finance what Wimbledon was to tennis. "We have the best playing field but few of the finalists are British nationals," he said. Pro-euro forces also argue that if Britain wants to have a say in the world economy, it must be through the E.U. Outside, "our strategy can only be that of a small open economy, hence ultimately reactive," explained Richard Portes, a professor of economics at London Business School. In a speech to the Economic & Social Research Council, he derided Britain's aspiration to a special economic relationship with the U.S. "From Silicon Valley we are invisible," he said.

Part of the euro's problems in Britain stems from the fact that with their eyes keenly on public opinion polls, neither of the main political parties has come out squarely in favor of its adoption. Prime Minister Tony Blair has shown himself adept at preaching both sides of the issue and has ruled out holding a referendum until after the next parliamentary election which must take place before May 2002. "In principle, a successful single currency within a single European market would be of benefit to Britain, in terms of trade, transparency of costs and currency stability," Blair told the C.B.I. earlier this month. "But in practice we can only sensibly join a successful single currency if it is in the best economic interests of Britain to do so." Clear? No wonder, according to an ICM poll taken for the lobbying group Business for Sterling last month, 58% of Britons want to stay in the E.U. but keep their pounds and pence.

In Scandinavia, the political argument has advanced significantly beyond the stalemate in Britain. In Denmark, a majority of voters came out for the euro for the first time last September, perhaps not coincidentally shortly after Denmark's central bank had to boost interest rates sharply to protect the krone in the wake of the Russian financial crisis. Last week, Danish Finance Minister Mogens Lykketoft said in a speech that there is "a good case for Denmark joining" the euro since two-thirds of the country's exports go to E.U. countries.

Karsten Skjalm, a euro expert at the Danish Institute of International Affairs, said it now seemed likely that the government would call a referendum by November next year with the intention of joining the euro by 2001. "Before, the debate was whether we would have the euro after 2002," Skjalm says, "but now it seems to be the euro by 2002."

In Denmark, as in Sweden, the main cost of remaining outside the euro has been a premium of about half a percentage point in interest rates over the rate set in Frankfurt by the European Central Bank. Both countries have adopted monetary policies designed to mimic the E.C.B. even though they are not formally in Euroland. Some economists fear that booming economic times may cause voters to focus on other issues. Many analysts believe that it would be easier to win adoption in the midst of a currency crisis like the one in August 1998. The Danish government also retains a strong and unpleasant memory of the electorate's initial rejection of the Maastricht Treaty on European Union in 1992. Although every leading newspaper and politician supported the treaty, voters turned against it at the last moment. The government wants to avoid the same mistake with the euro referendum.

Sweden's government has been even more cautious than Denmark's about embracing the euro, with Prime Minister Persson giving a kind of negative endorsement only last week. "It's impossible for us to say no," Persson told London's Financial Times. "We have only two options. 'Yes, we want to enter now' or 'Yes, we want to enter later.'" The latest opinion poll, published by the financial daily Finanstidningen before Persson's comments, said 45% of Swedes would vote yes for the unified currency, an increase of 2% since October, while 41% remain opposed. The Prime Minister is expected to refrain from taking a position on when to join until the issue is debated at a conference of his Social Democratic Labor Party in March.

Unlike Denmark, which has no natural resource industries, economists worry that Sweden's huge paper and pulp industry could be made more vulnerable to global forces with a one-size-fits-all monetary policy set in Frankfurt. That would remove one of the main tools for helping the wooded northeast in times of crisis. Per-Olof Edin, an economist at the Swedish Trade Union Confederation, notes that the traditional antidote would be for Sweden to devalue its currency, something not possible when the euro is adopted. "There may be no effect of joining the euro for five or 10 years, but sooner or later there is bound to come some economic shock in Europe like the oil crisis of the 1970s and the question is: Will there be a much higher cost to adapting because of the euro?"

But the bulk of Sweden's economy is dominated by big exporters, with names like Ericsson, Electrolux, Volvo and Saab. While they are prospering now, these companies are pushing hard for joining monetary union, raising fears that if Sweden doesn't join, the companies will act independently by moving to euro-zone countries. "Of course, many large Swedish companies can handle being outside, but it takes resources and we risk draining our country of competence," says Marcus Wallenberg, president of Investor, a holding company that controls 40% of the capitalization of the Stockholm Stock Exchange. "It works better to move Sweden into Euroland than having parts of Swedish industry do it anyway."

Klas Eklund, chief economist at Skandinaviska Enskilda Banken, Sweden's largest bank, believes that the recent shift in sentiment in favor of joining the euro is not due entirely to economic factors. "The political costs of staying outside are beginning to show," he said. Sweden has no voice in either economic or defense committees of the E.U., he notes, and with Sweden scheduled to take over the E.U. presidency in 2001, it will be deeply embarrassing if no decision on joining the euro has been taken.

The one place where the benefits of joining the euro seem unquestioned is in Greece, where the government of Prime Minister Costas Simitis took office in 1996 with a pledge to bring Greece into Euroland. In order to meet the economic and budgetary requirements for EMU membership, which it flunked during the first round, Greece has devalued the drachma by 12%, privatized indebted state companies and brought inflation down to 2% a year. The 2000 budget targets a deficit of 1.2% of GDP, well below the Maastricht criteria for joining.

Still, a rebound in inflation remains a concern that could derail the membership process. "Taming Greece's inflation is proving a big headache and it's bound to grow bigger," says Evrikos Sarsentis of Athens-based Telesis Securities. Interest rates in Greece currently stand at 11%, well above Euroland's 3% rate. As the two rates converge, Greece could experience the kind of boom now underway in Spain and Portugal and that could unleash explosive inflationary forces.

With Greece certain to apply next year and Sweden and Denmark leaning in that direction, pressure will increase on Britain not to be the only holdout. As the recent debate on withholding tax on investments showed, Britain desperately wants its voice to be counted when the big economic decisions are taken in Europe over the next few years. These include the question of "harmonizing" income and sales taxes as well as setting pan-European farm policy. Tony Blair may claim that the decision to join EMU will be based on economic criteria. But as Sweden and Denmark are now acknowledging, it's going to be increasingly difficult for a country to be heard if its leaders are forced to wait outside the closed doors marked euro when the decisions are being made.

With reporting by Anthee Carassava in Athens and Christine Whitehouse in London