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Analysis
Why Europe needs to resolve euro trilemma

Why Europe needs to resolve euro trilemma

Britain must delay vote to 2017 to lower Brexit chances

by David Owen, Advisory Board

Thu 14 Jan 2016

In April 1978, I attended the European summit in Copenhagen as British foreign secretary. There, I first heard Helmut Schmidt and Valéry Giscard d'Estaing, the German and French leaders, spell out their ideas for European monetary union. Little did I realise they were outlining a project that was doomed to destroy Europe’s then slowly evolving unity.

In retrospect, this was the first outward sign of the ‘vice of pretension’ that is doing so much to erode today's European Union. Britain concluded that the exchange rate mechanism launched by Schmidt and Giscard was at best premature for the UK, and declared it would not join. But it did join the overall framework, the European Monetary System, and signed up to its share of European currency units.

Now we know the ERM was flawed. The UK eventually joined in 1990 but was forced to leave in 1992, albeit with no significant consequences. The British government since 2010 has made clear that it is more than content to support an ‘efficiently designed’ euro area, as its continued failure harms the British economy. But virtually every necessary reform puts the euro system on the path to greater political integration, a direction of travel neither I nor many British people want to embark on.

A paper by Maurice Obstfeld, now chief economist of the International Monetary Fund, published by the European Commission in April 2013 when he was an academic at the University of California, is relevant here. ‘The euro area must confront a financial-fiscal trilemma: countries in the euro area can no longer enjoy all three [desired characteristics] – financial integration with other member states, financial stability, and fiscal independence – because the cost of banking rescues may now go beyond national fiscal capacities.’

Unless the British people see this euro area ‘trilemma’ resolved very soon, as well as recognition of the need to safeguard the interests of non-euro countries within the EU, Britain is likely to vote to leave when it holds a referendum on EU membership, most likely in June or September this year.

Since 2009, the US Treasury has been making determined representations to the euro area to act to disentangle the euro crisis. The message from Europe has been that the time is not yet right for substantive action. But when will it be right? As Obstfeld reminded us in 2013, ‘Most of EMU's first decade was passed in a singularly benign global environment. That allowed EMU to skirt the biggest potential challenges identified before its 1999 launch.’ According to Obstfeld, ‘the EU imposed the euro on a linked system of national economies with well-known structural rigidities in labour and product markets. Within each country, powerful national vested interests protected existing distortions’.

This EU unilateralism is now spreading to the EU ‘five presidents’, headed by European Commission chief Jean-Claude Juncker, who – we are told in leaks from Brussels – is discussing plans for a substantial new treaty, with a proposed timetable due to be published in early 2017. This has a significant bearing on British Prime Minister David Cameron's negotiating plans.

This creates an opening for a British referendum in November or early December 2017, a year later than currently planned. This would take into account possible treaty changes involving the European Economic Area, something I have long championed. But the UK is instead preparing for a referendum in 2016. Juncker and Cameron would be better served by bringing together their separate negotiations, and extending them to the end of 2017. It is not too late to negotiate for an expanded non-integrated European Economic Area to continue alongside an integrated euro area.

It is absurd to go on with the myth that Britain is negotiating only over the UK’s interests. Most of Cameron’s proposed changes can and should be presented as of value to Europe as a whole, not just the EU but the wider membership of the EEA and indeed, eventually, all European countries.

We need to wake up. We are all being fooled in the EU, not just the UK: by Cameron over this short-term fix, and by Juncker and the five presidents. It is time to call both Cameron's and Juncker’s bluff and restore some confidence to financial markets that Europe and the UK are getting their act together. If Cameron and Juncker fail to bring their negotiations together, and Britain is asked to vote in 2016, the chances of Brexit will markedly increase.

David Owen, a former UK foreign secretary, is a member of the OMFIF advisory board. This is an abridged version of a speech given in Berlin on 14 January to the 12th annual Berlin conference of the British Chamber of Commerce in Germany and the German-British Forum. Read the full text here.

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