Five economic tests

The five economic tests are the criteria defined by the United Kingdom Government that are to be used to assess the UK's readiness to join the Eurozone and adopt the Euro as its currency. In principle, these tests will be distinct from any political decision to join.

1. Are business cycles and economic structures compatible with European interest rates on a permanent basis?
2. If problems emerge, is there sufficient flexibility to deal with them?
3. Would joining the euro create better conditions for firms making long-term decisions to invest in Britain?
4. What impact would entry into the euro have on the UK's financial services industry?
5. Would joining the euro promote higher growth, stability and a lasting increase in jobs?

History of the tests

The five tests were designed in 1997 by British Labour Party Chancellor Gordon Brown and his assistant Ed Balls, allegedly in the back of a taxi while Brown was in the United States. Despite this uncertain pedigree, the IMF deemed them to be "broadly consistent with the economic considerations that are relevant for assessing entry into a monetary union"[1] (http://www.imf.org/external/np/ms/2001/121101.htm).

The UK Treasury is responsible for assessing the tests. It first did so in October 1997, when it was decided that the UK economy was neither sufficiently converged with that of the rest of the EU, nor sufficiently flexible, to justify a recommendation of membership at that time. The government pledged to reassess the tests early in the next Parliament (which began in June 2001), and published a revised assessment of the five tests in June 2003. This assessment was much weightier (at least literally) than its predecessor, running to around 250 pages and backed up by eighteen supporting studies, on subjects such as housing, labour market flexibility, and the euro area's monetary and fiscal frameworks.

The conclusions, though, were broadly the same; the Treasury argued that

1. There had been significant progress on convergence since 1997, but there remain some significant structural differences, such as in the housing market.
2. While UK flexibility has improved, we cannot be confident that it is sufficient.
3. Euro membership would increase investment, but only if convergence and flexibility were sufficient.
4. The City would benefit from Euro membership.
5. Growth, stability and employment would increase as a result of euro membership, but, again, only if convergence and flexibility were sufficient.

On the basis of this assessment, the government effectively ruled out UK membership of the euro for the duration of the 2001 Parliament. Since Labour has been re-elected in 2005, it may reassess the tests once more, though the debate on the European Constitution has recently upstaged that on the euro.

Significance

The tests are significant in the recent history of UK government for two principal reasons. First, they are a sign of the rise of economic analysis in policymaking. Previous decisions to join exchange rate regimes, such as the Bretton Woods system, did not appear to be preceded, either internally or externally, by such comprehensive assessments. In effect, the five economic tests seem to give the government's economists, particularly in the Treasury, a veto on UK membership of the euro. The size of the 2003 assessment, and the extent of consultations with prominent academic economists such as Barry Eichengreen and Robert Mundell, is probably unprecedented as an economic analysis published by a national government. Second, the publication of the assessments of the tests can be seen as part of the trend towards (at least superficial) greater openness on the part of government, also exemplified in the publication of dossiers on the evidence for Iraq's weapons of mass destruction, and in freedom of information legislation. Of course, sceptics will argue that the real motives and debates are not necessarily reflected in published material.

External links

• HM Treasury site on the Euro (http://www.hm-treasury.gov.uk/documents/the_euro/euro_index_index.cfm?ptr=9)
• Britain in Europe (http://www.britainineurope.org.uk/)
• No to the euro (http://www.no-euro.com/)