A little over a decade ago, the rage amongst economists was predicting the impact of the launch of the euro. I remember a study came across my desk predicting a slump in world nickel prices because euro-coins contained no nickel in case it irritated the sensitive skins of Finns. Another favourite report was that the euro would cause a bonanza for organised criminals because the high value 500 euro notes would make it easier to smuggle cash across borders. Then there was the heady stuff, such as euro replacing the dollar as the global reserve currency, and Britain being finished as an economic power for refusing to ditch the pound. But, alas, it wasn’t to pass. The hot topic amongst economists now is the break up the euro. How times have changed.
The recently-launched Wolfson Prize for Economics, offering £250,000 for the best submission on how to handle a country leaving the euro causing least economic chaos, has been inundated with over 600 expressions of interest, with many from the top institutions of the world. Indeed, a couple of the world’s most famous economists declined invitations to be on the judging panel because they wanted to submit their own entries. The prize – the brainchild of Lord Wolfson, the chief executive of Next – has still managed to attract a topflight panel of judges, being unveiled today. It is chaired by Derek Scott, Tony Blair’s former economic adviser, and also includes Charles Goodhart, former member of the Bank of England’s Monetary Policy Committee; Professor Jean-Jacques Rosa, former economic adviser to French prime minister Lionel Jospin; Professor Francesco Giavazzi, former economic adviser to the European Commission; and Professor Manfred Neumann, a former adviser to the German Bundesbank.
The prize is the second most valuable in the field of economics, surpassed only by the Nobel Prize, and the interest in it is a good example of the powerful effect of financial incentives. It is the free market of ideas in action.
It will be interesting to see which type of economist wins. The economics profession in general has not covered itself in glory on the euro. Granted, the euro was a political project, but academic economists were in general supportive, not just on the European mainland, but in the UK. In contrast, private sector economists – particularly those in the City – were notably sceptical. This might be because academic economists are more distant from the real economy, and more prone to liking a big idea; while City economists spend less time thinking about the big theories, and more analysing the real world movements of the economy, and observing the workings and power of the bond markets. And in a battle between an idea and a bond market, I know who I would put my money on.
Either way, we should all – including politicians – remember to take economic predictions with a pinch of salt. A decade ago, I did a piece for the World at One on Radio 4 asking whether economic forecasts were any better than weather forecasts, and started it with a clip of John Major, in his short stint as Chancellor, predicting that growth in the year ahead would be 2%; in fact the economy contracted by about 2%. He got the right magnitude, just the wrong direction.
We often have no choice but to rely on economic predictions (such as when deciding what to do with interest rates – or how to leave the euro while causing minimum economic damage), but politicians make a grave mistake if they ever believe economics is a precise science. Economic output is one of the most studied indicators there is, and yet forecasts of GDP are notoriously unreliable. Over the long run, there is no more accurate prediction than guessing that next years’ GDP growth will be the same as this years’. Anyone who said they were certain what would happen when a dozen countries merged their currencies was either deluded or lying. And this in itself was a very big argument against joining the euro. Any honest person has to admit that the euro always was a giant unprecedented experiment in economics – basically a massive politically-motivated gamble. My bottom line position at the time was that the euro was a massive gamble with our national economies, and that politicians really shouldn’t gamble like that. I remember making that case to Nick Clegg, then an MEP, who said he saw my point – but then rejoined that Chris Huhne was certain that the euro was a good idea. By all accounts, he still is. But the rest of us at least now have the benefit of hindsight: Britain was right to have stayed out.