Have we passed the five tests?

IT IS part of City folklore that the five economic tests we have to pass as a first stage towards entering the euro were scrawled on the back of an envelope by economic adviser Ed Balls when taxi-ing round Washington with Chancellor Gordon Brown back in 1997. If true, there can be few envelope jottings in history which have assumed such significance.

The tests themselves seem simple, but they are a politician's delight, because none of them lends itself to a straightforward yes or no answer. Each relies heavily on judgment and inevitably that judgment is coloured by where the person is coming from. Those who want to join the euro say the tests have already been met. Those who oppose entry say we still have a long way to go.

This should surprise no one. Anyone with a degree in economics knows it never gives you a straight answer on anything. So with those caveats firmly in place, how do we think we are doing on each test in turn?

1. THE test of economic convergence - are business structures and economic cycles compatible so that we can live with eurozone interest rates?

If the eurozone booms when we are depressed then it will be much harder for us to recover and grow. Some things have converged. In the last five years the rates of economic growth and interest rates are pretty much the same here as in the rest of Europe - certainly nowhere near as far apart as 10 years ago. So we seem to be going up and down broadly at the same time, which is the key issue.

Sceptics say this is irrelevant. They say our exports go to different places, our labour and capital markets are much more flexible, and that interest rate movements matter more to us because we all have mortgages. They say we are not like them at all. The truth is that business structures remain different but economic cycles are converging - so take your pick.

2. THE shock test - if problems emerge is there enough flexibility in the economy to deal with them?

The British economy prides itself on its flexibility and the proof of it comes with the fact that unemployment is now the lowest for 40 years and there is no sign of any inflation in spite of oil price rises, collapsing stock markets, a downturn in world trade and goodness knows what else.

Not so, say the unbelievers. This test misses the point. We have adjusted because we are flexible and outside the Eurozone. Once in, a lot of that flexibility would be lost and we would lose our capacity to adjust to shocks.

3. THE inward investment test - would joining the euro make Britain more attractive long term for firms looking to invest here?

Britain's slice of inward investment is getting smaller. In 1998 we had 28% of all investment coming into the European Union, whereas last year we had only 19%. In addition, the likes of Japanese car manufacturers say they only stay on the assumption that we will join soon.

This is a tough one for euro opponents, but in fairness there has been so much disruption in the world since the collapse of the dotcom boom that the decline in investment share could just be temporary. Meanwhile, they say, the actual amount of money being invested here, as opposed to our market share, has never been higher.

4. THE City test - what impact would euro membership have on the competitiveness of the City?

The City has prospered since the launch of the euro but then it has been riding the biggest boom in financial services that the world has ever seen. It has also grabbed a large slice of business denominated in euros so no rival continental centre has used the single currency successfully to undermine the City's position, but they will continue to try and may eventually succeed.

Working the other way is the risk that membership might make it harder for the City to withstand Brussels attacks on the personal and corporate tax breaks which the City uses to attract a lot of its business. This really is an impossible question to answer.

5. THE jobs test - will being in the euro create more growth and lower unemployment long term?

Manufacturers certainly think it would. They blame the high and volatile level of sterling for the huge loss in manufacturing jobs in the last five years, and the collapse of hundreds of businesses.

Unofficially, we must add a sixth test which does not exist but which many think is crucial, about the exchange rate. A lower rate for sterling would help but at what rate of exchange would we join? To get a jobs and growth boost we need to devalue, perhaps by 15%. But why should our European partners allow us to create and then lock in what would be a permanent competitive advantage? Again, therefore, there is no clear answer.