At a lunchtime meeting on 24 September, Sir Leon Brittan set out the main problems facing the European economy and the principal causes of Europe's current economic malaise. He listed three main tasks for European policy-makers: the preservation and extension of the open world economy, the reconstruction of Europe's industry, and the creation of a stable, long-run macroeconomic policy framework.

Sir Leon stressed that European leaders' most immediate task is to play their part in concluding the Uruguay Round. Whatever difficulties and political problems are involved, the potential benefits of a successful conclusion to the Round far outweigh its costs. The trade challenges arising from environmental and competition policy concerns also require a new Multilateral Trading Organization to handle the negotiations leading to a further opening of trade. The EC's experience as an independent, neutral body to arbitrate among trading partners should allow it to play a leading role in establishing such a body.

The reconstruction of European industry will require several measures to restore its competitiveness: increased expenditure on research and development and industrial investment, promotion of labour market flexibility and improved education and training. Europe's future lies not in continued subsidies and protection to traditional products, which are increasingly produced more cheaply elsewhere, but rather in the development of high-value-added, R&D-based industries. EC sectoral adjustment policies must also take account of the Central and East European economies, even before they become members, but temptations to extend EC quota or CAP-style arrangements eastward or create Europe-wide cartels must be resisted. The universal application of a strong competition policy is essential to create the climate of confidence in which producers and traders can plan for a continental-scale market.

Sir Leon then turned to consider the contribution of European monetary union to creating a stable, long-run macroeconomic policy framework. While the exchange rate stability provided by the ERM has underpinned the European single market, a single currency could achieve much more. The costs of commission alone on Europe's transactions may be as high as ECU 19 billion, or twice the direct costs of the trade barriers identified in the Cecchini Report. Until Europe has a single currency, its economy will remain fragmented, its single market incomplete, and its producers at a disadvantage against their main competitors.

The Maastricht plan for EMU also promises a break with the historical cycle of inflation and government deficit. While plans for a single currency have suffered a serious set-back in the past year, the difficulties all the way from Black Wednesday in September 1992 down to the August 1993 decision to widen the ERM bands arose from the incompatibility of free capital movements, fixed exchange rates and independent monetary policies. The origins of the crisis therefore lay not in EMU but in the operation of the ERM: allowing the parities to change as originally envisaged up to the start of Stage III if need be would have avoided our present difficulties. The crisis, moreover, says nothing about the workability of EMU since, once Stage III had begun, the parities could not change and interest rate policy would be set on a Europe-wide basis by the European Central Bank and not the monetary authority of the anchor currency. The strains of the past year would therefore simply no longer be possible.

The August crisis has nevertheless raised important doubts about the timetable for Stage III. Nevertheless, a large enough group should be able to meet the relevant convergence criteria by the end of the 1990s, since there is already a hard core for which these are achievable and which have the political will to move in that direction. But the crisis has made the expected path to EMU the natural hardening of central rates into fixed parities less likely. There are now two possible, diverging paths.

The old path can work only if monetary conditions ease and speculators expect no further interest rate falls in the member states that have been under pressure; even then, political `noise' could soon give rise to speculation quite unjustified by the fundamentals. Reintroducing capital controls to avert such difficulties is not a serious option: they would be contrary to commitments made by European governments to each other and internationally, undermine economic efficiency and price stability, and reduce the credibility of Europe's exchange rate policies and convergence programmes. They would be a step not towards a single currency but away from it.

Sir Leon therefore proposed, as an alternative path, that member states accept their parities may need to move in the run-up to Stage III and concentrate rather on preventing wild fluctuations that might raise concern about their underlying motivations for such realignments. They should take advantage of this increased flexibility to cut interest rates and kick-start their economies out of recession. Europe must not return to a zone of competing rather than cooperating monetary policies. The Council of Economics and Finance Ministers should take the opportunity to adopt tough common price stability and monetary growth targets at the beginning of Stage II. If applying such a target enables a country to reduce its interest rate, even by reducing its currency's value within the 15% band, this would not be competitive devaluation but simply a change arising from the national implementation of a mutually agreed anti-inflation policy. Such a framework will enable member states to respond better to their own economic needs while providing a step towards the goal of a single currency.