Professor Anton Muscatelli, economist and Principal of the University of Glasgow, writing in a personal capacity.
The current EU referendum debate has focused on the negatives of the choice. In part this is because the ‘Leave’ campaign has suggested that the UK would be free to shape its economic, social and regulatory environment outside of the EU, taking the ‘Remain’ campaign onto negative terrain.
The positive case for the European Union is based on the rationale for its creation in the 1950s. An economic vision derives from the institutions we create to govern our society. If we see the world through that historical and institutional lens we begin to understand why the alternative world proposed by the Brexit camp runs contrary to our economic and societal values.
The Treaty of Paris which set up the European Coal and Steel Community in 1951 and the Treaty of Rome which established the European Economic Community in 1957 are documents worth revisiting. In 1950 Robert Schuman, argued that the goal should be to make war between historic rivals France and Germany “…not just unthinkable, but materially impossible.”
Europe’s leaders, as the preamble to the Treaty of Rome explains, sought “to ensure the economic and social progress of their countries by common action to eliminate the barriers which divide Europe…” It spoke of the “essential objective…[being] the constant improvement of the living and working conditions of their peoples…” It also referred to the need to “…guarantee steady expansion, balanced trade and fair competition” and the need “…to ensure their harmonious development by reducing the differences existing between the various regions and the backwardness of the less favoured regions…”
In other words, the aim was to achieve peace though the pooling of resources and commercial policy, through the reduction of barriers to trade and the movement of capital and labour, combined with regional cohesion. The fundamental aim was to ensure that war and conflict would no longer be seen as the means to pursue national interests in Europe.
Opponents from one end of the political spectrum argue that the process of integration in the EU has gone too far. They point to the undoubted flaws in the design of the Eurozone which has seen economic conflict between countries like Germany, and countries like Greece who have suffered a debt crisis following the financial crisis of 2007-08. Whilst opponents from the other end of the political spectrum argue that the EU’s system of fiscal solidarity and fiscal pooling has not gone far enough, which is why the recent Eurozone crisis has not been solved.
In part the EU’s recent strains have emerged because we collectively did not realise the need for our institutions not to diverge too far from the preferences of Europe’s citizens. The concepts of a ‘single-speed Europe’ and ‘ever closer union’ which have been increasingly brought into question are not accepted to the same degree across the EU. Turning this argument on its head, however, it’s also undoubtedly true that the EU has constrained some of the centrifugal forces which throughout the history of Europe have brought conflict and war. Forces which since the 17th century caused conflict to spill over from Europe to the rest of the world. From the War of Spanish Succession to the two World Wars, Europe has been at the centre of conflict in pursuit of national interests.
It seems extraordinary that ‘Leave’ leaders such as Boris Johnson feel justified in comparing the EU to the Third Reich or Napoleon’s Empire. Re-reading the words of the leaders who set up the EU should remind us that their intent was to pool sovereignty for the common good of all the people of Europe.
The UK referendum provides a timely reminder that for the EU the answer lies in allowing continuous reform to ensure that in future, principally through the Council of Ministers and the European Parliament, the EU maintains a balance between checking the centrifugal forces of national interest and the centripetal forces which take government further away from its citizens. But this intent cannot be achieved by destroying a Union which has, without any doubt, been a force for stability, peace and security for our continent. The next decade, with the Eurozone crisis, mass migration into the EU, and the challenges of slow growth and climate change – all of which require solutions by collective, as opposed to individual, action should re-energise the EU.
The uniqueness of the EU Single Market
Understanding the origins of the EU is important, because it shows just how flawed the Leave side’s perspective is. The EU has lowered trade barriers between member countries, and has encouraged labour and capital mobility, which in turn has driven growth in income and employment.
The most flawed aspect of the ‘Leave’ campaign is their tendency to treat each of the economic variables involved in the campaign as items which the UK can independently choose. Their argument goes something like this: by leaving the EU, we can maintain ,indeed expand, our trade by maintaining our trade links with Europe and increasing them with the faster growing non-EU global economies. At the same time we can reduce EU immigration whilst maintaining capital flows and investment into the UK. We can also spend more at home on public services by not being net contributors to the EU budget and reduce the burden of regulation.
In reality not all these choices are available to us. If we leave we will need to choose between negotiating a preferential trade relationship with the EU, or standing alone to trade within the World Trade Organisation rules. The former will restrict our migration policy and will require us to continue contributing to the EU budget, as Norway and Switzerland do, and adhering to EU regulations. The latter could seriously harm our trade position and foreign direct investment into the UK which would hit our growth and our tax revenues and therefore our public services. Arguably in the latter case we might also not be able to choose to restrict migration in the long run, as we struggle to maintain competitiveness.
Reaching a trade deal with the EU after leaving will not be straightforward. Beyond the ‘Leave’ campaign clichés that the Germans will still want to sell us cars and the French will still want to sell us wine, the UK depends on EU trade more than our partners depend on us. To put this in context: UK exports to the EU are 12% of our GDP. Germany and France’s exports to the UK are 3% and 2% of their GDP. We matter more as a market to countries like Belgium, Netherlands and Ireland, and although we run a trade deficit with some EU countries, we don’t with all.
In 2014 around 45% of our exports went to the EU, or more than double what we exported to the USA and China the two biggest world economies. However, up to 63% of our exports go to countries covered by EU-negotiated trade deals), and this total will increase over time to around 85% as trade deals are negotiated with e.g. the USA. These would need to be renegotiated which is a massive task and one where our bargaining power is much diminished.
It’s anyone’s guess as to whether the EU will feel sufficiently benevolent to negotiate a trade deal with the UK or if there might be a qualified majority for such a deal. Many senior EU leaders have suggested that this is not likely to happen, in retaliation for the damage that Brexit will do to the EU. But if they do agree to a deal, at best it will follow the pattern of agreements with countries like Norway and Switzerland.
A Norwegian or Swiss-type deal will still require us to contribute to the EU budget. The UK is a net contributor to the EU budget which is used to pay for the EU Common Agricultural Policy, for research and for regional funding and assistance to help poorer parts of the EU. The UK also benefits from these investments. The UK receives a rebate which was worth £3.2bn in 2012 Forecasts from the Office for Budget Responsibility suggest that for the period 2014 onwards, the UK’s net contribution could be between £8.2-9bn. Although this sounds like a large sum, it’s actually just over 1% of our total public spending in the UK, which in 2014-15 was just over £700bn. More importantly, Norway only receives a 17% discount on this net contribution compared to the UK. Switzerland gets a more substantial discount (59%). However, it is also likely that if we pay less, we may also receive less in areas where the UK does particularly well , such as in research budgets. In reality the net saving may be very small indeed.
In addition, it is very likely that the EU will require, as in the case of EEA countries and Switzerland, continued free movement of labour between the UK and the EU. There are also certain quirks in their trade deals, which may disadvantage the UK. For instance, Norway is not part of the Common Fisheries Policy and the CAP, and in turn the EU taxes imports of Norwegian smoked salmon by 13%.
This is why some free-market economists supporters of ‘Leave’, have argued that we should not seek to do a trade deal with the EU, but opt to sit outside using the WTO rules. Most-favoured nation (MFN) tariffs would end up being imposed on around 90% of the UK’s goods exports to the EU. In areas where the UK runs a trade surplus with the EU such as non-crude oil and gas exports the tariff would be 4.1%. On wheat exports it would be 12.8%. More seriously non-tariff barriers might be raised, not only against our goods exports to the EU but also in services.
This really matters. The UK is a major exporter of financial and business services, and the EU single market is unique because unlike other regional trade deals around the world it has lowered non-tariff barriers to trade by ensuring common standards. The UK can negotiate its own trade deals outside the EU but it’s impossible to reproduce the EU single market. No other group of countries has managed to achieve this.
So those who advocate trade with more dynamic trade blocks should beware of this trap, and further flaws in this Brexit argument. First, there is no evidence that non-EU countries are ready to lower tariff and non tariff barriers on the UK. In a paper for the Royal Society of Edinburgh Charles Nolan from the University of Glasgow and I highlight that the UK’s total costs of exporting to the EU have fallen by about 15% since 1995. In contrast our total costs of exporting to the Emerging economies is over 20% higher than EU trade, and the costs of exporting to other OECD countries is around 15% higher. This is not driven by EU tariffs but non-tariff and other costs. Second, on a related point most economic models show that ‘gravity’ i.e. geographical vicinity is a major determinant of trade. Our value chains are closely intertwined with those of our EU neighbours, and disentangling these would be very expensive. We cannot change our physical location to move to Asia and so the Brexit argument is rather quixotic. Third, although in the WTO scenario we could limit labour mobility from the EU, it’s very likely that we may need to forego this in order to remain competitive. As we shall see below, we benefit hugely from skills from the EU in our key sectors.
The most serious problem of staying outside any EU trade agreement is the serious impact this might have on foreign direct investment into the UK. Being in the single market makes the UK attractive as a base for exporters. A Centre for Economic Performance report estimates that the UK has an about £1 trillion of foreign direct investment, of which half is from other EU countries, and much of the rest uses the UK as a platform to the single market.
The growth benefits from EU membership
Brexit supporters seriously underestimate the interdependence of trade, migration, and EU budget contributions which we would need to pay even if we left.
But the most serious misrepresentation of the Leave campaign is to ignore the productivity growth benefits we derive from trade, foreign investment, and the key skills we have imported from the EU.
We know that openness to the single market has benefited the UK in terms of economies of scale, and that investment and inward skills migration from the EU adds directly to productivity.
About 1.5m non-UK EU nationals currently live in the UK. They represent 5% of total employment. In some high-skill sectors the numbers are even higher: In finance and insurance it’s 6%, in manufacturing it’s over 7%; in science and technical roles over 6%. Most economics research shows that EU migrants are net contributors to the UK economy, adding more in GDP than is spent in public services.
These are only the static benefits. The dynamic benefits of importing skills from the EU are even greater. The additional human and physical capital adds to our productivity and growth. The Treasury estimates that UK GDP would be between 3.8% and 7.5% higher in the next 15 years, depending on whether the UK strikes a Norway-type trade agreement or a bilateral (eg Canada, Turkey or Switzerland-type) agreement, or if we simply adopt WTO rules.
The positive argument for remaining in the EU is rooted in the importance for our future of close economic relationships and common political and social institutions. The linkages we have built between our countries have brought not only peace and stability, but also have the greatest potential to maximise economic growth and to ensure social cohesion at a time of global economic uncertainty.
Those who argue that we should turn our back on the EU have struggled to show what a coherent alternative vision for the UK might look like. What is worrying is that their arguments instead hinge on the alluring appeal of ‘freedom’. Freedom from red tape; from immigration; from EU budget contributions. Reality looks rather less attractive. None of these so-called ‘freedoms’ are attainable without considerable economic and social costs to the UK. More seriously for those of us who believe that future prosperity depends on the sharing of values and a co-operative approach to objectives across international borders, Brexit would diminish the EU as well as the UK.
This piece was originally published in the Sunday Herald, 17 June 2016.
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