Common market economics

IN ALL THE arguments over Brexit, nothing generates as much heat as the economics of it. Being part of a large customs union brings gains from increased trade, but it can also divert trade from better non-EU markets and more efficient non-EU suppliers. Access to the world’s biggest single market offers clear economic benefits, but they come at the cost of regulatory burdens imposed by Brussels and a large net contribution to the EU budget. And there is no counterfactual: nobody knows what a Britain outside the EU would be like, or what sort of relationship it would have with the EU. The four biggest economic concerns are regulation, trade, foreign direct investment and migration.

Regulation is perhaps the Eurosceptics’ biggest bugbear. When trying to show how much Britain might gain from leaving the EU, they tot up all the costs of EU regulation, assert that there are no benefits from it and assume that, after Brexit, the whole lot could be scrapped. Yet the cost of that regulation is offset by benefits in fields like the environment, product safety and food standards. Regulation is also essential to apply common minimum rules across the EU that are at the heart of the single market, as even Thatcher realised when she signed the Single European Act in 1986. Similarly, completion of the single market in services would require more, not less, regulation at EU level.

Pram-makers beware

This is not to deny that EU regulation, like domestic regulation, can be excessive, although in Britain the biggest complaints are often caused by home-grown “gold-plating” when directives are transposed into national rules with excessive zeal. Some of the strongest supporters of Business for Britain, the Eurosceptic group, have more specific gripes. For example, James Dyson, an inventor and maker of appliances, was upset that his vacuum cleaners fell foul of EU environmental regulations, and Alan Halsall was unhappy that his Silver Cross prams were banned in France on dubious product-safety grounds. The EU’s working-time directive, which limits the number of hours employees can be required to work, has caused problems for many businesses and for Britain’s National Health Service (NHS), though a system of opt-outs has reduced its impact.

So has Britain’s EU membership caused it to be over-regulated? The OECD club of mostly rich countries has compared the extent of regulation in product and labour markets among its members and finds that Britain is among the least regulated countries in Europe (second only to the Netherlands on the first measure and to none on the second, see chart). Indeed, Britain compares favourably with non-EU countries such as America, Australia and Canada. And there is little to suggest that, if it were to leave the EU, it would tear up many rules: in areas ranging from the environment to financial services, British lobbyists have been in the forefront of those calling for more regulation, and Brexit would be unlikely to change that.

Moreover, if a post-Brexit Britain wanted to retain full access to the single European market, it would almost certainly have to stick with most of the accompanying rules. Eurosceptics have suggested that the 90% of British small businesses which do not export to the rest of the EU should be exempted from all single-market regulation, but that would simply not work, since many of them supply bigger businesses that do export to the EU; and they also face competition within Britain from small firms elsewhere in the EU.

By far the most intrusive and costly regulations for business are those imposed at home, not by the EU

Besides, by far the most intrusive and costly regulations for business are those imposed at home, not by the EU. Jonathan Portes, director of the National Institute of Economic and Social Research, a think-tank, reckons that restrictive planning rules and the new living wage recently proposed by the Cameron government constitute a far bigger (and more expensive) interference in the market than all the EU’s regulations put together. And domestic factors such as poor education and inadequate infrastructure represent far bigger obstacles to faster growth and employment than rules made in Brussels.

Trade follows the EU flag

The second big economic issue is trade. British trade with other EU countries has risen rapidly since 1973, though as the European economy has slowed, its share of the total is declining (the EU now takes over 51% of British exports of goods, see chart next page, and close to 45% if services are added in). Yet whether Britain is in or out, the EU will be a key partner. For non-members such as Norway or Switzerland, trade with the EU makes up a bigger share of the total than it does for Britain. The effects of EU membership on trade patterns are difficult to measure, but John Springford of the Centre for European Reform, another think-tank, and colleagues have carried out a modelling exercise which concluded that Britain’s trade with the rest of the EU was 55% greater than it would have been if outside.

The Eurosceptic case is that, after Brexit, Britain would not only retain full access to the EU’s single market but would be able to sign free-trade deals with many other countries, including America, China and India. Mr Paterson, the Eurosceptic Tory, argues that EU membership prevents Britain doing such deals, so that its trade with Asia, in particular, is lower than it should be. Yet this is not convincing. If EU membership is such a huge obstacle, how can Germany’s exports to China be three times bigger than Britain’s? Germany even sells more to India, part of the Commonwealth, than Britain does.

As for free-trade deals, Britain on its own would lack the bargaining clout of the world’s biggest trade block. Moreover, the EU and America are now deep in negotiations on a Transatlantic Trade and Investment Partnership (TTIP) that, if successful, will set the standards for a large chunk of future world trade. Trade negotiations are now more about regulations and standards than about tariffs, which gives more sway to big trade blocks than to individual countries. Indeed, the TTIP talks have made European countries outside the EU increasingly fretful.

Britain’s EU membership has also boosted inward investment. Over the past 20 years the country has been remarkably successful at attracting foreign direct investment (FDI). At least some of that came to Britain because the country was inside the EU’s single market; indeed a rising share of it (now almost half) comes from the rest of the EU. The car industry, all but moribund in the 1980s, is a good example: Britain now has more car factories (almost all foreign-owned) than France, and exports of cars and car parts, mostly to the rest of the EU, are at record levels. Some foreign investors, including Nissan, have stressed the importance to them of Britain’s access to the EU single market.

In the financial-services industry this matters even more. It accounts for as much as half of all FDI into Britain, and half of that in turn comes from the rest of the EU. FDI in financial services is more mobile than that in plant or machinery. And, given the broad integration of wholesale financial services across the single market, it seems clear that if Brexit were to create any barriers to exports of financial services to other parts of the EU, some of that investment would move. Two global financial-services giants, Deutsche Bank and Goldman Sachs, have already hinted that they might have to move some operations out of London.

Lastly, leaving the EU could have a significant effect on migration. As an EU member, Britain cannot block the movement of people from other EU countries—and migration from elsewhere in the EU now makes up half the British inflow. The government remains committed to reducing overall immigration from the hundreds of thousands to tens of thousands. Yet most businesses and economists agree that migration brings more benefits than costs. The number of EU migrants living in Britain, at around 1.8m-1.9m, is roughly the same as that of Britons living in the rest of the EU. But many of the British are retired and impose health-care costs on their hosts, whereas younger EU workers in Britain pay more taxes than they consume in benefits. If a post-Brexit Britain were to block or even just to reduce migration between Britain and the EU, which seems highly likely, that would certainly impose a net cost on the economy.

Adding it all up

What, then, would a Brexit mean for the British economy, allowing for all the regulatory, trade, investment and budgetary effects? Different people have done the sums in a variety of ways and the results have often been remarkable, not to say incredible. Some advocates of staying in have claimed that 3m jobs would be lost if Britain left, and some who want it to leave have talked of a potential 25% gain in GDP per person. More soberly, the Confederation of British Industry in 2013 estimated that the net benefits of EU membership might be in the order of 4-5% of GDP.

A recent report by Open Europe, a broadly Eurosceptic think-tank, summarises the results of studies carried out by others before adding its own. A NIESR paper in 2004 concluded that Brexit would reduce GDP by 2.25%, mainly because FDI would be lower. A report produced for the government by the Centre for Economic Policy Research in 2013 reckoned that annual GDP would be 1.24-1.77% smaller if Britain left, depending on what trading arrangement it was able to make with the EU. A 2014 paper for the more Eurosceptic Institute of Economic Affairs suggested that British GDP might rise by a net 0.1% because the benefits of less regulation and a lower budget contribution would outweigh trade and FDI losses. Open Europe itself reckons that a realistic range for the annual effect on GDP of Brexit would be between -0.8% and +0.6%, though the positive outcome would depend on the right mix of policies.

A fair conclusion might be that the economic consequences of Brexit may be negative but not that large. As Norman Lamont, a Eurosceptic former chancellor, puts it, Britain could do perfectly well outside the EU. Yet there are clear downside risks. It is a heroic assumption that a post-Brexit Britain would be an open economy pursuing the dream of free trade, liberalisation and open borders; more plausibly, it would turn inward and more protectionist, with tighter controls on immigration. It is also clear that Brexit would create huge uncertainties for business. Eurosceptics retort that they heard much the same when Britain chose to stand aside from the euro. But even that decision is now forming part of the government’s renegotiation.