Police guard the ECB ahead of the Blockupy protests of June 2013 © Michael Probst/ AP/ Press Association Images
Would Britain fare better if it were outside the European Union? The Prime Minister has promised an In/Out referendum in 2017 and the polls say that a vote today would have us heading towards the exit. Would that, as Eurosceptics claim, be a chance to shake off the costs and constraints of an economically and politically sick continent, and to build a prosperous future in a wider, more dynamic world? Or would it instead represent a reckless gamble—one which would damage Britain’s future prosperity?
Full disclosure: I have always been a believer in Britain’s role in Europe. As editor of the Financial Times in the 1990s, I supported the case for the United Kingdom’s membership of the euro. Pro-Europeans like me have had quite a few disappointments to cope with in recent years: the failure to complete the single market; design flaws in the eurozone that were brutally exposed by the global financial crisis; and today’s bleak economic outlook. But so far, most of the arguments on either side of the debate have been based on assertions, rather than hard data.
On the Eurosceptic side there are wild estimates of the costs of EU membership, and on the other, improbable figures about the number of jobs that would be at risk if Britain left. Nick Clegg has suggested 3m—but such figures should be taken with a pinch of salt.
However, the evidence is clear, for those willing to look for it. From an economic perspective, the risks associated with leaving the EU would be significantly greater than the costs of staying inside. Let’s start with the supposed costs of our membership of the EU, which are not as great as it is often claimed. The UK’s contribution to the EU budget, in net terms, is about £8bn a year, according to the Treasury, or around 0.5 per cent of GDP. That is far less, per capita, than the EU average of €244.
It’s most unlikely that we would save all our gross annual contribution of £13.8bn in the event of a British exit. To take one example, farmers receive EU subsidies of around £3.4bn a year from the EU. They are a formidable lobbying group, and would be pressing hard for compensation from the taxpayer in the event that these funds were withdrawn.
Regulation
In any kind of guessing game, the words “red tape” and “Brussels” comfortably fit alongside each other. Britain’s EU-hostile media constantly has fun with the latest daft ideas from the fringes of the European Commission, and businesses regularly complain that Britain makes a bad situation worse by “gold plating regulations,” making them more costly to follow. But if there is to be a single market, there must be common rules. Much more effective than a free trade agreement, which simply gets rid of tariff and subsidy barriers to trade, a single market grapples with non tariff barriers—such as different regulatory regimes—which are often a considerably larger obstacle to cross-border trade. For most people in this country, including our Prime Minister, the single market is probably the EU’s greatest achievement.
As Luuk Van Middelaar, the Dutch political philosopher and advisor to Van Rompuy, wrote in a recent book: “Building a market, unlike creating a free trade area, continually requires new legislation which, even if mostly technical, at times involves deeply political choices.” In Europe’s internet economy, who decides the rules on consumer privacy? In a European market for financial services, who picks up the tab when a bank goes bust?
Eurosceptics assign large numbers—up to 5 per cent of GDP—to the costs of EU regulation for British business. However, some of these regulations would be necessary if Britain were outside the EU, such as the rules dealing with hazardous chemicals. And the increased access to markets that ensues from Britain following these rules means that the net cost is likely to be rather modest.
The latest survey of the UK by the OECD, a group made up of the world’s major industrialised nations, showed that in 2008 the UK was ranked the least restrictive for product market regulation, not just of all EU countries, but of all OECD members—including the United States. For overall administrative regulation, Britain was number seven. The World Economic Forum’s Global Competitiveness Report for 2012-13 placed the UK eighth out of 144 countries for its overall competitiveness—this hardly suggests an economy that is being strangled by red tape. (Four other EU countries—Finland, Sweden, the Netherlands and Germany—came in ahead of the UK in this table.)
The Eurosceptic view of labour market regulation is also hostile. The working time directive, which requires a maximum working week of 48 hours, was introduced in the very different political climate of the early 1990s to make the single market more acceptable to trade unions. It’s had a real impact on the public sector, especially on British hospitals that rely heavily on junior doctors to care for patients out of hours. But the consequences for British businesses today are limited since they can use an opt-out allowing workers to put in more than the 48 hours a week.
The working time directive, along with the associated temporary agency workers directive, needs reforming; but it’s not important enough in economic terms to be a casus belli with Brussels. And the British would not be alone in seeking change. Implementation of the directive is patchy across the EU, and 16 countries are now using an opt-out. Agreement over the directive can hardly be beyond the reach of sensible negotiation.
The more important point is that the UK’s labour market has become a lot more, not less, efficient and resilient in the past few decades thanks in good measure to the reforms set in train by the late Margaret Thatcher. Private sector employment in this country has held up astonishingly well over the past five years, as workers have been willing to trade wages for jobs. That’s in marked contrast to what happened in both of the last two recessions. As a result, the unemployment rate is currently 7.8 per cent, way below the EU average of over 12 per cent. An index of employment protection legislation, again published by the OECD, shows that the UK is only slightly more restrictive than that of the US and Canada, and a very great deal less than elsewhere in the EU. When it comes to labour market rules, Britain belongs firmly in the Anglophone rather than the European camp. It’s not in the same league as the likes of Spain or France.
Benefits of membership
Membership of a 500m-strong single market brings tangible economic benefits. But it’s just as difficult to calculate those as it is the costs. So rather than dreaming up numbers on either side of the argument, it’s safest to suggest that in the context of Britain’s economy, which has an annual output of around £1.5 trillion, the net cost of membership is close to being neutral.
Those who argue that the costs of EU membership are crippling British business have to answer the German question: how is it that a country with a more regulated market for products and services, a more restrictive market for labour, and a higher EU budget contribution than Britain has turned itself into the world’s most successful export nation?
What are the positive benefits of EU membership to the UK economy? The most obvious answer is through foreign direct investment—international companies building up business activities in this country. This has never been more important—with household budgets under pressure and government cutting back, private sector investment will be a vital driver of growth and job creation.
Foreign-owned businesses are also a very important source of innovation and productivity growth. They are much more research intensive than their British-owned counterparts: they account for a quarter of all business research and development in the UK. In the past few decades, they have transformed whole sectors of the British economy, from motor vehicle manufacturing to financial services.
Half of all European headquarters of non-EU firms are based in the UK—more than in Germany, France, Switzerland and the Netherlands combined. The UK has been the leading destination for inward investment in Europe for many years, thanks in part to its language, location and legal system.
A survey by UK Trade and Investment shows that, of the companies it helped to locate in the UK during 2011-12, the two most important factors when considering the UK as an investment location were, first, that other similar businesses were already successful here and, second, that skilled workers were available. But next highest on the list came Britain’s potential as a gateway to other markets in the region: nearly three-quarters of investors rated this as either very or fairly important. For Japanese motor manufacturers in particular, the UK has been a very attractive launchpad for sales into Europe. That’s why, back in the 1990s, a number of them lobbied vociferously for UK membership of the euro. Their investment has rebuilt what was a moribund sector in this country, and turned it into a major export earner with a heavy focus on Europe. Four-fifths of the cars made in the UK are exported, the bulk of them to the EU. In 2012, a bad year for the European car market, 75 per cent of Toyota’s UK exports went to the EU.
To address Nick Clegg’s point about jobs: leaving the EU would not cause huge job losses overnight, and no doubt lots of people would find other things to do. All we know for sure is that, if leaving the EU were to damage the UK economy, then jobs would be lost over time.
The Square Mile
There’s a similar story in finance. A survey by TheCityUK, a body that promotes British finance, of 147 location decisions between 2006 and 2012, found that more than two-fifths of financial firms gave access to European markets as a core reason for choosing London. Financial firms also place a high premium on London’s attractions for talented workers from across the EU and beyond.
However, in June, Ernst & Young, the business services firm, published its annual survey of the UK’s attractiveness for investment. It contained some worrying findings. For the first time the UK slipped behind Germany in 2012 in terms of new projects secured. Ten years ago, the UK secured more than three times as many new inward investment projects as Germany. Now, global investors rank us behind Germany as Europe’s most attractive country for new investment in the years ahead. Germany has also maintained its lead over the UK in attracting projects from emerging economies like China.
Here again, there’s a German question for the Eurosceptics. Why is China choosing a country that is locked into the heart of what they see as a moribund union? There’s more. The Ernst & Young survey showed that inward investment in the UK was increasingly concentrated in the southeast—investment in England outside London in 2012 was nearly a quarter below the level two years earlier. And the most attractive sectors for foreign investors are seen as business and financial services, together with software. With a few exceptions, Britain is struggling to secure foreign investors in sectors like manufacturing, chemicals and electronics. And unless you believe that leaving the EU would create enormous cost savings and new dynamism for business in Britain, then it’s hard to think of any reason why the current debate about leaving Europe should be anything other than damaging to the UK’s attractions as a location for foreign investment.
Financial services are one of the prime sources of inward investment in the UK, and make up one of the sectors where the UK has real global strength. There are strongly opposed views in the City on the European question. If you believe the gossip columns, prominent hedge fund managers are becoming close to the UK Independence party. And Nigel Lawson, the former Chancellor of the Exchequer, claimed in an article for the Times in May that escaping from the “frenzy of regulatory activism” emanating from Brussels would be one of the prime economic reasons for quitting the EU altogether. On the other side of the argument, Gerry Grimstone, Chairman of Standard Life and of TheCityUK has said that: “It is really poppycock to believe that the City can survive in its present form if it is not an integral part of the European financial services framework. London must have complete and unfettered access to the wholesale euro markets.”
Growing Eurosceptism in the City partly reflects the broader national mood, but there are specific reasons for a more hostile attitude. One is the view that EU regulations since the financial crisis have been shaped in part by the idea in continental Europe that the financial catastrophe was a consequence of Anglo-Saxon capitalism. As François Hollande said in his election campaign last year, “mon véritable adversaire, c’est le monde de la finance.”
But the two initiatives that have been the source of particular rage in the City have been the proposed cap on bankers’ bonuses and, above all, the proposed financial transaction tax (FTT). Although the UK will have no part of such a tax, the Commission has made it plain that the FTT would apply to transactions in the City if the counterparty has had its headquarters within the FTT zone.
A second reason for tensions in the City stems from the nature of the eurozone crisis itself. Eurozone members are being forced to contemplate deeper integration to hold the system together. This would include a banking union, of which the UK would not be a member. One concern is that the integrity of the single market could be jeopardised by the actions of the eurozone core. Another is that those countries could attempt to discriminate against non-members, an example being the European Central Bank’s wish to locate clearing houses handling euro-denominated business within the eurozone as opposed to London.
So how can these arguments be unpicked? There is no doubting the EU’s importance to the City. Wall Street flourishes on the back of the vast US domestic economy. London, with no comparable domestic support, is built instead on the European economy. In 2011, £17.6bn of the UK’s £46.7bn trade surplus in financial services was derived from business with other EU member states. The single market is of crucial importance to non-EU firms locating a subsidiary in London and operating across the EU through branches of most types of financial services. That’s because, like firms from within the EU, the single market gives them a passport to carry their services across all 27 countries in the union. If they are cleared to operate in one country, they can do business in them all. If that passport were taken away in one country, there would be a strong temptation to move to another.
If the UK were to leave the EU, the strongest voices in financial regulation would be those with a cultural bias against what they see as London’s casino-type capitalism, and who would be looking for ways to weaken its competitive advantage. And London, for its part, would not be able to turn its back on an economic region which accounts for such a large part of its business. Much better for the UK to retain a seat at the regulatory table, working with allies to retain liberal and open capital markets. It’s not a lost cause—witness the way in which the FTT is being delayed and whittled down in the face of pressure from across Europe. It may turn out to be not much more threatening than stamp duty on share transactions, which the UK already imposes.
As bank lending shrinks across Europe, our European partners will need us more. Companies are increasingly seeking to raise money in the capital markets, and the US model is becoming more relevant. There, banks account for about a fifth of long-term company financing. In big European countries, the proportion is nearer 70 per cent. Europe will need a bigger, more active corporate bond market to finance growth, and London is best placed in Europe to deliver—provided it stays in the game.
If we don’t, the lights will not go out. In the words of Richard Gnodde and Michael Sherwood, co-Chief Executives of Goldman Sachs International, the threats “would manifest themselves over time, not overnight. It takes years for businesses to move headquarters and for other cities to build the houses, schools, office space and services needed to handle a new cadre of workers.” But, they conclude: “Large international and European companies see a Britain divorced from the EU as a much less attractive place. Threats to British involvement in the EU are threats to British business.” It’s one thing for a hedge fund to respond to unwelcome changes by moving to Switzerland; it’s quite another for a bank, with thousands of employees. And these are the ones who are most likely to see a British exit as a threat.
Trade
The effect on trade must also be considered. Roughly half of British exports go to the EU, a proportion that has been declining in recent years as emerging economies have gathered steam and Europe has languished. Between 2009 and 2012, exports of goods to the EU rose by just over 6 per cent, whereas those to the rest of the world jumped by more than a third.
However, exports to the emerging economies are modest. Britain sells more to Sweden than to India, and more to Denmark than Brazil. One reason for this is that Britain does not produce enough of the goods and services that these countries want. The OECD has analysed the export structure of the UK and Germany and compared this to the import structure of the BRIC countries. This shows that Germany is very strong in precisely those sectors where countries like China are most hungry for imports, especially machinery and transport equipment. But the UK is strongest in areas where imports to the BRIC countries are least important and in some cases face heavy protectionist barriers, such as financial and business services. So it makes no sense to suggest, as do some Eurosceptics, that if only British businesses were less preoccupied with Europe they could do a lot better in the faster growing economies of Asia. The stuff we are best at, these countries often don’t want.
Something that most countries want, however, is Scotch whisky, which is a test case of how the EU helps to amplify the commercial prospects of a British product. An analysis in the Economist earlier this year argued that “the EU is now the industry’s essential sword and shield for conquering world markets.” The EU still accounts for around two-fifths of total Scotch sales. When a new country joins the single market and removes its trade barriers, its consumption of whisky tends to shoot ahead. And whisky makers prefer common EU rules to lots of national regulations on everything from bottle sizes to labels.
Above all, the EU’s weight in global trade negotiations is crucial to an industry which still faces roughly 600 protectionist barriers around the world. Indians consume almost as much whisky as the rest of the world put together. But they mainly drink local stuff that would make any true Scot faint in horror. And they impose whacking tariffs of around 150 per cent on imported whisky, putting the real thing beyond the reach of all but the rich. Small wonder that the distillers are hoping for big things from the free trade agreement that the EU is now negotiating with India. The UK on its own would not have anything like the same clout around the negotiating table.
In other words, British exporters don’t just benefit from access to the single market. They also gain from free trade arrangements that the EU has negotiated with much larger parts of the globe. The big one that’s on the table now is a potential free trade agreement between the EU and the US.
An independent assessment of the impact of a successful Transatlantic Trade and Investment Partnership deal concluded that it could benefit the UK by between £4bn and £10bn a year. No one knows what the UK’s position would be in these trade deals if it were to break away from Europe. Would it have to negotiate them all again separately, and if so how long would it take and what might the terms be?
Terms of exit
Everything would depend on the conditions of an exit. One option might be to become like Norway, and join the European Economic Area. A Norwegian government report, published last year, said: “The most problematic aspect of Norway’s form of association with the EU is the fact that Norway is in practice bound to adopt EU policies and rules on a broad range of issues without being a member and without voting rights.” “ This,” the report adds coyly, “raises democratic problems.” This is not a prospect to set anyone’s heart beating.
Or Britain could aim for the Swiss position, and do business with the EU through a series of bilateral deals. But that would be painfully hard work, and would involve trade offs. With no agreement for financial services, for example, the Swiss have come up with their own very stringent set of rules. It’s unlikely that the EU would offer similar treatment to an economy of the UK’s size, especially in the aftermath of a painful divorce. Added to which, countries outside the EU, like Norway and Switzerland, don’t benefit from its free trade agreements. The Prime Minister has rightly knocked both of these ideas on the head. Nigel Lawson goes a step further and argues that “the relevant economic context nowadays is not Europe but globalisation, including global free trade, with the World Trade Organisation as its monitor.” But the WTO does not offer free trade, and does not cover services as fully as the single market.
Europe is a vital market for food and drink, the UK’s biggest manufacturing sector. Nine out of the top 10 markets for UK exports of food and non-alcoholic drinks in 2011-12 were in the EU. World Trade Organisation or not, tariffs on sales to the EU in important sectors like dairy products would be prohibitive if the UK was out of Europe. There would also be pressure from domestic producers—farmers, car manufacturers—to impose tariffs on imports both from the EU and the rest of the world, with damaging consequences for consumers.
That’s why a prominent Eurosceptic like Conservative peer Rodney Leach argues that exit would be a big mistake: instead, he believes, the UK should stay in the union and fight for reform. The Eurosceptic think tank Open Europe last year concluded, after an in-depth study, that “from purely a trade perspective... EU membership remains the best option for the UK.” Or as the Prime Minister put it in January, “continued access to the single market is vital for British businesses and British jobs.” Though it is impossible to put numbers on the potential risks to UK trade of an EU exit, it is fair to suggest that they would be substantial.
Science
Finally a subject that deserves more debate is science. Britain’s strong research base has made it a major beneficiary of EU science funding—nearly £5bn of so-called Framework Seven funding and £1.2bn from the European Research Council, which in the latter case is more than a fifth of the total. Earlier this year, it was announced that 80 out of the 302 senior researchers awarded a share in the latest tranche of Research Council money would be based in the UK, twice as many as the next most successful country. Some of Britain’s most globally successful research universities get a fifth or more of their research funding from Europe.
Research collaboration across borders, in projects like the EU-sponsored Innovative Medicines Initiative, is also very important, and so is the free movement of scholars. Paul Nurse, President of the Royal Society, points out that it was easier for our recent Nobel prize winners, the Russian-born Andre Geim and Kostya Novoselov, to come to the UK because they were already working in the Netherlands. In Nurse’s careful words, “looking at it from the perspective of science in the UK, it would be hard to make a case for us being better off outside the EU.”
Reform of EU
The good news is that there is now a growing appetite around the capitals of Europe for reform of both the governance and the operations of the EU. Europe badly needs growth, and the current crisis provides an opportunity for changes that might not have been politically possible in easier times.
The single market remains incomplete, notably in services. These now account for around 70 per cent of employment and value added within the EU, but for only 20 per cent of intra-EU trade—indicating the low tradability of services across borders. The 2006 services directive left national governments with too much discretion to decide what constitutes a barrier to the provision of cross-border services, and there are all kinds of areas where increased competition would boost productivity and quality. Construction and retail are obvious examples. We should also work to create a fully functioning digital single market, and one in information and communications technology. Employment law could be made much less intrusive to reflect today’s changed economic circumstances.
We should push for more free trade agreements and agree a deal with the US. This would provide a great platform for those who argue in favour of continued UK membership of the EU. More can be done, too, to ensure a better regulation agenda. It should be easier to scrap redundant legislation—at present, getting rid of a redundant law is almost as difficult as passing a new one. There should also be an independent EU authority to vet proposed legislation for its impact on growth and competiveness and do a better job of holding back legislation like the FTT.
Much will depend in the next few years on how the Prime Minister plays his hand. He knows that the way to achieve progress in Brussels is through consensus rather than by threats. He also knows that he is not alone in his wish to deliver what he described in his speech in January as “a more flexible, adaptable and open European Union in which the interests and ambitions of all its members can be met.”
He has potential allies across the continent. The risk now is that the loudest voices in this country will be those of the Eurosceptics, and that political considerations will cause him to negotiate with one hand behind his back, setting out too many red lines and, in the process, unsettling too many potential allies.
Business leaders have an important role to play here. They prefer to keep out of the political spotlight. But they are paid to assess, manage and, where necessary, mitigate risk. So if they believe, as I do, that the risk to British business of EU withdrawal exceeds the costs of membership by a wide margin, and has the potential to cause lasting economic damage to our country, they have a responsibility to speak out. Now.
This article is developed from the Gresham College Special Lecture 2013
