The economic consequences of leaving the EU

A group of experts finds that, after leaving the EU, the UK would face an invidious choice: sign up to the single market’s rules, or suffer economic damage.

In April 2016 an updated version of the report The economic consequences of leaving the EU: The final report of the CER commission on Brexit 2016 was published.

View press release.

The Conservative party has promised a referendum in 2017 on the UK’s membership of the EU. Opinion polls show that Britons are split on the issue – although recently, more have said they would vote to stay in than leave the Union. The possibility that Britain might quit the EU prompted the Centre for European Reform to invite leading economists, journalists, business people and EU experts to form a commission, to discuss the economic consequences of such a move. This is the commission's final report.

The standard critique of the UK’s membership of the EU is this:

• The EU does little to open markets on the continent, and so creates few opportunities for British exporters. It follows that leaving the EU would have little impact on Britain’s European trade.
• EU rules tie up the British economy in red tape, and constrain the UK’s ability to tap faster-growing markets outside Europe. A British exit would boost output by reducing the burden of regulation on business, and by freeing Britain to sign more free trade agreements with countries outside Europe.
• If Britain left the EU, it would win back its net contribution to the EU’s budget, which the Treasury estimates will be 0.5 per cent of GDP per year between 2014 and 2020.
• Immigration from the EU diminishes Britons’ employment prospects, and requires the British taxpayer to subsidise public services and provide welfare benefits for newcomers.

There are four reasons why these claims are ill-founded, and are a poor rationale for leaving the Union. First, the level of economic integration between the UK and the rest of the EU is very high, so healthy doses of competition and investment from elsewhere in the EU help to raise British productivity. Second, EU rules do not place large burdens on the British economy as a whole, or large constraints upon British exports to countries outside Europe: ‘Brexit’ would not be an economic liberation. Third, EU markets are of such importance to national prosperity that after a vote to leave, British negotiators would try to secure access to them. The experience of countries like Norway shows that this would involve accepting many of the rules of the single market, and a contribution to the EU’s budget, but with little influence on EU decision-making. Fourth, there is little evidence that migrants from elsewhere in the EU reduce Britons’ job prospects or their wages. A smaller proportion of EU immigrants receive benefits than do Britons, and EU migrants are net contributors to the public finances, helping to pay for the pensions and healthcare of an ageing society.

The scale of UK-EU integration

The economic aim of the EU is to deepen integration between member-states’ economies. Since trade between EU member-states is tariff-free, the EU has focussed on the non-tariff barriers to trade that arise from 28 different sets of national regulations. (It has done so by creating common minimum standards and getting member-states to recognise each other’s rules. For example, a British lawn-mower can now be sold across Europe, without having to comply with 28 different standards.)

Has this approach worked? Britain’s trade with fast-growing emerging economies, such as China, has been increasing more rapidly than with the EU. But this does not tell us whether the single market programme has been effective. British exports to China have been growing faster than its exports to France simply because the Chinese economy has been growing more rapidly.

The only good way to evaluate the worth of the single market is to measure UK trade with countries inside the EU and outside, and then control for economic size and other factors that affect trade, such as geographic distance. It is then possible to assess whether British trade with other EU member-states is higher than one would expect, given the size of their economies and their proximity.

• The CER constructed such an economic model. It shows that Britain’s EU membership has boosted its trade in goods with other member-states by 55 per cent. In 2013, Britain’s goods trade with the EU was £364 billion, so this ‘EU effect’ amounted to around £130 billion.² By comparison, the value of Britain’s bilateral trade with China was £43 billion that year.

Britain is highly integrated with the rest of the EU’s economy in other ways.

• In 1997, other EU member-states accounted for 30 per cent of the accumulated stock of foreign direct investment (FDI) in Britain; this proportion had risen to 50 per cent in 2012.
• In 2012 – at the height of the eurozone crisis – the value of UK banks’ assets held in the eurozone was 70 per cent higher than their US assets, despite the eurozone’s economy being only three-quarters the size of the US economy. The City of London has been a major beneficiary of the single market in financial services and the euro: the eurozone is a much larger market for lending originating in Britain than its economic size would suggest.

Would Brexit liberate Britain?

There can be little doubt that some of the EU’s regulations impose more costs than benefits. But many of its regulations are justified: there would be no single market without them. Moreover, European rules are not a major constraint upon Britain’s economy.

• According to OECD data, Britain has the second least regulated product markets in the developed world, after the Netherlands. Both are EU members.
• The OECD’s labour market protection index shows that Britain has similar levels of labour market regulation to the US, Canada or Australia – and far lower than continental European countries. EU employment rules therefore do little to inhibit Britain’s flexible labour market.
• It follows that leaving the EU and ‘de-Europeanising’ British regulation would do little to boost its economy.

In any case, Britain would find it difficult to avoid EU regulation even if it left the club. Outside the Union, the UK would lose access to the single market unless it signed up to EU rules. Membership of the European Economic Area (EEA) would resolve little. This group, which includes Norway, Iceland and Liechtenstein, has full access to the single market, but must sign up to all of its rules despite having little say in their drafting. The Swiss relationship is not much better: while it has a set of bilateral accords to give it access to some parts of the single market, it must regularly update its standards to match those of the EU, or risk a suspension of access. Were Britain to sign a free trade agreement with the EU, the latter would insist that British exports to the continent met EU product standards. And Britain would only be given full access to EU financial services markets if it matched EU rules. As access to the single market is of critical importance, Britain might perversely be left in a position where it would have ‘EU regulation without representation’.

Indeed, outside the EU, the UK could end up with little control over financial rules. The EU insists that non-members’ regulations are equivalent to their own, in return for limited access to the single market. The City of London – the eurozone’s largest wholesale financial centre – would be unlikely to enjoy unfettered access to eurozone financial markets if it were outside the Union. Eurozone authorities prefer wholesale activities – trading and lending between banks, rather than between banks and customers – to be conducted under their watch. The British government has taken the European Central Bank to the European Court of Justice over its attempt to make clearing houses specialising in euro-denominated trading relocate to the eurozone. If it left the EU, and did not join the EEA, the UK would have little recourse to institutions that police the single market. Banks, exchanges and private-equity and hedge funds would relocate some of their activities to Frankfurt or Paris.

But does the EU not hold back Britain’s trade with non-European countries, by imposing tariffs on their goods, for example? The CER’s trade model offers no evidence that Britain imports less from outside the EU because of EU protectionism. Nor does the EU constrain exporters: Germany’s exports to China have grown so rapidly that China is now its third largest trading partner after the rest of the EU and the US. And as multilateral trade negotiations have broken down, bilateral ‘free trade’ agreements have grown in importance. In such agreements, economic size matters: it is difficult to imagine the US contemplating such a far-reaching agreement as the Transatlantic Trade and Investment Partnership, a major EU-US trade deal that is currently under negotiation, with Britain alone.

Fiscal gains?

Ending Britain’s contribution to the EU budget is the most easily quantified benefit from leaving the Union. However, the same
trade-off applies: the EU insists that the price of unfettered market access is a fiscal contribution to the EU. EEA members and Switzerland help to fund the economic development of the poorer eastern half of the Union, by paying for infrastructure, R&D and training projects. If the UK were to pay into the EU budget upon the same basis as the Norwegians or the Swiss, its net contribution would fall by 9 per cent or 55 per cent respectively.

By quitting the EU, the UK could also leave the Common Agricultural Policy, which through its tariffs and subsidies drives up the cost of food for British consumers. But it would find it difficult to slash agricultural subsidies to zero. Wales and Northern Ireland are net beneficiaries of the EU budget. Their economies, particularly in rural areas, would
suffer from the loss of agricultural subsidies and regional development funds, and the British government would have to make up at least some of the shortfall.

Free migration is a benefit for Britain

Alongside frustration at regulation from ‘Brussels’, high levels of immigration from Central and Eastern Europe are the other main cause of British dissatisfaction with EU membership. Many fear that Central and East Europeans are damaging the employment prospects of low-skilled Britons and driving down wages. There is very little evidence that this is the case. And many Britons forget that there are many high-skilled European immigrants in the UK, who raise British workers’ productivity and hence their wages. But academic research shows that the combined impact of high- and low-skilled immigrants on British wages is small, and so immigration from the EU does not constitute a major reason to stay or to leave.

However, EU immigration is good for the public finances, as immigrants pay more in taxes than they receive in public spending. There are some costs that arise from higher demand for housing and public services. But current levels of immigration help Britain to deal with the costs of an ageing population, by replacing retiring workers, and by raising more taxes to pay for health and pension costs. Since hostility to immigration is pushing Britain towards the exit door, it is likely that the UK would restrict immigration from the EU upon exit. This would require Britain to increase taxes or cut spending.

Moreover, British people can live freely elsewhere in the EU, and this is a major benefit for the 1.8 million people who do so. The EU’s very large labour market gives Britons a bigger range of jobs to choose from. If their skills are in shorter supply in another member-state than they are in the UK, their income may be higher than if they stay put. And the rest of the EU – particularly France and Spain – is a major destination for British retirees: over 400,000 are living in other EU member-states.

In short, the high degree of economic integration between the UK and the EU will always require some system of shared governance. The EU will not allow the UK, upon leaving, to have the same level of access that it now has without paying a price. Britain will not be able to leave the EU and remain in the single market, unless it is willing to sign up to EU rules that it did not help to write.