Public Finance Cost Benefit Analysis

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Barbara Powell
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1 Should the citizens of the United Kingdom vote to leave the European Union? On June 23rd 2016 the citizens of the United Kingdom are expected to vote on a long awaited referendum to decide upon Britain's membership status in the European Union. Opinion polls suggest the outcome of the referendum to be close, but a recent failure from the UK s Prime Minister David Cameron to deliver a good deal with the EU after days of negotiations in Brussels seems to have swayed many voters towards separation. The debate has made it clear that, while Brexit may potentially bring some medium and longer term moderate economic and political gains to the UK, the unintended consequences have proven to be too difficult to predict and hence the actual costs of separation could end up being surprisingly significant. Thus, at this point it is important to assess whether there is a less risky and more cost effective way for UK citizens to obtain the benefits they are looking for while avoiding the pricy and possibly irreversible breakup with the EU? Take for example the immigration crisis, which is the most pressing subject for those backing the leave vote specially now that 67,000 refugees have arrived to Europe since the start of this year adding themselves to the one million that disembarked last year. While trying to reduce immigration will probably relief pressures to an already depressed economy with high levels of unemployment, most analysts agree that policies restricting the size of the UK labor supply would bring large and immediate adverse impacts to the economy. Such policy would make the UK less competitive by raising wages and by discriminating against the sort of productive people who, in a world of increasing labor mobility, the UK might actually want to attract. Other unintended consequences of Brexit on immigration include the fact that the UK would no longer have a say on European migration policies and no right to help in policing the tunnel entrance in Calais, France, perhaps leaving more room for entry to the thousands of migrants that have already massed trying to reach its shores. Supporters of Brexit argue that the UK would not suffer economically since it would still be able to maintain an open market with the union, its biggest trading partner, and it would benefit from ending its support the EU s budget (about 3,000 per household per year). Even if this were the case, there are still many other political and economic uncertainties that may offset these benefits and thus need to be addressed as possible unintended consequences. In particular, there are capital flight concerns since the UK would probably create more regulatory tightness, obstacles and challenges for investors, and visa problems for tourists. Thus, Brexit would incentivize many companies to move their European headquarters to other countries meaning that it would be missing out on significant positive fiscal and tourism spillovers. Moreover, there is great concern with regards to the costs of the UK s own unity because Scottish Nationalists have expressed their determination to bring about another vote on Scottish independence in a process that would hurt the UK s own budget should it decide to leave the union. These uncertainties have already affected the value of the pound sterling which has slid in value as financial markets have already started to react to statements and speculation about a possible Brexit. These international finance considerations are very relevant because capital flight and exchange rate volatility have high influence over future expectations of domestic interest rates and because they increase the country s risk premium. Thus, UK citizens must appropriately adjust their cost benefit analysis to allow for a larger discount rate to truly evaluate the present value of what they consider will be the future gains of Brexit. Altogether it is very difficult to accurately determine whether EU membership offers greater or lower advantaged with regards to economic and national security specially because the cost side of the equation is not fully understood. What is true is that it seems unlikely that leaving the EU will definitely solve the UK s immigration and economic problems which are at the core of the debate. Unintended consequences may be so large so as to offset these benefits and increased risks will reduce the present discounted value of future benefits. Hence, when weighting the arguments concerning the more certain consequences of a hypothetical Brexit against the more speculative stakes, UK citizens may want to consider a careful scenario adjusted type of cost benefit analysis that has enough uncertainty so as to realistically evaluate short and long term economic, geopolitical, and social considerations.

2 REFERENCES (*MAIN ARTICLES IN BOLD) Booth, Steven (2015) What would Brexit mean for immigration? Brookings Panel (2014) BETTER IN THAN OUT? THE PROSPECTS FOR AN IMPLICATIONS OF BREXIT Washington, D.C. Friday, October 10, brexit/ _uk_eu_brexit_transcript.pdf Economist, The (2016) - A background guide to Brexit from the European Union. In graphics: Britain s referendum on EU membership. Feb 24th The Brexit delusion, The Economist Feb 27th The real danger of Brexit, The Economist Feb 27th Gross, Jenny., and Norman, Laurence (2016) Deal Paves Way for U.K. Vote on EU Membership, Wall Street Journal Feb. 19, Hughes, Kent (2016) Will the House of the European Union Fall? The Wilson Center Mensch, Louise (2016)Britain, Better Off Out of Europe Feb , NY Times OpEd New York Times (2016) - Everyone Loses if Britain Exits the E.U. Editorial Board February 4, Leaving the E.U. Would Hurt Britain s Economy, Editorial Board March 6, Worstall, Tim (2016) Brexit, UK Financial Markets And The Efficient Markets Hypothesis, Forbes: Opinion, February 22, APPENDIX 1 Britain, Better Off Out of Europe

3 By LOUISE MENSCHFEB. 11, 2016 Brexit, the shorthand term for a British exit from the European Union, is finally on the table. For many of my compatriots, the idea is not a negative one; indeed, an escape from the ever greater encroachment of the European superstate on our national sovereignty is a goal we have devoutly wished for since Prime Minister John Major signed the Maastricht Treaty back in Today, at last, we are positively giddy at the thought of freedom. The Conservative prime minister, David Cameron, is delivering on his election promise of a referendum on membership in the union, with a vote due by the end of It will probably be held sooner, in June or September. Mr. Cameron would prefer Britain to stay in the union. Polls indicate that he is likely to be disappointed. Earlier this month, he returned from Brussels with a package of proposals so weak that Britain s newspapers united against it. His so-called brake on welfare benefits for European immigrants, for example, would require the agreement of other countries, would not be applied for more than a year and would eventually be phased out. Mr. Cameron also failed in his attempt to prevent child benefits being sent abroad for workers in Britain with dependents elsewhere in Europe. After these terms were announced, the pro-exit camp s lead in polls soared to nine points. One recent survey of Conservative Party members found that more than 70 percent supported Brexit. The European summit meeting next week could be Mr. Cameron s last chance to improve his deal. But with the president of the European Parliament, Martin Schulz, touring Britain and helpfully telling us that he would reverse any British gains, Mr. Cameron s prospects are not promising. The mood of the country, though, is optimistic. An amicable divorce, many consider, is better than a bad marriage. Brexit campaigners are excited by the possibilities of an independent future in the world. We believe that this vision is better not just for Britain, but also for our European allies. Sign Up for the Opinion Today Newsletter Every weekday, get thought-provoking commentary from Op-Ed columnists, The Times editorial board and contributing writers from around the world. First, the cash. Britain sends about 55 million, or about $80 million, per day to Brussels. To place that in context, Daniel Hannan, a Conservative member of the European Parliament, calculated that all the austerity cuts that the chancellor of the Exchequer, George Osborne, made during the last Parliament, amounted to 36 billion, while Britain s contribution to the European Union in the same period was 87 billion. Mr. Osborne could reverse every cut in public spending and still pay the deficit down faster if Britain were outside the European Union. Of course, it is not quite that simple. The European Union returns some of that money through spending in Britain, though not nearly the amount it takes out. In 2015, Britain s net contribution was 8.5 billion; in 2016, it is forecast to top 11 billion. If we ended these payments, we could end our austerity measures. The second issue is the wave of illegal immigrants effectively invited into Europe by Germany s chancellor, Angela Merkel. A growing proportion of Britons believes their country should accept fewer refugees; Turkey, where a majority of these migrants have come from, is already a safe destination. We also note that many are young men, of fighting age, who appear to have abandoned their families; the recent sexual assaults on women in Cologne, Germany, by marauding groups of migrants have confirmed the fears of many in Britain. With no curbs on the free movement of migrants under Europe s Schengen Agreement, British voters expect a wave of unwanted immigration once these migrants are given asylum elsewhere in Europe. We are unwilling to close our eyes to this, and we want our borders back.

4 Brexit was never a left-right issue. In the 1970s and 80s, it was supported by both Margaret Thatcher and the leftwing politician Tony Benn. The Labour member of Parliament Kate Hoey told me she believes the European Union stands for big business and tramples down British workers wages even as it exploits Eastern European ones. Ms. Hoey s view is supported by the left-wing labor union R.M.T. The fact that Conservative budget cuts are dwarfed by payments to the European Union is also not lost on liberal voters. On the right, Conservative cabinet ministers likely to lead the out campaign are the business secretary, Sajid Javid, son of a bus driver from Pakistan, and Priti Patel, the employment minister, daughter of Indian immigrants from Uganda (they became shopkeepers, as Mrs. Thatcher s parents were). Facing such campaigners, the bien-pensant pro-european left will have a hard time stigmatizing the Brexit coalition as anti-business Little Englanders. The case for leaving the union is, indeed, a positive one. Britain is the world s fifth largest economy, with deep cultural and economic ties to the English-speaking world. We are not anti-immigrant; rather, we wish to manage our own immigration policy. We are pro-free trade, and as the European Union s chief export market, we will not need to pay for access to its markets; and we want more freedom to trade with India, China and the rest of the world. The pro-european camp used to tell us that joining the euro was a good idea, and that to stay outside presaged disaster; instead, we ve seen a meltdown in Greece. The sky did not fall in Britain because we kept the pound and prospered. We do not plan to cut off our European allies. Britain s treaty with Portugal is the oldest formal alliance in the world. Post-Brexit, we would continue to trade with our European friends as we have for a thousand years. The European Union, however, is a relic of the 70s about as relevant as bell-bottom jeans. Indeed, the last time Britons were consulted on membership was 1975, when I was 4 years old. Europe is our past and future. We don t want to leave the Continent, just a failing bureaucracy. APPENDIX 2 The Economist: A background guide to Brexit from the European Union ON FEBRUARY 20th David Cameron, Britain's prime minister, set June 23rd as the date for a referendum on the country s membership of the European Union. His announcement followed a protracted renegotiation of the current conditions of Britain s membership at a summit in Brussels. The move immediately prompted government ministers to declare their backing for either the remain or leave campaigns. Mr Cameron strongly believes in the benefits of continued EU membership, but a handful of high-profile MPs, including justice secretary, Michael Gove, and London's mayor Boris Johnson, have pledged support for the out campaigners. In early 2015 the chances of Brexit Britain departing from the European Union seemed remote. Today, largely because of Europe s migration crisis and the interminable euro mess, the polls have narrowed. Some recent surveys even find a majority of Britons wanting to leave.

have constantly hassled him to adopt a tougher line with Brussels. His response has generally been to appease them.

5 Mr Cameron is himself partly responsible. Although he has repeatedly urged his party to stop banging on about Europe, his Eurosceptic backbenchers, scared witless by the rise of Nigel Farage s virulently anti-eu UK Independence Party (UKIP), have constantly hassled him to adopt a tougher line with Brussels. His response has generally been to appease them. One early morsel he threw them was the 2011 European Union Act, which requires any EU-wide treaty that passes substantive new powers to Brussels to be put to a British referendum. That sounded like a big concession, but no new treaties were then in prospect. In January 2013, Mr Cameron promised that, if the Tories were re-elected in May 2015, he would renegotiate Britain s membership and hold an in-out referendum by the end of Following his election victory in May 2015, the prime minister claimed to have embarked on a renegotiation to fix what he says is wrong with the EU. Yet he was deliberately vague about what changes he wants, partly for fear that if his shopping list leaks Eurosceptics in his own party will rubbish it as inadequate. At the European summit on October 15th-16th, however, he was told by his fellow heads of government to produce a list of precise demands in November if there was to be any chance of the negotiations being concluded, as he at one time hoped, at the December European summit. He did produce a list of demands but a deal still eludes him. The prime minister is now hopeful of getting an agreement by the end of February. The two campaigns, "Britain Stronger in Europe" and "Vote Leave", that are likely to form the offical lobby groups for each side in the referendum have set out their positions on the main topics that will form the basis

Concerns about the Commonwealth, the welfare state and sovereignty led it to miss the boat at the Messina conference in 1955, when the ECSC countries decided to form the European Economic Community,

6 for the referendum (see table). Britain s uneasy relationship with the European Union has a long history. In 1950 only 10% of Britain s exports went to the six countries that formed the European Coal and Steel Community (ECSC). Concerns about the Commonwealth, the welfare state and sovereignty led it to miss the boat at the Messina conference in 1955, when the ECSC countries decided to form the European Economic Community, the precursor of today s EU. Instead, in 1960 Britain cajoled six much smaller European countries into forming the European Free-Trade Association (EFTA). But in 1961 a Tory government under Harold Macmillan, impressed by the EEC s superior economic performance, decided to submit the first of several British applications to join. Britain eventually joined in 1973 under Edward Heath. 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, and close to 45% if

7 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, a London-based 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 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. 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.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. 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. What are the options if Britain decided to leave the EU? Most of the alternatives to full membership are unattainable, unappealing or both. The EU will not disappear as an institution or a big market. A post-brexit Britain will have to form a set of trading and institutional relationships with it. The uncertainty is over what these would be and how long they might take to negotiate. Broadly, there are five models to choose from. The first is to join the European Economic Area, a solution adopted by all but one of the EFTA states that did not join the EU. But the EEA now consists of just one small country, Norway, and two tiddlers, Iceland and Liechtenstein. The second option is to try to emulate

8 Switzerland, the remaining EFTA country. It is not in the EEA but instead has a string of over 20 major and 100 minor bilateral agreements with the EU. The third is to seek to establish a customs union with the EU, as Turkey has done, or at least to strike a deep and comprehensive free-trade agreement. The fourth is simply to rely on normal World Trade Organisation (WTO) rules for access to the EU market. The fifth, preferred by most Eurosceptics, is to negotiate a special deal for Britain alone that retains free trade with the EU but avoids the disadvantages of the other models, but it would be extremly hard or even impossible to negotiate this in an atmosphere, post-brexit, that would hardly be a warm one. In fact Britain has influenced the EU for the better. The European project it joined in 1973 had obvious flaws: ludicrously expensive farm and fisheries policies, a budget designed to cost Britain more than any other country, no single market and only nine members. Thanks partly to British political clout, the EU now has less wasteful agricultural and fisheries policies, a budget to which Britain is a middling net contributor, a liberal single market, a commitment to freer trade and 28 members. Like any club, it needs reform. But the worst way to effect change is to loiter by the exit.

The EU debate #1: Identity

The EU debate #1: Identity Q: Britain is a European nation. A: Geography has given Britain a shared cultural history with continental Europe. From the Roman Empire, to the Renaissance, and now through