Should the UK leave the EU? An analysis of the possible economic consequences of a Brexit Gianluigi Vernasca University of Essex Professorial Inaugural Lecture February 2016 Gianluigi Vernasca (University of Essex) Should the UK leave the EU? Professorial Inaugural Lecture February 2016 / 20
Introduction I The UK Conservative government is proposing a referendum on the UK membership to EU Huge political debate but little economic analysis so far What UK wants from EU (main economic aspects): (a) Restrict in-work and out-of-work benefits to EU migrants Reduce immigration from EU into UK (b) Protect UK markets from possible EU "excessive" regulation More independence on internal businesses (c) Reduce the UK contribution to the EU budget Opportunity cost The referendum can be viewed as a "credible threat" that can affect the bargaining power of UK vs EU in future negotiations on the points above. David Cameron (Nov 2015): UK may leave the EU if "his demands for EU reforms are met with a deaf hear"
Introduction II Arguments in favour of a "Brexit" (a) Trade: UK will still trade with EU and can increase trade with non-eu countries (b) Regulation: less regulation from EU will benefit UK businesses, especially the financial sector (City) (c) Immigration: reducing immigrants from EU will benefit UK workers (d) Fiscal impact: saving on the contribution to EU budget can be used to improve the UK economy We discuss each of those arguments Focusing on possible benefits and costs If possible costs of Brexit are higher than possible benefits UK should remain a EU member
Introduction III Finding "good" numerical values for possible costs and benefits is quite challening Example: (a) According to Minford et al. (2005): UK can gain between 3.2-3.7% of GDP by leaving EU (b) According to Ottaviano et al. (2015): UK can lose up to 3% of GDP by leaving EU Same question but very different answers
Trade UK is EU member since 1973 The EU is the largest trade partner of UK Total Trade (exports + imports) with UK Share of Total Trade Share of UK GDP 2014 2014 Germany 13.0 5.7 US 9.3 4.1 Netherlands 7.8 3.5 China 7.1 3.2 EU 53.0 23.0 Source: ONS and IMF World Economic Outlook 2015 53% of UK trade is with the EU. This accounts for 23% of the UK Real GDP (Rotterdam effect not relevant) In 2014 the UK had a Current Account deficit of 6% of Real GDP UK imports more than exports UK residents live above their means
The Trade Benefits of EU Single Market The EU Single Market reduces barriers to trade and improve competition among members Comparative advantages and reduction in prices faced by consumers Enhance effi ciency, economic growth and welfare CER report (2014) found that Britain s EU membership increased its trade with other EU members by 55% Greater economic integration between UK and EU Baldiger (2007) found that marks-up in the EU manufacturing industries decreased because of the EU Single Market Higher competition Lower prices
The Benefits of FDI Foreign Direct Investments (FDI) are commonly associated with movement of skilled labour and technological progress (R&D) Higher FDI Higher future economic growth In 1997 (FDI) from EU accounted for 30% of all FDI in UK. In 2012 that increased by 50% EU membership appears positively correlated with FDI in UK UK is currently the second largest receiver of FDIs after US Largest foreign investors in UK for FDIs: Australia, France, Canada, US and Russia Why? According to UCTAD (2010): main determinant of FDI is the local market size UK is attractive for FDIs because it provides access to the large EU market
Brexit and Trade I It seems that UK benefits in terms of trade and FDI from EU membership Brexit can have a negative impact on both (a) While tariffs may not increase, Technical Barriers (regulations and standards) will have an impact, especially for the financial services (UK comparative advantage) UK trade decreases (b) Higher technical barriers, more diffi cult for UK firms to trade with EU UK FDI decreases Pain and Young (2004) estimate that a Brexit can have an impact on FDI that can cost up to 2% of GDP in the long-run
Brexit and Trade II In the event of a Brexit can UK compensate with higher trade with emerging non-eu countries? Unlikely For example, Germany and France trade more with China than UK Being part of EU does not constraint trading with emerging markets Some suggested that UK can benefit from Brexit because UK is currently running a trade deficit with EU If the aim of Brexit is reducing imports then UK residents are clearly worse-off Overall: the costs of Brexit, in terms of trade, seem larger than the benefits
Immigration and UK Economy I The free movement of people is a fundamental principle of the EU single market Does immigration from EU hurts the UK economy? Migration is like trade: people move towards countries where they can be more productive (higher income) Welfare of the receiving country increases Giovanni et al. (2014) shows that the loss of restricting migration (independently of the countries of origin) can be up to 1.5% of the GDP of the receiving country The Migration Advisory Committee (2012) found no significant relationship between immigration and UK unemployment between 1975 and 2010
Immigration and UK Economy II Dustmann et al. (2013) found that immigration in UK has little effect on the average wage of UK-born workers: low-wage UK workers lose but high-wage UK workers gain Immigration can increase income inequality Since 2004, UK experienced an increasing influx of migrants from newly accessed EU countries (Latvia, Poland, Czech Republic, etc. etc.) Workers from those countries in UK low-skilled jobs (construction and services) However, using this evidence to suggest that EU immigration has a negative impact on UK workers is misleading It does not take into account immigration of high-skill workers that has a positive impact Dustmann et al. (2014) found that the fiscal impact of EU immigrants on UK is positive EU workers contribute more to the UK economy in tax revenues than they receive in benefits
Immigration and UK Economy III The number of EU claimants in Feb 2013 was 2.3%. In Feb 2015 was 2.0%
Brexit and Immigration Brexit can reduce immigration from EU Evidence suggests that UK will not gain by restricting EU immigration Dustmann et al. (2014) found that non-eu immigration has a negative fiscal impact on UK UK baby boomers is on the verge of retirement Labour demand in UK will need foreign workers Substituting EU migration with non-eu migration can have a negative impact on UK fiscal budget Overall: the costs of Brexit, in terms of reducing immigration, seem larger than the benefits
Regulation and UK Economy Is EU regulation a burden for the UK economy? The OECD data shows that in 2013 (a) The Netherlands has the lowest product regulation in the OECD. UK is the second less regulated country (b) Netherlands and Belgium have lower barriers to entrepreneurship than UK (c) Labour market regulation in UK is lower than in EU countries Being part of the EU (as Netherlands and Belgium are) does not seem to increase regulation burden Overall the UK has already relatively low regulated markets Leaving EU cannot improve much on this aspect
Brexit and Regulation Some EU regulation imposes more costs than benefits to UK businesses (e.g. Agency Working Directive) Brexit will improve by little UK deregulation UK has already low regulation Common regulations and standards are necessary for Single Market trade. Under Brexit the UK will still face EU regulation to trade with EU countries but without influencing the decision process Overall: the costs of Brexit, in terms of reducing regulation, seem larger than the benefits
Fiscal Impact of EU Membership UK is currently a net contributor to the EU Budget since 1973 UK pays more than it receives from EU
Fiscal Impact of EU Membership II Current net contribution is around 0.4% of GDP. Between 2014 and 2020 it is estimated to be between 0.4% and 0.6% Assessing the effects on UK economy of this contribution is not straightforward First: part of the EU Budget is used to subsidies EU farmers (Common Agricultural Policy (CAP)). This in turns increases the prices of agricultural products that UK imports from EU This reduces UK residents welfare Second: part of the EU Budget is used as Structural Funds to improve economic development of EU poorest regions Structural funds may increase UK residents welfare in the regions affected
Brexit and Fiscal Impact on UK Brexit implies that UK saves around 0.5% of GDP every year This is a potential benefit from Brexit The prices of agricultural products imported from EU could also be decreased further by abolishing tariffs on those imports This is another potential benefit from Brexit However Wales and Northern Ireland are net receivers from EU Budget under the CAP. The UK government will still need to provide subsidies to the farmers located there The UK government must replace some of the Structural Funds from EU with national funding Overall: the benefits of Brexit, in terms of fiscal impact on UK, may be larger than the costs
Brexit Options The costs and benefits of Brexit will depend on what arrangement will be in place between UK and EU Several arrangements are possible: (a) Norwegian style EEA (European Economic Area): UK still accesses the EU Single Market but must adopt EU standards and regulation with no influence over those. UK still contributes to EU budget and cannot impose immigration restrictions on EU citizens (b) Bilateral Agreements as Switzerland: UK and EU agree a set of bilateral agreements to access the EU Single Market in specific markets. In the sectors covered by the agreements the UK must follow EU regulation and standards (c) MFN case: UK operates under the WTO rules. No need to agree on common standards and regulation with EU. UK will face EU external tariffs which will decrease UK trade with EU
Conclusion It is crucial that the UK political debate over EU membership is based on objective economic analysis All the evidence suggests that the economic costs of Brexit are larger than the economic benefits The costs in terms of trade and FDI reduction offset the possible gain from saving on the EU budget Independently of the possible arrangements between UK and EU after a Brexit, it appears that in all cases UK will lose from leaving EU The opportunity cost is too high This does not mean that EU institutions should not be reformed to improve EU economic growth and stability Cameron (January 2016): "Brexit is not the best answer. The best answer is for Britain to stay in a reformed EU"