19 April 2016

The Brexit fantasy would lead to a messy divorce

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You can quibble with the numbers. You always can. But the impact of leaving the European Union is clear: it would make Britain poorer.

You don’t need to take the Treasury’s word for it. (And no, they didn’t support joining the euro, so Vote Leave can’t tar them with that brush.) It’s the conclusion of study after study, by highly respected independent economists such as those at the London School of Economics’ Centre for Economic Performance, as well as by expert international organisations, notably the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD).

Indeed, you don’t even need a formal econometric model to work out that Brexit would make us worse off. Simple logic will do. In the near term, leaving the EU would be a huge disruption and that uncertainty would at the very least dampen investment and growth. Longer term, Brexit would impede trade and lower foreign investment, stunting competition, productivity growth and living standards. Those losses dwarf saving the 26 pence a day each that are our net contribution to the EU budget or the likely benefits of deregulating Britain’s labour and product markets, which are already among the freest in the world.

To claim otherwise, Brexiteers deploy two sleights of hand. Since nobody thinks that uncertainty is good for the economy, they claim the disruption would be minimal: still a cost, but a small one. And since all the plausible alternatives to EU membership would make us worse off, they resort to the fantasy that Britain could keep all the benefits of the single market without paying into the EU budget or accepting freedom of movement, while also concluding more and better trade deals with the rest of the world. Dream on.

That Brexit would cause massive uncertainty is undeniable. Businesses are already putting their investment plans on hold, while the pound’s trade-weighted exchange rate is down by 6.3% so far this year. Since Vote Leave won’t even come clean about what their preferred alternative to EU membership is, the notion that in the post-referendum political chaos Britain could readily reach this undefined Utopia is fanciful. And aren’t they always insisting on how slow and resistant to change the EU is?

Leaving the EU would condemn the UK to years of crippling uncertainty. When Greenland got its independence from Denmark and left the EU, the negotiations took three years even though there was only one bone of contention: fish. Agreeing the EU-Canada free-trade deal has taken seven years and it still hasn’t been ratified. Disentangling Britain from the EU would be even more complex. Since companies wouldn’t know the terms on which they would be able to trade with the EU and the rest of the world in future, let alone how domestic regulations would evolve, they would surely delay and cancel investment and put employment decisions on hold.

To make matters worse, Britain’s economy is bankrolled by flighty foreigners who could easily take fright. Last year the UK borrowed a net £96.2 billion from the rest of the world, with the current-account deficit soaring to a peacetime record-high of 7% of GDP in the fourth quarter. Since domestic savings fall short of domestic investment, Britain relies on the “kindness of strangers”, as the governor of the Bank of England, Mark Carney, put it, to fill the gap. If foreign investors, who are motivated by financial returns not friendship, stopped lending and tried to pull their money out of Britain all at once, such a sudden stop would sink the economy into recession. If, more plausibly, outside investors simply demanded better terms to compensate for the increased risks of putting money in Britain, the pound would plunge and the risk premium on UK assets rise, as an excellent report by Absolute Strategy Research, one of the top research firms in the City of London, points out.

On top of the disruption of a messy divorce, Britain would suffer enduring damage by separating from the huge, wealthy market on its doorstep. Not only would trade with the EU be less free, Britain’s access to other export markets would be worse too.

The closest economic relationship with the EU that Britain could hope for is membership of the European Economic Area (EEA), along with Norway, Iceland and Liechtenstein. While Britain would retain access to the single market, trade would be disrupted by customs checks, rules-of-origin requirements and anti-dumping duties on British exports that EU authorities deem too cheap. Economically, then, Britain would be worse off. And politically, the Norwegian option would be disastrous. The UK would have no say in setting single-market rules that it would have to accept wholesale. It would have to pay into the EU budget without getting any spending in return. And it would be forced to accept two-way freedom of movement. In other words, Vote Leave, Lose Control.

The least-binding relationship with the EU would be to trade on the basis of World Trade Organisation (WTO) rules, as the US and China do. I love the WTO. I was once special adviser to its director-general. It would be fantastic if there were global free trade in goods and services under its auspices. But unfortunately, there isn’t. Trading with the EU on the basis of WTO rules would entail a 10% import duty on British car exports. It would mean financial institutions in Britain losing their passport to export financial services freely to the EU. Loss of access to the single market would also lower foreign investment, amplifying the damage. Britain would, though, gain the freedom to shoot itself in the foot by keeping out hard-working, tax-paying Polish and other EU migrants, which would entail Britons losing the right to live, work and retire in cloudy Germany or sunny Spain. That would make us poorer too.

Since neither of those alternatives is attractive, Brexiteers posit a third: the have-your-cake-and-eat-it option. They claim that in a new deal the EU would give Britain everything it wants because the UK buys more from the EU than it does from us, free trade is mutually advantageous, and the EU would want friendly relations with Britain.

Get real. The US also buys more from the EU than it does from them. But has that given Washington carte blanche in the Transatlantic Trade and Investment Partnership (TTIP) negotiations with the EU? Hardly. Moreover, exports to Britain account for only 3% of the rest of the EU’s GDP, while the UK’s exports to the EU amount to 13% of GDP. Clearly, the 27-strong EU would have the whip hand.

Ideally, all countries would realise that free trade was in their interests and adopt it unilaterally. But in the real world, governments are often captured by protectionist special interests. Would Germany’s car industry love to see trade barriers against British-made cars? You bet. Does Berlin generally bow to Volkswagen, Mercedes Benz and BMW? Ja natürlich. Would French farmers like to keep out low-cost British food produced in devalued pounds and “dumped” in the EU? Mais oui, bien sûr. Would Frankfurt, Paris, Luxembourg, Dublin and others like to get a piece of London’s financial-services business? Obviously. A key advantage of EU membership is that it protects us against such protectionist demands.

Brexiteers keep telling us that the EU imposes all sorts of terrible things on us. Yet they claim that if we left, the EU would suddenly roll over and give us everything we want. Really? The likes of Wolfgang Schäuble, Germany’s finance minister, are no pussycats – and if Britain provoked an economic and political crisis by leaving, EU governments would surely get their claws out. Above all, they would want to deter other governments from following Britain’s lead and to dent the electoral fortunes of anti-EU parties like France’s far-right National Front.

The claim that Britain could negotiate better trade deals with the rest of the world outside the EU is equally deluded. Post-Brexit, Britain would lose the benefits of the 50-plus deals the EU has negotiated and have to start from scratch. UK markets are generally open, so it would have few mercantilist bargaining chips. Its economy is much smaller than the EU’s so it would have much less clout. And it would be desperate for deals and so lack leverage.

Yes, Iceland and Switzerland have a free-trade agreement with China and the EU doesn’t yet. If UK negotiators were willing to offer the Chinese whatever they want while demanding nothing in return, Beijing might indeed sign on the dotted line. But if Britain had its own objectives – such as better access to China’s burgeoning market for financial services – a deal would prove much tougher. And if, as Boris Johnson recently suggested, Britain wanted to slap punitive anti-dumping duties on Chinese steel imports, it can expect a big fist, not a handshake.

As for the US government, it says it isn’t interested in a free-trade deal at the moment. The US has bigger fish to fry, such as the Trans-Pacific Partnership with eleven Pacific economies and the TTIP. Indeed, with the protectionist demands stirred up by Donald Trump and Bernie Sanders and echoed by Hillary Clinton, the next president and Congress are unlikely to be in a liberalising mood.

On the plus side, there may be benefits from reduced regulation outside the EU. But they aren’t huge. Britain already has the least-regulated labour market in the EU and the second-least regulated product markets, according to the OECD. Britain’s biggest regulatory burden is due to its extremely stringent planning regulations, which have nothing to do with the EU.

Vote Leave should be honest with voters: leaving the EU would make Britain poorer. By all means, try to persuade the British people that Brexit is a price worth paying. But don’t pretend it would be a free lunch.

Philippe Legrain, who was economic adviser to the President of the European Commission from 2011 to 2014, is a visiting senior fellow at the London School of Economics’ European Institute and the author of European Spring: Why Our Economies and Politics Are in a Mess — and How to Put Them Right.