Brexit: Are we better off In or Out of the EU?

Brexit: Are we better off In or Out of the EU?

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In or Out of the EU?

It must be stated upfront that it is very difficult to quantify the impact of an ‘out’ decision both in the short run and over a longer period. below are some possible scenarios based on how people tend to behave during periods of significant change, but first some background:

Article 50 of the Lisbon Treaty provides that the EU will negotiate a new agreement with any withdrawing country over two years. This can be extended but only by unanimous agreement from the remaining members. The withdrawing country has no say at all on the terms and conditions of exit.

The EU electorate are currently disillusioned with Brussels, evidenced by voters supporting the rise of nationalist parties in France, Germany, Italy and the Netherlands. It is likely the EU will be desperate to show that a decision to leave is painful so as to discourage others.

The dominant issue for the UK is how to maintain access to the world’s biggest market if no longer in the club. There has been a lot of comment on the Canadian Trade deal. Here are some of the details.

Canada has just completed a free trade deal with the EU but as yet it has not been ratified by the EU Parliament. It took 7 years to negotiate. Canadian negotiators sought to have EU tariffs eliminated for export industries in which Canada has a comparative advantage: forest products, information technology, chemical and plastic products, automobiles and certain agricultural sectors (pork, beef, seafood).. The immediate elimination of 98% of all EU tariffs (both industrial and agricultural), and almost all tariffs within seven years, should help Canada decrease its declining net export trade with the EU.

Canadian goods will also benefit from non-tariff barriers on the basis of the requirement to be accorded national treatment within the EU – meaning that they should be treated equally to local goods on regulatory issues applicable both at the border and once imported into the EU territory.

The EU pushed for strict rules of origin so as to prevent the deal becoming a way for U.S. exporters to indirectly access the European market. Although the details are not finalized, it appears that the EU has actually conceded to be more flexible on this. With respect to automobile exports, Canadian cars eligible for the tariff benefit will be required to have 50% Canadian content for the first seven years and 55% Canadian content once tariffs drop to zero. Canada was also able to secure what is effectively a waiver of EU rules of origin for up to 100,000 automobiles per year. In turn, Canada has agreed to recognise a list of 17 EU car standards as comparable to its own, with a commitment to further harmonisation of standards in the future.

The World Trade Organisation (formerly GATT)

The EU speaks with one voice in the WTO. Every EU country is a WTO member in their own right but work together to act as a single bloc. The EU itself is also a member.

The European Commission negotiates at the World Trade Organisation on behalf of the EU. The Commission coordinates with the EU Member States through the Trade Policy Committee and conducts EU policy following guidelines set down by the Member States in the Council of Ministers.

The Commission also regularly informs the European Parliament of key WTO issues. When an agreement is negotiated at the WTO, the Commission needs the formal authorisation of the Council and European Parliament to sign the agreement on behalf of the EU.

Currently the EU has trade agreements with 53 countries, covering 45% of world trade, and is actively negotiating with China, India and the USA.

A key consideration is how the UK would maintain access to these markets if we left the EU. If we leave, all these existing EU-negotiated arrangements would lapse. We cannot be sure of the impact but it will be disruptive, it may result in higher prices, it may reduce market access.

Below are some alternative models of engagement with the EU.

The Norwegian Model

Norway has full access to the single market through their membership of the European Economic Area. They are obliged to observe all EU regulations, to make payments to the EU budget (currently around 90% of Britain’s net payment per head). They have to abide by the four freedoms of goods, services, capital and labour. Consequently there are 13 EU workers per 1000 in Norway, compared to 2.7 in the UK. The total immigrant population in Norway is 15.6%. It is 11.9% in the UK.

The Swiss Model

Switzerland is not in the EEA. It has negotiated bilateral agreements which give it access to EU goods markets but only a few services. It has to abide by single market rules, contribute to the EU budget and accept the free movement of people. The Swiss have 7 EU workers per 1000, and 24% of its population are foreigners. In February 2014, 50.3% of the Swiss voted to limit mass migration. The EU has warned the Swiss that banning EU workers will result in the end of their trade agreement.

The Main Brexit Arguments

Britain is the fifth largest economy in the world. In 2014 we purchased £288 Bn worth of mostly goods from the EU. We sold them £227 Bn worth. Both sides have a vested interest in a trade deal. But this is unlikely to cover services, where we have a comparative advantage, so the numbers suggest they need us more than we need them. This is a false assertion. Britain accounts for 10% of EU exports, but the EU accounts for 46% of Britain’s. Britains’ biggest trade deficit is with Germany and Spain. Any trade agreement must be endorsed by all 27 members.

Argument 1: If Britain leaves, new trade deals could be struck quickly and easily.

This might be possible but the newly formed ASEAN group are more likely to negotiate with 500m potential consumers than 64m. If the negotiators represent 500m they have much more bargaining power than 64m.

The ASEAN members agreed this year to a single market which will ensure the free flow of goods, services, investment, and skilled labour. The members are Myanmar, Laos, Thailand, Cambodia, Malaysia, Singapore, Indonesia and the Philippines.

Argument 2: If Britain leaves the EU, the red tape which strangles UK businesses will disappear:

The OECD reports that the UK is one of the most lightly regulated product and labour market economies. The rules and regulations which cause the biggest problems are all home grown, e.g. planning, environmental and the living wage. We would have to untangle 1200 separate EU regulations which are integrated into UK law. This would take at least ten years.The lawyers will love it!

To trade with the EU we would still have to conform to all their technical standards (which are now being steadily adopted by the rest of the world).

Argument 3: If Britain leaves the EU, the free movement of people can be stopped and we can regain control of our borders.

In 2014, 91.6% of the British were from Britain, 4.6% were from the EU, and 3.8% from the rest of the world. Net migration in 2014 was 339,000, of which 201,000 were from the EU and 138,000 from the rest of the world. 25% of immigrants came from the Commonwealth.

The free movement of people is a key tenet of the EU. It is likely that full access to the EU market will not be granted if we limit movement (as per the Norwegian model). And government income will fall because studies both by Government and independent firms show that EU immigrants are net contributors to the Exchequer.

Additionally the NHS will face even greater shortages of key workers and our care homes will also face recruitment problems. Today there are sufficient vacancies for every unemployed person. Unemployment is 760,000. Britain is at full employment. The only way to solve this problem is to immediately raise the retirement age to 70 and make the British work longer.

How Eurosceptic are the Europeans?

Below are the results of previous EU referendums. The results imply that the French, the Dutch, the Danes and the Irish are not particularly inclined towards ever closer union, nor do they like the Euro very much. One can guess that if the Germans were allowed a referendum the results would be similar. The evidence suggests that the UK is not a lone voice against ever closer union and some of the apparent excesses of the system.

1992 Denmark 50.7% against Maastrict
1992 France 51.1% for Maastrict
1992 Switzerland 50.3% against EEA membership
2000 Denmark 53.2% against joining the Euro
2001 Ireland 53.9% against the Treaty of Nice
2003 Sweden 56.1% against joining the Euro
2005 France 54.9% against an EU constitution (which would have reduced sovereignty and demanded ever closer union)
2005 Netherlands 61.5% against the EU constitution
2008 Ireland 53.2% against the Treaty of Lisbon

NB the Irish were told to vote again in 2001 and 2008, and both results were reversed!

How Undemocratic is the EU?

The European Parliament is the second largest in the world with 751 members. Britain has 73 members. The elections are every 5 years and there are about 390m eligible voters.

Legislation can be initiated by the Commission (the civil service), the Council of Ministers (one from each member country), and the Parliament. The European Parliament used to be an expensive talking shop with limited powers, but successive treaties have made it one of the most powerful legislatures in the world. Its power now equals that of the Council of Ministers, which can initiate legislation using qualified majority voting for some types, but requires unanimous agreement for others. It then has to be ratified by the Parliament.

The Commission can present a proposal to Parliament and the Council which will only become law if both agree on a text, which they do (or not) through successive readings up to a maximum of three.

In its first reading, Parliament may send amendments to the Council which can either adopt the text with those amendments or send back a “common position”. That position may either be approved by Parliament, or it may reject the text by an absolute majority, causing it to fail, or it may adopt further amendments, also by an absolute majority. If the Council does not approve these, then a “Conciliation Committee” is formed.

The Committee is composed of the Council members plus an equal number of MEPs who seek to agree a compromise. Once a position is agreed, it has to be approved by Parliament, by a simple majority. This is also aided by Parliament’s mandate as the only directly democratic institution, which gives it greater control over legislation.

It is false therefore to describe the current arrangements as undemocratic. It is true only to say the British electorate choose not to exercise their democratic right: In 2014 only 35% turned out and voted. The EU average was 42%

EU Law

The doctrine of the supremacy (sometimes referred to as primacy) is a principle which states that when there is conflict between European law and the law of Member States, European law prevails; the norms of national law have to be set aside. This principle was developed by the European Court of Justice and, as interpreted by that court, it means that any norms of European law always take precedence over any norms of national law, including the constitutions of member states.

Although national courts generally accept the principle in practice, most of them disagree with this extreme interpretation and reserve the right, in principle, to review the constitutionality of European law under national constitutional law. The UK tends to accept the principle, some other countries less so.

EU Regulations become part of national law as soon as they’re passed by the European Parliament but EU countries must pass their own laws to put directives into practice. The UK has a reputation for copper plating directives and embodying them in UK law, some other countries view the directives in a more advisory capacity. Either way, the UK does not need to leave the EU in order to request that its national legislators take a less stringent approach to the enshrining of EU directives in law.

The possible Brexit scenarios

The market for goods

The principle of non-discrimination requires WTO members not to treat any member less advantageously than any other; grant one country preferential treatment, and the same must be done for all others. There are exceptions for regional free trade areas and customs unions like the EU, but the principle implies that, outside of these, the tariff that applies to the ‘most-favoured nation’ (MFN) must similarly apply to all.

In practice, this would prevent discriminatory or punitive tariffs being levied by either the EU on the UK, or vice versa. The maximum tariff would be that applied to the MFN. The EU’s MFN tariff has fallen over time, meaning that in this particular context the ‘advantage’ of membership has declined. On a trade weighted basis the MFN is 1.5% (please view this as an average).

However, given that MFN tariffs would be imposed on around 90% of the UK’s goods exports to the EU by value, it would necessarily mean many exporters becoming less price competitive, to varying degrees, than their counterparts operating within the remaining EU, and those within countries with which the EU has preferential trading relationships.

Similarly, because the UK has negotiated as part of the EU at the WTO, it is likely that it would inherit the EU’s tariff regime at the time of leaving, meaning, at least initially, higher prices would be faced by consumers buying imports from the EU and those countries with which the EU has a trade agreement.

Without any change, a 32% tariff would be levied on imports of wine (surely this is a reason to vote in!), and a 9.8% tariff on motor vehicles. The implications of a move to an MFN trading arrangement for exporters and domestic consumers would vary considerably by sector.

For instance, without a trade agreement, a tariff of 4.1% would be applied to liquefied natural gas exports from the UK to the EU; a tariff of 12.8% to wheat and meslin (a type of flour), and a tariff of 6% to unwrought aluminium, all items which the UK currently runs a trade surplus with the EU. There would be a 12.1% tariff on goods vehicles, and 3.8% on car components. In all, 1200 types of goods would be affected to varying degree.

The market for services

Obstructions to services trade are usually in the form of non-tariff barriers, such as domestic laws and regulations, also known as ‘behind the border’ measures. In general, services markets are more highly regulated than the market for goods. Often, regulation is intended to meet social objectives, or to correct failures in supply, rather than to directly restrict foreign suppliers, but the effect on market access for foreign companies can in some cases be highly restrictive.

EU Member States retain considerable national discretion over services regulation and supervision. Just as a fully level playing field in services trade does not exist within the EU, so exporters from outside the EU face different levels of market access in individual Member States.

However, the level of market access would generally be far more limited for UK exporters under a General Agreement of Trade and Tariffs (GATS ) arrangement than it is currently for a number of reasons:

1) Many restrictions that are forbidden within the EU remain applicable to firms outside the EU because Member States have made no commitments under the GATS schedules in those areas.
2) The EU (unlike the GATS) has pursued the harmonisation of regulation and supervision in several large services sectors, thereby taking away the justification of Member States to insist on national regulation in this respect.
3) The right of commercial establishment is guaranteed under EU treaties, significantly facilitating trade in services provided via the commercial presence of a foreign firm. Similarly, the free movement of labour facilitates trade in those services provided through the presence of people in the territory of another economy.
4) EU competition policy prevents, to an extent, barriers to services trade arising from incumbent firms benefitting from excessive market power.
5) The Treaty rights with respect to free movement of services, freedom of establishment, and free movement of labour are enforced supranationally by the Court of Justice of the European Union, underpinned by extensive case law on services exchange.

Under GATS, an independent panel can be appointed to settle and enforce disputes, but there is no presumed right of market access; the job of the panel is merely to assess whether the barrier in question is non-discriminatory. As well as affecting cross-border trade in services, these restrictions could also have implications for UK companies providing services through a commercial presence (effectively outward direct investment) in other Member States.

The EU treaties require that a service provider from one Member State be legally free to establish in another, while continuing to regulated by the authorities of its home country. A UK company that provides services through establishments in other Member States may find, if Britain is no longer a member of the EU, that it has to comply with the requirements of a foreign regulatory authority.

The Transatlantic Trade and Investment Partnership (TTIP)

This is a trade deal between the USA and the EU which has been conducted in secret. The ongoing discussions are about market access, specific regulation, and broader rules for cooperation. The biggest concern which has gained much publicity is the proposed Investor-state dispute settlement (ISDS). This is an instrument that allows an investor to bring a case directly against the country hosting its investment, without the intervention of the government of the investor’s country of origin. The fear is a US health services company could be awarded a contract to supply e.g. the NHS, and then the US investors claim the return is less than promised and so sue the NHS, or indeed the government, with any fees payable by taxpayers. But as so much of the deal is still confidential, this cannot be proved.

What will happen if Britain votes to leave?

The following scenario is my opinion based on history and current institutional arrangements. It is not written to be deliberately alarming, rather it is designed to be a reasonable economic analysis with some political consequences. But as you know economists are famous for getting things wrong!

As soon as the vote is announced and it is to leave, the forex dealers will sell sterling (they may well have been doing this in the weeks before the vote). The hedge funds will see the decline as a one way bet and very quickly sterling could hit $1.25 and €1.08.

In July the Government will fail to sell £10Bn of gilts at 2% (in January the gilts sale was only 1.1 x oversubscribed – normally it is covered up to 6 times). This will raise the long run interest rate to around 4%. The mortgage rate will respond immediately and mortgages will increase by 2% overnight. The housing market will shudder to a halt and prices will stop rising. It is possible but unlikely that prices will crash.

Assuming sterling does not recover from the rates predicted above, the UK inflation rate will rise to 3% by Jan 2017. The Bank of England will raise base rate to 2% by March 2017.

Cameron will resign. Boris, Gove and Duncan-Smith will claim the moral high ground, and one supposes a bid for the leadership.

By September 2016, retail sales will have stopped dead and the papers will be full of misery. Finance directors will begin to conserve cash as a recession begins. As government revenues collapse there will be an emergency budget in November with much deeper cuts in public spending than anyone expected, due to the soaring interest bill on the national debt.

As the Balance of Payments deficit continues to widen to 5% of GDP (due to a weak currency) the Treasury will argue that domestic demand must fall further as exports are not responding to lower prices.

In May 2017 unemployment will begin to rise and there will be a mass exodus of EU workers to a strongly recovering Europe.

This recession lasts three years. By the end of 2017 the Tories lose their working majority. Scotland demands another referendum and in 2019 they vote to leave the UK and apply to join the EU.

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Out of desperation, the UK is forced to do deals with the EU which are against its long term interest, but access to the market is regained (with the abolition of controls on EU workers). The Conservatives lose the 2020 election, the incoming Labour government has a majority of 5 with the SNP holding the balance of power. Yvette Cooper, the first female Labour UK PM, causes concern by appointing her husband as Chancellor of the Exchequer.

Points to bear in mind

It is companies not countries which trade with each other. Almost all countries have at least one world class local company, but it is like to be small and selling into global niches.

British companies prefer to trade with the old colonies or where culture and language is common. We have only a few large manufacturing businesses which possess a comparative advantage. We have many smaller companies with price premium niches (but whose owner-managers often avoid countries where the food is poor, or there is no sailing or skiing which they can combine with a business trip). These companies depend on highly skilled engineers, designers and IT specialists from around the world.

British exports are mostly premium priced, a lower exchange rate does not increase volumes by much if at all. It does however increase the profit margin.

We have significant comparative advantages in services. After the US, Europe is the biggest global market for services.

It takes a long time to establish a presence in new markets unless you are selling clearly differentiated goods on the internet.

So what should you do if you run a UK based business?

If you are exposed to currency risk, buy forward now.

As a precaution make sure you have banking arrangements which will allow you to survive a cash shortfall. Or begin to build a cash position.

Distribute this paper to all your employees; do not tell them how to vote but emphasise how important the vote is.

 

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