Understanding the case for Britain leaving the EU

The British Eurosceptics are on the march again. Much of this is the usual stuff and nonsense, based on Ukip’s good electoral performance last week, though that has more to do with an anti-politics mood, and worries over immigration, than EU membership. But of the noise has a more substantial basis. Former Conservative Chancellor and Europhile Nigel Lawson joined the fray with an article in The Times, shamelessly promoted by the BBC, advocating Britan’s departure from the EU. I see today that another former Tory cabinet minister, Michael Portillo, has joined in, though I’m not sure if he was ever much in favour of the EU in its current form – though this polyglot is anything but a Little Englander. An increasing proportion of Britain’s intellectual establishment is being persuaded by the case against Britain’s membership. I am interested to understand this phenomenon, rather than simply dismiss it. While any popular referendum will be won or lost on the basis of fear and ignorance (as we learnt from the AV referendum episode in 2011), I think it is important to engage in a more considered debate.

But I do need to declare an interest. I am a visceral supporter of the European Union project, and have been since I was a teenager. I was too young to vote in the 1975 referendum, which took place on the day of my Physics practical for A-level, but I was in no doubt where I stood a that point. I’m not sure where this feeling came from: it wasn’t my parents. I was a big admirer of Ted Heath, the former Conservative Prime Minister, which may have helped. Though while I fell out of love with the grumpy and inflexible Mr Heath, my Europhilia remained undimmed… though I shared it with replacement political heroes, Roy Jenkins and Shirley Williams. For all that, I hope I am able to put my emotions to one side to try and understand the arguments.

On doing the basic Internet research for this post, however, I found one thing rather striking. The absence of decent publicly accessible information on Britain’s relationship, and especially trade. The more serious analysis tends to have been done by Eurosceptic think tanks like Civitas. This Factcheck article from last year rather illustrates the point. This may be one of the reasons that Eurosceptics are making headway in the intellectual argument: the Europhiles aren’t really engaging, and where they do it is often weak stuff.

I think the intellectual case for leaving the EU is based on two key propositions: there is a huge dead weight of EU regulation which is dragging British businesses down, to say nothing of budget contributions; and the impact on trade of leaving the EU would be marginal, and the short term economic costs small. There are further arguments around sovereignty and immigration: but these are more emotional. Lord Lawson did not make much of them, so far as I could tell (I haven’t read his article, which is behind a paywall, though I did listen his BBC radio interview). I sense that behind the intellectual arguments there is a frustration with Britain’s slow economic progress, and a hope that leaving the EU would energise the country, perhaps rather like Japan has been energised by their recent change in economic policy.

Let’s look at each of the main propositions. First is the dead weight. I think this breaks down into the following areas: product regulation; financial services regulation; labour market policies; environmental standards; and agriculture and fisheries policy. Product regulation (on cars, for example) is probably the smallest worry. As we are increasingly global in our tastes, and need to export to pay for our imports, this is just a fact of life. International standards makes sense; I read an article in The Economist a little while back suggesting that the whole world was moving towards EU standards, making Brussels the regulatory capital of the world. There are clear advantages to the country being part of the creation process; but outside the EU the country could no doubt apply them more flexibly. I don’t think this is what is winding the Eurosceptics up.

Lord Lawson made a big deal about EU regulation of financial services harming the City of London and the country’s exports of financial services. As Britain loses weight in the EU, this is becoming more of an issue. There is a balance here: inside the EU it will be easier to export services to other EU countries; but outside it may be easier to do business with non EU countries. It is possible that the balance has shifted towards the latter. Behind this there seems to be a rearguard action by the City to undermine the idea that the British economy should be “rebalanced” away from its dependence on financial services. It’s no surprise that Lord Lawson is part of this rearguard.

Environmental policy is another ideological battle masquerading as an argument over the EU. There is a clear case for regulating such a cross-border activity as pollution and carbon emissions at an international level. But EU environmental policy has gone seriously off the rails recently. The Germans are building coal-fired power stations; biomass energy is being ramped up without regard to its wider environmental impact; political fudge has undermined the EU’s carbon trading scheme to the point of making it nearly useless. A weak economy makes higher environmental standards harder to fight for.

It is probably labour market and agriculture and fisheries policies that wind up the Eurosceptics more than anything else. Even Europhiles despair over agriculture and fisheries, though it is inching towards something a bit more sensible. The Working Time Directive is a major irritation to many employers in both private and public sectors. But British labour laws remain amongst the freest in the EU.

In summary, the EU surely does impose costs on the British economy, even if the sceptics exaggerate them. What of the benefits, and the costs of leaving? These centre mainly around trade. There are no tariffs in the EU, and there is a series of rights and enforcement structures that make non-tariff barriers difficult to apply. This reduces costs to British consumers and increases opportunities for British exporters. Membership of the EU is known to be important to some industries, especially the motor industry, and helpful to inward investment. One of the few proper analytical studies I found on the Internet suggested that gains from trade within the EU had been significant. Britain has become highly integrated with the rest of the EU, and for the most part, according to these academics, this has not come through simply switching from other world markets.

But leaving the EU does not simply mean this comes to an end. The benefits flow in two directions, and the remaining EU countries simply wouldn’t cut the UK off if it left. Britain imports substantially more goods from other EU countries than it exports to them (accounting for about half Britain’s trade deficit in goods). The statistics for trade with the EU in services, where the country has a world surplus, aren’t in the regular statistical release, and I haven’t found a breakdown. But the EU market on services is notoriously less free. Eurosceptics argue that if the continuing EU want to try putting barriers in the way of the UK’s exports, the UK has plenty of scope for retaliation. It should be perfectly feasible to negotiate a free trade deal. And, indeed, this would take the relationship to something like the organisation that Britain joined back in 1973, and subjected to a referendum in 1975.

Two arguments can be made against this line of reasoning. First is that the relationship between Britain and the rest of the EU is asymmetric: the trade matters to Britain more than it does to other EU countries. That will make negotiation harder. But a more fundamental issue is the rationale for EU regulation in the first place. It is largely to prevent unfair competition through laxer labour or environmental standards. And yet this “unfair” competition is exactly what Eurosceptics have in mind as a source of growth after Britain leaves: the benefits of membership without the costs. It is hard to see that other EU countries, more sceptical about unfettered free trade than most Britons, will not impose costs. Such is the experience of the deals that Norway and Switzerland have been left with. Why would the European nations be more generous to the UK outside the EU than in it?

So much of the cost of leaving the EU is in fact unknowable. Eurosceptics are happy to make the gamble. Behind this, I think, lies a classic libertarian view of the economy. The less government regulation and tax, the better for the economy as a whole. Leaving the EU would allow the regulatory burden to be lifted, creative forces to be unleashed, and the country to storm forward. They are quite excited by the prospect, after years of grind and stagnation. Those further to the left regard this as fantasy. A society that is lightly taxed and regulated is only good for a small elite and will fail to build the infrastructure required for long term prosperity. Would you rather live in America or Denmark? It is these conflicting visions of the way our country should be run that lie behind the argument over Britain’s EU membership.

The Euro crisis: structural failure or learning curve?

Coverage of the crisis in the Eurozone is astonishingly poor.  Commentators scarcely try to analyse the situation properly; instead they revert to one of two unsatisfactory critiques.  First, the Eurosceptic one, is that the Eurozone was always an unworkable idea and the best thing to do is abandon the whole thing.  The alternative, the Europhile critique, is that a currency union without political integration was a major mistake, and the best thing to do is move further towards the political integration of the union.

These positions are both unhelpful.  The Eurosceptics fail to see the benefits of the currency union, the awful logistics involved in unpicking it, or the unsatisfactory nature of floating currencies for most countries.  The Europhiles want to drag European peoples down a road they do not want to go.  There is a third way: that Eurozone governments change their countries’ economic arrangements so that they can live within the currency zone, more or less as it is currently configured.  This crisis is a learning experience.

The more far-sighted of the Eurozone’s designers did not want full political integration.  It was never to be a currency zone like the USA, with a federal government able to make massive fiscal transfers across the union to help balance out asymmetric crises.  Instead the single currency, alongside the single market, was meant to act as a discipline on national governments.  This would address the widespread failure of floating currencies, which allowed governments to buy time through currency depreciation rather than addressing economic inefficiency.  This was a process leading inexorably to hyperinflation and economic collapse – which was very clearly beckoning for Portugal in particular before the Euro project was taken on board.

Discipline was required in two particular areas: government finances and labour markets.  In the former case discipline is to be provided by the threat of default; in the zone it was impossible to evade default by debauching the currency.  The consquences of a sovereign default are very severe, and European leaders sought to prevent it through the muddled Growth & Stability Pact, which sought to restrict deficits and levels of government debt.  For labour markets the discipline was that without flexible labour markets, economies would become uncompetitive, creating unemployment.

But things went badly wrong almost immediately.  Bond markets did not seem to believe the default story, as spreads between the more creditworthy governments (like Germany) and the less so (Italy and Greece) were impossibly narrow.  Governments in the shakier countries (especially Italy, Portugal and Greece) found it much too easy to borrow cheaply and used this as an excuse for not proceeding with reform.

Labour markets were largely untouched by reform, as were other economic inflexibilities.  This caused major problems in Spain, Portugal, Italy and Greece whose economies became increasingly uncompetitive.  Only one country (apart from Ireland perhaps) really grasped the implications of living inside the Euro, and that was Germany.  After unification the German economy lost competitiveness and unemployment became a real problem.  But through its system of corporate deal-making between employers and unions, pay was restrained and other reforms instituted.  Competitiveness was duly restored, as was employment.  Unfortunately that made things worse for the laggards.

While the Eurozone had proved a failure in these two areas it proved a bit too successful in another: capital flows.  There was a lot of reckless lending, with quasi-public banks in Germany in prominence.  Capital flowed freely to countries, like Spain and Ireland, that didn’t really deserve it, allowing problems to be hidden in a property bubble.  And then Pop!  The Eurozone has lurched from one crisis to the next.

But the basic idea remains intact.  Markets now fully appreciate the risks of default and are pricing debt accordingly.  This is applying pressure on governments like Italy’s that the Growth & Stability Pact simply could not.  And the pressure to make market reforms is likewise proving unbearable.  It’s been a horrible experience for many, but this is not a structural failure: it’s a learning curve.

So what next?  The Greek government must default, and default properly (i.e. the principal must be cut rather than repayment simply deferred).  Maybe it will be forced out of the Euro.  If so, it will be a terrible example.  Some eurosceptics make it all sound rather easy (“decouple, default, devalue”), but it involves the utter collapse of the Greek economy with private savings being wiped out.  The hope would be that it would be easier to rebuild from the ashes than interminable limping along inside the zone.  Portugal and Ireland (whose crime was not to manage its banking system properly) may also go through some form of de-facto default.  But they will stay in the zone.  Portugal must go through a painful period of reforms, but at least for them this path is clearly better than being outside the Euro.

Meanwhile the Euro governments need to keep “kicking the can down the road”.  This is not as short-sighted as it sounds, since with each kick the various parties invovled understand the situation better and what needs to be done.  The default word is now openly talked of.  German bluster over not bailing out the profligate is gradually having to come to terms with the role German banks played in the disaster.  There is learning for the Germans too.  Bold decisive action can be disastrous – it didn’t help the Irish.  This way things are properly thought through.

Reforms?  Fiscal reforms are unnecessary.  But the banking system does need serious attention.  The regulatory system is badly coordinated.  There are too many cosy quasi-public banks who have been allowed to make silly investments.  Banks remain largely national affairs, with only a limited number of transnationals.  There is strong case for a centralised banking regulator.  And cross-border banking mergers need to be encouraged.

But the Eurozone is not dead; and neither are we on the verge of a more centralised European government.