The economic implications of leaving the European Union

1st February 2013

 The two sides in the potential EU referendum have already started drawing their battle lines.

As such, it is already difficult to form a judgement about the likely impact of EU withdrawal on the UK economy. On the one hand, the EU is a blood-sucking leech, draining our resources, destroying our farmers and launching a wave of inactive immigrants on our shores. On the other, there are those who say an exit would be a disaster for the UK economy. In particular, it would threaten the competitiveness of our financial services industry on which – like it or loathe it – much of our economy depends.

One thing has been immediately clear, financial markets prefer the UK as part of Europe. Sterling has come under pressure since the announcement, falling against most of the major currencies. There have been increased concerns about the viability of the UK’s AAA rating. As an objective assessment, markets believe there is an economic threat to an exit.

It is a theme picked up by the chief executive of Pimco who warned that David Cameron would need an economic ‘plan B’ if the UK were to exit the EU: “Whichever way you look at this, Prime Minister David Cameron has materially increased the probability that, beyond 2017, Poland rather than the UK will be among the three largest economies defining the scale and scope of European regional integration. Let’s hope that he also has a Plan B that would limit the potential downside to Britain’s standard of living,” Mr El-Erian wrote in the Telegraph.

There are also examples of specific industries that would suffer. The investment management industry would be under pressure said PricewaterhouseCoopers in a recent report. PwC hedge fund leader Rob Mellor said: “A UK asset management industry outside of Europe may face obstacles to the continued management of assets for EU-based investors. This is a fundamental risk to the growth of the industry.”

The sentiment was echoed by industry bodies such as the Investment Management Association in the UK and the European Fund and Asset Management Association.

“IMA chief executive Daniel Godfrey and Efama director general Peter de Proft said in a joint statement: “The UK asset management industry gains hugely from the single market,” as reported on trade website Money Marketing.

In a recent open letter, business leaders as diverse as Chris Gibson-Smith, chairman of the London Stock Exchange; Roger Carr, president of the Confederation of British Industry lobby group; Jan du Plessis, chairman of Rio Tinto Plc and Martin Sorrell, chairman of BT Group Plc raised concerns. This suggests that many industries are worried about their competitiveness if the UK does pull away.

However, putting a tangible figure on the cost to the economy of an exit is difficult. It is near-impossible to assess the impact on trading patterns because no-one knows what barriers would be erected, whether the US would restrict trade and the potential impact on the price of UK goods and services.

The Government’s Department of Business, Innovation & Skills estimates that EU Member States trade twice as much with each other as a result of the single market. Exports to other EU countries account for around half of the UK’s exports. Much of this is Germany and France at £27.5bn and £18.9bn respectively.

However, the US is the UK’s largest trading partner – with £31.7bn of exports and exports to the EU are diminishing – by 3.7 per cent over the past year. This may simply be a function of the economic malaise and poor growth across Europe, but it may signal a wider trend.  Exports to emerging markets have also increased at the same time in the Office for National Statistics report.

There are those who argue forcefully that the UK’s alignment to Europe is distracting attention from developing relationships with growth markets such as India or China. However, China and Europe are also strong trading partners and it may be that China, like the US, would be more willing to trade with the UK as part of the EU.

The pressure groups such as the cross-party Euromove suggests that the economic benefit of EU membership has equivalent to an increase in GDP of around £25 billion between 1992 and 2006.. In an economy of £1.44 trillion – this doesn’t sound very significant, particularly when the opposing side claims that EU membership effectively costs £65bn per year.

But ‘effectively’ is the key word. The latest statistics show that the EU costs are €11.3bn per year as the Guardian – roughly equivalent to one month’s borrowing. Other estimates are little more than speculation.

In their open letter, the business leaders estimated the loss to the exchequer from businesses that would move abroad as £25bn. To put that in context, the cuts to child benefit for top earnings will save the revenue £2.4bn per year reported on Reuters. If they are right, David Cameron may have to start making a lot more ‘difficult decisions’ on austerity.

But this argument is largely based on the idea of a ‘loss of influence’. It is a nebulous concept and difficult to quantify. One of the most comprehensive research documents on this was done by independent think-tank Open Europe.

It says: “In order to justify continuing commitment to the EU and avoid being driven by the electorate inexorably towards the exit door, Britain needs to carve out a new model for EU cooperation, remaining part of the customs union and Single Market in goods and services but substantially reducing the non-trade EU involvement and costs whenever possible.”

It also suggests that the UK forges closer links with higher growth economies, such as India or China, saying that – at the very least – this will give the UK greater bargaining power within Europe.

The economic arguments for either staying in or moving out of the EU are nearly impossible to quantify, which suggests Sorrell and Co may have a difficult argument ahead of them. Though in a weak economic climate, it is difficult to see why Cameron would take the risk that it will dent growth. In the absence of a clear economic advantage to membership, the public may choose to focus on other downsides.

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