March 23 2015

Establishing the economic facts in Scotland was difficult enough. It is exponentially more difficult to pin them down when looking at the whole of the UK and the impact of EU membership. The demands and opportunities of EU membership have shaped the whole of the UK’s economy as it is today. So establishing reliable counterfactuals  and alternative scenarios, and disentangling what is connected to EU membership and what isn’t, is intellectually challenging. On top of that, the whole debate is highly politicised, with little agreement on even the basic assumptions.

That is why today’s report from Open Europe on “What If” Britain left the EU is so important. It tries to step aside from the polemics; to set out the potential models for Britain’s relationship with the EU if we do vote to leave; and to put some costs and benefits on each. I am sure it will have a huge impact on the debate.

Four points strike me as central to its message.

First, both sides exaggerate the benefits and costs.

Leaving even on highly unfavourable terms costs the UK a year’s growth.  Leaving on favourable terms and driving through radical reform gives us an extra year’s growth. Neither is negligible and neither is game-changing. Indeed the transitional costs of shifting to the new steady state, as the economy adjusts, could easily outweigh the gains or losses either way. So a sense of proportion is in order.

Second, leaving the EU has a cost.

This is as you would expect.  Given what we know about the relationship between trade and growth, you would anticipate a hit to growth if the UK were to take itself out of a free trade area, and self-evidently adding an extra barrier to 40% of our exports would inevitably increase our costs. Those who argue for withdrawal have to accept this as their starting point.

Third, consequently, establishing some kind of free trade relationship between the UK and the EU would be vital.  

No FTA is perfect. It is hard to avoid the costs of rules of origin and border paperwork in any FTA relationship with the EU.  And, as the report’s sectoral studies show, it is particularly difficult to negotiate an FTA that offers the same benefits for services as for goods. That is not just a question of negotiating power but of the inherent difficulty – as Switzerland has discovered – of pinning down FTA rules that cover the constantly shifting provisions of services regulation within a single market.  Nevertheless, the best does not have to be the enemy of the good, and a wide-ranging UK/EU FTA could mitigate some of the inherent economic damage from leaving the EU, without compensating for it completely.   

Finally, leaving puts the UK’s economic destiny much more in its own hands.

Radical reform to product, services, and labour markets would boost the UK’s wealth.  Much of that radical reform is not possible or at least not politically conceivable within existing EU structures.  Similarly, much greater openness to trade than is possible behind the EU’s tariff barrier would generate structural change in support of the UK’s comparative advantages, and hence boost wealth.

But that reform would have to be radical. Much of it would be very difficult politically even within the UK political context, open though it is to major shifts in ways of doing things, and some of it would involve major changes in political direction, for example on climate and energy or migration.  Moreover, many of the forces opposed to EU membership, for example much though not all of UKIP, seem to advocate actually more restrictions and less reform in some areas.  This could actually reinforce the disadvantage caused by leaving the EU rather than compensate for it.

One clear conclusion from the report is that the best outcome overall for the UK would be to stay in an EU that was able to do deep structural reform.  It would avoid the loss of wealth created by exiting a customs union, while benefiting from the boost to growth from structural change. The fact that this doesn’t seem to be on offer is at the heart of the difficulties many free-marketeers have with the EU as it stands – and why a reform drive is necessary.

About the author

David Frost is the  Chief Executive of the Scotch Whisky Association,  which represents 25% of UK  food and drinks exports. Until recently, David served as the UK’s most senior trade diplomat. He is a member of  the Open Europe Advisory Council, and writes here in a personal capacity.