Tuesday, 19 April 2016

Osborne wheels out the big gun



The Governments campaign to convince us of the dire consequences of leaving the embrace of the EU continues with George Osborne publishing "HM Treasury analysis: the long-term economic impact of EU membership and the alternatives".  This feels like a big gun is being wheeled out. At 200 pages long it is certainly not short on size.

I have browsed the document, paying particular attention to the "Norway" / EFTA EEA option.  In this scenario, Britain leaves the political constructs of the EU but retains full single market access via the EEA agreement. As such, it involves minimal change to trade arrangements and so it is reasonable to expect no negative economic impact. However, the Treasury has forecast the EEA scenario would result in the UK economy being 3.8% lower in 2030 (compared with remaining in the EU) equating to £2,600 less per household.

Single Market / EEA advantages

In case we are in any doubt, the section "The UK’s economic membership of the EU" makes it clear that the Treasury case is based on trade and investment advantages that flows from the single market:
Almost three quarters of foreign investors cite access to the European market as a reason for their investment in the UK
Trade with the EU has been made easier because of the unique way the Single Market reduces barriers and costs to trade.
The Treasury report also confirms that EFTA EEA membership confers much of the Single Market benefits: "Membership of the EEA would give the most access" and would include financial services "non-EEA alternatives offer significantly less access to the Single Market in financial services".

The Treasury approach to the EFTA EEA scenario is described diagrammatically on page 154): estimate trade and investment impact => impact on productivity in the macroeconomic model => input into a "general equilibrium macroeconomic model" to determine the impact on GDP in 15 years time. 

In short, the answers produced by the Treasury's computer model depends critically on the assumptions made regarding trade and investment (think of climate change models and how they produce wildly different results by tweaking a few key variables).  So what are the assumptions made by the Treasury regarding differences between EFTA EEA and EU membership ?

1) EFTA EEA is outside Customs Union

Membership of the EEA would give the most access but would mean UK exporters facing increased transaction costs as a result of customs checks (page 10)
leaving the EU customs union – the principal difference in access compared to EU membership – would impose some new barriers on trade at the border (para 3.14)
The most obvious difference with EFTA EEA membership is that the UK would be outside the EU's customs union.  The benefits of this are that (i) the UK would be regain control of its external trade policy and be able to negotiate its own free trade agreements; (ii) imports to the UK would no longer be subject to the EU's Common External Tariff.  Tariffs could either be retained (in which case the revenue accrues to HMRC rather than the EU) or abolished (lowering prices for UK consumers and stimulating trade and economic growth, estimated to add 0.3% GDP as estimated in the recent report by the Centre for Economic Performance).

The downside is that UK exports to the EU would then be subject to Rules Of Origin (ROO) to certify their origin and so determine which import duties or restrictions apply (if any). The Treasury report estimates approximately 50% of UK exports to EU could be impacted (see para 2.62) and quotes a variety of sources and wide range for costs of ROO (Box A.1). However, a more authoritative source is an HM Government FOI response on EU membership (page 5) which quotes a ROO cost of 2% .  

Given that the EU accounts for approximately 40% of UK exports (after allowing for Rotterdam-Antwerp effects) and UK exports contribute 13.4% to UK economy (as per  ONS "Composition of Demand" statistics for 2013) , we can estimate this ROO cost as 50% x 2% x 40% x 13.4% = 0.05% of GDP (about 1/2000th) = negligible.

The other "customs union" issue alluded to by the Treasury report is "new barriers on trade at the border". Physical border checks may have been an issue for the 19th century German "Zollverein" customs union, which removed internal tariffs and unified the German states, but border checks are irrelevant in the modern world, as described by several recent EU Referendum blog posts:
  • The Transports Internationaux Routiers (TIR) scheme was launched by UNECE in 1949 to remove cross-border checks of goods in transit. In the 21st century, this scheme is being updated to e-TIR, a fully electronic, paper-free operation (posted 03/04/16).
  • Contrary to the Governments scaremongering, Brexit will NOT result in customs checks on the border between Northern Ireland & Eire (posted 05/04/16).
  • As of 2017, Rules of origin will be simplified, especially for EFTA EEA states - see EU web pages here and here and this EFTA web page (posted 19/04/16).

2) EFTA EEA excludes Agriculture & Fisheries

with the exception of agriculture and fisheries, EEA membership offers the same access to a level playing field for trade as EU membership. (para 2.69)
Membership of the EEA would give the most access but would mean ... the reintroduction of tariffs for agriculture and fisheries  (page 10)
EFTA EEA states are fortunate enough to be exempt from the Common Agricultural Policy (CAP) and the Common Fisheries Policy (CFP).  The downside is that the EEA agreement does not provide tariff free access to agricultural or fisheries products. However, the EEA agreement allows for country-specific protocols to bring products within the scope of the agreement (see EEA agreement protocol 3).  Given that EU agricultural exports to the UK are 3 times the value of UK exports to the EU, a tariff agreement on agricultural products is in the EU's interests.

Farmers contributed almost £10 billion to the UK economy in 2014 and collectively the food and farming sector is worth £103 billion (as quoted by the National Farmers Union).  Freedom from the CAP provides an opportunity for the UK to boost food production and the rural economy, as outlined by Owen Paterson, George Eustice and Farmers for Britain.

The CFP has been an ecological disaster and has devastated the UK fishing industry. Approximately 70% of the EU's fishing stock falls within UK territorial waters, yet the UK is a net importer of fish. Non-EU North Atlantic countries (Norway, Iceland, Greenland) all have thriving fishing industries. Anyone still in any doubt on the negative impact of the EU on the UK's fishing industry should read "The Betrayal of Britain's Fishing" by John Ashworth.

Regulatory compliance will continue based on regulations from international organisations, i.e. the "three sisters" of Codex Alimentarius, OIE & IPPC, as well as UNECE & OECD. In fact an independent UK will regain its voice and vote on these organisations and so will have more influence over these regulations .  For example, Norway exerts considerable influence via the Codex Fisheries Committee (which it hosts and chairs).

3) EFTA EEA states do not have access to the EU’s Free Trade Agreements (FTA's)

None of the alternatives discussed in this Section provide access to the EU’s FTAs around the world. (para 2.87)
While current EFTA EEA states do not have access to the EU’s FTA's, an independent UK would retain existing FTAs, based on the principle of international law regarding "continuity of treaties". Furthermore, joining EFTA would allow the UK to become a party to EFTA FTA's.

The Treasury report also makes great play of the EU's "clout" in negotiating FTA's and the potential for future EU FTA's.  The reality is rather less enticing:

  • The secretive EU-USA trade deal (TTIP) has been under discussion for approximately 10 years.
  • An EU-Mercosur FTA is stalled over agriculture (a recurring theme for EU trade talks).
  • Progress on FTA's with India, China and others also appears to have stalled.  
  • Negotiations with Japan have over-run their scheduled timescale with talks stalling on various points: agricultural products and processed food, public procurement, non-tariff measures and geographical indications. 
  • Forty-three years after the UK was required to abandon Commonwealth trading links in order to join the "Common Market", we have the promise of an FTA with Canada (CETA), but no FTA with Australia, New Zealand etc.
  • For all its "heft" and "clout", the EU's largest third country FTA to date is with South Korea, whose economy is half the size of the UK. 
It seems inconceivable that an independent UK outside the EU would not have already concluded FTA's major commonwealth allies and with its largest trading partner (USA). An independent and open-trading UK provides an agile, nimble counter-point to the lumbering EU which is constrained by accommodating the different protectionist concerns of the other 27 EU states.

As a trading group, EFTA have negotiated FTA's with a significant number of countries, often before the EU (including Canada in 2009).  Switzerland has negotiated a number of its own FTAs (including Japan in 2009 and China in 2014).  It is also worth noting that EFTA + UK would form the 4th largest trading group in the world - hardly a minnow.

4) EFTA EEA states are not as "integrated" as EU members states

The Treasury have estimated future trade and investment using  "gravity modelling", which models trade flows between two countries as a function of economic variables (e.g. GDP), geographic variables (e.g. distance) and cultural variables (e.g. common language).  Buried away in "Part 1: The impact of different EU relationships on UK trade" (page 156 onwards) are assumptions that EFTA EEA membership would result in reduced European trade and productivity relative to continued membership of the EU.  

The Treasury report cites various academic papers (para's A.22 to A.24), including Baier et al (2008), which conclude that EU membership increases European trade by more than EEA membership or FTA's. The Treasury report actually hints at where there may be a problem with this conclusion when it states "there are limited studies in this area possibly due to the small number of countries involved". Based on a limited data set and no attempt to understand EFTA trade/economies, it is extrapolated that Britain would become more "EFTA-like".  (Although, per head of population, Norway & Switzerland export 4-5 times as much to the EU and are twice as rich as the UK - in these respects becoming more "EFTA-like" seems like a good thing).

Another academic paper, Campos et al 2014, is cited to "suggest" an economic benefit from greater regional integration .  This paper compares the experience of regions in Norway with regions in Austria, Sweden, Finland for the period 1995-2000 (i.e. after these 3 countries left EFTA to join the EU). Interestingly, they concluded that Oslo (capital of Norway) had benefited the most over this period.  No consideration was given to how an "integration" effect may apply differently to Norway's already profitable regions based on agriculture/fishing and oil/gas.  In any case, a cursory glance at GDP growth for the period 1995-2014 for the countries involved suggests Norway has done rather better than its former EFTA colleagues.  In particular, Finland has suffered recently since it took the next step in "integration" by joining the Euro.

The recent Centre for Economic Performance report is cited in the Treasury report (Box A.3) which quotes these same academic papers. So perhaps it is unsurprising that the Treasury report displays the same "group-think" that greater regional integration produces greater economic benefit, even stating "there is a general consensus that certain types of regional integration increase FDI" and going on to assume  reduced FDI (Foreign Direct Investment) for the EFTA EEA scenario.

As we have seen, the only material difference to trading conditions in the EFTA EEA scenario is a negligible "Rules of Origin" impact.  So what exactly is this "regional integration" arising from EU membership that provides increased economic benefit ? The problem here for the Government is that the so-called "special UK status" is based on being less integrated than everyone else !  

Reading through the report, the Treasury appear to be trying to claim that the UK's "influence" within the EU is the magic "regional integration" ingredient: 
Referring to the Campos et al 2015  paper, the Treasury report states (Box 3.F) "The authors suggest their results identify an economic benefit of influence in EU institutions.
Section 1 summary states:  "Not least because of the UK’s influence, the flow of new EU regulation has reduced in recent years .......... The UK has significant influence over EU decision-making and the rules associated with the Single Market. This includes veto rights in the European Council. Throughout its membership, the UK has used its influence to maximise the benefits of the Single Market and to pursue a proactive agenda of economic policy reform." (See also paras 1.127 to 1.136).
This is to repeat probably the biggest lie of all regarding the Norway / EFTA EEA scenario - David Cameron's mantra "they have no say" - as refuted in an earlier post, Norway has more say over the Single Market rules than the UK or any other EU member state.

EFTA EEA as a positive for the UK

The Treasury report also makes assumptions regarding other "generic" Brexit factors, none of which suggest negatives for the EFTA EEA scenario:
Immigration. The Treasury assumes the same net international migration for all scenarios: down 329,000 per year in 2014 to 185,000 per year from 2021 onwards (para 3.45). Which is both optimistic and yet still in excess of Cameron's "migration in the tens of thousands" pledge.
- Public Sector Receipts. It is not clear whether reduced contributions from EFTA EEA membership have been factored in. However at 0.5% GDP, the UK's current net EU contributions are not hugely significant.
- "Uncertainty". The Treasury cite EU withdrawl, future UK-EU trade and trade with non-EU countries as requiring negotiation and being subject to uncertainty. However, a Government announcement that EFTA EEA will be adopted as a transition to a longer term settlement would remove economic and trade uncertainty. And as discussed above, an independent UK will retain the existing EU FTA's.

Rather than a negative, I see the Norway / EFTA EEA scenario providing positives for the UK economy: 
  • Advantages from leaving the Customs Union outweigh the negligible Rules of Origin impact;
  • Exiting the CAP & CFP are surely an economic positive for UK agriculture and fishing; 
  • An independent UK will retain existing EU FTA's and gain access to EFTA FTA's;
  • An independent and agile UK will have the agility to exploit future trade opportunities;
  • EFTA + UK forming the 4th largest trade block would also boost future trade negotiations;
  • The claims made for economic benefit from "regional integration" within the EU are risible.

Conclusion

The Treasury report is a long document and there are numerous pieces of mis-information which I will resist describing here as this post is already lengthy.

I have not looked in detail at the review of the FTA option - the Treasury seem to assume that the UK would use an exact replica of the Canada FTA, rather than using the Canada-EU FTA as a template for a bespoke UK-EU FTA deal. Nonetheless, it is valid to state that replicating EEA / Single Market access via a bespoke FTA would be technically more complex than any existing FTA's and daunting politically (requiring agreement from all 27 other EU states).  Continuing current Single Market access via the EEA agreement (which could be agreed by Qualified Majority Voting under article 50) as a transition to a longer term agreement removes economic risk and allows political/judicial freedom from the EU to be realised sooner.

It is therefore unsurprising that a Government that is committed to remaining in the EU at all costs has targeted the EFTA EAA option - but once you wade through the details of the report, it is clear that the its analysis of the EFTA EEA option is skewed.  

Osborne has wheeled out the big gun, taken aim at the EFTA EEA option, and if you peer through the fog it is clear he has missed the target.