April 2016 The economic consequences of leaving the EU The final report of the CER commission on Brexit 2016 Advisory Board Esko Aho Sir Richard Lambert Senior fellow, Harvard University, consultative Chairman of the British Museum, former partner for Nokia and former Finnish prime director-general of the Confederation of minister British Industry and editor of the Financial Joaquín Almunia Times Former vice-president and competition Pascal Lamy commissioner, European Commission President emeritus, Jacques Delors Institute Carl Bildt Philip Lowe Former prime minister and foreign minister Former director-general for energy, European of Sweden Commission Nick Butler Dominique Moïsi Visiting fellow and chairman of the Kings Senior adviser, Institut français des relations Policy Institute, Kings College London internationales Tim Clark Lord Monks Former senior partner, Slaughter & May Former general secretary, European Trades Iain Conn Union Confederation Group CEO, Centrica Mario Monti Sir Robert Cooper President, Bocconi University and former Special adviser to the High Representative Italian prime minister and former counsellor, EEAS Christine Ockrent Professor Paul De Grauwe Former chief executive officer, Audiovisuel John Paulson Chair in European Political Extérieur de la France Economy, London School of Economics Michel Petite Stephanie Flanders Lawyer Of Counsel, Clifford Chance, Paris Chief market strategist for the UK and Europe, Lord Robertson J.P. Morgan Asset Management Deputy chairman, TNK-BP and former Timothy Garton Ash secretary general, NATO Professor, European Studies, University of Roland Rudd Oxford Chairman, Business for New Europe Heather Grabbe Dev Sanyal Director, Open Society European Policy Chief executive alternative energy and Institute Brussels executive vice president, Regions, BP plc John Grant Kori Schake Former Executive Vice President Policy and Hoover fellow and distinguished professor at Corporate Affairs, BG Group plc West Point Lord Hannay Sir Nigel Sheinwald Former ambassador to the UN and the EU Director, Royal Dutch Shell and visiting Lord Haskins professor, King’s College London Former chairman, Northern Foods Lord Simon François Heisbourg Director, GDF Suez and former minister for Senior adviser, Fondation pour la Recherche trade and competitiveness in Europe Stratégique Lord Turner Simon Henry Chairman, Institute for New Economic Chief financial officer, Royal Dutch Shell plc Thinking Susan Hitch Pierre Vimont Manager, Lord Sainsbury of Turville’s pro Former, executive secretary-general, bono projects European External Action Service Wolfgang Ischinger Sir Nigel Wicks Global head of government affairs, Allianz Former Chairman, British Bankers’ Association Lord Kerr (Chair) Igor Yurgens Vice chairman of ScottishPower Chairman, Institute for Contemporary Development, Moscow Caio Koch-Weser Vice chairman, Deutsche Bank Group ABOUT THE CER 3 About the CER The Centre for European Reform is a think-tank devoted to making the European Union work better and strengthening its role in the world. The CER is pro-European but not uncritical. We regard European integration as largely beneficial but recognise that in many respects the Union does not work well. We also think that the EU should take on more responsibilities globally, on issues ranging from climate change to security. The CER aims to promote an open, outward-looking and effective European Union. 4 ABOUT THE COMMISSION About the CER commission on the UK and the EU single market The economic case for British membership of the EU has always rested on the country’s participation in the single market. The CER invited leading economists, commentators, business people and EU experts to form a commission to consider the economic consequences of leaving the EU. Commissioners shared ideas and advice in a series of commission meetings, and commented on drafts of the final report. Report authors John Springford Senior research fellow, CER Simon Tilford Deputy director, CER Philip McCann Professor of Economic Geography, University of Groningen co-author, trade and investment chapter Philip Whyte Former chief economist, CER Christian Odendahl Chief economist, CER ABOUT THE COMMISSION 5 Commissioners Kate Barker Former Member, Monetary Policy Committee, Bank of England Sir Brian Bender Former Permanent Secretary, UK Department of Business, Innovation and Skills Wendy Carlin Professor of Economics, University College London Nicholas Crafts Professor of Economics and Economic History, Warwick University Paul De Grauwe John Paulson Professor of European Political Economy, London School of Economics Gérard Errera Chairman, Blackstone Group France and former Secretary-General of the French Foreign Ministry Martin Hatfull Director of Government Relations, Diageo and former UK Ambassador to Indonesia Sony Kapoor Director, Re-Define Sir Richard Lambert Former Director, Confederation of British Industry and former Editor, Financial Times Lord Mandelson Former European Commissioner for Trade, and former Secretary of State for Business, Innovation and Skills Mariana Mazzucato RM Phillips Professor of Science and Technology, Sussex University Lord Monks Former General Secretary, Trades Union Congress and former General Secretary, European Trade Union Confederation Kevin O’Rourke Chichele Professor of Economic History, Oxford University Andrew Oswald Professor of Economics, Warwick University Christopher Padilla Vice-President, Governmental Programs, IBM and former Under-Secretary of Trade in the US Department of Commerce Jonathan Portes Director, National Insitute of Economic and Social Research Sir Michael Rake Chairman, BT Group plc and former President, Confederation of British Industry André Sapir Senior Fellow, Bruegel and Professor of Economics, Université Libre de Bruxelles Simon Walker Director, Institute of Directors Sir Nigel Wicks Former Chairman, British Bankers’ Association and former Chairman, EU Monetary Committee André Villeneuve Advisory Council Member, TheCityUK Martin Wolf Chief Economics Commentator, Financial Times 7 The economic consequences of leaving the EU The final report of the CER commission on the UK and the EU single market Acknowledgements We would like to thank BT, Diageo, JP Morgan and Shell for supporting this updated report. Thanks also to IBM and to TheCityUK for their support for the first edition. We are grateful to Gaaitzen de Vries of the University of Groningen for his work with the World Input-Output Database, and to Wolfgang Münchau, Jim Rollo, Peter Holmes, Stephen Woolcock and Hugo Dixon for providing evidence at commission meetings. Thanks to CER staff for comments on drafts and to Kate Mullineux for layout and production. Contents Summary Page 9 Introduction Page 17 Chapter 1: Trade and investment Page 21 1.1 The changing nature of global trade 22 1.2 The impact of EU membership on British trade 24 1.3 Is the EU responsible for this integration? 30 1.4 The consequences of exit for British trade 36 1.5 Alternative arrangements 38 1.6 Brexit and foreign investment 42 1.7 Trade negotiations with non-European countries 46 Chapter 2: Regulation Page 53 2.1 Why the EU regulates 55 2.2 The gains from ‘de-Europeanising Britain’ 57 CONTENTS 9 Chapter 3: The City of London Page 65 3.1 How the City of London came together 67 3.2 The City’s role in the European financial system 69 3.3 Britain and the banking union 73 3.4 The City and Brexit 77 Chapter 4: Migration Page 83 4.1 EU migrants and Britons’ employment prospects 84 4.2 The changing shape of the UK labour market 92 4.3 The impact of European immigration on housing and public services 95 4.4 Closing the drawbridge 99 Chapter 5: The EU budget Page 103 5.1 Ending British participation in the EU budget 104 5.2 The regional impact of ending EU spending in Britain 106 Conclusion Page 109 Appendix A: The CER’s gravity model Page 111 Appendix B: The impact of EU immigration on the UK labour market Page 113 10 CONTENTS 11 Summary Britain will hold a referendum on its membership of the EU on June 23rd 2016, three years after Prime Minister David Cameron announced his ‘renegotiation and referendum’ strategy. In 2013, after David Cameron’s announcement, the Centre for European Reform invited leading economists, journalists, business people and EU experts to form a commission to discuss the economic consequences of withdrawal from the EU. This is an update of the commission’s final report, which includes further evidence about the degree of economic integration between Britain and the rest of the EU; the changes in the relationship between the UK’s financial sector and the eurozone; and the impact of immigration from the EU on British wages and employment. But since our initial report was published in June 2014, we have found no new evidence to change our view that ‘Brexit’ would be economically costly – and the best way to mitigate those costs would be to ensure that the economic relationship between the UK and the EU replicates membership of the single market as closely as possible. In March 2016, three studies of the economic impact of ‘Brexit’ appeared in the space of four days – from the London School of Economics’ Centre for Economic Performance, Oxford Economics and PwC.1 All three organisations sought to model different economic relationships between the EU and the UK after Brexit, the results of which can be found in Chart 0.1. Their best cases were those that most closely replicated the current relationship – either through membership of the European Economic Area, like Norway, or remaining inside a customs union, like Turkey. Their worst cases were those in which Britain failed to sign a free trade agreement, and relied on a relationship governed by the rules of the World Trade Organisation (WTO). This would involve the biggest increase in tariff barriers – and, more important, non-tariff barriers – to trade, reducing the British economy’s productivity and curbing inward investment. 1: Swati Dinghra and others, ‘The economic consequences of Brexit for trade and living standards’, London School of Economics, March 2016; Oxford Economics, ‘Assessing the economic implications of Brexit’, March 2016; PwC, ‘Leaving the EU: Implications for the UK economy’, March 2016.