Report 04/2016 Where next? A liberal, free-market guide to Brexit Raoul Ruparel, Stephen Booth, Vincenzo Scarpetta About the Authors Raoul Ruparel Open Europe is a non-partisan and independent policy Co-Director think tank, committed to crafting and putting into action solutions to the European Union’s most pressing challenges. Open Europe’s Co-Director, Raoul is also a contributing We are committed to European Union reform. Our vision author for Forbes, writing on European economics for a slimmed-down, outward looking and dynamic EU rests and politics, and a member of the British Chamber of on four principles: Commerce Economic Advisory Group. • Boost jobs and growth. Enable and encourage free trade – internally and globally. Regulate business less, but better. • Embrace democracy. Be transparent and accountable to citizens, recognising the crucial Stephen Booth role of national parliaments. Cut the cost of Co-Director Brussels. • Focus on the big questions. Do not interfere in Stephen has led Open Europe research projects on areas that could be equally well handled at the EU regulation, justice and home affairs and the UK’s national or local level. trade with the EU. Stephen also directed Open Europe’s • Be flexible. Allow powers to flow back to the policy work on EU migration and free movement, which member states, and let some countries integrate featured prominently in the Prime Minister’s recent more than others. immigration speech. Disclaimer Open Europe will remain neutral in the EU Referendum campaign, confining ourselves to commenting as Vincenzo Scarpetta accurately as we can on the arguments and facts Policy Analyst advanced on both sides of the debate. Vincenzo specialises in the politics and economics of Southern Europe and is a regular commentator in print Acknowledgements and broadcast media across Europe. He has co-authored policy-changing Open Europe Intelligence on EU free We are also indebted to the hard work of our research movement, employment law, financial regulation and the interns Jayson Probin and Christopher Hughes da Silva in European Neighbourhood Policy. helping to put together this report. Offices Open Europe Open Europe Brussels Open Europe Berlin 7 Tufton Street 113-115 rue du Trône Oranienburger Straße 27 London B-1050 10117 Berlin SW1P 3QN Brussels Germany +44 (0)20 7197 2333 +32 (2) 540 86 25 +49 (0)30 2758 1365 www.openeurope.org.uk [email protected] [email protected] www.openeuropeberlin.de @OpenEurope 1 | Open Europe We Drive Change in Europe www.openeurope.org.uk @openeurope Contents Executive Summary 1 Introduction 5 Literature Review: An emerging economic consensus? 7 1 Trade 9 1.1 Coverage 9 1.2 Scope 15 1.3 Speed 17 1.4 Conclusions and policy implications 21 1.5 Trade Case Study- Agriculture 22 2 Immigration 28 2.1 The political climate 28 2.2 Why a liberal approach to migration is likely to remain important 31 2.3 Managing immigration in the century of globalisation 37 2.4 Conclusions and policy implications 42 3 Deregulation and competitiveness 44 3.1 Business desire for deregulation 44 3.2 What level of politically feasible deregulation? 45 3.3 Competitiveness 50 3.4 Conclusions 51 4 Conclusions: What are the implications for a new UK-EU relationship 53 Annex 1 55 Annex 2 59 Annex 3 60 www.openeurope.org.uk @openeurope Executive summary The EU referendum is a crucial decision about Britain’s future, but the campaign so far has failed to adequately address how life outside the EU might look. It will not be an apocalypse and it will not be a utopia. The growing economic evidence suggests that there would be a small negative economic result from Brexit, probably in the region of 0.5% - 1.5% of GDP in the long run, presuming a reasonable trade agreement is struck between the UK and the EU. The question then is whether the UK can use its new found freedoms to offset this cost or reverse it to a positive outcome. We believe it is possible, but the path to prosperity outside the EU lies through: free trade and opening up to low cost competition, maintaining relatively high immigration (albeit with a different mix of skills), and pushing through deregulation and economic reforms in areas where the UK has historically been sub-par compared to international partners. There is no doubt that such an approach would disappoint a number of people on the ‘Leave’ side and whether there is appetite for such changes in the UK is unclear. One thing that is clear is that Brexit cannot be all things to all people. Below, we outline the key priorities for a UK Government post Brexit: Trade The first step would be to try to strike a Free Trade Agreement with the EU and to maintain the FTAs Britain has with other states via the EU. As we outlined in our previous report, this is not an easy task and could take many years. The emerging consensus is that – taken by itself – there would be a small negative economic impact from leaving the customs union and the single market in the long run. The second step would be to build FTAs with other states to try to offset this effect. o Contrary to popular belief, countries don’t only strike free trade agreements with large states or economic blocs. Medium-sized economies such as Norway (80%), Australia (77%) and Canada (69%) have managed to strike FTAs covering a significant proportion of their trade – more than the UK at 63%. For Norway and Canada this is reliant on having reached an agreement with their largest trading partner – the EU in the UK’s case. However, Australia and New Zealand have proven a more diversified approach can also work. Striking deals with US and China would bring the UK’s share of trade covered by FTAs to over 81% – slightly higher than Norway’s. o Evidence suggests this will take some time. Globally, trade deals have usually taken anywhere between four and ten years to negotiate. The EU is not uniquely sluggish. o There is a trade-off between speed and scope. A more complex agreement addressing services and non-tariff barriers (NTBs) does seem to take longer. 1 Basic agreements focusing on goods tend more towards the four year end of the scale while more comprehensive deals tend towards ten years. o One option for the UK to speed up this process would be to dump the EU’s all or nothing approach. That way, the UK could strike initial agreements on removing tariffs on goods and revisit negotiations on services and NTBs at a later date. This would make sense for emerging market economies where tariffs are relatively high and the majority of UK trade is in goods – China, India and Brazil fit this category. o Striking a series of FTAs with Asian economies (China, India, Japan and ASEAN) could deliver a boost of up to 0.6% of GDP for the UK, going some way to offsetting the negative impact of leaving the EU customs union and single market. Alternatively, a unilateral free trade approach could deliver a boost of around 0.75% of GDP in the long run. o A case study of the agricultural sector highlights the tension between opening up to the rest of the world or continuing protectionism and subsidies. There are potential savings for both taxpayers (£1.5bn) and consumers (between £400m and £1.4bn) from liberalisation. However, this would mean creative destruction and would see a number of farms going out of business, not least because 19% of British farms do not currently make any profit. So far, comments from politicians suggest they are not willing to take on the established interests in this sector. How much more widely would this apply post-Brexit? o Recent controversies, particularly around the steel sector, highlight the potential political challenges to opening up trade with emerging markets and particularly non-market economies such as China. Striking trade agreements with such countries may well face significant grassroots opposition. The third step could be revisiting and updating older agreements. o Only eleven of the 33 EU FTAs currently in force cover services. Often the biggest difference between trade agreements does not come from the size of the negotiating parties, but whether it is a first generation agreement (basic, focused on tariffs and goods) or a more comprehensive second generation agreement (dealing with services, NTBs and regulation). Immigration While there would be political pressure to reduce immigration following Brexit, there are several reasons why we believe headline net immigration is unlikely to reduce much: o The business case for maintaining a flexible supply of labour. The evidence suggests that, with a record high employment rate, the UK’s labour market is already tightening; 2 o the political and economic challenge of finding policy alternatives to relieve pressure on the public finances caused by ageing demographics, where immigration can help smoothen the path to fiscal sustainability; o the effects of globalisation on migration flows, which the UK is not alone in experiencing; o and the likelihood of some constraints on UK immigration policy under a new arrangement with the EU. Nevertheless, free from EU rules on free movement, the UK would likely pursue a selective policy more geared towards attracting skilled migration, which could be more politically acceptable. Open Europe would recommend a system seeking to emulate the points-based systems of Canada and Australia. The system could be weighted strongly towards those with a job offer, but also offer a route for skilled migrants seeking work. Such a system could give priority to UK industries and employers suffering skills shortages but also allow a flexible supply of skilled workers to enter the UK labour force subject to a cap which could be varied depending on economic circumstances.